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 
 
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SUMMARY 
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¶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