* Govt faces dilemma over gasoline and diesel price rises
* Price-setting formula encourages speculators, hoarding
* Political obstacles may still block 10 pct price rise
By Eadie Chen and Chen Aizhu
BEIJING, May 26 (Reuters) - China must raise gasoline and diesel prices within days or risk more political lobbying and speculative fuel hoarding that would further erode the credibility of a landmark pricing reform launched just months ago.
The government faces a dilemma: raise fuel prices, rewarding speculators at the cost of hard-pressed farmers and industries; or leave them unchanged, betraying its pledge to make fuel prices more transparent and let them fluctuate more freely.
Only a sharp fall in crude oil
Beijing appeared on the brink of raising prices weeks ago, but pulled back at the last moment, industry officials say.
Speculation about an imminent increase returned last week after Sinopec <0386.HK> Chairman Su Shulin told reporters that Asia's biggest refiner was running in the red at $60 crude, and when he cited a government release earlier this month that appeared to lay out its pricing methodology for the first time.
"On May 7, the announcement said prices will change in 20 working days. Did you check until which day is 20 working days?" he asked, jokingly questioning a group of reporters.
In fact, analysts say an increase is long overdue after oil prices nearly doubled from their February lows. China has cut prices once and raised them once this year.
Gordon Kwan, head of energy research at Mirae Asset Securities, says prices need to go up about 10 percent for a "reasonable" profit margin in refining.
"If it doesn't happen, China must be either betting on crude prices turning back down, or be prepared for one-off subsidies for the domestic refiners, another 10 billion yuan ($1.47 billion) for the next three months for the industry," Kwan said.
If the gap with crude grows, the government may need a bigger price rise later, undermining its goal of stability.
CHANGE, OR NO CHANGE?
Analysts say Beijing's inaction of late shows little has changed under the new system, which is still opaque despite using an algorithm -- a 4 percent move in crude prices over 22 days, not 20 -- to decide if it's time for a change at the pump.
Worse still, that 22-day lag gives speculators time to move in, leading to widespread wholesale hoarding that has disrupted distribution across the country, researchers say.
"It's rational to stock up when you expect prices to rise and to clear out stocks when you expect prices to fall, so you can make risk-free profits," Deng Yusong, an analyst at a leading think-tank, said on Saturday, describing China's desire for both stability and near-market prices as "mission impossible".
"Fuel dealers can make a profit without any risk by buying ahead of an expected price change."
Unlike many countries, China doesn't let supply and demand determine the price of motor fuel. The government adjusts prices by edict, and only occasionally.
But a new system launched this year was supposed to bring more frequent changes, with fuel prices tracking global crude oil fluctuations more closely, guaranteeing a reasonable profit margin for refiners while offering consumers some protection.
It was also supposed to alleviate the sporadic shortages that China faced in recent years when high crude costs and low state-set fuel prices prompted refiners to cut output or export fuel rather than tot growing losses on the domestic market.
FUELLING RUMOURS
The reform stipulates that refiners will enjoy "normal" and "reasonable" margins when crude is below $80 per barrel, but thinner profits as crude rises further and nothing at all when it passes $130. By that formula, $60 crude oil means the refiners are due a little breathing space.
The problem is politics. Although the economic conditions for a price rise appeared to be satisfied on May 7, China's cabinet, the State Council, decided not to push it through.
Zhou Jiping, president and vice chairman of PetroChina <0857.HK>, notes that the wording of Beijing's decree says specifically that prices "can" be adjusted on the basis of global crude oil markets, not that they must be.
"The authorities will still make a comprehensive consideration of all factors to adjust the oil prices at an appropriate time and by an appropriate margin," he said.
That means Sinopec's lobbying is likely to face opposition from China's huge farm sector, which is struggling to make ends meet due to low crop prices after years of bumper harvests.
A diesel price hike would raise farm costs just as the agricultural season gets into its stride.
Raising prices could also encourage smuggling and black market trading, since China is oversupplied with diesel and gasoline. A price rise would trim demand while encouraging supply, worsening the imbalance between the two.
That would also be bad news for rival Asian refiners, since China would export even more fuel, following record-high diesel and near-record gasoline shipments in April.
China sees the new system as a stepping stone towards a free market, although it's unlikely to free prices fully unless it is sure of avoiding shortages and price spikes that could damage its economy and cause unrest.
"I believe oil will trade above $100 again by 2011, so they will need to switch to another system to motivate the domestic producers in two years' time," Kwan said. (Additional reporting by Jim Bai and Tom Miles; Editing by Ramthan Hussain and Jonathan Leff) ($1=6.823 Yuan)