In early March, the southern provinces suffered from severe diesel shortages and drivers lined up in front of gas stations for a drip of the lifeblood for their vehicles.

The oil crunch did not ease despite the efforts of refineries to fulfill market demand. Many gas stations had to restrict the volume for each car to enable more autos to refuel. Normally, they would allow one vehicle to add no more than 20 liters, about 100 yuan ($14.18).

The diesel shortage not only affected logistics and transportation, but also spread to agricultural production. Spring is the regular planting time for farmers, but the lack of oil made many farming tools useless.

China underwent widespread oil shortages last October that did not ease until this January. However, two months later, the diesel supply fell short of demand again, posing a question to many: What are the problems in energy supply chain?

A supply-demand trick

A strange phenomenon has hassled energy experts. Official figures have all indicated an abundant refined oil supply, but why is the market still hungry for oil?

On March 24, PetroChina and Sinopec, China's two major oil producers, both publicly stated that the current domestic refined oil supply was sufficient enough to guarantee the domestic demand.

Information from the National Develop-ment and Reform Commission (NDRC) website also showed that in the first two months, the refined oil output grew 10.5 percent year on year. The refined oil inventory rose 28 percent by the end of February compared with that of the very beginning of 2008, with diesel inventory jumping 46 percent. Judging by these statistics, the NDRC believed the ample domestic refined oil supply could absolutely guarantee the demand.

As a matter of fact, PetroChina and Sinopec have both increased their refined oil supply to the market. From January to March, Sinopec's Guangdong branch increased refined oil supply by 12.8 percent year on year to over 3.5 million tons. In March in particular, the company put in 1.25 million tons of refined oil in Guangdong market, up 21.7 percent from that of February. The retailing volume increased 27 percent compared with that of February.

Given the increasing supplies, Guang-dong is one of the provinces hit the hardest by the oil crisis.

Like Guangdong, other provinces in the south have all faced the same conundrum. Cities like Hangzhou, Nanjing, Ningbo, Fuzhou and Shanghai have reported serious diesel shortages even though the diesel supply in those cities increased in the first three months.

People were wondering why oil shortage occurred in times of sufficient inventory?

The answer

There are two market motives behind the strange phenomena: The monopolistic oil companies deliberately created such serious oil shortage to force the government to raise the price of oil and to seek refined oil pricing rights; Second, domestic refined oil prices fall far short of the international crude oil prices, leading to an outflow of domestic refined oil products.

Sun Baojiang, professor at China University of Petroleum, agreed on both assumptions, saying the problem stemmed from the refined oil pricing mechanism on the mainland.

Currently, the NDRC, the top economic planner, calls the shots in retailing prices of refined oil products, while oil producers and retailers must follow the decree of the government.

Confronted by surging international oil prices, the Chinese Government froze refined oil prices in a bid to tame the soaring consumer prices. A large proportion of the refined oil is imported. The retailers pay huge money to import oil, but only to find the domestic retail prices are kept strictly below their cost. Many of the gas stations are losing money and have stopped operating, and cars gather in front of those stations still open.

Statistics from the Guangdong Petroleum Industry Association show there were about 5,500 gas stations across the Guangdong, and half were privately owned. The prices between the import cost and the retailing prices forced private gas stations to stop selling oil. As a result, the number of gas stations in Guangdong was reduced sharply by half.

Many refineries chose to stock oil instead of selling it because they could not profit from operation.

"This round of the oil crisis is caused by shortage of selling, not the shortage of oil," Sun contended.

Apart from the factors mentioned above, some refineries sold refined oil to the overseas markets through legal and illegal ways to earn larger profits, leading to refined oil export boom.

Guangzhou Customs calculated that in 2007, Guangdong imported over 8.2 million tons of refined oil, dropping 18 percent year on year. At the same time, it exported 2.1 million tons, or 47 percent higher than a year before. In the first two months in particular, Guangdong's refined oil exports reached 771,000 tons, which was 2.7 times of that of the same period last year.

The coastal areas were exposed to more serious oil shortage, as it is relatively easy for companies in those areas to sell oil to the overseas market.

But Sinopec and PetroChina told a different story. Both attributed the shortage to heavy snowfall in the south, the biggest in half a century in the beginning of 2008, as more oil was needed to fuel the rehabilitation and spring agricultural work. Another factor was increasing international oil prices. Many of the domestic refineries and retailers expect the oil prices would continue to rise, thus delaying supply and storing oil as inventory. Rumors widely circulated that oil prices were certain to rise, further propping up retailers' confidence in a rising oil prices.

But people do not buy the two giants' story, blaming them for finding excuses for the oil shortage.

Coping with the crunch

"The fundamental solution to the oil crisis is to carry out reform of the refined oil pricing mechanism," said Yu Hui, a researcher at the Chinese Academy of Social Sciences.

Yu said the current oil prices on the mainland don't reflect the cost. "They know there is a shortage, but insist on stocking up on oil. They would rather export oil than sell domestically," said Yu.

Most of the oil shortages in history were eventually eased through government intervention. But the government has ignored one root problem: the lack of marketization of refined oil prices.

Shen Yuedong, an energy expert with the Shanghai Academy of Social Sciences, also believed in the long run, the market will play the most important role in pricing oil products, while government intervention is just an interim measure.

The mainland oil insiders have been calling for building oil pricing system with market competition, connecting domestic refined oil prices with the international prices, loosening control of refined oil wholesaling links controlled by PetroChina and Sinopec, and achieving fair competition in oil imports.

But for China at this stage of development, it is not realistic to fully open the oil market, as the majority of the consumers, including companies, cannot afford high oil prices.

The government was also faced with the oil problem. On the one hand, it has to suppress oil prices to fuel social and economic development. On the other hand, it must compensate refineries with huge amount of money lost in oil transaction, triggering people's criticism of its "favorable attitude to the oil companies."

The NDRC had considered adopting a new pricing mechanism on oil after the 2005 oil crisis. The NDRC planned to loosen control and let the oil prices decided by the market.

However, to date, the new pricing mechanism has not been adopted. The NDRC said it had taken consumers' interests into full consideration, and the consumer price index had been flying high in the recent two years.

Zhang Guobao, Director of the newly established National Energy Bureau, said the reform on refined oil pricing mechanism must be taken seriously in a step-to-step manner and a right timing was imperative. It means the domestic refined oil pricing mechanism will not be reformed in the near future, and this round of oil shortages needs government intervention.

Sinopec stated on March 24 that the company will continue to reduce inventory to guarantee sufficient supply. In the meantime, it will transport refined oil from Hainan Province to the Pearl River Delta region, which is hit the hardest by the oil shortages each time in history.