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By- Group 5

LONG LINES, LOST PROFITS :CHINAS REGULATED FUELS MARKET

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CONTENTS

Supply And Demand: Long Lines

State Oil Companies

Pricing Policy and WTO

Scrambling for Market share Closing Thoughts

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SUPPLY AND DEMAND

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SUPPLY DEMAND China, then being the top oil producing country in Asia with an estimated

2005 production rate of 3.6 mbpd from 18.25 billion barrels of proved crude oilreserves.

A net importer since 1993

Daily use of oil was over 6 million barrels

IEAs estimated - primarily driven by transport demand would increase 3.4%annually to 13 million barrels per day by 2030 while its domestic supply woulddecrease by1.5% annually

Resulting in shortfalls of up to 11million barrels per day

Chinas demand for refined oil products - more than doubled to 5.6

millions barrels per day between 1990 and 2003 Demand for gasoline and diesel fuels - increased from nearly 1 million to

2.7 million barrels per day

The transportation, industrial and agricultural sectors accounted for 41%, 22%and 18% of diesel consumption respectively.

Increase in number of cars and trucks from 25 million in 2004 to 100 million

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WHY LONG LINES

There has been enormous shortage of fuel throughout China from easternShanghai to southern Guangdong province and also in the capital Beijing.

The root cause was huge rise in unregulated international crude oil prices.

Media reported that chinas state owned oil companies had to buy crude oilat record high prices and sell refined products at prices as regulated by thestate

The result was long lines of cars, trucksand two-wheelers at the petrol pumps

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SUPPOSE THE GOVERNMENT WANTS TO REGULATE THE PRICE OF GASOLINE

(NOTE THAT BOTH RETAIL AND WHOLESALE PRICES ARE REGULATED.)

6

Supply

Demand

Price

Quantity

A

C

D

By regulating the price below the market equilibrium,(1) Buyers are encouraged to buy more(2) Sellers are encouraged to sell less (or discouraged to sell).

Price regulation(ceiling)

Excess demand

Hence, there will be excess demand(i.e., quantity demanded > quantitysupplied). Consumers will line up forthe product. Thus, consumers wind uppaying with waiting time.

(1)(2)

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THE IMPACT

Low regulated prices had three impacts:

Higher demand for oil.

Higher demand for complimentary goods such as carsand trucks-new found love of chinese middle classthanks to consistent 8-10% GDP growth rate over Past25 years.

Chinese oil companies and refiners are forced toexport all they can to take advantage of higher priceselswhere, even as the country remains a net oilimporter, relying on foreign stock

Back

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PETRO CHINA

PetroChina Co. Ltd was one of the worlds largest oil and gas Co.

Ranked 9th in Petroleum intelligence Weeklys top 50 companyrankings.

Was established in 1999 and headquartered in Beijing.

Listed 10% of its shares on the Hong kong and New York stockexchanges.

British Petroleum was a large purchaser of the IPO, sold at anestimated profit of $1 bn.

Warren Buffets holding co, Berkshire Hathway, held 13.3% of its H-shares at the end of 2004.

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PETRO CHINAS BUSINESS

Companys revenues were $46.9bn in 2004with an operating income of $17.7bn and netincome of $12.4bn.

The High- Margin upstream exploration andproduction business segment accounted for12%external sales, while low- margin downstreamrefining and marketing segment accountedfor70%

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PRODUCTION, RESERVES AND SUPPLIES

PetroChina held proved reserves of 10.9bn barrelsof oil and 44.6 trillion cubic feet of gas.

In 2004 Co produced 2.1 million barrels of oil perday and 2.3 billion cubic feet of natural gas perday, realizing avg prices of $33.88 per barrel of oiland $2.55 per thousand cubic feet of natural gas.

It supplied 82% of its crude oil production to itsownrefineries, 11% to Sinopec, 4% toregionalrefineries, and exported the rest.

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THE REFINERIES

Petro Chinas 25 refineries, locatedthroughout thenorth, processed 1.9mn barrels of crude oil

perday in 2004.

O/P for the year was 74mn tonnes for a widerange of refined pertoleum productsincluding:gasoline, diesel, kerosene, fuel oil, naphtha,asphalt, lubricants and paraffin

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SALES AND DISTRIBUTION NETWORK

Approx. 58mn tonnes of gasoline and diesel wereproduced, and 65 mn tonnes were sold through thecompanys retail and distribution channels.

Avg realized selling prices for gasoline and diesel were3543 and 3165 Chinese Renminbi (RMB) per tonnerespectively.

Out ofPetroChinas 17403 service station network-14309 are owned, 2937 are franchised and 427arewholly o r jointly owned by CNPC.

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ABOUT SINOPEC

China Petroleum & Chemical Corporation(Sinopec) was Chinas largest producer anddistributor of gasoline and diesel fuel.

It was established in February 2000.

32% of its shares were offered on the HongKong,New York and London stock exchanges inOct

2000, raising $3.4

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SINOPECS BUSINESS

Companys revenues were $74.9 bn in 2004,with an operating income of $7.6bn and netincome of $4.4 bn.

High Margin upstream exploration andproduction accounted for 4% of externalsales, while low- margin

downstream refining andmarketing/distribution segments accountedfor 11% and 55% of external salesrespectively.

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PRODUCTION, RESERVES AND SUPPLIES

Sinopec held proved reserves of 3.3bn barrels ofcrude oil and 3 trillion cubic feet of natural gas.

In 2004 co produced 749 thousand barrels of oilper day and 567 mn cubic feet of natural gasper day.

Two- thirds of the cos production came from its

Shengli field located in Shandong.

Avg prices realized were $33.28 per barrel of oiland $2.11 per thousand cubic feet of natural gas.

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THE REFINERIES

It was the 4th largest refiner with a 2.9mnbarrel per- day capacity.

The cos 26 refineries accounted for nearlyhalf of chinas total domestic distillationcapacity.

In 2004 it processed 133 mn tonnes of crudeoil, producing 115 mn tonnes of refinedproducts.

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SALES AND DISTRIBUTION NETWORK

Over 27mn tonnes of gasoline and 61mn tonnes ofdiesel were sold in 2004 at avg realized prices ofRMB 3762 and RMB 3215 per tonnes respectively.

Retail accounted for 67% of gasoline and 49% ofdiesel sold.

Sinopecs retail distribution networ totaled 30352service stations, 3482 of which were franchised

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PRICING POLICY

1998 - SDPC set refined product prices

Adjustments infrequent and not a

reflection of international marketsPump prices were liberalized

International prices were at a 10yr low

and product smuggling was on a rise

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Pump Price Liberalization Retail-Guidance Price for Gasoline and

Dieselbased on Singapore FOB tradingpractice

Prices set by the companies could be +or5% of guidance price

Wholesale prices 5.5% below

eachcompanys retail price Internal sale prices were not regulated SDBC began publishing Retail-

GuidancePrices on monthly basis

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2000

Special Customer Prices

No mark-ups to military / national reserves2001 March

PRC stopped regulating Crude Oil prices

but not Gasoline and Diesel 5% premiums to Airways and Railways

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NEW PRICING POLICY

Chinas New secret Oil product price scheme

Government benchmarks remained yet rules became less

transparent and retail pricing flexible

NDRC successor to SDPC published guidance priceintermittently

Guidance prices based on Weighted Average of Singapore(60%), Rotterdam (30%) and New York (10%) trading prices

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PRICE PARITY BREAKDOWN

The price parity method introduced by the Chinesegovt. in 2001 was abolished in 2003 after theoutbreak of SARS.

Few increases in retail prices of gasoline anddiesel were made in between. These increaseshowever were not enough to cover up the lossesof downstream oil companies.

In this of environment of high global crude prices,exploration and production business prosperedby selling crude oil at international prices.

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PRICE PARITY BREAKDOWN

This led to a shortage of gasoline and Dieselsupplies in China.

The Latest Price hike that the Chinesegovernment passed on to the consumerwas just before the summer Olympics of2008.

The recent cool off in crude oil prices from anall time high of $140/barrel to a low of around$40 a barrel has somehow solved theproblem of the Chinese government for thetime being.

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WTO

Chinas accession to the world trade organisation (WTO) on Dec.11th2001helped open its refined products market to foreign competition.Oncerestricted to local companies, retail distribution was liberalized inDec2004 with wholesale distribution scheduled to open in Dec. 2006.

Even with the elimination of sales barriers, Petrochina, Sinopec

,Chinaoil(CNPC) and Zhuhai zhenrong would continue to dominatechinaswholesale market, fuel storage and transportation infrastructure,placingindependent retailers at a severe disadvantage

Major Roles Of WTO

The three main WTO-related changes that will most directly affect the Chinaoil and gas industry are:

The reduction of tariffs The elimination of certain non-tariff barriers to trade The opening of the retail and wholesale markets to foreign participation

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Chinas entry into WTO will affect tariffs on some, butnot all, oil and gasproducts.

Tariff Reduction Pre WTO Post WTOCrude Oil 6% zero

Gasoline 9% 5%

Diesel 6% 6%

Kerosene 9% 9%

Fuel Oil 6% 6%

LNG 6% 5%

Lubricating Oil 9% 6%

China has agreed to eliminate quotas and licenses on the importof refined petroleum products by 2004, and to increase quotasby 15%each year until 2004.

The current import ban on gasoline and diesel fuel will alsoreportedly be lifted immediately upon WTO entry.

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SCRAMBLE FOR MARKET SHARE

Domestic competition had become cutthroat with national players accused of both restricitingsupply and increasing prices of wholesale products sold to independent retailers

The global majors formed partnerships with China s national firms in an attempt to gain a foothold inthe countrys most desirable market.

BP Selling retail fuel since 1996. BP- Sinopec ( 60% owned by Sinopec ). BP- Petro china( 51% owned by Petro china).

Exxon Mobil Entered into an agreement with Sinopec in Sept 2000 to develop a 500 service station JV in Guangdong The JV was to be 55% owned by Sinopec, with Exxon Mobil and Saudi Aramco evenly splitting the rest.

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ROYAL DUTCH SHELL

Kerosene supplier. Oil depots and filling stations by 1948 Re-entered fuel market in 1996, opening service

stations in Guandong, Beijing, Tianjin, Nanjwing and

Wuhan Joint venture with sinopec, signed in 2004 to establish

new service stations in Jiangsu and Shanghai. Sinopec 60% owner and exclusive fuel supplier. Planned to acquire 400 service stations fromSinopecs

existing network Both companies agreed not to compete in areas jointly

covered.

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TOTAL FRANCE

Established in Wuhan in October 2004. Sinochem- Total

had to set up network of 200stations in Beijing, Tianjin, Heibei and Lianing.

Another partnership in September 2005 to set300service stations in Jiangsu, Zhejiang andShanghai.

Sinochem controlled 51% of both deals.

Total was located in north eastern coastal city ofDalian.

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COMPENSATION

Profits had been shifted from the oilproduction and marketing and distributionsegment.

Received government subsidies.

Sinopec and Petrochina received a rebatefrom the government on value added taxon oil products such as gasoline anddiesel

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CONCLUSION

To protect the poor and hold back inflation,governments across Asia, including china, have eithersubsidized fuel prices by using their own budgets , or worse,kept them low by twisting retailers arm.

The low fuel prices, which have helped to fuel Chinaseconomic growth, are not sustainable, and China cannot buildpower plants fast enough to satisfy the excess demand atcurrent controlled prices. It will be interesting to see howChinas competitiveness is affected when firms are forced toabsorb the full cost (or more of the cost) of energy inputs into

production decisions. "The government should smash the duopoly by introducing

more market players in the oil sector including privatelyowned oil companies and foreign firms