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WIKI ANALYSIS
Sinopec Shanghai Petrochemical Company Limited (NYSE: SNP), 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.
Although SPC has historically benefited from the Chinese government’s control of the market, the government set unfavorably low prices for SPC's products in 2006. These low prices, added to a sharp increase in crude oil prices, have been detrimental to SPC's profit margins. However, as China recently joined the World Trade Organization, it is likely that petrleum price controls will be lifted, leaving SPC to fend for itself in a free market. To prepare itself, SPC has taken initiatives to strengthen management and improve efficiency.
Company Background
Sinopec Shanghai Petrochemical Company is one of the largest chemical-refining petrochemical companies in China, accounting for over 12% of China’s petrochemical industry in 2006. 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.
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.
In the second quarter of 2008, Sinopec saw profits fall 87%, as rising oil prices, and the Chinese government's price ceilings on gasoline destroyed the company's margins.[1]
Recent & Ongoing Initiatives
Although SPC's net sales increased by 10.46% in 2006, its net profit fell 56.77% from the previous year, largely a result of the governmental price regulations imposed on the Chinese petrochemical market. Profit margins in the oil refining business decreased substantially; as a result, SPC is trying to compensate by streamlining its operations. Current initiatives include reforming its smaller, auxiliary businesses and improving efficiency by implementing a more centralized management structure. Additionally, SPC is striving to become more efficient with its resources. This means using the minimal amount of raw materials and energy necessary to distill and manufacture its products. Statistics show that indicators of efficiency, such as number of non-scheduled suspensions, have been improving as a result of these initiatives. SPC also plans to enter the high-end chemical market, where most of the demand is currently met by foreign companies.
Sinopec recently entered into an agreement with the Iranian government to develop the Yadavaran oil field, thought to contain $12-18 billion worth of oil; the company was able to enter the agreement before competitors because the Chinese government is in great need of secure energy resources, and so has no problem with Iran's nuclear power initiatives, or with the country's demands to operate the company's production facilities.
Products & Markets
About half of SPC’s sales come from petrochemicals, including intermediate petrochemicals, resins and plastics, and synthetic fibers. With the exception of petroleum products, SPC is a major competitor in every product market in which it participates. SPC is also currently the biggest domestic ethylene and acrylic fiber producer.
SPC’s primary market is the People’s Republic of China (PRC). With the Chinese economy currently experiencing a period of rapid, large-scale industrialization, petrochemicals are in high demand. China's growth for the first three quarters of 2007, for example, was as high as 11.5%, contributing to Sinopec's year-on-year Q1-Q3 revenue growth of 13.62% and EBIT growth of 38.28%. SPC especially benefits from its proximity to the demanding Shanghai area, which reduces its transportation costs to the metropolis. Customers in Eastern China, one of the fastest growing regions in the PRC, account for most of SPC’s revenues.
The company is also experimenting with the viability of biodiesel in an attempt to decide whether replacement of conventional fuels with biofuels is economically feasible.
| Annual income data (in millions of CNY) | 2002 | 2003 | 2004 | 2005 | 2006 | |
|---|---|---|---|---|---|---|
| Net Revenue | 21,723 | 28,943 | 38,664 | 45,190 | 49,918 | |
| Operating Expense | 20,293 | 26,936 | 33,639 | 42,662 | 49,365 | |
| Operating Income | 1,430 | 2,006 | 5,025 | 2,528 | 553 | |
| Operating Margin | 6.58% | 6.93% | 13% | 5.59% | 1.1% | |
| Net Income | 1,125 | 1,568 | 4,146 | 1,869 | 850 | |
| Profit Margin | 5.18% | 5.42% | 10.7% | 4.14% | 1.7% | |
Trends and Forces
In 2006, the global economy experienced strong growth, with significant industrial expansion in China. The economic growth in China was very beneficial to the petrochemical industry overall; a variety of other factors, however, affect this industry, and SPC, specifically.
Crude Oil Prices
In the past years, crude oil prices have been one of the most significant determining factors of SPC's profitability. Last year, crude oil costs accounted for 67.7% of the company’s annual cost of sales. And because 2006 oil prices hiked to record highs (an average 17.84% increase for the year), SPC's net profits fell 56.77% from 2005. Despite the growing demand for petrochemicals, the higher prices forced SPC to process 6.03% less crude oil in 2006. Because almost all of SPC's crude oil is processed into petroleum products such as gasoline, diesel, and jet fuels, the total volume of these goods produced fell as well, though sales did increase over 10%. With so many of its products dependent of crude oil, higher oil prices can have a significant impact on SPC's bottom line.
SPC does extract some of its own fuels, like crude oil and natural gas; the rising cost of extraction for oil has also been contributing to declining margins, though realized prices have been increasing because of the difficulty of extraction is coupling with increasing demand. Overall, the effects on the company have been negative; year-on-year Q1-Q3 extraction costs have risen 18.62%, contributing for segment EBIT falling 29.15%.
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. In 2006, however, the government favored consumers over refiners, keeping refined petroleum prices artificially low. Any change in the government’s set prices will significantly affect SPC, since it has no option but the charge these prices, regardless of conditions in the global oil market. In June, 2008, the Chinese government was forced to raise the ceiling on refined products (17% for gasoline, 18% for diesel, and 25% for jet fuel) because Sinopec has been losing money.[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. SNP has said that it will use similar buyouts to further privatization, leading investors to drive up SPC's stock in anticipation of a buyout. SNP 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 SNP 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. Additionally, four large-scale ethylene units in Saudi Arabia and Kuwait are scheduled to begin operations by the second half of 2008; this could present additional competitive pressure for SPC as these units come online.
| SUNOCO | CHEVRON | VALERO | EXXON MOBIL | Royal Dutch Shell | SINOPEC | WESTERN REFINING | ConocoPhillips | BP | LUKOIL(1) | Eni S.p.A(1)[3] | Total S.A. | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Refinery Capacity (Million BPD) | 0.91[4] | 2.139[5] | 2.99[6] | 6.2[7] | 3.678[8] | 3.376[9] | 0.238[10] | 1.986[11] | 2.678[12] | 1.135[13][14] | 0.544 | 2.604[15] |
| Number of Refineries (including partial interests) | 5[16] | 18[5] | 16[17] | 37[7] | 40[18] | 17[19] | 4[20] | 12[11] | 17[12] | 9[21] | N/A | 25[15] |
| Number of Retail Gas Stations | 7,785[22] | 25,000[23][24] | 5,800[17] | 10,516[25] | 45,000[26] | 29,279[27] | 153[28] | 8,340[29] | 22,600[30] | 6,287[31] | 6,441 (in Europe) | 16,425[15] |
(1) Latest data is for 2007
References
- ↑ Bloomberg News: "Sinopec Second-Quarter Profit Falls 87% on Oil Refining Losses"
- ↑ Seeking Alpha: "Sinopec and PetroChina: Still Refining at a Loss"
- ↑ E 2007 Annual Report
- ↑ SUN 2008 10-K, Item 7, Page 35
- ↑ 5.0 5.1 CVX 10-K 2009, Item 1, Page 24
- ↑ VLO 2008 10-K, Item 1, Page 3
- ↑ 7.0 7.1 XOM 2008 10-K, Item 6, Page 43
- ↑ RDS’A 2008 20-F, Results, Refining Data
- ↑ Sinopec Investor Relations, Operational Statistics for 2008
- ↑ WNR 2008 10-K, Item 7, Page 34
- ↑ 11.0 11.1 COP 2008 10-K, Item 1, Page 16
- ↑ 12.0 12.1 BP 2008 20-F, Item 1, Page 29
- ↑ Lukoil Investor Relations – Fact Book 2008, Page 15
- ↑ Conversion factor is 1 BPD = 50 tonnes per year
- ↑ 15.0 15.1 15.2 TOT 2008 20-F, Item 4, Page 36
- ↑ SUN 2008 10-K, Item 1, Page 1
- ↑ 17.0 17.1 VLO 10-K 2008, Item 1, Page 1
- ↑ RDS’A 2008 20-F, Results, Manufacturing
- ↑ Sinopec Refining Overview
- ↑ WNR 2008 10-K, Item 1, Page 19
- ↑ Lukoil Investor Relations – Fact Book 2008, Page 16
- ↑ SUN 2008 10-K, Item 1, Page7
- ↑ CVX 10-K 2008, Item 1, Page 25
- ↑ CVX 10-K 2008, Item 1, Page 26
- ↑ XOM 2008 10-K, Item 2, Page 25
- ↑ RDS’A 2008 20-F, Results, Marketing
- ↑ Sinopec 2008 Annual Report, Business Review and Prospects, Page 20
- ↑ WNR 2008 10-K, Item 1, Page 3
- ↑ COP 2008 10-K, Item 1, Page 18
- ↑ BP 2008 20-F, Item 1, Page 30
- ↑ Lukoil Investor Relations – Fact Book 2008, Page 60
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