China: Defining The Real, Future Profit Motive

Sinopec-Mar16

By John Richardson

IF you picked up the phone and talked to the right people, or sat down with them face to face, it was possible to in the past come away with the impression that creating and maintaining jobs in China always came first. A distant second priority felt as if it was the profitability of its state-owned companies.

But successful business strategies are, of course, not just built on one set of perceptions picked up during phone calls and meetings. We instead also need hard and reliable data to guide us in the right direction. The above chart provides this kind of data, as it shows that:

  • Sinopec invested $41bn (Rmb 288bn) from 1998 until 2014 in capital expenditure for refining, and $33bn for chemicals.
  • Over this period, it has $11bn at EBIT level in refining, and made just $15bn in chemicals. Overall, it has therefore invested $74bn in capital expenditure for a combined EBIT of just $4bn.

No Western refining and/or chemicals company would be able to return results anywhere close to as bad as this, if your definition of bad is straightforward returns of EBIT over capital expenditure.

But Sinopec is, of course, majority state-owned. This meant that its role was at the very worst to maintain employment – and ideally to create lots of new jobs. If that meant poor returns on investment, and even losing money on a variable cost basis by running plants very hard in weak market conditions, then so be it.

So much for history, even though it is worth noting that some people missed this history. They instead thought that Sinopec, other state-owned companies in China – and also state-owned companies elsewhere – cared about the narrow definition of what making a profit means in the West. This led them into some costly mistakes.

What about the future then?

One school of thought is that as China’s economic reforms accelerate, the future will be different. This school of thought rests on the notion that reforms mean a greater focus on the Western definition of profitability.

But when you talk to some of contacts, it is again possible to come away with the impression that jobs remain the top priority in China.

Sure, the nature of the new jobs that China wants to create in its eastern provinces will be higher-value jobs, and so expect further commoditisation of specialty chemicals.

But in the case of commodities plants in eastern China, why shouldn’t it run its say purified terephthalic acid plants a lot harder over the next few years in order to minimise the impact of the overall economic slowdown?

Out West, the impression I get is altogether different. Here, it feels as if the priority is to create new jobs in basic manufacturing. Achieving this objective will include a very aggressive expansion of coal-based commodities polyolefins capacities.

I am sure, though, that it just as possible to talk to a different set of people, inside and outside China, and gain an entirely different impression of what the future holds – one that will increasingly be based on Western measures of profitability.

But it is again data that matters – hard data. So take a look at the second chart below. It shows the targets for ethylene and propylene equivalent self-sufficiency under the 13th Five-Year-Plan (2016-2020).

China13thFYPOlefinsTargets

Analysing the data in this chart, it tells us that:

  • In ethylene equivalent terms (i.e. imports of ethylene and what ethylene is used to make downstream), net imports rose by 2m tonnes to 17.4m tonnes between 2010—2014, but are expected to rise by just 5% to 18.3m tonnes by 2020.  Under the plan, China’s self-sufficiency rate would thus rise from 49% in 2014 to 62.9% in 2020.
  • In propylene equivalent terms, net imports rose by 1m tonnes to 9m tonnes by 2014, but are expected to fall by 60% to just 3.6m by 2020. China’s self-sufficiency rate would thus rise from 67% in 2014 to 93% in 2020.

Sure, you can argue that the government either doesn’t mean – or cannot achieve – what it says. But I for one would not bet against the Chinese government,  given my impressions of its determination to achieve its overall objectives.

In the past, how successful have you been in betting against the success of Chinese government top-line objectives?

,