Sinopec benefits from fuel price floor but share price reflects uncertainty on profit booking
NDRC says extra revenues resulting from policy must be set aside
Beijing’s latest tweak to the mainland’s petroleum fuel pricing policy will bolster the cash flows of state-backed refining titan China Petroleum & Chemical (Sinopec), but how much it will boost its profit is less clear.
Regardless, the price floor the energy price regulator, the National Development and Reform Commission (NDRC), has put under refined fuel products like diesel, petrol and jet fuel is positive news for the oil major, which had been suffering steep losses in upstream oil production as crude prices fell to well below its production costs.
In the middle of last month the NDRC said domestic refined fuel prices would not be cut if international crude oil prices fell below US$40, swelling Sinopec’s downstream refining profit margin and cash flows as the prices of its raw material, crude oil, sank to their lowest in more than 12 years.
“The NDRC’s recent directive to set a US$40 floor for auto fuel prices should more than offset [the impact of lower crude prices on upstream operations],” a report by Barclays’ analysts said of the impact on Sinopec. “The gains [from refining] may be transient but cash flow is now similar to that [when the Brent crude benchmark price was] at US$100 a barrel [in 2013-14].”
Sinopec, the world’s second-largest oil refiner, was a net beneficiary of the latest policy since it refined five times as much crude oil as it produced, they said.
What is less clear, is whether and by how much Sinopec can book the profit gains on its refining operation.
This is because the NDRC said in a circular last week that the extra revenues from the price floor policy must be set aside and put towards a fund to finance emission reductions, fuel quality upgrades and national oil security enhancement initiatives.
It said overly low fuel prices would stoke unnecessary demand and worsen pollution.
The policy is in line with its previous practice of allowing refiners to charge higher prices on their fuel after they invested in facilities to upgrade fuel quality and cut pollution.
Even if Sinopec cannot book the extra revenues as profits due to accounting interpretation of the usage restriction on the extra cash flows, it would benefit from higher cash flows that would help bolster its chances of maintaining future dividend payouts.
Sinopec’s share price has reflected the uncertainty of the accounting profit upside.
After rising 13 per cent in the two weeks after the floor was first introduced last month, it has fallen 5.4 per cent since the NDRC’s January 13 announcement that the extra revenues would need to be set aside in the fund, compared with a 3.5 per cent decline in the Hang Seng Index.
Amid depressed oil prices, Barclays’ analysts said the price floor policy would result in a net increase in Sinopec’s cash flow when Brent was either higher than US$40 – through upstream production – or lower than US$40 – via fatter refining margins.
With mature and high-cost fields, they estimated Sinopec’s upstream oil production operation required crude prices of US$75 to US$80 to break even when both cash operating costs and asset depreciation costs were considered.
While bolstering refining margin, a downside impact of putting a floor on fuel prices is that it would dampen price-cut-induced demand growth.
“China has set a floor at US$40 a barrel for [petrol] and diesel prices below which prices at the pump will not be cut, thereby reducing demand elasticity,” Neil Beveridge, a senior analyst at American brokerage Sanford Bernstein, said.
He forecast China’s refined fuel demand growth would slow to 3 per cent this year from 5 per cent last year, when consumption growth was “exceptional” thanks to strong growth in car ownership and air travel volume.
He expected mainland China’s petrol demand growth – the biggest driver of its crude oil demand – to slow to 7.5 per cent this year from 9 per cent last year.
It was still relatively strong growth, he said, which together with jet fuel consumption growth of 9.2 per cent expected for this year would offset a 2 per cent decline in diesel demand growth due to weak industrial output and construction activities.
However, another factor that drove China’s crude oil demand growth last year – the filling of national strategic oil reserve tanks – is expected to wane this year.
This is because there were signs that phase two of the strategic crude oil reserve facilities were nearly filled up, while new storage capacity was under construction, Beveridge noted.
Although Beijing has for years indicated it has a long-term objective of letting domestic petroleum fuel retail prices be determined by market forces, Beveridge said the latest refinement of the pricing system showed that it would continue to play a key role in setting prices.