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Reforms to open China's Sinopec to private investment

The move is part of state-owned enterprise reforms that hope to make the companies involved more competitive and market oriented

Sinopec, China's second-largest national oil company, is carrying the torch for Beijing's state-owned enterprise (SOE) reforms. The company is pushing ahead with a major restructuring that it says will open the company to more private investment while making the company more competitive and market-oriented. At the same time, it is benefiting from broader energy sector reforms that have seen it earn more for the natural gas it produces and fuel it sells at the pump. 

Early signs that the reforms are paying off for Sinopec came in late August. The company reported a net profit of 52.27 billion yuan ($8.49bn) for the first half of this year, buoyed by higher natural gas prices, strong performance in its refining sector, higher oil and gas production and lower spending levels. The profit was 11.8% higher than the previous year and easily beat analysts' estimates. 

Many see it as a sign that the changes in the energy sector over the past year have tilted the playing field to Sinopec's advantage. "This is no flash in the pan, in our view, as China's SOE reform is structural and wide-ranging in the strategic energy sector," says Gordon Kwan, an analyst at Nomura, an investment bank. 

Sinopec is in the process of selling up to a 30% stake in its marketing business, which includes more than 30,000 petrol stations across China, the largest network in the country. Analysts at Bernstein Research have valued the stake at as much as $22bn. "The restructuring of Sinopec's marketing division is the biggest and boldest move of any of the SOE reforms we have seen so far," Bernstein's Neil Beveridge said in a recent note to clients. 

Beveridge sees a lot to like in Sinopec's opening of its marketing business to private investors. Mostly that is because Sinopec has so poorly managed the business. The business of selling petrol in North America, Europe and much of the rest of the world has been transformed in recent years, with less and less of the profits coming from the pump and more coming from convenience store sales and other services. In the UK, grocers use fuel as a loss-leader to get customers through the door. 

That revolution has not come to China yet. Whereas service stations in the US typically get well over half of their profits from convenience store sales, Sinopec still relies on fuel sales for more than 99% of its profits. Oil companies, Beveridge notes, are built to find and produce oil and gas, not squeeze profits out of snack and drink sales at their services stations. Most oil majors have long since sought to keep their brands on the sign in front of the station while leaving the management of the station itself to those better equipped. "Retailers, not oil majors are better custodians of fuels marketing networks. This is the big idea behind Sinopec's move to restructure fuels marketing" says Beveridge. "Introduction of private capital and expertise will enable a transformation of the marketing business, which could double operating income over time."

Wide-ranging

Sinopec has shortlisted 37 bidders for the 30% stake, according to Fu Chengyu, Sinopec's chief executive. Fu says he expects to complete the sale by the end of the third quarter. The list of bidders includes a wide range of companies from foreign retailers to logistics firms to Chinese insurers and even the Chinese tech powerhouse Tencent, indicating the company is thinking broadly and creatively about how to squeeze the most out its fuel network. 

The company has not said so publicly, but most analysts expect the marketing unit to be spun off as a stand-alone business and listed, though with the state-owned company holding on to a majority of shares. The company listed its engineering unit last year, and is reportedly planning a $1.5bn initial public offering for its oilfield services business later this year.

Still, not everyone is convinced. Laban Yu, an analyst at the investment bank Jefferies, has taken a negative view towards the sale, questioning the growth potential of the retail network itself and whether or not the sale marks serious reform for the company. 

Yu has valued the 30% stake in the marketing business at between $11bn and $15bn, lower than most others. He has questioned how many more stations Sinopec will be able to add to its network in the next few years as demand growth slows. He has also questioned the potential for Sinopec to increase profits from non-fuel sales, arguing that it will be a long time before Chinese consumers have the wealth to spend like their Western peers. "As China becomes more affluent, consumer propensity to pay a premium for convenience should increase. By 2025, however, China's appetite for convenience shopping should still be substantially lower than that of the US," argues Yu. "Now just because we would not pay much more (than $15bn) does not mean someone else will not be convinced to pay more. Chairman Fu has a reputation of being very persuasive."

More importantly, though, Yu has questioned whether the sale will mean genuine reform at Sinopec, or whether it is simply a cash raising exercise. "There is nothing in this restructuring that fundamentally changes management incentives at the [listed company] or parent company level," argues Yu. While new private investors could be introduced into the business, potentially even helping to improve its performance, it does not change the structure of Sinopec, which ultimately sees the state sitting on top. 

Rather, Yu argues, the listed arm of Sinopec will use the proceeds from the sale to buy upstream assets at an inflated value from its parent company, which needs a cash injection after spending around $36 billion buying oil and gas field around the world over the past decade. 

This hints at a deeper criticism of president Xi Jinping's SOE reform effort. Xi wants to change the way China's lumbering state companies do business, arguing they need to be more market-oriented to compete on a global level and continue to carry China's economy forward. But he and others in the Communist Party are not willing to give up control of key sectors. While Sinopec has opened its retail business to private investors, for instance, greater private and foreign involvement in the company's more strategically important upstream business remains out of bounds for reform. That means the reforms will only ever be partial, which many argue could undermine the whole campaign. 

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