To fall or not to fall? While analysts ponder what the future holds for the financially crippled China Aviation Oil (Singapore) Corp Ltd (CAO), they do not expect the firm's problems will sound alarm bells within China's jet fuel supply market.

But they do suggest the Singapore-listed firm's business troubles may accelerate the segment's opening to greater competition.

"Our business ... will not be dampened by the import gap left by CAO's US$550-million trading loss," a senior official with the Strategic and Development Department of China Aviation Oil Holding Co (CAOHC).

"As a matter of fact, two-thirds of the domestic jet fuel supply come from local oil producers, and the remaining part is imported. Even though CAO has halted operations, we can ... buy oil from other importers." Parent company CAOHC owns 60 per cent of CAO.

CAOHC, the official said, is preparing to establish another subsidiary to replace CAO.

"The plan is to establish the firm as a subsidiary under CAO. We are working on details to establish it," released Bian Hui, CAOHC's spokesman.

Bian hinted CAOHC might begin bidding, globally, to import jet fuel import for next year.

However, he remained coy about the timing of the subcompany's creation, and about the amount of investment likely to be involved. He said further details will be released eventually. "I cannot provide more details at the moment," Bian said.

One of CAOHC's priorities is to guarantee the money injected into the subsidiary will be safe, Bian added.

"Before there is an actual investment, we have to create a mechanism to safeguard the future company's money, and to make sure it will be used only to purchase jet fuel," Bian added. Any reshuffle at CAO will be in keeping with practices in a market-oriented economy, he added.

"I suppose the final solution will be market-based, because the trouble is deeply rooted in the market," Bian said.

When asked about a possible reshuffle, Bian said he could not speculate about the outcome, as there are many variables, based on market circumstances.

"But we are quite confident, because, in addition to the failure in speculative oil trading, CAO has done quite a decent job in other businesses, such as importation of jet fuel and overseas investment," Bian stressed.

The Chinese Government requires jet fuel, which it categorizes as a special oil product, and which is in high demand, must be managed centrally.

Given CAOHC's virtual monopoly over the segment, the price of domestic jet fuel can be two times of what is charged in the international market.

Domestic airlines have long been unhappy, and have often cried foul, over this situation.

"Our per-passenger per-kilometre revenue is almost on par with our US counterparts, but oil costs usually account for 3 per cent of their expenditure, while the proportion for us is about 30 per cent," a local airline employee said, on condition of anonymity. "If we can manage to keep fuel costs down, there will be room for further growth."

The civil aviation authority's statistics indicate jet fuel expenses account for 20-30 per cent of local carriers' overall costs.

"We hope there will be greater competition in the jet fuel supply market to counter the negative effects resulting from the monopoly," said Liu Gang, manager of China Eastern Airlines' Beijing office.

"The monopoly also is not good for CAOHC's development. In fact, CAO's losses are proof of internal control problems at CAO," Liu added.

Analysts suggest CAO's financial troubles may provide Chinese authorities with a great opportunity to end the monopoly.

"It may be an opportunity for the country's oil watchdog to think about easing control over the sector. In fact, some local oil producers have long been interested in entering the segment," said Zhao Baoling, professor of the Research and Development Department under the Civil Aviation Management Institute of China.

Zhao said greater competition, and even foreign investment, can be eased into the sector.

"The involvement of foreign capital may help, in terms of strengthening internal control and balancing power, while greater competition will divert risks and lead to higher service standards," Zhao suggested.

He said it is natural for the industry's authorities to maintain tight control over oil supply, as that is a national security matter.

However, at the microeconomic level, the market should be the fundamental driving force, Zhao suggested. "Only in this way, can service quality be enhanced and risks be fended off."

For the time being, Zhao suggested, the pace of reform may be slower than expected. He said authorities should step up the process.

China imports about one-third of the nearly 8 million tons of jet fuel it uses annually. But given the nation's galloping economic expansion, and increasing aviation capacity, its jet fuel demand is growing at a double-digit pace.

China, which entered the World Trade Organization three years ago, is expected to open its domestic retail oil sector by the end of this year.

It is expected to open its wholesale sector by the middle of 2006.

Chinese authorities have not announced how they plan to open the aviation oil sector.

However, the CAOHC official hinted his firm might consider finding partners to diversify its stakeholding structure, and to take advantage of its partners' core strengths.

Sinopec Group and China National Petroleum Corp (CNPC) last month signed a deal with CAOHC to secure a share of the latter's domestic jet fuel distribution network.

CAOHC owns 51 per cent of the joint venture; Sinopec, 29 per cent; and CNPC, 20 per cent. The venture will supply jet fuel to more than 100 airports in China. "It is, in fact, a sign of market openness," CAOHC's official said.

Another CAOHC official said allegations of a sector-wide monopoly are erroneous, as the Shanghai Pudong International Airport is allowed to import some of its jet fuel.

On November 30, CAO announced it was seeking court protection from creditors, after it reported losing US$550 million through speculative oil trading.

A short time later, CAOHC asked China's four State-owned traders -- Unipec, Chinaoil, Sinochem and Zhuhai Zhenrong Corp -- to take over CAO's existing import contracts, as an import agent.

Unipec is the trading arm of Sinopec Corp, and Chinaoil is a unit of PetroChina, whose major shareholder is CNPC.

The four State-owned traders controlled China's jet fuel imports in the 1990s, before CAO won the bidding, in 2001, to operate as a virtual monopoly.

(Business Weekly December 15, 2004)