Thoughts on the development prospects of the local refining industry in Shandong

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This post was last edited by lhyhzc on 2009-6-5 at 17:52. The following text is from Sina Blog, published on January 16, 2009. Post it for everyone to discuss; which of the views do you support and which do you not support? Thoughts on the development prospects of the local refining industry in Shandong. The energy sector is a strategic industry that is crucial to a country’s economy and people’s livelihood, and all countries spare no effort to support its development. Compared to the needs of China’s social and economic development, its energy structure is characterized by a high proportion of coal, a low proportion of oil, and some natural gas. As a result, China is highly dependent on imported crude oil, with this dependence already exceeding 50%. Furthermore, today’s major oil-producing countries are largely under the control of the United States and its allies, which represents a potential disadvantage for our country to some extent. As a result, since the late 1990s, our country has gradually begun to consolidate the enterprises involved in crude oil extraction, focusing on expanding its supply of crude oil resources both domestically and internationally. The above are the main factors affecting China’s crude oil policies and related industrial policies; they are also the key factors influencing the business practices of enterprises in various sectors such as crude oil extraction, processing, and sales in China. However, a close examination of the development of China’s oil and energy industry over the past decade reveals certain **changes in policies and corporate practices. First of all, it can be seen that some policies were not entirely correct; those influenced by monopoly interests were particularly problematic. For example, the closure of small and medium-sized refineries at the end of the 1990s clearly violated the principles of a market economy. In recent years, such crude administrative measures have not been employed in this industry (which is also partly due to China’s 30 years of reform and opening up, during which market-oriented principles have become deeply ingrained in society). Secondly, the policies of ** as well as those of the monopoly enterprise groups themselves are also adjusted in response to changes in external conditions; for example, in recent years, the state-owned enterprises in the oil industry have realized that attempting to gain control over all aspects of oil extraction, processing, and distribution is something that goes beyond their strategic capabilities. I. A brief analysis of China’s energy policies related to crude oil: In China, there is an **absolute monopoly in oil extraction and distribution. The purpose of this monopoly is not to restrict competition, but rather to concentrate efforts on developing sources of oil supply, especially overseas. The main entities responsible for this are the three large state-owned enterprises: CNPC, Sinopec, and CNOOC. Accordingly, in the wholesale and distribution of refined oil, these three giants are also encouraged and supported to play a dominant role. 1. Crude oil: Crude oil is the most important primary energy source at present. Due to the severe imbalance between crude oil consumption and its distribution, competition among countries, especially among major powers, is becoming increasingly fierce. It is no exaggeration to say that they will go to war just to secure access to crude oil. In our country’s case, especially given the highly centralized management system driven directly by the central authorities, this is perceived by ordinary market participants as an absolute monopoly. This fact is not denied; reference can be made to Document No. 97 issued in 2006 by the General Office of the State Council, titled “Guiding Principles on Promoting the Adjustment of State-owned Capital and the Restructuring of State-owned Enterprises.” Given its background, it is clear that this document relates to the adjustment of state-owned assets – it was not issued directly by the State-owned Assets Supervision and Administration Commission but rather by the General Office of the State Council, which underscores its importance. The document explicitly states that in key sectors that are vital to national security and the economy – such as military industry, power grids, petroleum and petrochemicals, telecommunications, coal, air transportation, and shipping – the state economy should maintain absolute control. ” In fact, our country’s policy also stems from the aforementioned global context of a severe imbalance between crude oil consumption and resource distribution. Since our country itself has limited oil reserves, and globally, the main oil resources are controlled by the United States and its allies, it is obvious that the U.S. employs policies aimed at containing our country; therefore, we must concentrate our efforts and rely on external support to strive for access to oil resources. Of course, this is related to the fact that our country had just started its reform and opening-up period, and there was a shortage of private capital to undertake such strategic tasks. However, even in the United States and the EU, although it is so-called listed companies that undertake such tasks, they operate at a strategic level in full accordance with **will**, striving to align their business activities with the scope within which **will** and **power** can be exerted. The consequences of acting blindly beyond the limits of **power** or against **will** are obvious. In summary, in this field, at least at the current stage, local refineries should not get involved ； One more thing to add: **it’s not that we oppose the involvement of local refineries; rather, by taking into account the international environment as well as the capabilities of these local refineries, we wisely refrain from allowing them to take on challenges that are beyond their means.** 2. Refined oil distribution: The wholesale and retail of refined oil represents the final stage in which energy giants strive to achieve economic profits after securing crude oil resources, and they generally do not readily give this up to others ； Furthermore, at the current stage in our country, the prices of refined oil and gas play a special role in stabilizing social and economic price indices; **from this perspective, direct price control measures should not be applied to them, and therefore local refineries should also avoid getting involved on a large scale. 3. Refining and processing stage: It can be seen that local refineries can only get involved in the refining and processing stage. However, in addition to being heavily constrained by the upstream and downstream processes mentioned earlier, this stage also has several notable characteristics, including large scale per project, high capital intensity, high technology requirements, and the need for a high level of management expertise. In the early stages, China’s oil management system began to be reformed since the end of the last century, with the aim of achieving **dominance, especially** in controlling crude oil supply and the distribution of refined oil products ； As for the intermediate refining stage, state-owned enterprises, with their main focus on finding oil, have been less attentive to the development of this intermediate refining phase. In recent years, some central state-owned enterprises have begun to explore the petrochemical industry in Shandong on a tentative basis. However, given their demanding tasks of searching for oil overseas as well as the need to import oil and gas (to take just one example, China’s oil and gas import projects from Central Asia cost hundreds of billions of yuan), such efforts can only remain tentative for a long time, and this sector will not become a primary focus for these central state-owned enterprises. In the long term, regarding the Shandong market, the pattern in which the market is divided between Sinopec and local refineries – with Sinopec’s processing capacity accounting for only about one-third, but it still holding an advantage due to its various key strengths in crude oil and refined oil wholesale and retail – will remain in this relatively balanced state. In summary, in the long term, without strong financial resources and a favorable policy environment, it is difficult for local refineries to develop a vertically integrated business model similar to that of central state-owned enterprises in this sector, which should naturally be led by such enterprises, spanning the entire process from crude oil extraction and processing to the wholesale and retail of refined products ； However, for a considerable period of time, domestic refineries can serve as a very important component in filling the gap left by central state-owned enterprises in the refining and chemical processing sector. II. Analysis of various policies regarding local refining enterprises in Shandong 1. The origin of local refining enterprises in Shandong In accordance with the \"Notice from the General Office of the State Council transmitting the opinions of the **Economic and Trade Commission and other departments on cleaning up small oil refineries and standardizing the circulation order of crude oil and refined products\" (Guo Ban Fa No. 38), China carried out a nationwide campaign to clean up small oil refineries with an annual processing capacity of 1 million tons or less (including 1 million tons). Following nearly two years of cleanup and restructuring, Shandong Province closed 19 refineries as a result, reducing its crude oil processing capacity by 3.93 million tons. Following the rectification efforts, **the relevant authorities, in order to protect the legitimate interests of the enterprises that were retained, issued the “Notice on Publishing the List of Small Refineries That Were Retained After Rectification” (Document No. Guo Jing Jiao Shi Hua 1095). This document listed the enterprises that were kept in operation; in Shandong Province, 20 such enterprises were identified (the list is provided in Attachment 1). This is how the 21 refineries in Shandong Province came into existence – with one additional enterprise being the “Ji Jun Ji Base Petrochemical Company”, which is a military-owned enterprise and not subject to this regulation. It is also the reason why Shandong’s refineries have, over the years, resisted the unfair competition from Sinopec in order to protect their right to develop legally. 2. The competition between local refineries and Sinopec over the “large-scale refining” project in Qingdao. In the first half of 2003, Sinopec proposed to local authorities, through its investment in building a plant in Qingdao, Shandong, that they reduce the processing capacity of local refineries by 10 million tons. In October 2003, ** in Shandong Province and Sinopec Group jointly issued a document (see Sinopec Document No. [2003] 486), deciding to shut down local refineries with a total processing capacity of 10 million tons. Of this amount, 7 million tons related to Shandong Province, involving 15 enterprises; 10 of these enterprises were shut down while 5 shifted to other types of production. In the end, due to strong protests from local refineries and the lack of relevant legal regulations, the matter was dropped. 3. Shandong Province’s current attitude toward local refining enterprises: On April 7, 2004, the Shandong Provincial Economic and Trade Commission convened a meeting with the People’s Bank of China, various commercial banks, and some local refining enterprises to discuss issues related to loans for these enterprises. The meeting reached the following key agreements (see Document Lu Jing Jiao Yun Zi [2004] No. 205): First, in accordance with Document Guo Jing Jiao Shi Hua (2000) No. 1095, the 21 local refining enterprises remaining in Shandong Province are legitimate and serve as key players in the province’s petrochemical industry ； Secondly, there is no policy-related risk associated with banks’ loans to local refineries, and it is hoped that banks will continue to provide support in terms of credit. 4. Conclusion: Firstly, in 2003, Shandong Province agreed to Sinopec’s request to assist in shutting down 10 local refineries, with the aim of attracting Sinopec to invest in a 10-million-ton refining project in Shandong; it was merely a temporary measure. Secondly, Shandong Province’s ** and Sinopec shut down 10 legitimate enterprises in order to carry out a particular project; this is essentially an illegal act stemming from a planning-system mindset, and it has no legal basis. Thirdly, given the complex local interests, the livelihoods of workers, and the broader issues related to social stability, it is also impossible to carry out the plan to shut down 10 legitimate enterprises legally; any forced implementation would have disastrous consequences. Finally, against the backdrop of a unified domestic and international market, Sinopec’s actions hold little practical significance; this is essentially an act of unfair competition that reflects the greedy nature of its monopoly capital, but it is destined not to achieve the goals it seeks. III. Analysis of demand factors: The main products of local refining enterprises are gasoline and diesel, while various chemically processed products play a secondary role. The use of gasoline and diesel as energy sources for vehicles is essentially aimed at meeting the needs of various passenger and freight transportation services. Therefore, data on various types of passenger and freight transportation can serve as the best supporting data for diesel consumption. As for the volume of passenger and freight transport, it is related to economic development, total population size, the number of vehicles in use, and the development of road infrastructure. Economic development and total population size exert a positive demand effect on the volume of passenger and freight transport, while the number of vehicles and road infrastructure provide supplementary support; both are essential. Given that the sales radius for gasoline and diesel cannot be too large, we have based our analysis on the aforementioned data, focusing on the relevant figures from Shandong and the surrounding provinces of Hebei, Henan, and Jiangsu – a total of four provinces that have the greatest impact on the sales activities of Shandong’s local refining companies. As can be seen from the table above, these four provinces account for about 28% of China’s total volume of passenger and freight transport. Therefore, this group of four provinces should be at the forefront in terms of China’s overall passenger and freight transport volume. Based on economic development and population figures, these four provinces account for one-third of the country’s total. As the core provinces of the East China and North China economic zones, as well as the economic backbones of the Yangtze River Delta and Bohai Sea economic regions, they are undoubtedly key drivers of China’s economic development and will play a crucial role in future economic growth. Furthermore, in terms of geographical location, Hebei and Henan are the provinces that serve as pathways from the Northeast and the Bohai Sea region to the central part of the country ； Hebei, Shandong, and Jiangsu serve as the connecting provinces between the Northeast and the Bohai Rim region and the Yangtze River Delta, boasting inherent advantages in terms of transportation. In terms of road infrastructure, these four provinces are undoubtedly at the forefront across the country, as can be clearly seen from indicators such as the length of highway networks, road density, and highway coverage. From this, we can draw a conclusion: the local refining enterprises in Shandong enjoy a uniquely advantageous sales market. IV. Analysis of China’s refined oil pricing mechanism and its impact on enterprises 1. Tax and fee reforms A plan for reforming the taxes and fees related to refined oil was recently announced, with implementation set to begin at the beginning of 2009. The main element of this plan is an increase in the consumption tax on gasoline and diesel. The overall approach remains one based on volume: the tax rate per liter for gasoline rises from 0.2 yuan to 1 yuan, while that for diesel increases from 0.1 yuan to 0.8 yuan. This is roughly equivalent to around 1,300 yuan per ton for gasoline and around 910 yuan per ton for diesel (calculated based on 1,300 liters per ton). It is also reported that this additional amount of consumption tax falls within the companies’ affordability. Moreover, even after the implementation of the new consumption tax scheme on refined oil products, there is still room for a further reduction in their prices, which means that companies can achieve decent profit margins at the current prices. 2. Market-based pricing mechanisms and their impact on enterprises: Looking at the evolution of China’s refined oil pricing mechanism over the years, it can generally be summarized as follows: “The overall principle for pricing is market-based, but prices are kept under appropriate control to support the country’s economic growth goals.” In accordance with Document No. 37 issued by the General Office of the State Council in 2008, the general principle underlying China’s pricing mechanism for petroleum products (mainly refined oil) is to continue to link the price of domestically produced onshore crude oil directly to international market prices. Domestic refined oil prices continue to be indirectly linked to international markets in a controlled manner. The pricing of refined oil products must reflect changes in international oil prices and corporate production costs, while also taking into account supply and demand conditions in the domestic market ； It is necessary to reflect the scarcity of oil resources in order to promote resource conservation and environmental protection, while also taking into account the capacity of all sectors of society to cope. ” The specific regulations state that: \"The domestic ex-plant price of refined oil is determined based on international crude oil prices, plus the average domestic processing costs, taxes, and an appropriate profit margin.\" When the average price of crude oil in the international market changes by a certain amount over a period of time, the prices of domestic refined petroleum products are adjusted accordingly. Furthermore, in order to \"take into account the capacity of all sectors of society to bear the costs,\" it is stipulated that \"prices for gasoline and diesel shall continue to be set through** fixed pricing and** guideline prices\" ； When crude oil prices in the international market continue to rise or experience sharp fluctuations, appropriate adjustments to the prices of gasoline and diesel should be made to mitigate their impact on the domestic market. The reason for exercising moderate control over prices is ostensibly to take into account the affordability of various sectors of society, but the underlying reason lies in the relatively weak economic foundation of our country; in particular, most enterprises have limited technical capabilities, and they rely more on relatively inexpensive factors of production such as land, labor, and natural resources to gain a competitive advantage in international markets. Furthermore, given the global economic fluctuations triggered by the U.S. financial crisis, although Chinese enterprises have accumulated experience over the years, their financial resources remain significantly insufficient compared to those of developed countries (the high debt levels of most Chinese enterprises are directly related to this). This situation limits their ability to make significant breakthroughs in key areas such as technology, research and development, and branding, leaving them in a weak position. Most of the products in which our country has a comparative advantage are those with low added value and low income elasticity; as a result, they are particularly affected by economic recessions. Of course, this situation is not caused by the enterprises themselves; ultimately, it stems from the weak economic foundation in our country, which severely restricts investment in human capital (primarily in terms of spending on education). Investment in human capital is a long-term endeavor that requires efforts to start from an early age – it is impossible to imagine a person who is illiterate being able to skip elementary and middle school and go straight to university for higher education. Such results cannot be achieved through short-term, large-scale investments over just a few years. Therefore, in the previous few decades, **strategies were actually adopted to appropriately lower factor prices across various aspects in order to support the rapid development of enterprises and facilitate the swift accumulation of initial capital. Starting in 2004, the concept of scientific development was promoted in an effort to achieve sustainable development. Macro-control was introduced over certain industries with high energy and resource consumption; part of this was to put a limit on the practice of companies in these industries using relatively low costs for factors of production to expand on a large scale, thereby wasting hidden subsidies. **The intentions are good, but our country’s overall economic foundation, especially its research capabilities, is relatively weak; this makes it **impossible to adopt radical measures to fully marketize the prices of all key factors at once, allowing enterprises to develop their own ‘self-sustaining capabilities’ through global competition**. Therefore, over a fairly long period of time, gradually refining the prices of various elements and moving steadily toward market-based pricing becomes the **overall plan ； However, viewed from another perspective, this also means that **moderate control will continue to be exercised over the prices of various factors over this fairly long period, in order to help enterprises gradually enhance their competitiveness. In fact, it’s not just our country that does this; all countries, based on their own national conditions and development goals, employ various forms of subsidy strategies, tangible or intangible. For example, the relatively low oil prices in the United States, which have been a topic of much discussion online, are to some extent a form of subsidy provided by the U.S. government to consumers and businesses (by using the U.S.’s strong economic power to maintain low oil prices, thereby subsidizing businesses and consumers). Based on this analysis, we can conclude that **the approach to reforming the prices of refined oil products should be the same, namely a gradual transition toward market-based pricing, although certain control measures will still be in place for a certain period of time. As for the impact on a specific refining and petrochemical company, a market-based pricing mechanism has only advantages and no disadvantages. However, market-based competition is the best \"teststone\"; the company that is able to reduce unit costs and increase overall productivity by expanding its scale and improving its manufacturing processes – in other words, that manages to exceed the industry average – will be able to remain unbeaten ； Failing to reach this average level will also result in gradual elimination by the market for the same reason of \"marketization\". The emphasis on the average level is because the various enterprises within an industry have developed to their current state through their own participation and competition; as a whole, the industry therefore necessarily possesses particular rationality ； For individual companies, it is sufficient to compare with the average level. V. A brief analysis of the impact of fluctuations in crude oil prices from July to October 2008: International crude oil prices reached record highs in August 2008, before dropping rapidly to around $40. In terms of purchase price, it reached its highest level of 5,980 yuan per ton (including taxes) in August 2008; thereafter it began to drop rapidly, and by October the average purchase price had fallen to 4,344 yuan per ton (including taxes). However, in terms of the product’s selling price and the price margin, it was at a high level in August, though the price margin was relatively small ； In September, it remained at a high level with slight further increases, resulting in a rapid expansion of the price difference ； By October, the selling price of the products was reduced, but the degree of decrease was smaller than that of the raw material purchase prices; as a result, the price gap continued to widen. In short, it was only more than two months after a significant drop in raw material prices that a gradual reduction in the prices of finished products began; this gave companies enough time to absorb the impact of the raw materials purchased at relatively high prices in August. As a result, the profitability of these companies was not affected by the price cuts. VI. Conclusion: Under normal market conditions, in the medium term, we should consider getting involved with those local refineries that possess strong comprehensive capabilities. It is mainly based on the following fundamental factors: First, after all, Shandong currently has a total processing capacity of around 60 million tons, of which local refineries account for two-thirds; thus they hold a dominant position in terms of volume. Therefore, the best among them are certainly worth investing in. Furthermore, no matter how strong the influence of central state-owned enterprises is, their penetration into this field is still in its initial stages; costs need to be taken into account, and time is also required ； Moreover, based on previous market trends, the entry of central state-owned enterprises has mainly taken the form of mergers and acquisitions, and such mergers and acquisitions are beneficial rather than harmful to the banks providing credit. Third, even if central state-owned enterprises try to seize the refining and chemical industry market by launching large-scale new projects, we have enough time and flexibility to respond accordingly. Since large-scale projects invariably require approval, our bank can easily keep track of such information ； Moreover, the construction period for large-scale refining and petrochemical projects is generally two to three years or more, giving our bank sufficient time to assess the situation and rearrange the corresponding credit measures. Regarding the normal situation, it is worth noting that after the significant and rapid drop in crude oil prices earlier on, there is little room for further sharp and substantial declines ； Of course, this doesn’t mean that prices won’t fluctuate in the future; it simply emphasizes that large adjustments of both significant magnitude and rapid pace like those seen recently are unlikely to occur again. By ruling out this scenario, the market will reach a relative equilibrium, which is a normal state in which volume and price remain relatively stable and can be reasonably predicted. From a market perspective, crude oil prices have stabilized at low levels, providing refiners with a favorable profit margin. With both prices and volumes stable and solid profit margins available, this is an excellent time for our bank to get involved. Appendix 1: List of local refining enterprises in Shandong that were retained in accordance with the “Notice on Issuing the List of Small Refineries Retained after Rectification” (Guo Jing Jing Shi Hua 1095). 1. Shandong Binhua Group Co., Ltd. 2. Shandong Guangrao Petrochemical Group Co., Ltd. 3. Jinan Petrochemical Group Co., Ltd. 4. Shandong Hengyuan Petrochemical Co., Ltd. 5. Kenli Petrochemical Plant 6. Jinan Great Wall Refinery 7. Shandong Changyi Petrochemical Co., Ltd. 8. Boxing County Lubricant Factory 9. Weifang Lianhong Chemical Co., Ltd. 10. Zibo Qifeng Petrochemical Co., Ltd. 11. Shandong Lihua Yi Group Co., Ltd. 12. Shandong Dongying Petrochemical Plant 13. Huantai County Petrochemical Plant 14. Linzi District Chemical Plant, Zibo City 15. Shandong Dongming Petrochemical Group Co., Ltd. 16. Dongying Hualian Petrochemical Plant 17. Shenxian County Petrochemical Plant, Shandong Province 18. Qingdao Guangyuanfa Group Company’s Asphalt Factory 19. Qingdao Chongjiao Asphalt Co., Ltd. 20. Shandong Huaxing Petrochemical Group Co., Ltd. 21. Jinjun Base Petrochemical Company (not listed in the original list; an enterprise within the military system)