Oil in China

FU CHENGYU has global ambitions. In 2005 he led CNOOC, a state-run Chinese energy giant, to make an audacious takeover bid for Unocal, an American oil-and-gas firm. That provoked a protectionist backlash, and CNOOC retreated. (It has since won approval to buy Nexen, a Canadian energy firm.) In 2011 Mr Fu took over as boss of China Petroleum & Chemical Corp (Sinopec), another state-run outfit. He has tried to transform the domestically focused firm into an international oil giant.

Three things make people take Mr Fu seriously. First, he wields a lot of clout in Beijing. Second, his push to diversify away from low-margin refining ought to shore up Sinopec’s balance-sheet. Third, foreign investors hope that his bold management style will bring better corporate governance. On all three counts, however, he has suffered setbacks.

Beijing is reeling from the worst smog on record, and the public’s mood is as foul as the air. China’s new leaders, ever wary of anything that might cause unrest, have promised to clean up the pollution quickly. Among their targets are the country’s antiquated, filthy oil refineries. Yet Mr Fu, when asked about the smog, harrumphed to Xinhua, an official news agency, that his refineries were not at fault. He blamed lax regulations. That prompted gales of derisive laughter online.

Sinopec is not like a Western oil firm. As an arm of the state (and a more powerful one than the environmental-protection ministry) it has a lot of say in writing its own rules. That is perhaps why in much of China regulations allow the sulphur content in petrol to be as high as 150 parts per million, whereas European standards cap it at 10 ppm. A pundit in the Shanghai Daily said his comments were “a massive public-relations disaster” and “highlighted a serious lack of responsibility”.

This row will hit Sinopec’s finances hard. They were already suffering because, unlike its Chinese peers, Sinopec is heavily exposed to refining. It owns half of the country’s refining capacity. The snag: Sinopec must buy crude at global prices but its refined petrol and diesel can be sold only at artificially low prices set by the government. The result is red ink (see chart).

Now Sinopec will be squeezed further. The ruling State Council announced earlier this month that it will unveil new standards for diesel in June and petrol in December that will cap the sulphur content at 10 ppm, to be implemented nationwide by 2017. Refiners must upgrade facilities, or else. Sinopec already spends a fortune maintaining and upgrading its refineries. Moody’s, a ratings agency, says it will need to spend an additional 30 billion-40 billion yuan ($4.8 billion-6.4 billion), most likely paid for by borrowing.

This huge outlay and the unwelcome focus on refining run counter to Mr Fu’s strategy. His plan calls for Sinopec to diversify away from refining and into exploration. He also plans to acquire billions of dollars of upstream assets (such as foreign oil wells) from Sinopec’s unlisted parent.

Deep wells, deep debts

To do so, Sinopec may need to go deeper into debt. That points to the third recent blow to Mr Fu’s credibility. This month Sinopec irked investors by unveiling a $3 billion share placement with a handful of parties that diluted the holdings of minority shareholders. The firm says the money will be used for “general corporate purposes”, whatever that means.

Corporate-governance scolds will squawk if Sinopec uses the $3 billion to buy upstream assets. It would be even more worrying, adds Tom Reed of Argus Media, an industry publisher, if it needs shareholders to fund its working capital, as a recent regulatory filing suggests. That may mean it is facing a cash squeeze, says Mr Reed. Nobody is suggesting that a Chinese national champion could go bust. Still, Sinopec’s prospects may be dimming, like the sky over Beijing.

The Economist