China’s New “For Profit” Chemicals Industry? Think Again….

Business, China, Company Strategy, Economics, Fibre Intermediates, Olefins, Polyolefins

SinopecEBIT

By John Richardson

IF you think that running a chemicals company in China can be compared to running one in the West then please take a look at the above chart.

This is an updated version of a chart Paul Hodges and I have run on Sinopec in the past, which includes the full-year 2014 financial results.

As you can see, Sinopec lost Rmb 75bn ($11bn) at the EBIT (earnings before interest and tax) level in refining, and made just Rmb110bn ($15bn) in chemicals (red) in 1998-2014.

Overall, in refining and in chemicals, it has invested $74 billion in capital expenditure for a total operating profit at EBIT level of $4bn.

No Western company would dream of investing $74 billion over 16 years for a total EBIT return $4 billion.  But Sinopec is not a Western company because it is 73% owned by the Chinese government. Its mandate is to be a reliable supplier of raw materials to downstream users, to maintain employment and boost living standards.

This also explains why its average operating rates have been above 100% for ethylene/propylene since 2000, as the chart again shows; in other words, it has run its plants hard when it has been losing money because Sinopec’s role is to keep people in work.

The same, to a large extent, applies to PetroChina, the other state-owned oil, gas, refining and petrochemicals major.

And even China’s privately-owned chemicals companies are not always run for profit. Here is a “case study” of how it can work in the private sector:

  • A local government official meets with the head of a private chemicals company and says, “Hey, I’ve got this fantastically cheap piece of land I want to sell you for a project. And don’t worry about financing as I know the people who run the local branches of the state-owned banks”.
  • The head of this  chemicals company realises that, even with cheap land and low-cost financing, his project still doesn’t’ add up because there is already an oversupply of purified terephthalic (PTA) acid in China.
  • But he goes ahead anyway because he knows that if he starts losing money on every tonne of PTA he produces, the local government will step into help with some extra funding.
  • And what’s in it for the local authority? They get to still make money from the cheap sale of this land because they acquired the land in the first place from next to nothing from a local farmer. Land sales like this help to pay for education, healthcare and other social services because of insufficient cash transfers from the central government in Beijing.
  • Once the PTA plant is up and running, it will also create lots of jobs and so boost local GDP. It will also be an important source of tax revenue. So the local government has every reason to keep this loss-making entity running in all market conditions.

Why the history lesson? Because I worry that overseas chemicals companies are in danger of falling into the trap of believing that economic reforms will quickly change all of the above.

“Local capacity additions will slow down quite dramatically, and very quickly, in both the ethylene and propylene value chains. The reason is that domestic companies are being forced to focus more on profits per tonne of production,” said one very senior source with an Asian petrochemicals producer told me recently.

“This is a great opportunity for us. We can export more as China’s self-sufficiency ratios begin to decline,” he added.

His views are pretty typical of several conversations I have had over the last month.

But change will not happen overnight. Local authorities will fight tooth and nail to keep building new chemicals plants because the way that they are financed will take a long time to change.

Plus, even though I believe that Beijing does in theory want to create a new generation of more profit-focused chemicals companies, these companies will still have to perform social and political roles.

The big difference between today and tomorrow will only be the nature of these social and political roles, as I will discuss in more detail in my next post.

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