South Korea extends oil tax cut but with lowered reduction rates

South Korea has decided to extend the tax cut for automotive fuels through the end of August but will lower the cap for the reduction in a compromise to meet lingering inflationary pressure and address concerns about the country's dwindling tax revenues, the finance ministry said June 18.

The country has provided tax cuts for automotive fuels -- diesel, gasoline and butane -- since November 2021 to help cope with the upward pressure on inflation sparked by surging pump prices.

In January last year, the government restored tax reduction for gasoline to 25% from a legal cap of 37% cut, while maintaining tax cuts for diesel and butane at 37%. The 32-month-long tax cut was supposed to expire at the end of June.

"The government has decided to extend the tax cut for auto fuels by an additional two months through the end of August with the cap for the reduction adjusted," the Ministry of Economy and Finance said.

Tax reduction for gasoline will be lowered to 20% from 25% currently, and tax cut for diesel and butane will be eased to 30% from 37% currently, according to the ministry.

The lowered tax cap for reduction will effectively raise pump prices of gasoline and diesel by Won 41/liter ($0.03/l) and W38/l, respectively, it said.

"Whether to extend the tax cut further beyond end-August will be decided later by considering global circumstances, inflation, consumer sentiment and other related factors," the ministry said.

Local refiners welcomed the decision to extend oil tax cut, but expressed concerns that lowered tax reduction rates may weaken domestic demand with narrowing cracking margins.

"Refining margins declined to $5.4/b in late last month, compared with $15/b in the first quarter," a refiner official said, noting that oil demand and margins can be further affected by raised pump prices, with lingering inflationary pressure.

Currency factor

South Korea's weak currency could also translate into higher retail fuel prices for vehicle owners in Asia's fourth-biggest economy even though benchmark crude and oil product outright prices have been rangebound the past year, fixed-income securities analysts and a middle distillate marketer at a major South Korean refiner said.

The national monthly average retail diesel price was Won 1,432/liter ($1.038/liter) in April, the highest since the October 2023 average of Won 1,559/liter ($1.129/liter), latest data from state-run Korea National Oil Corp. showed. Retail 92 RON unleaded gasoline price averaged Won 1,634/liter ($1.184/liter) in April, the highest since September 2023.

"The reduced rate of fuel tax cuts, as well as the won's sharp weakness would continue to elevate prices at the pumps ... that's not going to help consumer sentiment heading into the peak summer driving season," said a wholesale distribution and marketing manager at S-Oil.

"South Korea imports all of its refinery feedstock crude oil requirements ... weak South Korean won against the dollar means that end-consumers would eventually have to bear that cost burden," said an analyst at Meritz Securities in Seoul.

The exchange rate weakened to Won 1,400/$1 April 16 and continues to hover around a 17-month low as the risk-sensitive Asian currency has been weighed by a relatively low Bank of Korea interest rate and a shrinking trade surplus over the past couple of years.