Fuel price hike cannot offset refinery losses

sinopec_400A profit warning by Chinese oil refiner Sinopec has advised investors to expect net profits for the first six months of 2008 to be less than 50% of its RMB34.92bn (US$5.1bn) profit in the first half of 2007.

The company blamed high international prices and an artificially controlled domestic market for oil products in China for the steep drop in performance.

Due to the strict control over refined oil prices in the People’s Republic of China a distortion to the correlation of the refined oil prices and crude oil prices occurred,” said the company in a statement. “[We had] taken various measures to guarantee the supply for the refined oil market in the PRC, which resulted in great losses in the oil-refinery business and massive decline in overall performance of the Company in the first half year.”

Energy liberalization

Severe losses in the refinery and power sectors prompted the government to take action earlier this year. In June, the National Development & Reform Commission announced price hikes in diesel, jet fuel and natural gas while capping the cost of coal, moves which many observers say is the beginning of energy price liberalization in China.

But according to B2B networker Tootoo.com, the June price hikes will not fully offset Sinopec’s losses.

Chinese domestic refined product prices remain artificially low under government control, and refineries, in particular Sinopec, will continue to suffer, says Tootoo.com. The rumour of a looming cut in oil VAT subsidies is particularly bad news for the sector, says the firm.

“The refining sector is still very far away from reducing losses although the loss rate has decreased after the recent adjustment of oil prices,” a senior Sinopec official told a Tootoo.com correspondent.

JPMorgan analyst Frank Li has said if the average oil price is US$120 per barrel, Sinopec’s quarterly operating loss on refining business will be as high as RMB31 billion (US$4.5 billion). “On the other hand, Sinopec’s combined quarterly profits from petrochemical exploration, production, marketing and chemical operation is only about RMB24 billion,” Li said in a research note.

Li believes that without additional financial assistance, or a further increased refined oil retail price, the losses will continue. Additionally, Sinopec will have to import 1.5 million tons of diesel in the second quarter, which will cause around RMB31 billion in deficits, exacerbating the company’s financial burden.

JP Morgan has downward revised Sinopec’s net profit anticipation to RMB18.9 billion, down 67%.


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