Sinopec Gets Gift From Parent
A new major deal involving oil refining giant Sinopec (HKEx: 386; Shanghai: 600028; NYSE: SNP) is highlighting China’s unusual system of advantageous family relationships between its major publicly-listed firms and their untraded state-owned parents. In many ways these ties are similar to real family relationships that, for example, might see a parent lend money to a child interest-free and with no repayment schedule. China’s big publicly-listed companies like Sinopec often use these relationships to get assets or other benefits from their parents on terms they would never be able to find in the open market.Sinopec’s latest family tie-up will see it pay $1.5 billion for overseas oil- and gas-producing assets now held by its parent. (English article) In this case it’s not exactly clear how much of a bargain Sinopec is actually getting, since the media reports I read didn’t say how much the assets might be worth on the open market. I suspect the assets are probably worth quite a bit more than the $1.5 billion price.
But equally important, this “purchase” helps Sinopec quickly move towards its goal of producing more oil for use in its refining operations. Of China’s 3 major oil producers and refiners, Sinopec is perhaps in the most difficult position because it relies largely on oil purchased on the open market to supply its refining operations. By comparison, rivals PetroChina (HKEx: 857; Shanghai: 601857; NYSE: PTR) and CNOOC (HKEx: 883; NYSE: CEO) produce much more of their own oil, which they can use in their refining operations, helping to shield them from big price fluctuations in the global oil market.
Its reliance on purchased crude oil often puts pressure on Sinopec’s profits, especially when oil prices are high. Its problems are compounded by the fact that it can’t pass on increased costs to consumers due to China’s strict regime of state-set prices for many of its products. Sinopec last week blamed the government’s price controls partly for a 13 percent drop in its 2012 earnings, as its 2 chief rivals also cited similar reasons for their own profit declines. This latest purchase will at least allow Sinopec to shield itself a bit better from global oil price fluctuations by boosting its proven oil reserves and actual oil production by 9.1 and 11.2 percent, respectively.
This kind of deal shows at once both the advantages and disadvantages of investing in massive Chinese companies closely tied to their state-owned parents. This relationship is allowing Sinopec to make a significant stride toward its goal of producing more of its own oil with a single purchase. A similar move by a true commercial company would probably require several years, and would include many risks that Sinopec never had to make because its parent took all the risks.
But this kind of relationship can also encourage the publicly traded company to become complacent and even behave irresponsibly because it believes its parent will always come to rescue it in times of trouble. This cozy parent-child relationship also carries the risk that companies like Sinopec could be forced to execute government policy even when such actions aren’t necessarily in its best commercial interests.
That kind of risk was on display about a year ago, when CNOOC became embroiled in a diplomatic controversy after exploring for oil in waters claimed by both Vietnam and China. (previous post) Most truly commercial companies would never drill in such areas due to the high potential for conflict. Sinopec’s new purchase certainly looks like a gift from its parent in this case. But the same parent-child relationship will inevitably have its costs, undermining Sinopec’s image as a real commercial company and potentially forcing it to take more politically motivated actions in the future.
Bottom line: Sinopec’s purchase of oil producing assets from its parent should help the company in achieving some of its targets, but will ultimately undermine its image as a true commercial entity.
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