Early Monday, Sinopec (NYSE:SNP), China's biggest refiner and the country's second-largest integrated oil company, reported results that showed the effect government price caps are having on refiners' profitability.
The company, formally known as China Petroleum and Chemical Corporation, announced that revenue for the six months ended June 30 climbed approximately 34% to $61.8 billion, fueled primarily by a 32% gain in refined product revenue and a 24% increase in petrochemical sales. (For currency translation purposes, $1 = 7.976 yuan.) External crude oil and natural gas sales (i.e., those not used internally for refining or chemical production) climbed roughly 40% to $1.5 billion and represented 2.5% of total sales.
You'd normally think that such strong revenue growth would lead to similar gains in profitability, right? Unfortunately, that's not the case in China. There, for reasons of "social stability," the government imposes price caps on gasoline sold to various lower-income groups such as farmers and cab drivers. As a result, gasoline prices tend to be 20% below international levels despite Beijing's allowance of two rate increases earlier this year.
The effects of these price caps were starkly illustrated by the fact that Sinopec reported first-half profits of $2.7 billion or EPS of $0.03, up a mere 8.9% from last year's period. Losses in the company's main refining business (65% of total sales) mushroomed from a loss of $163 million last year to one of roughly $2.1 billion in the past six months. Luckily, these losses were offset by the exploration and production business, which saw profits climb 87% to $4.2 billion.
That being said, Sinopec is primarily a refining company, and I don't know if I'm entirely comfortable owning a company that operates with its main business being subject to government-mandated price controls. I also don't like the fact that, due to these price controls, Sinopec's short-term debt jumped to $8.2 billion, up more than 61% in the first half of the year.
Don't get me wrong -- I think shares of Sinopec will probably reward investors in the long term. But until the Chinese government relaxes its position on price controls, I'd rather own shares of a company with more exposure to the upstream business and less reliance on refining: PetroChina (NYSE:PTR).
Fool contributor Will Frankenhoff does not own shares in any of the companies mentioned above. Get a risk-free 30-day trial of any of the Fool's newsletters by clicking here. The Fool's disclosure policy is always refined.
