US embassy cable - 05TAIPEI4229

UNCLAS SECTION 01 OF 03 TAIPEI 004229 
 
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PLEASE PASS AIT/W AND USTR 
USTR FOR TWINELAND AND AWINTER 
 
SENSITIVE 
E.O. 12958: N/A 
TAGS: ECON, EPET, ENRG, TW 
SUBJECT: Taiwan Betting on Lower Crude Oil Prices 
 
 
1. (SBU) Summary: Taiwan's first gasoline price war broke 
out in September after world crude oil prices reached record 
highs.  Privately owned Formosa Petrochemical Corporation 
(Formosa) raised prices by almost 10 percent because of 
increased costs.  However, government owned Chinese 
Petroleum Corporation (CPC) held gas prices steady.  CPC 
continues to sell gasoline below cost and, by its own 
estimate, is losing NT$200 million (US$6 million) a day. 
The government has tried to ease CPC's losses by providing a 
three-month tax holiday on gasoline.  This will allow CPC to 
keep gas prices artificially low until elections in 
December.  Taiwan expects crude oil prices to decrease in 
the future.  End Summary. 
 
Background 
---------- 
 
2.  (U) State-owned CPC lost its monopoly on gasoline sales 
in 2000.  Formosa jumped on the chance, quickly capturing 
nearly 30 percent of the market.  Formosa is a publicly 
traded company controlled by the sprawling Formosa Plastics 
Group, the tenth largest chemical company in the world in 
terms of sales.  Since then, CPC and Formosa have settled 
into a comfortable arrangement with Formosa holding on to 
one third of the market and CPC holding the rest. 
 
3. (U) Until August 2005, both companies charged the same 
price for wholesale gasoline and diesel.  Both companies 
also moved their wholesale prices in virtual lock step, 
usually announcing price changes within hours of each other. 
This situation held steady for the last 19 price 
adjustments.  But in August 2005, Formosa notified dealers 
of a 9.7 percent increase and, remarkably, Chinese Petroleum 
did not follow suit. 
 
4. (U) Formosa stood fast despite criticism from customers 
and gas stations.  K.Y. Lin, Director of the President's 
Office at Formosa said that retail sales by the company's 
gas station franchisees dropped by 60 percent.   By the end 
of September, CPC had 90 percent of the domestic gasoline 
market. 
 
5. (U) On September 29, 2005, a month after Formosa 
announced its price increase, Premier Frank Hsieh announced 
that Taiwan would slash commodity taxes on gasoline, diesel, 
and fuel oil by 25 percent.  Hsieh said the temporary 
measure would last for three months until December 31. 
Taiwan's Ministry of Finance reported that the three-month 
tax holiday would cost NT$6 billion (US$180 million) in tax 
revenue.  Soon after the announcement, Formosa said that it 
would re-enter the domestic market and bring down wholesale 
prices to match CPC's wholesale prices.  As of October, 
Formosa is regaining its market share and retail gasoline 
prices have stabilized at the fixed price of NT$2.54 per 
liter (US$2.88 per gallon). 
 
Gas prices being kept artificially low in Taiwan 
--------------------------------------------- --- 
 
6. (U) Gasoline prices in Taiwan have typically been the 
lowest among the East Asian economies; Korea, Singapore, 
Hong Kong and Japan.  A year ago, the average price for 
gasoline in Taiwan was NT$22.60 per liter (US$2.56 per 
gallon). In comparison, at the same time last year, the 
price of gasoline in U.S. dollars per gallon in Hong Kong 
was US$5.62, in Seoul US$4.71, and in Tokyo US$3.84. Over 
the past year gasoline prices in Taiwan have climbed NT$3 
(US$0.09) to NT$25.40 per liter (US$2.88 per gallon).  Until 
this past August, the reason for the low price had nothing 
to do with government subsidies.  Dr. Bor Yun-chang, 
resource economist at the Chunghua Institute for Economic 
Research, a non-profit think tank, explained that gasoline 
prices are low in Taiwan because Taiwan's gasoline taxes are 
the lowest in Asia at approximately NT$7-8 per liter 
(US$0.80-0.90 per gallon). 
 
7. (SBU) This has all changed since August when crude oil 
prices reached record highs.  Since then, gasoline prices in 
Taiwan have been artificially held down through government 
intervention.  Dr. Bor estimates that without government 
control, gasoline in Taiwan would cost NT$30 per liter 
(US$3.40 per gallon).  CPC officials have reported in the 
Taiwan media that they are losing money on gasoline sales as 
long as crude oil prices stay above US$60 a barrel. 
 
Formosa's smart business tactics 
-------------------------------- 
 
8. (SBU) Dr. Chi-Chao Wan, a professor at Tsinghua 
University and a member of the Executive Yuan's new energy 
task force, explained how Formosa's hardnosed business 
strategy forced Taiwan officials to reduce gasoline taxes. 
When supply shortages pushed refined gasoline prices higher 
in August 2005, Formosa realized that it could make a 
windfall exporting gasoline instead of selling it in Taiwan. 
The international refined gasoline market was at an all time 
high in August.  As a result, Formosa raised wholesale 
prices to decrease domestic demand.  It then exported the 
gasoline at a higher price to other countries. 
 
9. (U) Formosa's move angered customers and, more 
importantly, the hundreds of franchisee gas stations that 
were locked into long-term contracts with Formosa.  These 
gas stations had no choice but to raise prices and watch CPC 
affiliated gas stations take their business.  Taiwan media 
reported angry gas station owners threatening a mass rally 
at Formosa headquarters.  However, Formosa skillfully ended 
any protest by reimbursing gas station owners for their 
losses.   Formosa calculated that even with the 
reimbursement, they were still turning a profit. 
 
10. (U) K.Y. Lin told AIT that exporting gasoline was an 
unavoidable business decision.  He told AIT, that with 
skyrocketing crude oil prices, it cost Formosa US$64.50 to 
purchase and refine a barrel of oil.  But with gasoline 
prices holding steady, their return on every barrel of oil 
was only US$61.  Once the spot market in refined gasoline 
reached US$70 a barrel, Formosa realized it could reimburse 
gas station owners and still make a profit. 
 
CPC's larger market share leads to greater losses 
--------------------------------------------- ---- 
 
11. (U) K. Y. Lin also said that Formosa knew that if they 
priced themselves out of the domestic market, it would force 
the Taiwan authorities to act.  Since CPC was selling 
gasoline at a loss, the more business Formosa gave them, the 
more money CPC would lose.  Eventually, the Taiwan 
authorities would have to intervene to help CPC.  Dr. Bor 
agreed with K.Y. Lin's assessment and explained the process 
in more detail.  He told AIT that if CPC needed to supply 
gasoline to all of Taiwan it would start a chain reaction 
that would lead to exponentially greater losses.  CPC has 
long-term crude oil contracts that only guarantee a certain 
volume of crude oil.  Once that volume is exceeded, CPC 
would need to buy from the international spot market to make 
up the difference.  The spot market is even more expensive 
and would lead to even greater losses. 
12. (U) For CPC, holding gas prices down was a political, 
not an economic decision.  CPC is government owned and 
CPC's president is a political appointee.  In response to 
questions about CPC's mounting losses, Kuo Ching-tsai, the 
company's chairman was reported by the Taiwan media to have 
said "there is something of higher concern than the short- 
term loss reflected in its financial report.  CPC is 
obligated to take more care of people's need and the 
overall national economic development." 
 
Taiwan reduces taxes to help CPC and entice Formosa back 
into the domestic market 
--------------------------------------------- ----------- 
 
13. (U) On September 29, 2005 Premier Frank Hsieh announced 
that Taiwan would reduce commodity taxes on gasoline and 
diesel by NT$1.8 (US$0.20 per gallon) for three months. 
K.Y. Lin believes that the reason the government decreased 
taxes was because it wanted to stop CPC's losses.  Since CPC 
did not decrease prices after the tax break, the tax break 
amounts to a NT$1.8 increase in profits for CPC. 
Essentially, the government is transferring the tax income 
to CPC. 
 
14. (U) K.Y. Lin said that Formosa's gas stations are now 
able to compete because of a combination of decreasing world 
crude oil prices and Taiwan's tax largess.  Since the spot 
market in refined gasoline is no longer as high as it was in 
August, it is no longer as profitable for Formosa to export 
the gasoline and reimburse gas station owners.  Dr. Bor said 
that Formosa may not want to antagonize Taiwan officials 
because there are many other business projects that Formosa 
is working on that need approval.  For example, Dr. Bor said 
that Formosa has been negotiating with Taiwan to allow it to 
build a naptha cracking plant in the PRC. 
 
15. (SBU) Shih-Ming Chuang, Director of Division of Policy, 
International Affairs, Information Statistics at the Bureau 
of Energy told AIT that he believes Premier Hsieh is 
prepared to keep reducing taxes to keep gasoline prices low. 
Chuang said that if crude oil prices do not come down by 
December, "Hsieh may remove all commodity taxes." 
 
Tax decrease timed to December elections 
---------------------------------------- 
 
16. (SBU) Dr. Bor said that there are also political reasons 
for the tax decrease.  The tax decrease is being timed to 
keep prices low until the end of the elections in December. 
Bor explained how the ruling party wants to avoid handing a 
political victory to the opposition party.  Bor said, 
Formosa is "like the Microsoft of Taiwan." Y.C. Wang, the 
founder of Formosa, is respected and admired by many in 
Taiwan because of his rags to riches success story.  Bor 
said if the government did not find a way to draw Formosa 
back into domestic gasoline market it would be evidence that 
the ruling party is bad for business. Bor said that "if 
Formosa is giving up on Taiwan, than people are worried." 
 
17. (SBU) Comment: Taiwan is bent on keeping gasoline prices 
locked at NT$25.40 per liter (US$2.88 per gallon), at least 
until after the elections in December 2005.  Taiwan will 
accomplish this through a combination of gasoline tax 
reductions and having government owned CPC sell at a loss. 
The breaking point for the Taiwan authorities will be when 
Formosa finds it more profitable to export gasoline rather 
than sell it to the domestic market.  End Comment.