Giant refiner looks for relief from Beijing

China Petroleum & Chemical Corp (0386), also known as Sinopec, continued to be squeezed in 2007 by the combination of government price controls on finished products and high crude-oil import costs.

Analysts warn the oil giants performance this year hinges on how much relief the mainland government will provide.

We continue to view Sinopec as a cheap stock and reiterate our buy rating, but it remains a longer-term call, Deutsche Bank analyst David Clark said after the firm issued its 2007 results last week.

Net profit rose just 5.5 percent to 56.53 billion yuan (HK$63 billion) last year. The results were dampened by losses of 10.45 billion yuan in its refining division.

Sinopecs refining operations require an oil price of US$76 (HK$592.80) per barrel to break even.

Given suppressed retail prices, no detailed timetable for price hikes and a lack of clarity on the size of government subsidies going forward, more losses can be expected, CLSA analyst Gordon Kwan said.

Sinopec may spook investors with a loss of 11 billion yuan for the first quarter of 2008, according to Kwan.

Such losses can continue to mount going into the second quarter, he said.

After the results announcement, Sinopec management told analysts that the government is concerned with the imbalances in the refining sector and has set up a special body within the National Development and Reform Commission to evaluate relief options.

Sinopecs downstream operation is unlikely to achieve prof

itability in the medium term, so earnings growth is dependent on government compensation, Morgan Stanley analyst Wee-kiat Tan said.

Despite an attractive valuation, we believe there are still significant policy risks, Tan said.

Sinopec expects crude oil prices to remain high in 2008 and the mainland governments tight control on prices of refined oil products to continue, Sinopec chairman Su Shulin said.

The prices of most petrochemical products will see a relatively high level of fluctuation this year, Su added.

This March, Sinopec received a subsidy of 12.3 billion yuan from the government. Of this, 4.9 billion yuan was booked as subsidy income for 2007, while 7.4 billion yuan was booked for the first quarter of 2008.

The most effective policy solution would be for Beijing to remove or reduce the value-added tax that Sinopec pays on imports of crude oil, JPMorgan analyst Frank Li explained.

Citi analyst Graham Cunningham said he expects the situation to get better by the second half of the year.

We continue to believe the present situation in Chinas refining sector is unsustainable and will improve on a six- month view, Cunningham said.

Also, growth in Sinopecs other businesses could help offset refining losses. Su said Sinopecs natural-gas business will expand considerably this year, helped by completion of the Sichuan-East China Gas Project, which is expected at the end of the year.

The company plans to expand its natural gas production by 12.5 percent, to 317.79 billion cubic meters. As the Puguang gas field comes on stream in 2009, Sinopec should benefit from Chinas growing gas market, Morgan Stanleys Tan said.

Ethylene production is expected to grow 2.8 percent this year, to 672.0 million tonnes.

Management is also guiding for refinery throughput to grow 11.8 percent to 174 million tonnes.

This growth is supported by the new 10 million tonnes per annum Qingdao refinery, which should be operational in the middle of this year, Deutsche Banks Clark said.

Sinopec plans to increase capital expenditure this year by 11 percent, to 121.8 billion yuan.

Capital expenditure will be focused on the Sichuan-East China Gas Project and on building capacity in the Tahe and Shengli oil fields and the Puguang and Erdos natural gas fields.

Although Sinopec will see significant refining losses in the first quarter of this year, the government is likely to implement price increases for finished products later this year, Macquarie analyst David Johnson said. Johnson said he is also looking for crude-oil prices to decline from the current peak.

Longer-term, we expect the government will move to create a pricing environment that allows some positive return for refiners, albeit small, he said.

2008-04-26

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