China's Sinopec carves out two-pronged strategy to cut feedstock costs, lift refining margins

China's top refiner Sinopec's twin strategy for the fourth quarter of 2022 and next year would involve optimizing crude procurement costs by carefully picking grades, as well as timing for the imports while leveraging on plentiful oil product export quotas handed out by Beijing in an effort to boost refining margins, company executives said during the third quarter earnings call late Oct. 28.

Adjusting the crude slate due to changing trade flows following the Russia-Ukraine war, the strengthening US dollar, questions around domestic demand recovery, and availability of sufficient oil product export quotas are the key factors that will influence plans for not just Sinopec but refiners across the country.

"From Q4 and next year, we will concentrate on optimization of the crude procurement schedule and slate to lower our feedstock costs," said Song Zhenguo, deputy head of Sinopec's finance department.

A fall in crude prices coupled with weak domestic oil products demand amid tight zero-COVID controls pushed Sinopec to a Yuan 8.9 billion ($1.32 billion) operating loss in Q3, compared with Yuan 14.2 billion operating profit in Q2, according to Song.

In January-September, the segment's operating profit was Yuan 20.02 billion, dropping 62.4% year on year, according to Sinopec's Q3 earnings report.

Falling crude prices also prompted an inventory loss of Yuan 3.1 billion, according to Song.

"Earnings decline not a surprise given downstream weakness in China," Bernstein Research said in a research note Oct. 28.

Refining margins, throughput outlook

Chinese refineries usually have negative product sales margins as the oil product prices are correspondingly set to be at a crude price level lower than the actual feedstock cost, especially when the spot premium, freight and insurance are high, due to the country's pricing mechanism.

Sinopec cut its throughput by 8.2% year on year to 59.31 million mt (4.74 million b/d) in Q3 against its 5.78 million b/d primary capacity, while its oil product output declined 6.4% to 34.08 million mt over the period, the company's Q3 earnings report said.

Song said an increase in oil product exports helps to improve refining margins as the refiner will need to boost crude throughput, which in turn would aid in reducing unit processing costs.

"Our oil product exports are profit-oriented. Currently, the gasoil crack is good while jet fuel is not bad, but gasoline lags behind," a senior Sinopec official said during the call. He said the company will prioritize domestic product supply, then optimize the export volume and product slate, which was echoed by its state-owned peer PetroChina.

Asia's benchmark FOB Singapore 92 RON gasoline crack spread against second-month Dubai swaps averaged $2.79/b to date in Q4, down sharply from the Q3 average crack spread of $10.17/b and on course to set the lowest quarterly margin since the average of minus 40 cents/b in Q2 2020, S&P Global Commodity Insights data showed.

Meanwhile, the second-month Singapore gasoil swap crack against Dubai swaps averaged $38.90/b to date in Q4, slightly lower than the Q3 average of $41.62/b but higher than first half average of $30.52/b and the 2021 average of $9.61/b, the data showed.

"Fourth quarter margins are expected to rise with additional fuel exports quota and higher domestic demand," Bernstein Research said.

Sinopec in late September gained an additional 6.5 million mt of clean product export quotas, with its total allocation rising 4.3% year on year to 15.36 million mt in 2022.

A few Sinopec refiners said they will maximize utilization of the quotas in Q4 to earn more US dollars, offsetting exchange loss for crude procurement amid currency appreciation. Gasoline and jet fuel demand has remained weak in China due to ongoing COVID-controls, while domestic gasoil supplies have been tight since September as it is the peak season for fishing, harvesting and construction.

Downstream headwinds hit capex

Sinopec may cut capital expenditure in the chemical sector due to the current short-term headwind although its long-term development strategy of transforming oil production to embrace more petrochemical production remains intact, said Huang Wensheng, the vice president and secretary to Sinopec's board.

"Due to the market changes, our cash flow is weaker than expected. Generally, we would downward adjust the investment plan, which is subject to the board's approval," Huang said.

In contrast, the upstream led state-run peer PetroChina plans to lift capex in Q4.

Sinopec spent Yuan 104 billion ($14.32 billion) in the first three quarters, only accounting for 52.5% of its annual capex target of Yuan 198 billion for 2022, although it was up 15.9% year on year, according to its Q3 earnings report.

Its investment in the chemical segment edged down 0.7% year on year to Yuan 29.5 billion in January-September, accounting for 44.6% of the Yuan 66.1 billion budget for 2022. The segment posted a Yuan 4.5 billion operating loss in January-September in contrast to an operating profit of Yuan 15.09 billion in the first nine months of 2021, the Q3 earnings report mentions.

Song attributed the operation loss to the combination of negative gross unit margins and a reduction in sales volumes. "Product price increases in the end-user market lagged about 22% behind the surge in feedstock costs," Song said, adding that the pandemic and the oversupplied chemical market had dampened Sinopec's sales volumes.

Another Sinopec senior official updated progress on the company's key projects:

• Zhenhai Petrochemical's 11 million mt/year CDU and 600,000 mt/year PDH unit: to be delivered in end-2024
• Zhenhai Petrochemical's 1.5 million mt/year ethylene plant: project in progress
• Yangzi Petrochemical's 260,000 mt/year residual hydrotreater, 280,000 mt/year fluid catalytic cracker, 70,000 mt/year gas fractionation unit, 150,000 mt/year S-Zorb: to be delivered in mid-2023
• Gulei Petrochemical's 800,000 mt/year ethylene plant, 800,000 mt/year EVA plant: construction to be completed in 2-3 years
• Tianjin Nangang's 1.2 million mt/year ethylene plant: to be delivered in December 2023
• Hainan Petrochemical's 1 million mt/year ethylene plant: launched in September 2022
• Ethylene plants at Zhenhai, Maoming, Yuyang, and Luoyang gained initial approval from the National Development Reform Commission.

Sinopec's operating results

*Oil, gas outputs from both domestic and overseas

Source: Company report

Sinopec's domestic production (million mt)

^ Divide Sinopec's output by China's total production

Source: Company report, the National Bureau of Statistics

Sinopec's oil product sales ( million mt)

Source: Company report