Surging crude oil prices squeeze profits

Sinopec (0386) and PetroChina (0857) may continue to see their profits eroded by surging crude oil prices after the National Development and Reform Commission ordered the two major gasoline producers to ensure sufficient oil supplies to distributors.

At the same time, a reform in the state-controlled pricing mechanism for refined oil this year seems unlikely, analysts said.

Shares of the two oil giants dropped yesterday, with PetroChina closing at HK$10.72, down 3.42 percent, while Sinopec fell 3.24 percent to HK$7.76.

Prices of refined products in the mainland are under government control and are lower than world market averages, which creates a tougher business environment for the country's refineries.

The last gasoline price hike was in May 2006, but the rate was cut in January this year amid the drop in global crude oil prices. Since then, gasoline and diesel prices in the mainland have remained unchanged despite a 17 percent jump in the Brent Crude Index in the first half, putting greater pressure on refinery companies.

"Refiners have been losing money since May," said DBS Vickers analyst Gideon Lo. "The more refined products they sell, the more they lose."

Bloomberg reported last week that Sinopec will move forward a two- month scheduled maintenance for its Shanghai plant to mid-August from December, considering surging crude oil prices. Also, it had slowed down discussions with Saudi Arabia about some refinery projects.

Lo said the refiners are bargaining with the government through these tactics, while protecting themselves from bleeding severely. He added that a huge shortage or panic in the market was unlikely.

"With domestic supply becoming increasingly tight as a result of negative refining margins, we believe [the NDRC's announcement] is a warning to the companies to be sure the product shortages of 2006 do not reoccur," Citigroup analyst Graham Cunningham wrote in a report.

While analysts generally believe Sinopec will post a profit for its refining business in the first half, the outlook for the second half is poor - considering the rising crude oil price.

Nevertheless, a liberalized pricing mechanism of refined products - a free market which analysts believe would be the ultimate solution to the problem about negative refining margins - seems unlikely this year, given that Beijing will not loosen its control over commodity prices in order to maintain a relatively stable social environment.

Some form of compensation or subsidy from the government is expected, as in the past two years, rather than a price hike.

"There are too many things that the government wants to control," Lo said. He said it is unfair to sacrifice the fortunes of some companies - such as refiners - in order to achieve a low inflation rate but high GDP growth, and that may discourage companies from making further investments.