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Sinopec Shanghai Petrochemical Company Limited (NYSE: SHI), a subsidiary of Sinopec Corp., is one of the largest chemical-refining petrochemical companies in China. Sinopec is currently the biggest domestic ethylene and acrylic fiber producer, and the company also produces important refined oil products, intermediate petrochemicals, resins, and synthetic fibers, for a predominantly Chinese market. Although SPC has been partially privatized, the Chinese government, in addition to setting domestic petroleum prices, retains considerable influence over the company's management and provides SPC with subsidies.

Company Overview

Sinopec Shanghai Petrochemical Company is one of the largest chemical-refining petrochemical companies in China. It is a vertically integrated company that mainly processes crude oil into synthetic fibers, resins, and plastics, as well as other intermediate petrochemical and petroleum products.

Diagram illustrating Sinopen SPC's ownership
Diagram illustrating Sinopen SPC's ownership

SPC is a subsidiary of the China Petrochemical & Chemical Corporation, which grew out of the Shanghai Petrochemical Complex in 1972. By the end of 2005, SPC had built up a primary crude oil processing capacity of 14,000,000 tons, an expansive utilities system, loading and unloading handling facilities on ocean and inland waterways, and railway and highway transportation. Considering that China is still a net importer of petrochemical products (especially high-end), there is considerable growth potential for domestic companies such as SPC.

In July 1993, SPC became the first company incorporated under the laws of the People’s Republic of China (PRC) to make a global equity offering, and its shares were listed on the Shanghai Stock Exchange, the Hong Kong Stock Exchange, and the New York Stock Exchange. Despite the company’s public offering, the Chinese government maintains strong control over the company’s operations. Sinopec, SPC’s parent company, has indicated that SPC might become completely privatized. In the meantime, however, the government still has significant influence over the company’s operations.

Business & Financial Metrics[1]

In 2009, SHI generated a net income of ¥1.59 billion on revenues of ¥47.3 billion. This represents a significant turnaround from 2008, when the company lost ¥ 8.01 billion on revenues of ¥59.3 billion.

Trends and Forces

Oil price per barrel since 1997
Oil price per barrel since 1997

Chinese Government

The Chinese government affects SPC in a number of ways, including its control over prices, influence in SPC’s management, and its provision of both taxes and subsidies.

  • Government control over prices
    • Historically, governmental control has been beneficial for SPC. By placing price controls on petroleum products such as gasoline, diesel, and kerosene, the government all but guaranteed large profit margins and prevented potentially damaging price wars between SPC and its competitors.[2]
  • Price controls could potentially magnify profit margin shifts caused by changing crude oil prices
    • In a free market, the prices of petroleum-derived products should be self-correcting, reflecting the cost of crude oil. As crude oil prices drop, competing companies could lower prices on their petroleum products to gain market share. As crude oil prices rise, companies would have to raise prices to maintain profits. However, since the Chinese government does not update prices often enough to account for constantly changing crude oil prices, changes in profit margins are amplified. For example, if crude oil prices fall but the Chinese government fails to immediately lower prices, SPC's profit margins would increase dramatically. With crude oil prices accounting for 67.7% of the company’s annual sales cost, this effect can be quite significant.
  • Is SPC ready for free market competition?
    • Now that China has entered the World Trade Organization, these price controls should eventually disappear. SPC would then have to struggle for market share in a truly competitive market. Because SPC has relied on government policy to even the playing field, it may not be prepared to compete with other petrochemical companies that have long operated in a free market. Anticipation of this competition has helped trigger many of the aforementioned initiatives to strengthen management and increase efficiency.
  • Possible conflict of interest in SPC management
    • Furthermore, SPC is still indirectly a subsidiary of the Chinese government. Therefore, all of SPC’s executive officers are also indirectly appointed by the Chinese government. This brings the risk of these executives putting the interests of the Chinese government ahead of the interests of SPC's investors.
  • New, higher tax rate a possibility
    • China has proposed a unified tax rate of 25%. This would be detrimental to SPC’s profits, who currently benefits from a preferential 15% tax rate.
  • Government subsidies
    • SPC currently receives RMB 2.1 million in annual subsidies. Any change in SPC's relationship with the government could jeopardize this subsidy and indirectly lead to higher costs (and lower profits).

Privatization

In the past, SPC's parent company, China Petroleum & Chemical (SNP), has paid a premium 10%-15% over market price to buy out minority shareholders of some of its other former subsidiaries. SHI has said that it will use similar buyouts to further privatization, leading investors to drive up SPC's stock in anticipation of a buyout. SHI has released multiple statements in an attempt to dispel this speculation; these statements were largely ignored by investors, who continue to speculate about a buyout of SPC. If SHI does ever recommence buyouts, it would be beneficial for holders of SPC stock. However, existing hype may have already led to an overinflation of SPC's stock price.

Competition

SPC’s major competition comes from Sunoco (SUN), Valero Energy (VLO), and Sinopec Beijing Yanhua (also a subsidiary of Sinopec). Currently, SPC has managed competition well because of the government's price controls and its proximity to large customer bases. However, the expected future revocation of these price controls, and the increased competition that will ensue, could put heavy pricing pressure on SPC.

References

  1. SHI 2009 20-F pg. 1  
  2. Seeking Alpha: "Sinopec and PetroChina: Still Refining at a Loss"
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