Sinopec’s results confirm China’s focus on employment and self-sufficiency, not profit
on June 1, 2017

Sinopec May17China’s strategies for oil, refining and petrochemical production are very different from those in the West, as analysis of Sinopec’s Annual and 20-F Reports confirms.  As the above chart shows, it doesn’t aim to maximise profit:

□  Since 1998, it has spent $45bn on capex in the refining sector, and $38bn in the chemicals sector
□  Yet it made just $1bn at EBIT level (Earnings Before Interest and Taxes) in refining, and only $21bn in chemicals

As I noted last year:

Clearly no western company would ever dream of spending such large amounts of capital for so little reward. But as a State Owned Enterprise, Sinopec’s original mandate was to be a reliable supplier of raw materials to downstream factories, to maintain employment. More recently, the emphasis has changed to providing direct support to employment, through increased exports of refined products into Asian markets and increased self-sufficiency in petrochemicals”.

Commentary on China’s apparent growth in oil imports confirms the confusion this creates.  Western markets cheered last year as China’s oil imports appeared to increase, hitting a record high. But they were ignoring key factors:

□   China’s crude imports were indeed 14% higher at 7.6 million bpd – nearly a million bpd higher than in 2015
□   But 700 kbpd of these imports were one-off demand as China filled its strategic storage
□   And at the same time, China’s refineries were pumping out record export volume: its fuel exports were up around one-third during the year to over 48 million tonnes

As Reuters noted:

This broadly suggests China’s additional imports of crude oil were simply processed and exported as refined products.”  In reality, ”China’s 2016 oil demand grew at the slowest pace in at least three years at 2.5%, down from 3.1% in 2015 and 3.8% in 2014, led by a sharp drop in diesel consumption and as gasoline usage eased from double-digit growth.”

The issue was simply that Premier Li was aiming to maintain employment in the “rust-belt provinces”, by boosting the so-called “tea-pot refineries”.  He had therefore raised their oil import quotas to 8.7 million tonnes in 2016, more than double their 3.7 million tonne quota in 2016.  As a result, they had more diesel and gasoline to sell in export markets.

China OR May17

The same pattern can be seen in petrochemicals, as the second chart confirms.  It highlights how Operating Rates (OR%) for the two main products, ethylene and propylene, remain remarkably high by global standards.  This confirms that Sinopec’s aim is not to maximise profit by slowing output when margins are low.  Instead, as a State Owned Enterprise, its role is to be a reliable supplier to downstream factories, to keep people employed.

□   Its OR% for the major product, ethylene, hit a low of 94% after the start of the Financial Crisis in 2009, but has averaged 102% since Sinopec first reported the data in 1998
□   Its OR% for propylene has also averaged 102%, but has shown more volatility as it can be sourced from a wider variety of plants. It is currently at 100%

Understanding China’s strategy is particularly important when forecasting demand for the major new petrochemical plants now coming online in N America.  Conventional analysis might suggest that China’s plants might shutdown, if imports could be provided more cheaply from US shale-based production.  But that is not China’s strategy.

Communist Party rule since Deng Xiaoping’s famous Southern Tour in 1992 has always been based on the need to avoid social unrest by maintaining employment.  There would therefore be no benefit to China’s leadership in closing plants.  In fact, China is heading in the opposite direction with the current 5-Year Plan, as I discussed last month.

The Plan aims to increase self-sufficiency in the ethylene chain from 49% in 2015 to 62% in 2020.  Similarly in the propylene chain, self-sufficiency will increase from 67% in 2015 to 93% in 2020.

It is therefore highly likely that China’s imports of petrochemicals and polymers will continue to decline, as I discussed last month.  And if China follows through on its plans to develop a more service-based economy, based on the mobile internet, we could well seen exports of key polymers such as polypropylene start to appear in global markets.

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