Improvements in Negotiations

The most effective way for Korean oil refinery corporations to enter the Chinese market is to eliminate China’s tariff and non-tariff barriers as soon as possible. However, as the Korea-China FTA has already taken effect, additional negotiations will have to be pursued. These could take place at the Regional Comprehensive Economic Partnership (RCEP),⁴⁵ at which negotiations are currently organized.

Korea and China did agree to have further negotiations over two years immediately after the FTA come into effect. However, according to the chapter 22 of the agreement,⁴⁶additional negotiations were to be limited to services and investments. So further negotiations may not include trade of products and other non-tariff barriers.

For this reason, negotiations through the RCEP are needed to address these issues.

These negotiations would be on the basis of reciprocity, as it is almost impossible to modify the signed agreements. If Korea asks for the accelerated opening of the oil market, China may, in return, demand the opening of Korea’s vulnerable agricultural market. However, discussions could take place on the rules of origins concerning lube base oil and a method for determining the prices of petroleum products that can create non- tariff barriers. Although additional negotiations were slated for three years after the FTA taking effect, more attention should be paid to the RCEP, which will occur a bit earlier.⁴⁷

The RCEP, a mega-regional economic agreement for negotiations between the 10 ASEAN governments and their six FTA partners,⁴⁸ was launched in November 2012. Talks have covered an extensive range of areas—

products, services, investments, intellectual property rights, legal systems, rules of origins, non-tariff barriers, and technical barriers. As such, it serves as an alternative means for further negotiations involving the number of FTAs. In an effort to keep the U.S.’s influence in the Asian region in check, China actively participates in the

45 Regional Comprehensive Economic Partnership

46 According to the Korea-China FTA (Chapter 22, Article 2), in regard to the trade of services and investments, revision should be made in accordance with further negotiations.

47 During the initial negotiation, the settlement of agreement was slated to be made by the end of 2015, but a series of negotiations continued in 2016. KOTRA sees the outlook for the final settlement as uncertain (KOTRA & KOTRA Overseas Market News, August 19, 2016).

48 The six partners are Korea, China, Japan, India, Australia, and New Zealand, and the ASEAN 10 countries are Laos, Malaysia, Myanmar, Vietnam, Brunei, Singapore, Indonesia, Cambodia, Thailand, and the Philippines.

RCEP arrangement. However, as the RCEP is a multilateral meeting with representatives from 16 countries, it has limitations. Due to varying degrees of market openings among member states, it can be harder to arrive at a consensus. Up to August 2016, 14 rounds of official negotiations had been conducted, but detailed requirements have yet to be established.

According to existing studies, as Korea and China show differences in trade liberalization rates and negotiation approaches, there is a differentiation in their negotiation strategies (see Tables 5-1 and 5-2).

Table 5-1. Major Issues Regarding RCEP

Issues Descriptions

Trade Liberalization

Rates

⋅ (Korea, China, and India) Trade liberalization rate is suggested as 40%

⋅ (Japan and ASEAN) Eliminating the tariffs of 80% of items within 10 years

⋅ (Australia and New Zealand) Demanding for more than 80% of the trade liberation rate

Negotiation Approaches

⋅ (China and India) Subsequent negotiations from products

⋅ (Japan, Australia, and New Zealand) Package settlement of all areas, including norms

Source: RCEP Negotiations and Strategies by Member Countries and Industrial Responses, 3p, KOTRA (January 28, 2015)

Table 5-2. Strategies by Major RCEP Member Countries

Countries Strategies

China

·Pursuing the integration of the Asia-Pacific region

·Keeping the U.S.-led TPP in check

Japan

·Pursuing a mega-scale FTA as part of the growth strategy of “Abe-nomics”

·Establishing an Asia-Pacific free trade region through the TPP and RCEP

·Accelerating trade investments and economic cooperation

Australia

⋅ Reducing the prices of manufactured goods from RCEP member states Expanding the export opportunities of dairy and food products

Expanding the opportunities in the services sector, including finance, medicine, and education

Countries Strategies

New Zealand

·Complementing the previously signed FTA

·Creating synergy by participating in the TPP and RCEP simultaneously

Indonesia ·Market opening through gradual elimination of tariffs considering the damages for its local market

Malaysia

·Expanding the overseas businesses of domestic companies

·Opening the market on a gradual basis

Singapore

·Relieving non-tariff barriers and pursuing an integrated market through standardization and unification

Thailand ·Focusing on the trade of products and services/investments

Vietnam

·Pursuing the development of the fabric industry

·Nurturing the electricity and electronics industries

·Reforming into a transparent government through the privatization of state-owned corporations

Source: RCEP Negotiations and Strategies by Member Countries and Industrial Responses, 4p, KOTRA (January 28, 2015)

Even though Korea is taking a relatively passive stance in the opening of multilateral markets, more and more ASEAN countries, including Japan, are active in the opening their markets, raising the likelihood of reaching more consensus on oil industry trade than the Korea-China FTA. Therefore, in preparation for such a possibility, the RCEP agreement as well as the Korea-China FTA ought to be complemented as follows:

1) Revision of Rules of Origins

By adding the criteria of regional value content (RVC⁴⁹) to the rules of origins of lube base oil, it is necessary to review whether it is appropriate to revise the rules to apply to a change of tariff heading and regional value content. The change of tariff heading has up to six digit numbers; thus, as observed from Chapter 3, lube base oil, which is produced primarily from foreign-imported lubricating grease, does not come under the rules of origins. However, if about 40% of regional value content is added, the lube base oil may possibly be subjected to the rules of origins. This can be observed elsewhere from the difference in prices between lube base oil, transacted in the global market, and ingredients.

49 Regional Value Content

Figure 5-2 illustrates the prices of lube base oil (Group Ⅱ & Group Ⅲ) in Northeast Asia and the prices of vacuum gas oil (VGO). From the second half of 2014, due to a sudden drop in global crude oil prices, the prices of lube base oil and vacuum gas oil were expected to fall concurrently. However, as the difference in the prices of lube base oil and ingredients has widened, the added value rates of lube base oil⁵⁰ increased to a large degree.

The added value rates of Group Ⅲ, since the fourth quarter of 2014, have surpassed an average of 40%, expanding to over 60% in the first quarter of 2016. The added value rates of Group Ⅱ have increased 45% on average in the first quarter of 2016.

Figure 5-2. Comparisons of Lube Base Oil, Feedstock Prices, and Added Value Ratio

Source: IHS Global Lubricants Service, Quarterly Base Oil Margin 1Q16

According to the market conditions, the rates of added value may continue to change, but as the economy of China, India, and Southeast Asia is growing rapidly, the demand for transportation and construction is expected to increase drastically. Therefore, the current trend of added value rates of lube base oil cannot be seen as a temporary phenomenon. If the Asian economy continues to grow stably and as Group Ⅲ is traded higher than Group Ⅱ, the rates of added value may reach more than 40% in the future.

Considering the market conditions, it seems desirable for Korean oil refinery companies to modify the rules of origins for lube base oil to the “change of tariff heading or more than 40% of regional value content.”

Also, as some prescribed food products, clothes, fabric, and machinery products are selectively subject to the application of more than two rules of origins, it would not be problematic to apply the same rule to lube base oil.

2) Acceleration of Tariff Decline for Major Petroleum Products Exported to China

As further Korea-China FTA negotiations are anticipated to be limited, the RCEP negotiations could cover an accelerated tariff reduction for petrochemical products, as Korea exports of these to China are highly competitive.

Even though the market openings for gasoline, diesel, and heavy oil, which were discussed in the Korea- China FTA, have been somewhat minimal, China has been imposing 1% of temporary tariffs and maintaining the tariff barriers at a lower level. However, the speed of tariff reduction has slowed down or been excluded for products such as lube base oil, asphalt, propylene, and BTX, as these are categorized into either sensitive tracks or highly sensitive tracks. In addition, in the case of asphalt, the agreed tariffs are higher than tariffs imposed by

50 (Lube base oil prices-ingredient prices)/lube base oil prices

the APTA. Therefore, the tangible effects of tariff reduction probably will not be seen until 2019. Korean oil corporations, for the time being, will not be able to enjoy the full benefits of the Korea-China FTA. In this regard, the follow-up negotiations concerning the Korea-China FTA need to concentrate on the opening of services and investment markets, alleviating non-tariff barriers, and modifying the rules of origins. Also, the RCEP could focus on the reduction of tariffs on petroleum products.

As shown in Table 5-3, most of the RCEP member states show low most favored nations (MFN) tariff rates for petrochemical products. Therefore, it is worth considering, as a realistic alternative, in complementing the results of the Korea-China FTA.

Table 5-3. MFN Tariff Rates of RCEP Member Countries in Petrochemical Sector

Countries

MFN Tariff Rates (%)

Average Maximum

Oil

Korea 4.4 8.0

China 4.5 9.0

Japan 0.6 8.0

India 4.9 10.0

Australia 0.0 0.0

New Zealand 0.5 5.0

Indonesia 0.2 5.0

Malaysia 0.5 5.0

Philippines 1.0 3.0

Thailand 6.1 10.0

Singapore 0.0 0.0

Chemica ls

Korea 5.7 271.0

China 6.5 47.0

Japan 2.2 7.0

India 7.9 10.0

Australia 1.8 10.0

New Zealand 0.8 10.0

Countries

MFN Tariff Rates (%)

Average Maximum

Indonesia 5.1 150.0

Malaysia 2.7 50.0

Philippines 3.8 30.0

Thailand 3.3 30.0

Singapore 0.0 0.0

Source: WTO, International Trade and Market Access Data (October 12, 2016)

3) Demand for Liberalization of Chinese Oil Market

As mentioned above, China’s current transportation diesel price system is a risk factor for stable exports of petroleum products. The control on prices by the Chinese government has long been a controversial issue in relation to China’s desire for market economy status (MES⁵¹) from the WTO, in which China participated in 2001.⁵² However, if China is given market economy status at the end of 2017, it may have a negative impact on Korea’s petroleum products exports to China.

With protracted low oil prices, the prices of transportation diesel in China have stayed at international price levels, but if oil prices increase in the future, the Chinese government may go back to its previous price restriction policy.

Therefore, in future negotiations concerning the Korea-China FTA, the Korean government should take the price system of China as a non-tariff barrier, strongly requesting that the Chinese government liberalize prices.⁵³ Also at the RCEP negotiations, China’s current restriction on prices should be made public and shared with all member states. As most of the RCEP participating countries are WTO members and retain market economy status, China’s current price system would be of common interest. Then if problems arise through multilateral discussions, the Chinese government may feel a high level of pressure at the follow-up FTA meetings.