Energy & Chemical Sector: Seeking Investment Opportunities in a Background of Reform

By Lian Yidong, Beijing Capital Futures Co., Ltd.

In a background of continual adjustment of the economic structure and relatively slow GDP growth, traditional energy and chemical enterprises will face challenges whereas policy-benefited enterprises, clean energy enterprises and high-tech enterprises will have more opportunities.
The stock prices in Chinese exchanges fell again in 2013. The Shanghai Stock Exchange composite index was down by 6.75% and Shenzhen Stock Exchange composite index was down by 10.91%. The performance of the stock market in China was at the bottom in various major stock markets of the world. We can say that the sustained reduction of the stock market in China has reasons in both the national economy and institutional structure of the securities business. When major stock indexes in the United States and Europe are seen to hit historical new highs, can 2014 be a turning point for the stock market in China? In parallel, how will the energy & chemical sector perform? These questions are what investors are pondering.

Energy & chemical sector outperformed the stock market in 2013

In the whole year of 2013 the overall financial performance of the energy & chemical sector was disappointing, especially Sinopec and PetroChina. The annual reduction in share price of both companies was over 11%. Not only the energy & chemical index was affected, a pressure was also produced on the entire stock market. The profit-making of most energy and chemical enterprises fell short of anticipation. One reason was that the overall slowdown of China’s economic growth limited demand growth. The other reason was that China’s capacity to make most chemicals was in surplus. Imbalanced supply/demand resulted in price drops for most chemicals. Take chemicals in the futures market for instance. Except for the price of plastics, which increased slightly in 2013, prices of other varieties all declined. Natural rubber prices fell more than 30%. With prices falling, enterprises had a hard time, operating rates were cut and some sectors had to reform.
Needless to say, some chemical sub-sectors performed quite well in 2013. For example, pesticides, chemical fibers (spandex), daily chemicals, dyestuffs, coatings, marine equipment and shale gas were outstanding. They not only outperformed the stock market, but also created some super bull stocks. Sino Geophysical Co., Ltd., which provides services to oil companies in seismic data processing and integrated oil discovery, gained the right to the prospecting and development of the 05/31 oil block in the Bohai Sea and became one of the few domestic enterprises mastering the world’s advanced third-generation seismic imaging technology. The company’s share value grew 326.82% in 2013, holding the fifth place in the two stock markets of China. Jiangshan Co., Ltd., which produces pesticide glyphosate, Huafon Spandex, which produces spandex, and Zhejiang Lonsen and Runtu Co., Ltd., which produce dyestuffs and pigments, became stars of 2013’s stock markets.
It can be seen that in the overall reduction of the stock market in 2013 there were still some bright spots in the energy & chemical sector. The performance of the sector was better than the stock market, but could hardly reverse the status of the entire energy and chemical sector. The overall situation is related to the ongoing economic restructuring of China. Economic restructuring will continue for a considerable period of time, and its impact on the energy & chemical sector will certainly also continue.

The macro economy is still in a complicated and variable state

The economic situation around the world improved somewhat in 2013. Most outstanding was the brisk rehabilitation of the economy in the United States. The economies of advanced countries gradually got out of the shadow of the debt crisis. The unemployment rate in the United States had already dropped to 6.6% in January 2014, being the lowest since October 2008. Data in other aspects such as real estate and commercial sales were also much better. These factors promoted the stock market in the United States repeatedly hit historical new highs. The American economy can still grow quite rapidly with only small fluctuations in 2014. This will greatly help advanced countries in Europe to completely shake off the economic doldrums.
The economic situation in China is more complicated. First of all, as the economic structure is in a period of adjustment, GDP growth will not be very rapid. According to market projection, the GDP growth will be lower than 8% in 2014 and the goal of macro control will likely be maintained at around 7.5%. In this way, the government will not issue large-scale economic stimulus schemes and the status of slack demand can hardly change fundamentally. Secondly, the monetary policy cannot keep its independence either. As funds outstanding for foreign exchange become more enormous, the appreciation of Renminbi to U.S. dollar can hardly be reversed. There were frequent cases of “credit crisis” in 2013 and 2014 will be no different. The government needs to take necessary measures to guide the capital flow to the manufacturing sector. Lastly, local governments have huge debts, totaling around RMB19 trillion in 2013 and likely to exceed RMB20 trillion in 2014. Schemes for solving the problem can hardly start implementation in near future. All these factors pose challenges to the sustainable development of the economy.
Judging from the economic situations at home and abroad, therefore, China’s economic development will be erratic in 2014. The positive influence on the enthusiasm of the capital market may not be as great as anticipated. Problems in the stock market itself are also yet to be solved. As a result, there will not be so many overall investment opportunities in the stock market, and structural investment opportunities may sometimes emerge.

Seeking investment opportunities in a background of reform

The National Energy Administration issued the “Guiding Views for the Energy Work in 2014” at the beginning of 2014. It is proposed in the document that a scheme be formulated for comprehensively deepening institutional reform of the energy sector. Focuses include market-opening reform of oil/gas upstream sectors (oil/gas prospecting, development and import), reform of oil/gas midstream sectors (oil/gas pipelines) and improvement of oil/gas pricing mechanisms. The market-opening of oil/gas upstream sectors will bring huge opportunities and benefits to private investment institutions and ordinary consumers and also benefit some listed companies, most of which own oil refineries. By national policy, they can purchase feedstock only from the four oil giants of China, and the cost is therefore high. Once the market is opened, the profits of these enterprises will improve drastically.
Trading of crude oil futures will also be proposed this year. In this way, risk hedge tools will be provided to a great number of state-owned and private oil-product producers and traders. Production and operation modes of these enterprises will be shifted. Such changes will finally be reflected in their financial statements.
The new-materials sector will still be one of the bright spots in the energy & chemical sector this year. Electronic chemicals, high-performance polymer materials and glass fiber materials are major chemical new-material sectors for the production development of some listed companies. Specific products include liquid crystal polymers, color polymerized carbon powder, electronic-purity reagents, special rubber and plastic polymers, fluorine resins and glass fiber reinforced plastics. New-material stocks can still seize the attention of institutional investors and have eye-catching performance.
The apparent consumption of natural gas in China was 169.2 billion cubic meters in 2013, an increase of 12.9% over the previous year. The output of natural gas in China was 121.0 billion cubic meters, only an increase of 9.8%. Supply shortage is still the main feature of the natural gas market. Such status will not be changed in 2014. With the support of state policies, the recovery of non-conventional natural gas will be strengthened. According to projection made by the Ministry of Land and Resources, the total output of shale gas, tight sand gas and coal-bed gas in China will be doubled to reach 700 million tons oil/gas equivalent in 2030, accounting for 1/3 of the total natural gas output. Investments made by PetroChina and Sinopec in the development of shale gas will have a drastic increase in 2014 and a new profit growth point will hopefully be formed.
On December 17, 2013, the Ministry of Land and Resources held a news release conference of achievements made in the prospecting of seawater natural gas hydrates in 2013. High-purity new natural gas hydrates were first discovered in eastern seawaters of the Pearl River Basin. It means that major breakthroughs have been made in the prospecting and development of natural gas hydrates in China. The large-scale application of natural gas hydrates still needs to take a considerable period of time, but relevant service companies will be benefited in advance. Listed service companies include China Oilfield Services Limited and Offshore Oil Engineering Co., Ltd., which are engaged in offshore drilling services and logging while drilling services, as well as Jereh Oil Services Co., Ltd., LandOcean Energy Services Co., Ltd., HBP Technology Co., Ltd. and Furui Special Equipment Co., Ltd., which will be benefited from the logging service, production, storage and transportation of natural gas hydrates.
As the economic structure has sustained readjustment and the GDP growth is at a relatively low level, some traditional energy and chemical enterprises will be faced with some challenges and will not have many investment opportunities. By contrast, in a macro background of reform some policy-benefited enterprises, clean energy enterprises and high-tech enterprises will still have opportunities to play their part. The performance of the energy & chemical sector will still be better than the stock market in 2014. It will be one of investment orientations worth the great attention of investors.