CHINA ANNOUNCES PETROCHEMICAL INDUSTRY SUPPORT PLAN

UNCLAS SECTION 01 OF 04 BEIJING 000665

SENSITIVE
SIPDIS

STATE PASS USTR FOR STRATFORD, WINTER, MCCARTIN, READE,
VENKATARAMAN, KEMP, MILLER, MALMROSE
DOC FOR MELCHER, SAUNDERS; LORENTZEN AND SHOWERS (5130);
HEIZNEN(6510)

E.O. 12958: N/A
TAGS: ECON ENRG EPET EIND ETRD CH
SUBJECT: CHINA ANNOUNCES PETROCHEMICAL INDUSTRY SUPPORT PLAN

REF: (A) Beijing 151; (B) Beijing 326; (C) Beijing 425; (D) Beijing
443; (E) Beijing 515; (F) Beijing 583, (G) 2008 Beijing 4614

This cable is Sensitive but Unclassified (SBU) and for official use
only. Not for transmission outside USG channels.


1. (SBU) SUMMARY: China's State Council announced a petrochemical
industry support plan on February 19, the eighth of ten such plans
intended to help key industries weather the economic crisis.
Similar to the other revitalization plans (reftels),the
petrochemical industry support plan seeks to stimulate domestic
consumption, speed up industry consolidation, and add production
capacity, but it proposes few specific concrete measures. It
appears the beneficiaries of the plan will be large, state-owned
petrochemical companies. If plans to accelerate the construction of
key refining and ethylene projects are implemented fully, some
smaller companies, in particular many of the country's
privately-owned refineries, could find it hard to compete. Embassy
contacts remain optimistic that the plan will help the industry
weather the economic slowdown and that new production capacity will
prepare the industry for future growth. They acknowledge, however,
that the plan's effectiveness will hinge on the recovery of other
industries that rely on petrochemical products. END SUMMARY.

Plan emphasizes restructuring, resource optimization
-------------- --------------

2. (SBU) The State Council approved a new support plan for the
Chinese petrochemical industry on February 19 - the eighth of ten
plans formulated to help key industries weather the economic crisis.
(See reftels A-F for reporting on autos, steel, textiles,
machinery, shipbuilding, IT/electronics, and light industry.) The
announcement emphasized that the petrochemical industry support plan
would focus on industrial restructuring, optimization of the
industry's product mix, technology upgrades, and more effective use
of resources. The plan seeks to achieve these goals by speeding up
the construction of large-scale oil refining and ethylene projects,
closing outdated petrochemical production facilities, limiting the
"blind development" of the coal-to-chemicals industry, and stopping
approvals for projects that "only aim at production expansion."


3. (SBU) Like the other industrial support plans, the announcement
listed only very general support measures. As announced, the plan
seeks to execute the following policies.

a) Implement measures to stimulate demand for petrochemical
products, enhance supervision of imports and exports, and perfect
the pricing mechanism for energy products;

b) adjust the production structure for fertilizers, pesticides, and
other agricultural chemicals by better allocating resources,
reducing production costs, and increasing supply; perfect the
fertilizer storage/reserves system; expand diesel supply networks in
rural areas;

c) speed up construction of key refining and ethylene projects;
upgrade production technology; promote efficient use of resources
and develop a recycling economy;

d) control total production output and eliminate outdated
facilities; stop project approvals for projects whose sole aim is to
expand production; strictly limit "blind development" of the
coal-to-chemicals industry;

e) perfect taxation policies; speed up implementation of refined oil
products reserves system; increase credit support to the industry;

f) Improve corporate governance and risk management.

2008 and 2009: A double whammy to the industry
--------------

4. (SBU) China's petrochemical industry, in particular the refining
business, has been hard hit twice in the past year: first by record
high international crude prices in mid-2008 and second by the global
economic crisis, which began to impact the industry in October and
November 2008. In the middle of 2008, as crude oil prices were
approaching their July peak, China's refiners were reportedly losing
as much as USD 59.35 per barrel because they were unable to pass on
rising crude costs to customers due to government price controls on
gasoline, diesel, and other petroleum products. Sinopec, China's
largest refiner by capacity, imports 70 percent of the crude that it
processes. It reported earlier this year that its 2008 profits
would plunge by 50 percent yoy as a result of these price
disparities. According to the China Petroleum and Chemical Industry
Association (CPCIA),the country's three largest oil companies -

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PetroChina, Sinopec, and CNOOC - are expected to have combined
profits of RMB 222.8 billion (USD 32.6 billion) in 2008, a yoy
decrease of 31.3 percent.


5. (SBU) Just as pressure from high international crude prices
started to ease early last fall, the economic crisis took hold, and
demand for petrochemical products began to slide in tandem with weak
growth in China's manufacturing and construction sectors (about 43
percent of China's oil demand comes from industry according to
Credit Suisse analysis). Reduced diesel and gasoline demand in the
domestic shipping industry and changing consumption habits of
China's emerging middle class -- including sluggish demand for
automobiles -- has also resulted in reduced sales of refined oil
products. According to the CPCIA, which represents more than 70
percent of China's petrochemical companies, the petrochemical
industry posted negative income growth in December 2008, the first
decline in 10 years.

Plan's success depends on recovery of other sectors
-------------- -

6. (SBU) CPCIA Vice Chairman Zhao Jungui told Econoff the
petrochemical industry welcomes the government's efforts to address
the industry's concerns. He explained that the industry sees the
plan as an effort to support it through the current crisis while
also strengthening prospects for long-term growth. He noted that
the plan was developed through close consultation with industry
representatives, but his organization is still waiting to receive
additional details. Dr. Zhu Tong, an energy researcher at the
Institute of Industrial Economics at the Chinese Academy of Social
Sciences (CASS),told Econoff in a separate meeting that one of the
most important roles of the plan is to restore confidence among
business leaders and investors. Zhao agreed that the plan will
boost confidence and said he remains optimistic that the plan will
work. He acknowledged, however, that its effectiveness will hinge
on the recovery of other industries that rely on petrochemical
products such as shipping, heavy industry, and construction.

Plan repackages some existing initiatives
--------------

7. (SBU) Details about the petrochemical industry stimulus plan
remain murky and some aspects of the plan appear intended to codify
already existing policy measures. Plans to "perfect the pricing
mechanism for energy products," for example, reflect ongoing fuel
pricing and taxation reforms, which have been under discussion for
years. A new pricing mechanism was announced in December 2008 and
took effect on January 1 this year (ref G). Plans to further reform
oil product pricing would likely have moved forward regardless of
the new petrochemical industry revitalization plan. CPCIA's Zhao
noted that fuel price reforms may be bolstered by the State
Council's decision to include this initiative in its official
industry support plan announcement.


8. (SBU) Initiatives to speed up construction of key refining and
ethylene projects also appear to be aimed at supporting ongoing
efforts to boost China's refining capacity and restructure the
petrochemical industry. These plans have been in development since
at least 2006 when the National Development and Reform Commission
(NDRC) urged that capacity be increased after warning that oil
refining facilities were stretched to the limit. CASS's Zhu told
Econoff there were already more than twenty major petrochemical
projects (mostly oil refineries and ethylene plants) scheduled for
completion during the twelfth Five-Year Plan (2010-2015). Zhu
conjectured that as a result of the new industry support plan, the
completion of these projects (some of which are reportedly already
under way or in the advanced planning stages) might be accelerated
by several years.


9. (SBU) Likewise, plans to limit investment in coal-to-chemicals
projects reflect NDRC's ongoing efforts to discourage investments in
resource-intensive industries. CASS's Zhu noted that in the past,
provincial governments in coal-rich regions had frequent
confrontations with central NDRC officials regarding approvals for
coal-to-chemicals projects, which local governments viewed as a good
source of tax revenue. In Zhu's view, by including a statement in
the support plan that discourages investment in coal-to-chemicals
projects, NDRC strengthened its position on this issue. He noted,
however, that this is less relevant in the current economic climate.
"Now that oil prices are low, these kinds of projects are less
attractive to local governments because they're less profitable. It
will be easier for local government officials to accept this policy
because it is no longer in their economic interest to promote
coal-to-chemical projects," Zhu explained.

Tempest ahead in China's teapot refineries

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--------------

10. (SBU) Similar to the other industrial revitalization plans, the
petrochemical industry support plan targets large-scale enterprises,
in this case the downstream operations of state-owned petrochemical
companies. By aiming to eliminate outdated facilities and by
stopping approval of projects intended to simply add capacity to
existing operations, the plan will likely put pressure on some of
China's smaller, less-efficient petrochemical companies. This will
include China's mostly privately-owned "teapot" refineries, which
account for about 20 percent of China's current refining capacity.
According to CPCIA's Zhao, central government authorities are
encouraging mergers and acquisitions within the sector. As a result,
some smaller petrochemical companies, including teapot refineries,
will be either acquired by larger companies or shut down. CASS's
Zhu added that if NDRC will not approve projects whose sole purpose
is to increase capacity, teapot refineries will no longer be able to
expand and they will gradually be phased out.

Plan supports acceleration of large-scale projects
-------------- --

11. (SBU) As CASS's Zhu pointed out, the revitalization plan will
likely lend high-level support to pre-existing stimulus and refining
expansion measures aimed at constructing new, large-scale
petrochemical production facilities. According to state media
sources, approximately USD 58 billion will be allocated to fund the
construction of up to 20 new large-scale refineries and
petrochemical projects. (Note: These projects are separate from
the petrochemical industry support plan. Funding for these projects
will reportedly be drawn from a separate fiscal stimulus package and
will likely require additional funding from the companies
themselves. End Note.) It remains unclear when all of these
projects, which could add as much as 2.19 million barrels per day in
production capacity according to figures reported widely in the
press, will come online.

But can China absorb extra capacity?
--------------

12. (SBU) Some analysts have pointed out that the construction of
such a large number of petrochemical projects could lead to the
untimely oversupply of oil and chemical products as the economy
heads into a downturn. Media reporting suggests this could reduce
petrochemical companies' return on investment in the new facilities,
as the excess capacity could come online at a time when profits are
still being squeezed by sluggish demand. (Comment: It remains
unclear how project costs will be divided between the petrochemical
companies and central and local governments. End Comment.)


13. (SBU) The International Energy Agency (IEA) announced a downward
revision of its 2009 oil demand forecast for China in late January,
projecting that oil demand would grow by 1.1 percent, nearly 3.3
percent below an earlier published estimate. According to Chinese
customs data, crude imports were down 13 percent yoy in the first
two months of 2009 and the state-run media reports that the
country's crude stocks rose 34 percent in January alone. (Comment:
It is unclear whether this refers to commercial stocks or strategic
petroleum reserves (SPR) or both. Media reports this week suggest
that China has filled its SPR, which some sources estimate holds up
to 100 million barrels. End Comment.) With reserves reportedly
filled to the brim and sluggish domestic demand predicted for at
least the first half of the year, Chinese oil companies have reduced
refinery runs and turned to exporting refined products. Customs
statistics state that Chinese oil product exports rose 8.5 percent
yoy in January and February this year.

Extra capacity will be needed in long-term
--------------

14. (SBU) Embassy contacts told us they are not concerned about
short-term overcapacity, as the industry will need additional
capacity to cope with rising demand once the economy recovers.
CASS's Zhu reported that there is currently a balance between
refining capacity and petrochemical demand, but by constructing new
refineries and other petrochemical facilities now, China will be
prepared for future demand growth. CPCIA's Zhao agreed that "now is
the time" to construct new petrochemical production facilities.
"These projects will create jobs in the industry, reduce energy
consumption, and lead to lower production costs by achieving
economies-of-scale," he explained. Zhao noted that China relies on
imports to meet about 50 percent of its petrochemical needs. "China
is a developing country with huge growth potential in the
petrochemical sector," Zhao asserted. Jiang Xinmin, Assistant
Director of the Energy Research Institute, a think tank that advises
the government, echoed Zhao's and Zhu's views on the long-term
benefits of accelerating the projects. In a late-February media
interview Jiang said, "pushing (refinery and chemical plant)

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projects forward will support demand for basic materials, keep
people employed, and ensure fuel and petrochemical capacity is ready
when the economy takes off again."

Comment: Big ideas, but few details available
--------------

15. (SBU) The government's petrochemical industry support plan
measures appear to be mostly intended to boost confidence among
industry leaders and provide a high-level stamp of approval for
existing measures intended to restructure and streamline the
industry. This will likely benefit large-scale state-owned
enterprises over the longer-term, but will offer minimal immediate
relief to the industry. The plan provided no information on plans
for tax relief or subsidies, and it remains unclear at this point
how the plan would affect U.S. exporters or U.S. companies operating
in China. There is a possibility that the government would favor
Chinese firms in the construction of the proposed large-scale
refining and petrochemical projects, but statements to that effect
were not included in the plan. As has been the case with other
plans, the petrochemical industry revitalization plan is filled with
lofty goals, but few hints as to how these objectives will be
achieved.