The “Why” Behind Sinopec’s Investment Freeze

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By John Richardson

SINOPEC has announced that it will halt some of its new petrochemicals investments. This could involve the postponement of up to three cracker projects with a combined ethylene capacity of 2.8m tonnes/year, according to this excellent story from my ICIS colleague, Fanny Zhang.

The company confirmed that the 1m tonnes/year Qingdao Petrochemical Co cracker project, in Shangdong province, will not start up as scheduled in 2016.

Sinopec Hainan Refining & Chemical Co’s 1m tonnes/year cracker project, in Hainan province, has also been delayed beyond its planned 2016 commissioning, market sources told ICIS.

And a third Sinopec cracker project – at Zhanjiang in Guangdong province – has been postponed beyond 2016, said the same market sources. Last September, the capacity of the project, which is integrated upstream to a proposed new refinery, was reduced to 800,000 tonnes/year from 1m tonnes/year.

Sinopec told ICIS that it was pausing some of its petrochemicals investments because of “fierce competition”, although it insisted that it had the upstream integration and feedstock flexibility to adequately cope with competition from the Middle East – and we presume , also, the US.

Nevertheless, the state-owned oil, gas, refining and petrochemicals major talked about restructuring its feedstock slate and achieving a better balance in its product chain and market penetration.

As far as feedstocks are concerned, the blog understands that Sinopec is looking to increase the use of liquefied petroleum gas (LPG) in some of its crackers. Perhaps, also, importing ethane from the US might be an option, if the questionable economics of this emerging trade prove to be sound enough.

Sinopec stressed that all of its projects would now be re-evaluated based on profitability.

This feels to us like a significant change in direction. Traditionally, Sinopec has operated very much as a utility to support downstream industries. It has run its plants at operating rates often in excess of 100%, even in weak market conditions, and as a result – as the slide above indicates – has achieved very poor profitability by US and European standards.

Why? Because the Chinese government’s priority had been to ensure supplies of chemicals and polymers to downstream industries in order to grow manufacturing output.

But many downstream industries are now struggling with oversupply and are burdened with bad debts. China’s new leaders are committed to resolving this problem through forcing widespread consolidation.

Making more uncompetitive chemicals and polymers to supply more uncompetitive manufacturing capacity is therefore no longer a priority, as China moves away from its investment-focused growth model.

There are other reasons why we think Sinopec’s petrochemicals business  may need to focus more heavily on profitability, which are:

  • Last November, during China’s critically important Third Plenum, it was announced that dividend payments from the state-owned enterprises (SOEs) to the government would be raised from 0-15% to 30%. This will, of course, make the SOEs focus much harder on the bottom line.
  • If other economic reforms progress as China’s top leaders intend, the SOEs will have significantly reduced access to cheap project financing, cheap land and cheap electricity.
  • Late last month, Sinopec said that it planned to spend 22.87 billion yuan (US$3.67 billion) on 803 projects to improve the environment, with about half the money devoted to four areas: reducing chemical-oxygen demand, a measure of water contamination, and releases of the toxic water pollutant ammoniacal nitrogen, and cutting emissions of sulphur dioxide and nitrogen oxide, which are major air pollutants. These costly upgrades to refineries will now be more easily afforded, thanks to the liberalisation of government controls on gasoline, diesel and other fuel prices. But still, the money will have to be found from somewhere – and it looks as if companies in general will find it harder to avoid environmental rules, due to tougher enforcement.

We also think that the environment in general, as well as the bottom line, might be another factor behind the Sinopec decision.

In the developed regions of China, rising income levels have been accompanied by greater concerns over the quality of life – hence, the protests that have recently blocked some paraxylene (PX) projects. Two of the three cracker projects listed above – in Shangong and Guangdong – are in very-developed provinces. And whereas the third project is in the less-developed Hainan province, its economy is already booming thanks to tourism and its status as a Special Economic Zone.

And China’s Premier, Li Keqiang, has also declared “war on pollution” , as the government recognises that China’s growth model has led to chronic air, land and water pollution – leading to hundreds of thousands of premature deaths.

This, of course, doesn’t mean that petrochemicals projects cannot be pursued in the developed eastern and southern provinces. It does mean, however, that they will have higher environmental compliance costs and so Sinopec might have to be more selective about its investments.

Interestingly, though, in the same ICIS news story, Sinopec said that it was still seriously looking at coal as an alternative petrochemicals feedstock.

It has a 3.6m tonne/year coal-to-olefins (CTO) project in Inner Mongolia that is expected to come on stream in early 2017, which is unaffected by the investment freeze.

Go Figure? The CTO process is renowned for its high consumption of water in water-stressed areas such as Inner Mongolia. There are also claims that it produces more pollution than naphtha cracking.

Two different government strategies could be in play here. There might be a greater focus on the environment in the developed regions. But in the much-poorer western provinces, the priority feels as it could involve using local petrochemicals capacity as a building block for wider industrial development – and thus job creation.

The CTO process can enjoy lower variable costs compared with naphtha cracking, say some consultants.

But capital costs are around 2-3 times higher per tonne of ethylene than those for a naphtha cracker. Sinopec’s greater focus on the bottom line could therefore be as “region specific” as its focus on the environment.

Sinopec is, as we said, state-owned and state-run company and so this has to be factored in to all the analysis of the company’s strategy.

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