A new oil giant?

Refining his strategy: Liu Deshu

When it comes to vertical integration, Andrew Carnegie is something of a role model. In fact, Carnegie Steel helped to pioneer the concept by participating in every stage of the steelmaking process, owning the iron ore mines and the steel mills themselves, as well as the ships and railroads that carried raw materials and finished products. The company even dug up its own coking coal.

Liu Deshu wants to follow the Carnegie model. Since his appointment as general manager of Sinochem Group in 1998, his aim has been to transform the state-owned company into an oil empire. With a large supply of foreign oil assets, combined with a major domestic retail arm, the company has a strong presence both downstream and upstream in the industry.

The missing link is in the middle: the company lacks its own refining facilities.

Sinochem’s forthcoming IPO of its subsidiary, Sinochem Corp, looks like it might fill that gap, as the predicted proceeds – between Rmb20 billion and Rmb35 billion (i.e. up to $5.5 billion) – will be used to fund a refinery project in Quanzhou.

Depending on the final pricing, it could become China’s sixth-largest listing. The deal is expected to be completed early next year.

The Quanzhou refinery will be located on the Fujian coast and is scheduled to be put into commercial operation by the end of 2013. It will be able to refine as much as 12 million tonnes of crude a year, creating products such as gasoline, diesel, jet fuel and polypropylene.

In addition to the Quanzhou plant, the company has a “tacit understanding” with the local government in Zhoushan in Zhejiang province, to set up another refinery on Liuheng Island, reports 21CN Business Herald. Although this project has yet to be approved, it offers further evidence that Sinochem plans to beef up its refinery capabilities further.

The profitability of the Quanzhou refinery will depend very much on future government policy, as the state controls fuel prices, meaning that refining companies are unable to transfer the full cost of operations onto final consumers through higher prices.

Why get into such a business? A report in the China Securities Journal suggests that the price-cap policy may soon change. “The key is China’s policy change when Sinochem’s Fujian plant is completed in a couple of years,” Shi Yan, energy analyst at OUB-Kay Hian told Bloomberg. “If higher retail prices are allowed, the plant will be very profitable.”

Sinochem is China’s fourth largest oil company (for more on its history see WiC7), as well as a huge player in the fertiliser industry (see WiC75). It is also involved in real estate, including its subsidiary Franshion Properties. Group profits hit Rmb9.1 billion in 2010 on Rmb335.3 billion of revenue, reports Bloomberg.

Still, investors looking into the IPO may want to take note of a report released in May this year by the National Audit Office, which was critical of Sinochem, reports the Economic Observer.

The report focused on losses accrued by three of its subsidiaries, largely due to poor risk management. It also highlighted overseas oil and gas development projects not living up to profit forecasts in their feasibility studies.

But the Sinochem IPO will still join the queue for an A-share listing. Despite the poor market conditions – the Shanghai Composite Index is down 10% year-to-date – there has been at least one IPO on every trading day of the year, raising an average Rmb979 million per deal, reports FinanceAsia.

Nor does the supply of new shares look set to dry up. China Railway Materials was another large company in the headlines last week, with plans for a Rmb14.7 billion IPO. Commentators see the news as a sign that capital-raising for rail-related busineses may begin anew, after a halt following the deadly Wenzhou crash in July.

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