VINACHEM

Markets used to cheer when China’s exports rose, believing this showed the global economy was in good shape. They are still hopeful today, despite the 25 per cent fall in February’s exports. But closer analysis of China’s important refining and petrochemical sector shows that a paradigm shift is under way.

No more is China’s economy based on importing raw materials and exporting low-cost manufactured goods. Instead, the focus is on using the new capacity built during the 2009–13 stimulus period to maintain employment and boost China’s self-sufficiency.This has two important consequences for companies and investors.

• It means that China’s status as a leading oil importer has decoupled from its domestic use, making judgements about oil market demand and its own economic outlook more complex.

• It also means that traditional exporters have lost their markets in China and are instead seeing Chinese exports enter already over-supplied Asian markets, causing margins to slide.

Diesel markets highlight some of the changes under way. China’s diesel consumption dropped 4% in 2015 as its economy slowed, but refiners were able to raise runs to 10.5m bbls/day by boosting exports. Diesel exports rose 75% versus 2014, whilst gasoline and jet fuel exports rose 16%.

Runs are expected to increase 5% in 2016 as China has doubled fuel-export quotas, leading to expectations of at least a 70% rise in diesel exports. In turn, this will pressure Asian refining margins, which are expected to average about a third less in 2016 at around $10/bbl.

Petrochemical markets are similarly changing direction, as China focuses on building self-sufficiency in critical areas. China used to be the world’s largest importer of PTA (terephthalic acid), the main raw material in polyester manufacture. But annual imports have collapsed from 6.5m tonnes to near zero over the past four years, as China’s own capacity has ramped up.

China was also the leading importer of PVC, but these volumes have similarly disappeared as domestic production has risen 39% since 2010, while China’s construction boom has ended. Other major petrochemical products seem set to follow the same path: polypropylene imports are already suffering as major new domestic capacity comes online.

These developments also highlight the key role of state owned enterprises (SOEs) such as Sinopec in supporting the change of direction. Sinopec is China’s largest refiner and petrochemical producer and, as the chart shows, it has invested $41bn (Rmb 288bn) since 1998 in capital expenditure for refining, and $33bn for chemicals. Over this period, it has lost $11bn at EBIT level in refining, and made just $15bn in chemicals. Overall, it has therefore invested $74bn in capex, for a combined EBIT of just $4bn.

Clearly no western company would ever dream of spending such large amounts of capital for so little reward. But as an SOE, Sinopec’s original mandate was to be a reliable supplier of raw materials to downstream factories, to maintain employment. More recently, the emphasis has changed to providing direct support to employment, through increased exports of refined products into Asian markets and increased self-sufficiency in petrochemicals.

We can expect this trend to continue during the new Five Year Plan for 2016–20. China’s main focus is now on its New Normal policies, which aim to create a more service-led economy based on the mobile internet. But it cannot allow its Old Normal economy, originally based on export-led growth and infrastructure spending, to disappear overnight. Sinopec therefore has a vital role to play in maintaining employment and wage growth in the urban areas.

These developments highlight the more complex investment world that we are entering as the Great Unwinding of policy stimulus continues.