Sinopec & China arrive in New Normal of low growth and profit

Economic growth

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Sinopec Aug14Sinopec is China’s largest chemical producer and its second largest refiner.  The blog’s annual review of its published Results confirms its uniqueness in global markets.

The numbers confirm that it remains focused on increasing production, not profit.  It will be No 2 in global ethylene capacity next year as a result.  The chart above highlights the key metrics, based on the 15 years since 1998:

  • It has spent Rmb 260bn ($36bn) on refining capex* and Rmb 223bn ($31bn) on chemicals capex (blue columns)
  • It has lost Rmb 73bn (-$11bn) in refining at EBIT level**, and earned Rmb 105bn ($15bn) in chemicals (red)
  • Collectively, therefore it has spent Rmb 483bn ($67bn) on capex, and earned Rmb 32bn ($4bn) at EBIT level

Nowhere outside China could this situation exist.  No company would normally be able to spend $4.2bn/year on capex, but earn only $0.3bn/year at EBIT.

Equally, no company outside China would average an Operating Rate (OR%) of 102% on ethylene and 103% on propylene over the 13 years since 2000 (green columns).

The rationale is simple, however, when one remembers that Sinopec is 74% owned by the Chinese government.  Its aim is to be a reliable supplier of raw materials to keep the economy growing, and living standards rising.  As long as it continues to do this, then China’s Communist Party can expect to remain in power.  Profit is irrelevant in this position.

Most companies and investors still find it hard to accept this wider context.  They imagine that in the end, Sinopec will become more like a Western company.  But why should it?  China is a relatively poor country:

  • Average per capita consumer spending in the towns is just $2600/year
  • Rural incomes are only a third of urban ones
  • Social unrest would break out overnight if Sinopec stopped production or aimed at Western profitability levels

It is little use hoping against hope that it will shutdown units due to cost pressures.  It has never run its units to create profitability in the past, as the published numbers show.  So why should it change policy now?

It is only our rose-tinted glasses that prevent us from seeing this reality.

CHINA IS RAMPING UP PETCHEM EXPORTS TO HELP MAINTAIN EMPLOYMENT
Meanwhile, major change is well underway in China’s economy due to the collapse of its export markets in the West, as state-owned China Daily confirmed last week:

“The concept of a “New Normal” for the world’s second largest economy is now prevailing both at home and abroad.”

In turn, this means that the petrochemical industry, like other major industries, faces an urgent need to adapt.  As the blog warned in last year’s review, under the heading ‘Sinopec adapts to the New Normal’:

As the world transitions to the New Normal, Sinopec’s new role will be to support the growth of China’s domestic demand. This will have considerable implications for the global petchem industry:

  • Sinopec will continue to maximise production; as the chart shows, its average Operating Rates have been consistently over 100% since 2000
  • This will dramatically reduce the need for imports, particularly from Asia and NAFTA, as domestic GDP growth will also be well below earlier levels

“The blog highlighted this potential in the first edition of the Study in 2011. Now it is becoming reality.  But unfortunately very few companies have yet begun to appreciate the dramatic changes that will result. They now need to catch up very quickly.”

The rationale for these developments is simple, even if it doesn’t fit with Western financial logic.  The new leadership has to burst the property bubble to maintain political and social stability.  So it therefore needs to compensate by boosting employment in other parts of the value chain.

Thus China is now well on the way to becoming a major exporter of many key petrochemicals.  And it will continue to reduce its import needs from Asia and other regions as fast as possible.

 

* capex = capital expenditure   ** EBIT = Earnings Before Interest & Taxes

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