Sinopec And The Blog’s Favourite Triangle

Triangle.pngBy John Richardson

ONE of Sinopec’s subsidiaries, Shanghai Petrochemical, has weighed-in to the debate over US shale gas by warning that cheap petrochemicals imports from the States could erode the whole of China’s competitiveness.

“We can’t tell how severe the blow will be, but it will pose a serious challenge, and the entire industry will need to brace itself for the hit,” said Shanghai Petrochemical vice-chairman Wang Zhiqing, in the South China Morning Post earlier this month.

“We need to reduce costs and differentiate our products by adding more value,” he added.

We once again return to our favourite triangle (see above), which was created fellow blogger Paul Hodges. Sinopec has traditionally not been about making money, but instead has been tasked by Beijing with supplying cheap petrochemical raw materials to China’s vast manufacturing industry.

The focus was on creating jobs in order to lift hundreds of millions of low-income Chinese out of poverty, rather than on a strong bottom line for Sinopec.

But we think the Sinopec business model has now changed because:

• Beijing wants a more sophisticated manufacturing industry as China attempts to escape the “middle income trap”. This involves less protection of state-owned companies from intenational markets.

Demographics mean that, at least in the developed eastern and southern coastal provinces, job creation is no longer the priority. Instead, it is about the quality rather than the quantity of growth, which is connected to the technological upgrades vital for escaping the middle-income trap.

Thus, perhaps Sinopec will have to take cheap US exports on the chin and get on with becoming more of a higher-value internationally competitive company, as Wang’s comments perhaps indicate.

We are not suggesting that Sinopec will have to close-down petrochemicals capacity in the face of increased volumes of very competitive imports. That wouldn’t make any sense because the company’s refineries need a home for naphtha in order to make gasoline etc.

But it could be that the opportunities for further capacity growth in basic petrochemicals are more limited.

The blog also wonders how Sinopec is going to absorb the extra costs of upgrading all of its refineries to meet higher-fuel standards.

Sinopec chairman Fu Chengu ended up in hot water with the Shanghai Daily in February when he claimed that it was lax government fuel standards, rather than refiners seeking to save costs, which were the main cause of Beijing’s dreadful smog crisis and growing wider concerns over pollution.

As the Shanghai Daily wrote: “Much of China still uses the National III vehicle emissions standard, which are similar to the Euro III standard – allowing the sulphur content in gasoline to be as high as 150 parts per million.

“The Euro V standard caps the sulphur content at below 10 ppm.

“Shanghai and some relatively developed regions like Jiangsu and Guangdong use the National IV standard.

“Sinopec is not violating any rule or law in supplying most of China with National III standard fuel. But it does benefit from relatively low fuel-quality standards.”

In response to the bad publicity, Sinopec said that it would upgrade desulphurisation facilities at 12 subsidiaries by the end of this year, and would start selling cleaner gasoline that met the National IV standard from next year.

This has triggered concerns about rising fuel prices.

There is already upward pressure on fuel prices because the subsidy system for pricing gasoline etc has twice been reformed since 2009, with the latest change taking place in March this year.

But the positive news is that these reforms have allowed Sinopec to enjoy a stronger stand-alone bottom line, as it can more accurately reflect the fluctuations in the costs of imported oil in the prices it charges for gasoline and diesel etc. It is also better able to plan production to prevent fuel shortages.

The new market-oriented system for pricing fuel was a factor behind Sinopec’s 25% improvement in first quarter 2013 net profit.  

Perhaps we have answered our own question here as to how Sinopec will pay for upgrading its refineries. The adjustments in the fuel-price mechanisms might well be partly designed to give it the revenue to make the necessary changes.

And if Sinopec follows through on its pledge to help clean-up China’s foul air, it might be better able to attract and retain the talent necessary for it to move up the petrochemicals value chain!

China’s educated middle classes, who can afford to get out of the country, are increasingly doing so because of concerns over pollution and food safety, the blog heard during its recent visit to China.

Attracting and keeping expatriates is also becoming much harder, as the New York Times wrote in this very worrying article. 

If you can’t guarantee the safety of your children, what’s the point of a big salary?

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