April 09,2008

Sinopec a Victim of China's Price Distorting Energy Policy

By Ma Wenluo
 

When China’s biggest oil refining enterprise, China Petroleum & Chemical Corporation�/span>Sinopec�/span>, issued its disappointing financial performance for 2007, the international price of crude oil was once again on the verge of surpassing $110 per barrel. This not only means that Sinopec will have to continue coping with high crude oil prices but also represents a significant challenge to China’s controversial energy policy.

According to Chinese accounting rules and regulations, Sinopec’s net revenue and revenue increase in 2007 was lower than those registered in 2006. Revenue reached 1204.843 billion Yuan, up 13.5%, while 2006 saw revenue increase by 30.72%. Net income rose 5.5% to 54.9 billion Yuan, in comparison, 2006 saw net income increase by 28.08%. In short, Sinopec’s performance failed to meet general expectations. Goldman Sachs had predicted that Sinopec’s net income would reach 64.1 billion Yuan, and JP Morgan forecasted that net income would hover around 56.5 billion Yuan.

In fact, the net profit attributable to the company’s equity shareholders before extraordinary gains and losses in 2007 was only 49.6 billion Yuan, a little less than the previous year when it reached 50.1 billion Yuan. This is the first time in the past several years that Sinopec has seen its net income drop, and the 13.6 billion Yuan loss in its oil refining business was the main factor behind this unpredicted drop. This has come at a time when Exxon Mobil, the world’s largest listed oil refiner and the biggest company by market value, declared a net income of $40.6 billion in 2007, that is equivalent to $184 million of net revenue every week, the highest revenues recorded in U.S history.

Sinopec’s loss wasn’t due to any mismanagement in its operations; rather, it was caused by China’s outdated energy policy that is struggling with rising international oil prices. In order to curb the increasingly severe inflation, the Chinese government has imposed price control on all oil products. To answer doubts about the excessive profits earned by the monopolistic Chinese National Petroleum Corporation (CNPC) and the Sinopec, China has imposed special oil gain levies (rainfall tax) on their high profits. These profits were caused by the high price of crude oil on the domestic market, prices that were in line with that of the international market. The money was used to subsidize underprivileged people and industries affected by rising oil prices. In 2007, 72.4% of Sinopec’s crude oil was imported, and this has resulted in a much smaller oil gain levy than that of the CNPC, which reached 6.84 billion Yuan. If oil prices were to increase on the domestic market, the resulting smaller loss in the oil refining business would not compensate for the loss incurred by the larger special oil gain levy. On the other hand, in order to satisfy the refiners who have been complaining about the restriction imposed on oil prices, the Ministry of Finance has been giving them financial subsidies to help cover their losses. Two weeks before Sinopec issued its annual financial report, it received a 12.3 billion Yuan subsidy, of which 4.9 billion was included in its 2007 report, only compensating for 36% of its total loss in the oil refining business. In 2005 and 2006, the company received subsidies valued at 10 billion and 5 billion Yuan, respectively.

At current domestic oil prices, $68 per barrel of international crude oil is the price where cost equals revenue for Chinese oil companies. If the international oil price rises above this level, Chinese oil enterprises start losing money. Although Sinopec can now afford a crude oil price of about $76 per barrel, it is nevertheless confronted with a more than $30 gap between the price it pays on the international market and what consumers pay at the pump. "When the crude oil price was $100 per barrel, the loss of selling every ton of oil was 2000 Yuan" said Zhou Yuan, Sinopec’s Vice-Executive President. The combined net profit of the first three quarters of 2007 was 48.7 billion Yuan, this means that in the fourth quarter, the net profit was only 1.4B Yuan, the high crude oil prices (above $90 per barrel on average and above the restricted refined oil price) having eaten into the profits of its other business branches.

When the international oil price rose above $90 per barrel, the National Development and Reform Commission( NDRC) decided to lift the price of gasoline, diesel oil and kerosene to 500 Yuan per ton, but this has not changed the situation in some regions where there is still a lack of refined oil. In early March 2008, oil shortages in Southern China were spreading across the country to Shanghai and Beijing; China is now facing a new round of "oil dearth". This has paved the way for renewed calls to increase the price of refined oil. "We have to be responsible to the nation as well as our other stakeholders." This is the dilemma that the two oil giants have to face as they try to balance a variety of expectations.

Theoretically, the price of refined oil should be determined by the market; yet in China, where crude oil prices are determined by the international market, while refined oil prices are controlled by the state apparatus, Sinopec’s declining revenues and the oil shortages affecting the country shouldn’t come as a surprise to anyone. However, since the price of refined oil has major consequence for people from all walks of life and a deep effect on society as a whole, the government’s policy of fixing a low price for oil while subsidizing oil companies, taking into account rising CPI and inflation pressures, has been the subject of controversy. One thing is certain; the NDRC is under heavy pressure as it decides whether or not to increase the oil price.

"The oil shortage is in fact a problem of price", said Zhang Guobao, the first Director of China’s Energy Bureau. The department is expected to have a major role to play in any future energy price reform. "In China, the energy problems are a result of the industry’s structure, as well as in the pricing system. The price reform is fundamental, but it is also a test for the leaders of the Energy Bureau" said doctor Yang Fuqiang, Vice-President and chief representative of the Beijing bureau with the Energy Foundation of America.

China’s energy problem is so severe that the China’s former president, Jiang Zemin, has published a thesis called: "Reflections on China’s Energy Problem". He pointed out that "oil supply is of utmost importance to energy safety". Talking about the price of energy, he wrote that "the price should reflect the scarcity of resources, the supply and demand in the market and the cost of ecological protection and environmental preservation, only through this can we send the correct signal to all the market players." He also emphasized that "we should further improve oil pricing mechanism and gradually join the international market." This thesis has already attracted the attention of experts and government officials.

 

 

 

 

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