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Cablegate: China/Energy: Fuel Shortages Tied to Independent

VZCZCXRO2560
PP RUEHCN RUEHGH RUEHVC
DE RUEHBJ #7052/01 3180826
ZNR UUUUU ZZH
P 090826Z NOV 07 ZDK
FM AMEMBASSY BEIJING
TO RUEHC/SECSTATE WASHDC PRIORITY 3371
RHMFIUU/DEPT OF ENERGY WASHINGTON DC
INFO RUEHOO/CHINA POSTS COLLECTIVE
RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/USDOC WASHDC
RHEHNSC/NSC WASHDC

UNCLAS SECTION 01 OF 03 BEIJING 007052

SIPDIS

STATQ FOR EAP/CM - SECOR
STATE FOR EEB/ESC - SIMONS/HAYMOND/WECKER
DOE OEA FOR CUTLER, NAKANO
TREASURY FOR OASIA DOHNER, CUSHMAN
USDOC FOR 4420

STATE PASS USTR FOR STRATFORD

SIPDIS
SENSITIVE

E.O. 12958: N/A
TAGS: ECON ENRG PGVO EINV EPET EFIN CH
SUBJECT: CHINA/ENERGY: FUEL SHORTAGES TIED TO INDEPENDENT
COMPANIES' SWING CAPACITY

REF: BEIJING 06396

-------
SUMMARY
-------

1. (SBU) China's ongoing struggle with fuel shortages underscores
the role of both independent refiners, which control approximately
15 percent of capacity, and independent retailers, which run half of
the country's filling stations. Experts we spoke with believe that
last week's gasoline and diesel price increases are insufficient to
bring most independent oil refiners back into the market.
Meanwhile, national and provincial independent oil associations are
laboring to give their members more voice and presence in the
market. This includes looking abroad for partners and stressig the
need for improved product quality. Howver, the Central Government
appears intent on marginalizing the independents -- in part on
environmental grounds -- and at least one province we just visited
is following suiT Given the inability of government-run oil
companies to expand refining capacity rapidly enough to compensate
for any loss of independent supplies (amid rapidly rising fuel
demand), Beijing appears stuck with the independents for the time
being. This awkward mixture of capped prices with dependence on
market-incentivised producers/sellers will likely leave the
government struggling with the choice between filling station
shortages or consumer resentment against higher costs as long as
international oil prices remain at current levels. END SUMMARY

--------------------------------------------- ----
ONE WEEK ON, LOCAL PRESS DEBATES OIL PRICING MOVE
--------------------------------------------- ----

2. (SBU) One week after Beijing raised gasoline and diesel prices in
hopes of alleviating growing fuel shortages (ref), local Beijing
newspapers are highlighting the debate over the move's merits. On
one side stand China's national oil companies (NOCs), which assert
that their oil refinery operations are still losing money despite
the price increase. They cite their warnings months ago to the
Chinese Government that prices should increase. Standing in
opposition, local consumers are unhappy at paying more for fuel
while the NOCs earn large profits (the companies' refinery losses
are more than offset by profits in other areas, such as
petrochemicals). There is also growing backlash against the high
salaries and lavish benefits many locals claim NOC employees earn.
The China Economic Times, the official newspaper of the State
Council's Development Reform Commission (DRC), reports that the
Chinese Government is considering both viewpoints as it monitors the
country's oil supply situation.

----------------------------------------
EXPERTS SEE NEED FOR FURTHER PRICE HIKES
----------------------------------------

3. (SBU) A senior DRC official told Emboffs this week that the
shortages suggest a need to end regulated refined oil product prices
and pass along the true costs of energy prices to consumers, in part
to encourage conservation. Separately, a Sinopec (the top refining
company) executive told us that the price increase is insufficient
to bring independent refiners back online in forc_ (Note:
Independents are estimated to account for 12 to 19 percent of
refinery capacity. End note.) Sinopec is buying oil and refined
lQ9QLBUproducts in the international market and increasing its refinery
output to ease the shortage, said the executive.

4. (SBU) The Sinopec executive said Bhe company expects
international oil prices to fall by late-December. The firm is
paying close attention to the impact of rising oil prices on the
United States economy, since oil prices might soften if the economy
cools. Executives from a major international oil company we spoke
to agreed that many independents probably will remain on the
sidelines. Sinopec and other Chinese national oil companies (NOCs)
are incapable of fully making up for the capacity loss, according to
the western executives.

-----------------------------------
ROLE OF INDEPENDENTS COMES TO LIGHT
-----------------------------------

5. (SBU) The recent gasoline and diesel shortage has brought the
role of Chinese independent oil companies into the light. A senior

BEIJING 00007052 002 OF 003


official in China's independent oil association, the China Chamber
of Commerce for the Petroleum Industry (CCCPI), told us this summer
that the 1,000 plus CCCPI members do business throughout the
domestic oil supply chain, but are most prominent in the refinery
and retail sectors. China's independent refiners possess more than
one million barrels per day of capacity, around 15 percent of total,
and independent retailers operate some 50,000 gas stations, half of
China's total.

6. (SBU) The CCCPI official said that independent refiners rely on a
mixture of imported fuel oil (fuel oil is exempt from China's strict
crude oil import restrictions) and crude oil supplied by the NOCs to
supply their refineries. Similarly, independent oil retailers rely
heavily on the NOCs for gasoline and diesel supplies -- their
Achilles Heel, he suggested. The vulnerability for the independents
surfaces when the NOCs restrict supplies during fuel shortages in
favor of their own filling stations. The NOCs also disrupt supplies
as a way to counter business threats, such as on one occasion
several years ago when they drove an independent lubricant company
from the market. The CCCPI official added that the NOCs also
frequently target independent gas stations in areas where they want
to expand their retail business. (Comment: The CCCPI official did
not mention the role of theft. Other experts have told us that as
much as 10 percent of China's domestic oil production is siphoned
off, mostly to independent refiners. Shengli oilfield in Shandong
Province alone likely loses more than 100,000 barrels per day. End
Comment.)

----------------------------------------
INDEPENDENTS LOOK ABROAD FOR SUPPLIES...
----------------------------------------

7. (SBU) The CCCPI officials said that the independents have tried
to get around their supply problems by looking abroad for alliances
with foreign governments and companies. The association now has
ties with similar organizations in Canada, Kazakhstan, and Russia to
facilitate interaction between its members and private companies in
those countries. For example, 40 CCCPI member companies attended a
2006 oil and gas forum in Pakistan resulting in several deals.
CCCPI hopes that some member companies will develop exploration and
production opportunities abroad later this year, said the official.

--------------------------------------------- ---
...WHILE TRYING TO IMPROVE THEIR COMPETITIVENESS
--------------------------------------------- ---

8. (SBU) The CCCPI official stated that independents need to improve
their competitiveness. Most important is improving product quality,
which would make independents more attractive to retailers as an
alternative to NOC suppliers. Independents also must improve their
after-sale services and where possible expand their sales territory.
Such improvements require cooperation among the independents that
so far has been lacking. The official said that the association
hopes that a large independent group company can evolve if such
cooperation materializes. The previous attempt at an integrated
private oil company, the Great Wall Oil Company, failed, but the
association believes that such a company is still possible, said the
official.

--------------------------------------------- --
BEIJING REGULATORY MOVES CONSTRICT INDEPENDENTS
--------------------------------------------- --

9. (SBU) Despite the association's optimism, Beijing has issued new
regulations that restrict the independents as a market force. New
foreign investment regulations issued on November 7 include
prohibitions on foreign firms investing in refineries with less than
160,000 barrels per day of capacity. This limits independent
refiners' access to outside capital and cuts off a possible
alternative source of oil to refine. Earlier this year, Beijing
began opening up its oil import market. The CCCPI publicly called
for 600,000 barrels per day of licenses to be given to independents.
Instead, Beijing limited the independents to 135,000 barrels per
day. Furthermore, Beijing spread the licenses across 15 companies,
effectively diluting any one company's market impact.

--------------------------------------------- -------
VIEW FROM PROVINCES EQUALLY BLEAK FOR INDEPEDENTS...
--------------------------------------------- -------


BEIJING 00007052 003 OF 003


10. (SBU) A representative for an independent oil company
association in Shandong Province, the Shandong Chamber of Commerce
for Petroleum and Clean Fuel Industry (SCCPI), recently told Econoff
that inadequate supplies constantly plague its members as well.
SCCPI members hope better ties with local and foreign businesses can
help alleviate this persistent problem. Local independents
recognize a need to improve the quality of petroleum products if
they want to become more competitive. Independent retailers
frequently sell poor quality fuels and lubricants, often advertised
and priced as high-end goods. The SCCPI representative said that
his organization is in frequent contact with the national
independent oil company association and has ties to similar
provincial associations in Guangdong, Heilongjiang, Hebei, Jiangsu,
Xinjiang and Zhejiang.

-------------------------------------
... AS LOCAL GOVERNMENT TURNS UP HEAT
-------------------------------------

11. (SBU) A senior Shandong Development and Reform Commission (DRC)
official told us that local independents oil companies face a grim
future. Independents must invest in technology upgrades and reduce
emission levels if they want to stay in business much longer.
Independent refiners in the province have long been supported by
local governments because of the jobs and tax revenue provided by
the companies. This protection is in jeopardy. The Shandong DRC
official said Shandong Province supports Beijing's goal of closing
down small, inefficient, and environmentally unfriendly industrial
plants. An energy consultant in Beijing told us that several very
profitable independent refiners in Shandong Province recently closed
because they recognized that their local and provincial government
protection would likely soon run out.

--------------------------------
COMMENT: CAN'T LIVE WITHOUT THEM
--------------------------------

12B(SBU) China's recent fuel shortages are largely a result of
independent refiners being forced to shut down because regulated
refined oil product prices offer insufficient margins when set
against the cost of imported oil. Although new environmental
regulations appear on the surface to threaten the futureNof the
independents, China's oil companies cannot possibly build refineries
and gas stations fast enough to meet the country's rising demand to
compensate for the capacity loss. Beijing could obviate the need
for some of the independents by allowing the market to set fuel
prices and further opening its market to foreign oil companies eager
to do business here. An Exxon Mobil official recently told us that
the company already has a joint venture refinery in Fujian and a
co-branded retail network, although it too claims to be losing money
on refinery operations. Exxon officials say that although Sinopec
agreed in principle to share government subsidies for losses on the
refinery project, they have yet to receive any payments.

13. (SBU) However, both options -- market pricing and market access
for foreign companies -- threaten the NOCs. These factors taken
together suggests the independents are likely to remain a fixture of
China's fuel market for the foreseeable future -- and the government
may well struggle with fuel shortages so long as it keeps oil prices
well below international prices.

RANDT

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