The recent surge in international oil prices, driven by escalating tensions in the Middle East, has deepened the South Korean government's deliberations on an exit strategy for its oil price cap, which has been in effect for over seven months. While the price cap has successfully restrained domestic fuel prices, the rise in global oil prices above $110 per barrel complicates the timeline for ending the program.
According to the Korea National Oil Corporation, the benchmark price for Brent crude oil rose to $116.72 per barrel on October 23, marking a 3.14% increase from the previous trading day and the highest level in about six months since April 29. West Texas Intermediate (WTI) also increased by 3.8% to $103.27.
The recent spike in international oil prices is attributed to concerns over supply disruptions due to instability in the Middle East. Attacks on Saudi Arabian energy facilities by Houthi rebels and maritime transport uncertainties in the Strait of Hormuz have heightened fears regarding oil supply. Brent crude prices rose by 6% over the past week, while WTI increased by 2.3%.
Despite the rising international oil prices, domestic fuel prices in South Korea remain stable. In the third week of October, the average price for regular gasoline was 1,856.1 won per liter, and diesel was 1,842.5 won per liter, continuing a 23-week streak of declines since the third week of May.
The stability in domestic prices is largely due to the government's implementation of the oil price cap. Since introducing the cap on March 13, the government has designated maximum prices 11 times to curb domestic fuel price increases.
The Ministry of Trade, Industry and Energy has frozen the 11th oil price cap, which will be in effect for four weeks starting October 17. Based on refinery supply prices, gasoline is set at 1,784 won per liter, diesel at 1,773 won, and kerosene at 1,380 won. These prices have remained unchanged for about four months since a 150 won reduction in the seventh price cap at the end of June.
Recent research has confirmed the price stabilization effects of the price cap. A report from the Korea Institute for Industrial Economics and Trade analyzed 1,512 gas stations nationwide and estimated that the relative price of regular gasoline compared to premium gasoline has decreased since the implementation of the price cap.
Specifically, during the first price cap period, the price was estimated to be 45.75 won lower per liter, while during the second to sixth periods, it was 165.51 won lower, and after the seventh cap, it was 239.48 won lower. This analysis compared the relative price changes of regular gasoline against premium gasoline, which is not subject to the price cap.
The institute suggested that the price cap may have buffered consumer prices against increases due to rising international oil prices or accelerated the reflection of international price declines in domestic selling prices. Bank of Korea Governor Shin Hyun-song also noted during a National Assembly audit on October 23 that the price cap has been measured to reduce inflation by 0.6 percentage points.
However, concerns are growing that the prolonged price cap could increase fiscal burdens. The government has allocated a total of 5.6497 trillion won for compensating oil companies for losses, including 4.2 trillion won from this year's contingency fund and 1.4497 trillion won from next year's budget. The amount included in next year's budget is intended to settle losses incurred during the fourth quarter of this year due to the price cap.
Nonetheless, the actual compensation amounts to be paid to oil companies have yet to be finalized, as the government is currently verifying the costs and appropriate margins for each company. Particularly, if domestic supply prices are kept at a certain level while international oil product prices rise, the costs to cover the price differences may increase. Conversely, ending the price cap could lead to a rise in domestic fuel prices reflecting previously suppressed international price increases, potentially burdening consumers.
The conditions for reviewing the termination of the price cap proposed by the government have not yet been met. The government has outlined key conditions for considering the end of the program, including the cessation of the Middle East conflict, normalization of shipping in the Strait of Hormuz, and stabilization of international oil prices around $90 per barrel. However, as the Middle East conflict continues and shipping uncertainties in the Strait of Hormuz persist, it remains challenging to determine when the price cap might end, especially with international oil prices now exceeding $110 per barrel.
Concerns regarding the prolonged price cap were also raised during the recent audit. Governor Shin remarked that while South Korea's fiscal situation is relatively sound, allowing for some continuation, he expressed doubt that it could be a long-term solution.
* This article has been translated by AI.
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