Fitch: China's refining profit margins are expected to benefit from policies to curb vicious competition

Fitch Ratings expects that China's "anti-involution" policy aimed at curbing vicious competition will provide moderate support to the financial performance of the refining industry. With stricter restrictions on new capacity and the elimination of some existing capacity, profit margins are expected to stabilize. However, Fitch believes that the overcapacity of downstream petrochemical producers will persist, thus continuing to pressure profit margins.

The government's latest "Work Plan for Stable Growth in the Petrochemical Industry (2025-2026)" sets stricter capacity regulations for the refining industry, continuing the previous goal of phasing out 2 million tons/year and below atmospheric distillation units. According to the latest plan, the scale of new capacity can only be less than the eliminated capacity, indicating that national refining capacity will remain flat or even decline in the coming years.

As of the end of 2024, China's crude oil refining capacity has reached 955 million tons, close to the government-set cap of 1 billion tons. Fitch believes this cap is a hard constraint, as in the past, when capacity approached the limit, regulatory authorities would enforce capacity reductions, the most recent of which occurred in 2022 when several small "independent refiners" were forced to exit.

Affected by the popularity of electric vehicles and the expansion of electrification, China's gasoline and diesel consumption is declining, but petrochemical demand is rising with economic expansion. This has prompted China National Petroleum Corporation (NOC) to invest in oil-to-chemical refining capacity, which may partially offset the weakening of traditional fuel sales.

Fitch expects that the control of new capacity in the action plan will help enhance market concentration and eliminate backward capacity, leading to a moderate recovery in refining profit margins. However, if the government's capacity control is less effective than Fitch expects, an increase in output may drag down the recovery of profit margins.

In the petrochemical sector, the work plan mentions reducing the risk of overcapacity in industries such as coal-to-methanol, but Fitch believes that making significant adjustments to the petrochemical sector is challenging. The government may continue to support large integrated projects to fill the supply gap for high-end petrochemical products, but this also poses greater challenges in resolving low-end overcapacity, especially since the diversification of the industry and the production interconnections between products make it difficult to precisely control the supply of a single product. Therefore, Fitch believes that the "anti-involution" policy will have limited short-term impact on the supply of petrochemical products.

Fitch stated that in recent years, the pace of capacity expansion for basic products such as ethylene and propylene, as well as polymers like polyethylene (PE), polypropylene (PP), polyvinyl chloride (PVC), and propylene oxide, has outpaced consumption. The growth rate of exports for these basic products is insufficient to resolve the overcapacity dilemma, and it is expected that the low profitability in this sector will persist.

Among the issuers rated by Fitch, integrated national oil companies such as China National Petroleum Corporation (PetroChina (00857.HK), A/stable) and China Petroleum & Chemical Corporation (Sinopec (00386.HK), A/stable) are expected to benefit from the increased industry concentration in the refining sector. Their vertically integrated business structure provides them with a high degree of self-sufficiency and low raw material costs, which can alleviate profit margin pressures during downturns in the petrochemical industry.

Additionally, Fitch also expects that with the commissioning of several large projects in recent years, the capital expenditure pressure on national oil companies will ease between 2026 and 2030, thereby supporting profit margins. The aforementioned benefits are expected to be more pronounced for PetroChina, as its capital expenditure is primarily focused on the upstream sector and typically declines in tandem with weakening oil prices