The Ministry of Public Security said authorities have detained at least 32 people in a nationwide campaign against so-called gutter oil, and seized more than 100 tons of the oil, China Daily reported in a lengthy article exposing the scandal.
Reports on the crackdown were also carried by other Chinese media. Some reports said gutter oil could cause cancer.
The crackdown comes after the ministry found out about a criminal network working in 14 provinces, including Zhejiang, Shandong and Henan, authorities said.
The China Daily said gutter oil is illegally recycled cooking oil that is scooped up from sewage drains and gutters behind cooking establishments. The report said in some cases, restaurants sell used cooking oil collected in buckets.
The gutter oil issue is the latest in a number of scandals relating to food safety in the country. The scandals have included melamine-tainted infant formula and pork tainted with the banned chemical clenbuterol -- which helps make the meat leaner but can be harmful to humans -- China Daily reported.
Under Chinese law, those convicted of producing or selling toxic or harmful food can face life sentences.
"This is the first time that we busted a major network and destroyed an underground industry that collected, sold, refined, and distributed illegal cooking oil," said Liu Shaowu, the public security ministry's director of security management.
The report said the wholesale price of legal, legitimate oil in China is about 10,000 yuan, or $1,560 a ton, while gutter oil sells for around 8,000 yuan to 9,000 yuan.
Gutter oil is widely present across the market, with some estimates of 2.25 million tons being used annually.
"To put it another way, there is a chance you will eat gutter oil once in every 10 times you eat out in China," the Global Times reported. "Among the food safety scandals plaguing China, illegal cooking oil probably affects the largest number of consumers."
The report said without a revolutionary change in the Chinese cooking style, it would be a lasting challenge to eradicate illegal cooking oil.
Professor Dai Peng at the Chinese People's Public Security University told China Daily it would be difficult to root out the problem, which he blamed on unscrupulous restaurant owners and a lack of supervision by enforcement agencies.
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