CNPC, Sinopec set to ride out oil sector woes

Source:Global Times Published: 2017/5/21 22:03:39

Illustration: Peter C. Espina/GT

In the coming few years, we expect China's refining capacity to rise as new refineries begin operating and demand growth remains sluggish. As a result, utilization rates, and subsequently profit margins, will likely decline for Chinese refiners.

Construction of a Yunnan refinery project by the country's biggest oil and gas producer, China National Petroleum Corporation (CNPC), has been completed and the unit is preparing for production.

We expect China's total refining capacity to increase to around 850 million tons by the end of 2020, representing 3.3 percent annual growth from around 720 million tons at the end of 2015, as a number of large refineries come on stream. China's leading oil refiner Sinopec Corp is constructing the Sino-Kuwait integrated refining project in South China's Guangdong Province. In addition to these State-owned enterprises, several private-sector companies are also building or planning to start large refinery projects, drawn to the sector's increased profitability following changes the Chinese government made in 2013 to the mechanism for pricing refined products.

On the demand side, we expect refining throughput volume growth will slow to around 2 percent per year by 2020 from around 5 percent during 2010-15, mainly due to weaker domestic consumption growth amid China's slowing economic growth. But exports will likely grow at a faster pace, providing a partial offset.

Net exports of refined products rose by 40-60 percent during the past three years, and amounted to 33.6 million tons in 2016, equivalent to about 10 percent of China's domestic consumption, according to our estimates. We expect exports will continue to grow faster than domestic consumption during the next few years as refiners seek overseas buyers for their products amid the weak domestic demand and increased supply. Nevertheless, we expect that export quotas set by the Chinese government will prevent Chinese refiners from flooding overseas markets with cheap products.

Against this backdrop, we expect CNPC and Sinopec's profit margins from their downstream businesses to weaken moderately during the next two to three years from their high levels in 2016. The two companies reported large profit increases in their refining businesses last year, thanks largely to favorable government policy, the low oil price environment, the companies' efforts to improve operational efficiencies, and their product slates. The two companies' refining margins will likely contract over the next three years as the increasing overcapacity and resulting competition narrow the spread between crude prices and wholesale gasoline and diesel prices

However, CNPC and Sinopec's downstream businesses will see only moderate margin compression. China's pricing mechanism for refined products allows refiners to pass changes in crude oil prices to consumers in a timely manner, which helps them maintain stable downstream margins. CNPC and Sinopec receive additional downstream-margin support from their large retail and distribution networks. CNPC and Sinopec's refining margins will be under pressure as overcapacity induces wholesale price competition among refiners, but the companies' retail and distribution segments will benefit due to lower purchasing costs.

Although we expect CNPC and Sinopec's profits from their refining businesses to decline moderately during the coming few years, the increased profits from their upstream businesses, which have benefited from the recovery of crude oil prices in late 2016, will offset the impact of declining refinery profits on the companies' overall financial results and keep their overall operating profit relatively stable. And the companies' integrated downstream and upstream businesses will continue to provide some hedging benefits under different oil price scenarios.

And more importantly, we believe the two State-owned companies will continue to receive a very high level of support from the Chinese government because they will remain strategically important to the country's energy supply even as the government allows more private-sector companies to enter the oil and gas industry. This continued support is one of the key drivers of the two companies' ratings.

Therefore, CNPC and Sinopec's overall credit quality will remain strong.

The increase in refining overcapacity will have a bigger impact on smaller refiners than on CNPC and Sinopec because most of the smaller refiners have much smaller scale and less integrated operations. The increasing wholesale price competition will squeeze smaller refiners' margins, and the refiners are unlikely to benefit from the competition owing to their small retail networks.

The article was compiled based on a research report by rating agency Moody's Investors Service.

Posted in: INSIDER'S EYE

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