Jiang Jiemin, who recently stepped down as Chairman of PetroChina Company Limited, apologized to shareholders in May. “We know that it is retail investors and minority shareholders who have been stuck with PetroChina’s A-shares. The combined investment of the top ten shareholders accounts for less than 3% of the total A-shares issued. I’m really sorry.”
The apology left many people puzzled.
As China’s largest oil producer, PetroChina pumped out 11.1 million barrels of oil and oil equivalent (including natural gas, etc.) in 2007. But its share prices continued to slide while the prices on the international market have skyrocketed. At one point, the shares bottomed out at RMB15.4 (US$2.2) per share from a peak of RMB48.6 (US$7.0) per share at the beginning of the IPO, a 70% drop in value in just six months. During the same time, international oil prices have soared by 50%.
“With the windfall profits tax and the price inversion between oil and petroleum products, PetroChina could not enjoy the benefits from high oil prices, and worse, the higher the oil prices go, the less profit there is,” explains Li Chen, an analyst with Guosen Securities, “The share prices naturally go down because earnings are weaker.”
The so-called windfall profits tax refers to a government-imposed special tax on profits from oil products when the oil prices are beyond US$40 a barrel. The government takes a 20% special oil gain levy of anything beyond that. After that, for every increase of US$5 a barrel, the tax jumps by 5%. So, when oil prices hit US$130 a barrel on the international market, PetroChina is forced to pay a windfall profits tax US$33.5 per barrel, while the cost of pumping out the oil reaches US$50 a barrel.
It would seem that PetroChina could get a gross margin of more than US$40 a barrel in that case, but in reality, the price inversion between oil and petroleum products makes the profit shrink. The price inversion is even worse than the tax issue.
The prices of petroleum products in China are restricted to a government-regulated price range, which sellers are only allowed to exceed by a maximum of 8%.
“The regulated price range became even narrower when the government began to implement measures to curb inflation at the end of 2004. The government only made a few limited adjustments to the oil prices,” says a senior officer with PetroChina, “The result was that while the international oil prices rocketed past US$100 a barrel, the prices of oil products in China increased by only RMB2 (US$0.29) per liter (3.785 liters=1 gallon). So, the prices of oil products are even lower than the price of raw oil! In fact, the international price of 93 octane gas is about twice what it is in China.”
The price inversion has meant massive losses in large-scale oil-refining at PetroChina. In 2007, it produced 71.38 million barrels of petroleum products, but lost RMB20.6 billion (US$3 billion) in refining. Sales of petrochemicals resulted in a net profit of RMB7.83 billion (US$1.1 billion), but when the refining losses are factored in, the net loss is actually RMB12.77 billion (US$1.8 billion). “We are paying the bill for below-market consumer oil prices for the entire country!” exclaims the senior officer at PetroChina. Compared with SinoPec, PetroChina’s refining business has two other disadvantages: its refineries are too small and they are far away from the major consumption markets, which further amplifies the losses.
According to the senior officer, even though China National Petroleum Corporation (CNPC, of which PetroChina is a subsidiary) was given rich upstream resources but feeble refining capacity when it was incorporated in 1998, PetroChina is much weaker than Sinopec in terms of profitability and the ability to counteract risks.
In addition to tumbling profits, the plunging share prices after such a high premium are predictably causing distress for shareholders. There have even been points at which the price dropped under the level of subscription, while the prices of PetroChina’s H-shares dropped nearly 50%.
“Jiang shouldn’t have said that PetroChina would allow shareholders to ‘share’ its profits. Now I’m stuck with the company because I actually believed him!” says one agonized investor. But what if Jiang did want shareholders to share the profits, and the A-shares were issued at 80% of the price of H-shares. Retail investors were so confident about PetroChina at the time, calling it “the most profitable enterprise in Asia”, that they chose to ignore the risks. They rushed in to gobble up shares and forced the price up to RMB48.6 (US$7.0) a share, three times the offer price and more than twice the peak price of PetroChina’s H-shares at HK$20.25 (US$2.59) per share. The result was inevitable.
But one month before PetroChina issued A-shares, the prices of its H-shares had already soared to twice the offer price. So, even if the A-shares were issued at 80% of the price of H-shares at that time, it was not cheap, and anybody with a modicum of common sense would have realized that.
“The entire situation results from the monstrous capital market in China,” claims an analyst from a global investment bank. “Most market players can only go with the ‘bigger fool’ theory (when an investor hopes that even though he paid too much for a stock, there is still another investor that will pay even more for it) since capital is not allowed to flow freely and short-selling is curbed.”
He say investors have nowhere to go but the stock markets and real estate because China does not have a deregulated capital market and there are still no other investment outlets for the free money. In addition, investors tend to gravitate to enterprises with good reputations. To make money, retail investors have no choice but to follow the “bigger fool” theory. The biggest losers are the ones who get in at the height of the hype.
