Sell Sinopec

Robert Hsu, February 01, 2008

I first recommended China Petroleum and Chemicals—commonly known as Sinopec (NYSE: SNP)—back in May 2006 as a play on higher oil prices and decreasing regulation in China's gasoline market.

But recently news has come out that suggests the Chinese government will no longer ease price controls. In the China Strategy Dispatch that I e-mailed to you on January 17, I told you that China's government, which is worried about inflation, decided to impose price freezes on key commodities including gasoline, fertilizers, meats, milk and noodles. I moved Sinopec to a hold in our portfolio while I researched the situation further.

Now I want you to sell your stake in Asia's largest oil refiner and distributor. For the full year 2007, Sinopec produced 2.3% more crude oil compared to 2006. With increased production and a higher crude oil price, earnings from the company's exploration and production division should have been higher in the second half of last year.

What we're likely seeing is the damaging effects of China's decision to maintain tight price controls on Sinopec's products. This is simply not an environment that the company can flourish in and it could actually wipe out the company's core earnings in the coming months.

Beijing's desire to curb inflation has turned the tide back to more state controls and less of a free market for fuels. The government also seems less willing to continue to provide subsidies that have helped the company for the past year.

Because of rising inflation in China, the possibility of reduced subsidies and no sign of a full liberalization of oil product prices anytime soon, I recommend that you sell your shares of Sinopec.

For more information regarding China's oil industry or rising inflation, subscribe to China Strategy today.

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