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seeks to achieve these goals by speeding up the construction of large-scale oil refining and ethylene projects, closing outdated petrochemical production facilities, limiting the "blind development" of the coal-to-chemicals industry, and stopping approvals for projects that "only aim at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 - BEIJING 00000665 002 OF 004 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 BEIJING 00000665 003 OF 004 -------------- ¶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) BEIJING 00000665 004 OF 004 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.