Like oil refiners everywhere, China Petroleum and Chemical Co. (NYSE:SNP), better known as Sinopec, had a tough year in 2009. The company’s revenues were down nearly 7%, but EPS was up more than double on a big improvement in operating profit. The profit gain was mainly attributable to a loosening of tight central government control on the price of refined products.

Throughout all of 2008 the government forced refiners to sell at below cost to insulate the population from the fearsome rise in crude oil prices. In 2009, these price controls were relaxed and profits recovered nicely.

Sinopec has also been on a buying spree in recent months. The largest deal was the acquisition of ConocoPhillips Corp.’s (NYSE:COP) 9% stake in the Syncrude joint venture for about $4.65 billion. The company also acquired rights to deep-water assets offshore of Angola, buying a 55% stake in a joint-venture with Angola’s national oil company for $2.46 billion. Sinopec bought the stake from its parent company, China Petrochemical Corp.

Coughing up more than $7 billion could easily strain even a company the size of Sinopec. It expected that it would borrow from Chinese banks for at least some of the cash. However, the government has tried to put a lid on bank loans, which have gushed out of the banks and contributing to the overheating of China’s economy.

What Sinopec has decided to do is issue fixed-income, exchange-listed bonds worth about $2.93 billion. This is the largest offering ever in China of this type. The company plans to use the proceeds to repay bank loans and to add to its working capital as it develops its Angolan and other acquisitions.

Sinopec is, once again, doing the government’s bidding by issuing these bonds. Bonds play almost no role in funding Chinese companies, most of which just line up at well-stocked banks with their hands out. Because the banks have so much cash and are so willing to lend it out, investment in real estate and housing, in particular, are driving up prices and inflating a couple of bubbles that the government would rather not see burst.

China has two ways to try to cool the overheating economy. First, allow the currency to appreciate by a significant amount. The government has so far been unwilling to do that.

The second is to reduce the amount of credit available. The government hopes that fixed-income bond issues like this one will soak up some of the economy’s demand for credit. Without a shift away from investments in real estate and housing, China faces the imminent problem of seriously mis-allocated capital and will have to pay a heavy price to straighten things out.

Part of that price will be increased expenditures for energy, particularly crude oil. China is currently consuming about 8.1 million b/d, and is on pace to increase demand by more than 10% by the end of the year. That’s 25% of the estimated global crude oil production increase for 2010.

Chinese firms other than Sinopec are also actively buying upstream assets in an effort to moderate the effects on the country’s economy from rising crude prices. Cnooc Ltd. (NYSE:CEO) spent $3.1 billion for a 50% stake in an Argentinian oil company and PetroChina Ltd.’s (NYSE:PTR) parent company has joined BP plc (NYSE:BP) in a deal to operate a large oil field in Iraq.

Cnooc, which reported quarterly results today, more than doubled first-quarter revenues compared with the same period a year ago, and increased production by nearly 32%. Interestingly, the company did not provide a profit number.

If Sinopec’s bond issue is successful, it’s not too big a stretch to think that Cnooc and PetroChina and others might follow suit. The companies have substantial assets and steady revenue streams for years to come. By issuing exchange-listed bonds, the Chinese oil companies could ease the demand for credit from China’s banks, and restrain the explosive growth that the country seems unable to slow down.

Paul Ausick

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