20-F 1 form20-f.htm FORM 20-F form20-f.htm
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________
FORM 20-F
(Mark One)
 
o
REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934
 
OR
 
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
   
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2013
 
OR
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
OR
 
SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
DATE OF EVENT REQUIRING THIS SHELL COMPANY REPORT ……………….
   
FOR THE TRANSACTION PERIOD FORM ____________ TO __________

COMMISSION FILE NUMBER 1-15138

中国石油化工股份有限公司
 
CHINA PETROLEUM & CHEMICAL CORPORATION
(Exact name of Registrant as specified in its charter)
_______________________
 
The People’s Republic of China
(Jurisdiction of incorporation or organization)
_______________________
 
22 Chaoyangmen North Street
Chaoyang District, Beijing, 100728
The People’s Republic of China
(Address of principal executive offices)
_______________________
 
Mr. Huang Wensheng
22 Chaoyangmen North Street
Chaoyang District, Beijing, 100728
The People’s Republic of China
Tel: +86 (10) 5996 0028
Fax: +86 (10) 5996 0386
(Name, Telephone, Email and/or Facsimile number and Address of Company Contact Person)
________________________
 
Securities registered or to be registered pursuant to Section 12 (b) of the Act.

Title of Each Class
 
Name of Each Exchange
On Which Registered
American Depositary Shares, each representing
 100 H Shares of par value RMB 1.00 per share
 
New York Stock Exchange, Inc.
     
 H Shares of par value RMB 1.00 per share
 
New York Stock Exchange, Inc.*
 
*   Not for trading, but only in connection with the registration of American Depository Shares.
Securities registered or to be registered pursuant to Section 12 (g) of the Act.
None
(Title of Class)
 

 
 

 


Securities for which there is a reporting obligation pursuant to Section 15 (d) of the Act.
None
(Title of Class)
Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report.
 
H Shares, par value RMB 1.00 per share
25,513,438,600
A Shares, par value RMB 1.00 per share
91,051,875,187
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
 
Yes X                     No__
 
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
 
Yes __                     No X
 
Note - Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from their obligations under those Sections.
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
Yes X                     No__
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files)*
 
Yes__                     No__
 
*This requirement does not apply to the registrant in respect of this filing.
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer X                     Accelerated filer __                    Non-accelerated filer __
 
Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:
 
               U.S. GAAP ___
 
International Financial Reporting Standards X
as issued by the International Accounting
Standards Board
 
Other ___

If  “Other” has been checked in  response to the previous question,  indicate by check mark which  financial statement item the registrant has elected to follow.
 
Item 17__                      Item 18__
 
If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
Yes __                     No X
 
(APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PAST FIVE YEARS)
 
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. *
 
Yes__                     No__
 
*This requirement does not apply to the registrant in respect of this filing.


 
 

 
 
Table of Contents
 
Page
ITEM 1.
 
IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS
6
 
ITEM 2.
 
OFFER STATISTICS AND EXPECTED TIMETABLE
6
 
ITEM 3.
 
KEY INFORMATION
6
 
   
A.
 
SELECTED FINANCIAL DATA
6
 
   
B.
 
CAPITALIZATION AND INDEBTEDNESS
8
 
   
C.
 
REASONS FOR THE OFFER AND USE OF PROCEEDS
8
 
   
D.
 
RISK FACTORS
8
 
ITEM 4.
 
INFORMATION ON THE COMPANY                                                                                      
16  
   
A.
 
HISTORY AND DEVELOPMENT OF THE COMPANY
16
 
   
B.
 
BUSINESS OVERVIEW
18
 
   
C.
 
ORGANIZATIONAL STRUCTURE
33
 
   
D.
 
PROPERTY, PLANT AND EQUIPMENT
33
 
ITEM 4A.
 
UNRESOLVED STAFF COMMENTS
35
 
ITEM 5.
 
OPERATING AND FINANCIAL REVIEW AND PROSPECTS
35
 
   
A.
 
GENERAL
35
 
   
B.
 
CONSOLIDATED RESULTS OF OPERATIONS
38
 
   
C.
 
DISCUSSIONS ON RESULTS OF SEGMENT OPERATIONS
40
 
   
D.
 
LIQUIDITY AND CAPITAL RESOURCES
51
 
ITEM 6.
 
DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
54
 
   
A.
 
DIRECTORS, SUPERVISORS AND SENIOR MANAGEMENT
54
 
   
B.
 
COMPENSATION
60
 
   
C.
 
BOARD PRACTICE
61
 
   
D.
 
EMPLOYEES
62
 
   
E.
 
SHARE OWNERSHIP
63
 
ITEM 7.
 
MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
63
 
   
A.
 
MAJOR SHAREHOLDERS
63
 
   
B.
 
RELATED PARTY TRANSACTIONS
64
 
   
C.
 
INTERESTS OF EXPERTS AND COUNSEL
65
 
ITEM 8.
 
FINANCIAL INFORMATION
65
 
   
A.
 
CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION
65
 
   
B.
 
SIGNIFICANT CHANGES
66
 
ITEM 9.
 
THE OFFER AND LISTING
66
 
   
A.
 
OFFER AND LISTING DETAILS
66
 
ITEM 10.
 
ADDITIONAL INFORMATION
67
 
   
A.
 
SHARE CAPITAL
67
 
   
B.
 
MEMORANDUM AND ARTICLES OF ASSOCIATION
67
 
   
C.
 
MATERIAL CONTRACTS
74
 
   
D.
 
EXCHANGE CONTROLS
75
 
   
E.
 
TAXATION
75
 
   
F.
 
DIVIDENDS AND PAYING AGENTS
79
 
   
G.
 
STATEMENT BY EXPERTS
79
 
   
H.
 
DOCUMENTS ON DISPLAY
79
 
   
I.
 
SUBSIDIARY INFORMATION
79
 
ITEM 11.
 
QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
79
 
ITEM 12.
 
DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
83
 
ITEM 13.
 
DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
84
 
ITEM 14.
 
MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS
84
 
   
A.
 
MATERIAL MODIFICATIONS TO THE RIGHTS TO SECURITIES HOLDERS
84
 
   
B.
 
USE OF PROCEEDS
84
 
ITEM 15.
 
CONTROLS AND PROCEDURES
84
 
ITEM 16.
 
RESERVED
85
 
ITEM 16A.
 
AUDIT COMMITTEE FINANCIAL EXPERT
85
 
 
 
1

 

ITEM 16B.
 
CODE OF ETHICS
85
 
ITEM 16C.
 
PRINCIPAL ACCOUNTANT FEES AND SERVICES
86
 
ITEM 16D.  
 
EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
86
 
ITEM 16E.
 
PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
86
 
ITEM 16F.
 
CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT
86
 
ITEM 16G.
 
COMPARISON OF NEW YORK STOCK EXCHANGE CORPORATE GOVERNANCE RULES AND CHINA CORPORATE GOVERNANCE RULES FOR LISTED COMPANIES
87
 
ITEM 16H.  
 
MINE SAFETY DISCLOSURE
90
 
ITEM 17.
 
FINANCIAL STATEMENTS
90
 
ITEM 18.
 
FINANCIAL STATEMENTS
90
 
ITEM 19.
 
EXHIBITS
90
 



 
2

 


CERTAIN TERMS AND CONVENTIONS
 
Definitions
 
Unless the context otherwise requires, references in this annual report to:
 
 
·
“Sinopec Corp.”, “we”, “our” and “us” are to China Petroleum & Chemical Corporation, a PRC joint stock limited company, and its subsidiaries;
 
 
·
“Sinopec Group Company” are to our controlling shareholder, China Petrochemical Corporation, a PRC limited liability company;
 
 
·
“Sinopec Group” are to the Sinopec Group Company and its subsidiaries other than Sinopec Corp. and its subsidiaries;
 
 
·
“provinces” are to provinces and to provincial-level autonomous regions and municipalities in China which are directly under the supervision of the central PRC government;
 
 
·
“RMB” are to Renminbi, the currency of the PRC;
 
 
·
“HK$” are to Hong Kong dollar, the currency of the Hong Kong Special Administrative Region of the PRC; and
 
 
·
“US$” are to US dollars, the currency of the United States of America.
 
Conversion Conventions
 
Conversions of crude oil from tonnes to barrels are made at a rate of one tonne to 7.35 barrels for crude oil we purchase from external sources and one tonne to 7.1 barrels for crude oil we produce, unless otherwise specified, representing the American Petroleum Institute (“API”) gravity of the respective source of crude oil. Conversions of natural gas from cubic meters to cubic feet are made at a rate of one cubic meter to 35.31 cubic feet.
 
Glossary of Technical Terms
 
Unless otherwise indicated in the context, references to:
 
 
·
“billion” are to a thousand million.
 
 
·
“BOE” are to barrels-of-oil equivalent; natural gas is converted at a ratio of 6,000 cubic feet of natural gas to one BOE.
 
 
·
“primary distillation capacity” are to the crude oil throughput capacity of a refinery’s crude oil distillation units, calculated by estimating the number of days in a year that such crude oil distillation units are expected to operate, excluding downtime for regular maintenance, and multiplying that number by the amount equal to the units’ optimal daily crude oil throughput.
 
 
·
“rated capacity” are to the output capacity of a given production unit or, where appropriate, the throughput capacity, calculated by estimating the number of days in a year that such production unit is expected to operate, excluding downtime for regular maintenance, and multiplying that number by an amount equal to the unit’s optimal daily output or throughput, as the case may be.
 

 
CURRENCIES AND EXCHANGE RATES
 
We publish our financial statements in Renminbi. Unless otherwise indicated, all translations from Renminbi to US dollars were made at the averages of middle exchange rate of Renminbi as published by State Administration of Foreign Exchange (“SAFE”).
 

 
3

 

 
The following table sets forth noon buying rate for US dollars in Renminbi for the periods indicated, as provided by the H.10 statistical release of the U.S. Federal Reserve Board.  We do not represent that Renminbi or US dollar amounts could be converted into US dollars or Renminbi, as the case may be, at any particular rate, the rates below or at all. On April 11, 2014, the noon buying rate was RMB 6.2111 to US$1.00. 
 
 
 
   
Noon Buying Rate(1)
 
Period
 
End
   
Average(2)
   
High
   
Low
 
   
(RMB per US$1.00)
 
                         
                         
2009
    6.8259       6.8295       6.8470       6.8176  
2010
    6.6000       6.7603       6.8330       6.6000  
2011
    6.2939       6.4475       6.6364       6.2939  
2012
    6.2301       6.2990       6.3879       6.2221  
2013
    6.0537       6.1412       6.2438       6.0537  
October 2013
    6.0943       6.1032       6.1209       6.0815  
November 2013
    6.0922       6.0929       6.0993       6.0903  
December 2013
    6.0537       6.0738       6.0927       6.0537  
January 2014
    6.0590       6.0509       6.0600       6.0402  
February 2014
    6.1448       6.0816       6.1448       6.0591  
March 2014
    6.2164       6.1729       6.2273       6.1183  
April 2014 (through April 11, 2014)
    6.2111       6.2073       6.2123       6.1966  
 
__________
 
(1)
The exchange rates reflect those set forth in the H.10 statistical release of the U.S. Federal Reserve Board.
(2)
Annual averages are determined by averaging the rates on the last business day of each month during the relevant period. Monthly averages are calculated using the average of the daily rates during the relevant period.


 
4

 

 
FORWARD-LOOKING STATEMENTS
 
This annual report includes “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995.  All statements, other than statements of historical facts, included in this annual report that address activities, events or developments which we expect or anticipate will or may occur in the future are hereby identified as forward-looking statements for the purpose of the safe harbor provided by Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. The words such as believe, intend, expect, anticipate, project, estimate, predict, plan and similar expressions are also intended to identify forward-looking statements. These forward-looking statements address, among others, such issues as:
 
 
·
amount and nature of future exploration and development,
 
·
future prices of and demand for our products,
 
·
future earnings and cash flow,
 
·
development projects and drilling prospects,
 
·
future plans and capital expenditures,
 
·
estimates of proved oil and gas reserves,
 
·
exploration prospects and reserves potential,
 
·
expansion and other development trends of the petroleum and petrochemical industry,
 
·
production forecasts of oil and gas,
 
·
expected production or processing capacities, including expected rated capacities and primary distillation capacities, of units or facilities not yet in operation,
 
·
expansion and growth of our business and operations, and
 
·
our prospective operational and financial information.
  
These statements are based on assumptions and analyses made by us in light of our experience and perception of historical trends, current conditions and expected future developments, as well as other factors we believe are appropriate in particular circumstances. However, whether actual results and developments will meet our expectations and predictions depends on a number of risks and uncertainties which could cause actual results to differ materially from our expectations, including the risks set forth in “Item 3. Key Information ¾ Risk Factors” and the following:
 
 
·
fluctuations in crude oil prices,
 
·
fluctuations in prices of our products,
 
·
failures or delays in achieving production from development projects,
 
·
potential acquisitions and other business opportunities,
 
·
general economic, market and business conditions, and
 
·
other risks and factors beyond our control.
  
Consequently, all of the forward-looking statements made in this annual report are qualified by these cautionary statements and readers are cautioned not to place undue reliance on these forward-looking statements.  These forward-looking statements should be considered in light of the various important factors set forth above and elsewhere in this Form 20-F.  In addition, we cannot assure you that the actual results or developments anticipated by us will be realized or, even if substantially realized, that they will have the expected effect on us or our business or operations.
 

 
5

 

ITEM 1. 
IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS
 
Not applicable.
 
ITEM 2. 
OFFER STATISTICS AND EXPECTED TIMETABLE
 
Not applicable.
 
ITEM 3. 
KEY INFORMATION
 
A.         SELECTED FINANCIAL DATA
 
The selected consolidated statement of income data (except per ADS data) and consolidated cash flows data for the years ended December 31, 2011, 2012 and 2013, and the selected consolidated balance sheet data as of December 31, 2012 and 2013 are derived from, and should be read in conjunction with, the audited consolidated financial statements included elsewhere in this annual report. The selected consolidated statement of income data and consolidated cash flows data for the years ended December 31, 2009 and 2010 and the selected consolidated balance sheet data as of December 31, 2009, 2010 and 2011 are derived from our audited consolidated financial statements which are not included elsewhere in this annual report and the financial statements of the acquired businesses described below.
 
We acquired from Sinopec Group Company part of interest in Sonangol Sinopec International Limited ("SSL") in 2010. As we and these companies are under the common control of Sinopec Group Company, our acquisitions are reflected in our consolidated financial statements as combination of entities under common control that is accounted for in a manner similar to a pooling-of-interests. Accordingly, the acquired assets and related liabilities have been accounted for at historical cost and our consolidated financial statements for periods prior to the combinations have been restated to include the financial condition and the results of operation of these companies on a combined basis.
 
On May 29, 2013, our shareholders approved at the annual general meeting the declaration and payment of a final cash dividend of RMB 0.20 per share for 2012 and the issuance of two bonus shares converted from retained earnings and one bonus share transferred from share premium for every 10 existing shares held by the shareholders on relevant record date. As a result of the issuance of bonus shares and capitalization, the weighted average number of shares has been retrospectively adjusted for the years prior to January 1, 2013, and accordingly the basic earnings and diluted earnings per share have been adjusted retrospectively.
 
Moreover, the selected financial data should be read in conjunction with our consolidated financial statements and “Item 5. Operating and Financial Review and Prospects” included elsewhere in this annual report. Our consolidated financial statements are prepared and presented in accordance with International Financial Reporting Standards, or IFRS, as issued by the International Accounting Standards Board.
 

 
6

 
 
 

   
Year Ended December 31,
 
   
2009
   
2010
   
2011
   
2012
   
2013
 
   
(RMB in millions, except per share, per ADS data and number of shares)
 
Consolidated Statement of Income Data(1):
                             
Operating revenues
    1,345,052       1,913,182       2,505,683       2,786,045       2,880,311  
Operating expenses
    (1,254,383 )     (1,808,208 )     (2,400,153 )     (2,687,383 )     (2,783,526 )
Operating income
    90,669       104,974       105,530       98,662       96,785  
Earnings before income tax
    86,574       103,663       104,565       90,642       95,052  
Tax expense
    (19,591 )     (25,681 )     (26,120 )     (23,846 )     (24,763 )
Net income attributable to equity shareholders of the Company
    63,129       71,782       73,225       63,879       66,132  
Basic earnings per share(2)
    0.560       0.637       0.650       0.566       0.570  
Basic earnings per ADS(2)
    56.00       63.69       65.00       56.62       56.96  
Diluted earnings per share(2)
    0.556       0.631       0.625       0.545       0.534  
Diluted earnings per ADS(2)
    55.62       63.08       62.46       54.46       53.41  
Cash dividends declared per share
    0.123       0.146       0.177       0.231       0.244  
Segment Results
                                       
  Exploration and production
    23,894       47,149       71,631       70,054       54,793  
  Refining
    27,504       15,851       (35,780 )     (11,444 )     8,599  
  Marketing and distribution
    30,300       30,760       44,696       42,652       35,143  
  Chemicals
    13,779       15,011       26,732       1,178       868  
  Corporate and others
    (2,205 )     (2,342 )     (2,640 )     (2,443 )     (3,412 )
  Elimination of inter-segment sales
    (2,603 )     (1,455 )     891       (1,335 )     794  
  Operating income
    90,669       104,974       105,530       98,662       96,785  
Shares
                                       
  Basic weighted average number of A and H shares
    112,713,170,700       112,713,267,514       112,713,299,453       112,853,724,741       116,102,910,373  
  Diluted weighted average number of A and H shares
    114,126,739,474       114,126,836,287       116,733,935,215       118,412,133,133       121,858,818,276  
 
 
   
As of December 31,
 
   
2009
   
2010
   
2011
   
2012
   
2013
 
   
(RMB in millions)
 
Consolidated Balance Sheet Data(1):
                             
Cash and cash equivalents
    8,782       17,008       24,647       10,456       15,046  
Total current assets
    201,479       260,229       342,755       365,015       373,010  
Total non-current assets
    692,930       727,642       794,423       892,929       1,009,906  
Total assets
    894,409       987,871       1,137,178       1,257,944       1,382,916  
Total current liabilities
    (315,921 )     (336,406 )     (444,240 )     (513,373 )     (571,822 )
Short-term debts and loans from Sinopec Group Company and its affiliates (including current portion of long-term debts)
    (75,216 )     (35,828 )     (80,373 )     (115,982 )     (163,870 )
Long-term debts and loans from Sinopec Group Company and its affiliates (excluding current portion of long-term debts)
    (152,725 )     (174,075 )     (154,457 )  
(162,116
)     (145,590 )
Total equity attributable to equity shareholders of the Company
    (379,515 )     (419,604 )     (472,328 )     (510,914 )     (568,803 )
Total equity
    (405,506 )     (451,036 )     (507,344 )     (548,036 )     (621,626 )
 
 
   
Year Ended December 31
 
   
2009
   
2010
   
2011
   
2012
   
2013
 
   
(RMB in millions)
 
Statement of Cash Flow and Other Financial Data(1):
                             
Net cash generated from operating activities
    165,513       170,333       150,622       142,380       151,893  
Net cash (used in)/generated from financing activities
    (46,411 )     (56,294 )     (2,516 )     5,628       31,519  
Net cash used in investing activities
    (117,355 )     (105,788 )     (140,449 )     (162,197 )     (178,740 )
Capital expenditure
                                       
    Exploration and production
    54,748       53,801       62,050       79,071       105,311  

 
 
7

 


Refining
    15,468       20,015       25,767       32,161       26,064  
Marketing and distribution
    16,996       30,829       30,387       31,723       29,486  
Chemicals
    27,258       18,422       16,980       23,616       19,189  
Corporate and others
    1,505       1,894       2,488       2,397       5,076  
Total
    115,975       124,961       137,672       168,968       185,126  
__________
(1)
The acquisition of 55% equity interest of Sonangol Sinopec International Limited (SSI) in 2010 from Sinopec Group Company were considered as “combination of entities under common control” and accounted in a manner similar to pooling-of-interests.  Accordingly, the acquired assets and liabilities have been accounted for at historical cost and the consolidated financial statements for periods prior to the combinations have been restated to include the financial condition and results of operation of these acquired companies on a combined basis.  The considerations for these acquisitions were treated as equity transactions.
(2)
Basic earnings per share have been computed by dividing net income attributable to equity shareholders of our company by the weighted average number of shares in issue. Basic and diluted earnings per ADS have been computed as if all of our issued or potential ordinary shares, including domestic shares and H shares, are represented by ADSs during each of the years presented. Each ADS represents 100 shares. The weighted average number of shares for the years prior to January 1, 2013 has been retrospectively adjusted as a result of the issuance of bonus shares and capitalization in 2013, and accordingly the basic earnings and diluted earnings per share have been adjusted retrospectively.

B.         CAPITALIZATION AND INDEBTEDNESS
 
Not applicable.
 
C.         REASONS FOR THE OFFER AND USE OF PROCEEDS
 
Not applicable.
 
D.         RISK FACTORS
 
Risks Relating to Our Business Operation
 
Our business may be adversely affected by the fluctuation of crude oil and refined petroleum product prices.
 
We consume a large amount of crude oil to produce our refined petroleum products and petrochemical products. While we try to adjust the sale prices of our products to track international crude oil price fluctuations, our ability to pass on the increased cost resulting from crude oil price increases to our customers is dependent on international and domestic market conditions as well as the PRC government’s price control over refined petroleum products. The PRC government could exercise certain price control over refined petroleum products once international crude oil prices experience a sustained rise or become significantly volatile. As a result, our results of operations and financial condition may be materially and adversely affected by the fluctuation of crude oil and refined petroleum product prices.
 
Our continued business success depends in part on our ability to replace reserves and develop newly discovered reserves.
 
Our ability to achieve our growth objectives is dependent in part on our level of success in discovering or acquiring additional oil and natural gas reserves and further exploring our current reserve base. Our exploration and development activities for additional reserves also expose us to inherent risks associated with drilling, including the risk that no proved oil or natural gas reservoirs might be discovered. Exploring for, developing and acquiring reserves is highly risky and capital intensive. Without reserve additions through further exploration and development or acquisition activities, our reserves and production will decline over time, which may materially and adversely affect our results of operations and financial condition.
 

 
8

 
 
 
We rely heavily on outside suppliers for crude oil and other raw materials, and we may even experience disruption of our ability to obtain crude oil and other raw materials.
 
We purchase a significant portion of crude oil and other feedstock requirements from outside suppliers located in different countries and areas in the world. In 2013, approximately 81.8% of the crude oil required for our refinery business was sourced from international suppliers, some of which are from countries or regions that are on the sanction list published and administered by the Office of Foreign Assets Control, or OFAC, of the US Department of Treasury, including Iran and Sudan. In addition, our development requires us to source an increasing amount of crude oil from outside suppliers. We are subject to the political, geographical and economic risks associated with these countries and areas. If one or more of our material supply contracts were terminated or disrupted due to any natural disasters or political events, it is possible that we would not be able to find sufficient alternative sources of supply in a timely manner or on commercially reasonable terms. As a result, our business and financial condition would be materially and adversely affected.
 
Our business faces operation risks and natural disasters that may cause significant property damages, personal injuries and interruption of operations, and we may not have sufficient insurance coverage for all the financial losses incurred by us.
 
Exploring for, producing and transporting crude oil and natural gas and producing and transporting refined oil and chemical products involves a number of operating hazards. Our operations are subject to significant hazards and risks inherent in refining operations and in transporting and storing crude oil, intermediate products and refined oil products. These hazards and risks include, but are not limited to, natural disasters, fires, explosions, pipeline ruptures and spills, third-party interference and mechanical failure of equipment at our or third-party facilities, any of which could result in production and distribution difficulties and disruptions, environmental pollution, personal injury or wrongful death claims and other damage to our properties and the property of others. There is also risk of mechanical failure and equipment shutdowns both in general and following unforeseen events. In such situations, undamaged refinery processing units may be dependent on or interact with damaged process units and, accordingly, are also subject to being shut down.  Even though we have a strong institutional focus on the safety of our operations and have implemented health, safety and environment management system within our company with the view to preventing accidents, and reducing personal injuries, property losses and environment pollution, our preventative measures may not be effective. We also maintain insurance coverage on our property, plant, equipment and inventory, but our insurance coverage may not be sufficient to cover all the financial losses caused by the operation risks and natural disasters.  Significant operating hazards and natural disasters may cause interruption to our operations, property or environmental damages as well as personal injuries, and each of these incidents could have a material adverse effect on our financial condition and results of operations.
 
On November 22, 2013, our Donghuang II pipeline located in Qingdao Economic and Technological Development Zone ruptured, resulting in oil leakage into the covered municipal drainage trench. The municipal drainage trench exploded and caused severe casualties and injuries to the surrounding pedestrians, residents and rescue team. The accident caused 62 deaths and 136 injuries and a direct economic loss of RMB 751.7 million, according to the investigation report issued by the State Council investigation team. We were responsible for paying our portion of required compensation to third parties. Our payments would be funded mainly from our Safe Production Insurance Fund that have been accumulated in the past years, as well as claims under the business catastrophe insurance policy that we maintained with a third-party commercial insurance company. In addition, a number of our directors, supervisors and senior management members were imposed disciplinary penalties by the State Council. Losses incurred or payments required to be made by us due to operating hazards, natural disasters or accidents such as the Qingdao pipeline accident, if they are not fully insured, may have a material adverse effect on our financial condition and results of operations.
 
The oil and natural gas reserves data in this annual report are only estimates, and our actual production, revenues and expenditures with respect to our reserves may differ materially from these estimates.
 
There are numerous uncertainties inherent in estimating quantities of proved oil and natural gas reserves, and in the timing of development expenditures and the projection of future rates of production. Adverse changes in economic conditions may render it uneconomical to develop certain reserves. Our actual production, revenues, taxes and fees payable and development and operating expenditures with respect to our reserves may likely vary from these estimates.
 
The reliability of reserves estimates depends on:
 
 
·
the quality and quantity of technical and economic data;
 
 
·
the prevailing oil and gas prices applicable to our production;
 

 
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·
the production performance of the reservoirs; and
 
 
·
extensive engineering judgments.
 
In addition, new drilling, testing and production results following the estimates may cause substantial upward or downward revisions in the estimates.
 
Oilfield exploration and drilling involves numerous risks, including risks that no commercially productive crude oil or natural gas reserves can be discovered and risks of failure to acquire or retain reserves.
 
Our oil and gas business is currently involved in exploration activities in various regions, including in some areas where natural conditions may be challenging and where the costs of such exploration activities may be high. As a result, our oil and gas business may incur cost overruns or may be required to curtail, delay or cancel drilling operations because of many factors, including, but not limited to, the following:
 
 
·
unexpected drilling conditions;
 
 
·
pressure or irregularities in geological formations;
 
 
·
equipment failures or accidents;
 
 
·
oil well blowouts;
 
 
·
adverse weather conditions or natural disasters;
 
 
·
compliance with existing or enhanced environmental regulations;
 
 
·
governmental requirements and standards; or
 
 
·
delays in the availability of drilling rigs and delivery and maintenance of equipment.
 
The future production of our oil and gas business depends significantly upon our success in finding or acquiring additional reserves and retaining and developing such reserves. If our oil and gas business fails to conduct successful exploration activities or to acquire or retain assets holding proved reserves, it may not meet its production or growth targets, and its proved reserves will decline as it extracts crude oil and natural gas from the existing reservoirs, which could adversely affect our business, financial condition and results of operations.
 
We have been actively pursuing business opportunities outside China to supplement our domestic resources. However, there can be no assurance that we can successfully locate sufficient alternative sources of crude oil supply or at all due to the complexity of the international political, economic and other conditions. If we fail to obtain sufficient alternative sources of crude oil supply, our results of operations and financial condition may be adversely affected.
 
Our exploration, development and production activities and our refining and petrochemical business require substantial expenditure and investments and our plans for and ability to make such expenditures and investments are subject to various risks.
 
Exploring, developing and producing crude oil and natural gas fields are capital-intensive activities involving a high degree of risk. Our ability to undertake exploration, development and production activities and make the necessary capital expenditures and investments is subject to many risks, contingencies and other uncertainties, which may prevent our oil and gas business from achieving the desired results, or which may significantly increase the expenditures and investments that our oil and gas business makes, including, but not limited to, the following:
 
 
·
ability to generate sufficient cash flows from operations to finance its expenditures, investments and other requirements, which are affected by changes in crude oil and natural gas prices and other factors;
 
 
·
availability and terms of external financing;
 
 
·
mix of exploration and development activities conducted on an independent basis and those conducted jointly with other partners;
 

 
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·
extent to which its ability to influence or adjust plans for exploration and development related expenditures is limited under joint operating agreements for those projects in which it has partners;
 
 
·
government approvals required for exploration and development-related expenditures and investments in jurisdictions in which it conducts business; and
 
 
·
economic, political and other conditions in jurisdictions in which it conducts business.
 
We intend to expand our exploration and production segment and, from time to time, construct new and/or revamp existing refining and petrochemical facilities, which require substantial capital expenditures and investments, there can be no assurance that the cash generated by our operations will be sufficient to fund these development plans or that our actual future capital expenditures and investments will not significantly exceed our current planned amounts. Our inability to obtain sufficient funding for development plans could adversely affect our business, financial condition and results of operations.
 
Our development projects and production activities involve many uncertainties and operating risks that can prevent us from realizing profits and cause substantial losses.
 
Our development projects and production activities may be curtailed, delayed or cancelled for many reasons, including equipment shortages or failures, natural hazards, unexpected drilling conditions or reservoir characteristics, pressure or irregularities in geological formations, accidents, mechanical and technical difficulties and industrial action. These projects and activities, which include projects focused on non-conventional oil and gas exploration and development, will also often require the use of new and advanced technologies, which may be expensive to develop, purchase and implement, and may not function as expected. There is a risk that development projects that we undertake may not yield adequate returns. In addition, our development projects and production activities, particularly those in remote areas, could become less profitable, or unprofitable, if we experience a prolonged period of low oil or gas prices or cost overruns.
 
Our business may be adversely affected by actions and regulations prompted by global climate changes.
 
The oil and gas industry in which we operate is drawing increasing concerns about global climate change in recent years.  A number of international, national and regional measures to limit greenhouse gas emissions have been enacted. For example, more than 190 nations are signatories to the Framework Convention on Global Climate Change, commonly known as the “Kyoto Protocol”.  The implementation of the Kyoto Protocol in a number of countries and other potential legislation limiting emissions could affect the global demand for fossil fuels. Although the first commitment period under Kyoto Protocol expired in 2012, nations who are parties to Kyoto Protocol adopted an amendment to the Kyoto Protocol (the “Doha Amendment”) at a conference held in Doha, Qatar, in December 2012. Under the Doha Amendment, the second commitment period for implementation of the amended Kyoto Protocol was extended to 2020. The PRC government has also announced proposals to introduce a “carbon tax”, which may have an adverse impact on our operations. If China or other countries in which we operate or desire to operate enact legislation focused on reducing greenhouse gases, either independently or in response to the Kyoto Protocol, it could result in substantial capital expenditure from compliance with these laws, and revenue generation and strategic growth opportunities could also be adversely impacted.
 
Our overseas businesses may be adversely affected by changes of overseas government policies and business environment.
 
We acquired a 55% equity interest of SSI who has a 50% interest in Angola Block 18 in 2010. Since the end of civil war in 2002, the Angola government has focused on economic recovery and social development. It has made substantial progress on stability of its social and investment environment in recent years, and keeps continuity and stability on the oil production related policies. However, Angola is still one of the most undeveloped countries defined by the United Nations, and its social and investment conditions are subject to certain risks, including without limitation, the income distribution gap among nationals, a high unemployment rate, and the problem of discretionary execution of its laws and regulations. Angola entered into the Organization of the Petroleum Exporting Countries, or the OPEC, in 2006, and therefore it is also subject to the oil-output restriction imposed by the OPEC. Although Angola has a relatively complete legal system, significant uncertainties remain in the effectiveness of enforcement of judicial decisions. In addition, Angola suffers from other social issues such as significant polarization of wealth distribution and unemployment that affect the country’s overall stability.
 
In addition, in respect to the oil production management in Angola, if there is any malfunction on our water or gas injection systems, the maintenance work may take a long time and our oil production capacity and outputs may decline. In
 

 
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respect to the reserve management in Angola, as more oilfields are developed, water cut in oilfields may increase and the oil reservoir pressures may decrease, which may materially and adversely affect our oil production capacity and reserve development.
 
In 2013, Sinopec International Petroleum E&P Hongkong Overseas Limited, a joint venture owned by Sinopec Group Company and us on a 50:50 basis, acquired from Sinopec Group Company (i) 50% interest in CIR, (ii) 49% interest in Taihu, and (iii) 50% interest in Mansarovar. Each of CIR, Taihu and Mansarovar is engaged in oil and gas exploration, development and production business, with CIR based in Kazakhstan, Taihu in Russia and Mansarovar in Colombia.  These countries have experienced, or may experience in the future, political instability, changes to the regulatory environment, changes in taxation, expropriation or nationalization of property, civil strife, strikes, acts of terrorism, acts of war and insurrections. Any of these conditions occurring could disrupt or terminate our operations, causing our development activities to be curtailed or terminated in these areas, or our production to decline, could limit our ability to pursue new opportunities, could affect the recoverability of our assets and could cause us to incur additional costs.
 
Risks Relating to Our Industry
 
Our operations may be adversely affected by the global and domestic economic conditions.
 
Our results of operations are materially affected by economic conditions in China and elsewhere around the world. Although nations around the world have adopted various economic policies to mediate the negative influences caused by factors such as the slowdown of world economic development and the European financial crisis, it is uncertain how soon the world economy can be fully recovered. Our operations may also be adversely affected by factors such as some countries’ trade protection policies which may affect the export and some regional trade agreements which may affect the import.
 
Our operations may be adversely affected by the cyclical nature of the market.
 
Most of our revenues are attributable to sales of refined petroleum products and petrochemical products, and certain of these businesses and related products have historically been cyclical and sensitive to a number of factors that are beyond our control. These factors include the availability and prices of feedstock and general economic conditions, such as changes in industry capacity and output levels, cyclical changes in regional and global economic conditions, prices and availability of substitute products and changes in consumer demand. Although we are an integrated company with upstream, midstream and downstream businesses, we have limited ability to mitigate the adverse influence of the cyclicality of global markets.
 
We face strong competition from domestic and foreign competitors.
 
Among our competitors, some are major integrated petroleum and petrochemical companies within and outside China, which have recently become more significant participants in the petroleum and petrochemical industry in China. On December 4, 2006, Ministry of Commerce of the PRC promulgated the “Administrative Rules for Crude Oil Market” and “Administrative Rules for Refined Petroleum Products Market”, which open the wholesale market of crude oil and refined petroleum products to new market entrants. As a result, we face more competition in both crude oil and refined petroleum product markets. We also expect to face competition in both domestic and international petrochemical product market as a result of our domestic and international competitors’ increasing production capacity. Increased competition may have a material adverse effect on our financial condition and results of operations.
 
Risks Relating to Our Controlling Shareholder
 
We engage in related party transactions with Sinopec Group from time to time which may create potential conflict of interest.
 
We have engaged from time to time and will continue to engage in a variety of transactions with Sinopec Group, which provides us with a number of services, including, but not limited to, ancillary supply, engineering, maintenance, transport, lease of land use right, lease of buildings, as well as educational and community services. The nature of our transactions with Sinopec Group is governed by a number of service and other contracts between Sinopec Group and us. We have established various schemes in those agreements so that these transactions, when entered into, are under terms that are at arm’s length. However, we cannot assure you that Sinopec Group Company or any of its members would not take actions that may favor its interests or its other subsidiaries’ interests over ours.
 

 
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We are controlled by Sinopec Group Company, our ultimate controlling shareholder, whose interest in certain businesses compete or are likely to compete with our business.
 
Sinopec Group Company has interests in certain businesses, such as oil refining, petrochemical producing and overseas exploration and development, which compete or are likely to compete, either directly or indirectly, with our businesses. To avoid the adverse effects brought by the competition between us and Sinopec Group Company to the maximum extent possible, we and Sinopec Group Company have entered into a non-competition agreement. In 2012, we received from Sinopec Group Company an undertaking to avoid its competition with us.  For details, please refer to the descriptions under “Item 7. Major Shareholders and Related Party Transactions – A. Major Shareholders”. Notwithstanding the foregoing contractual arrangements, because Sinopec Group Company is our controlling shareholder, Sinopec Group Company may take actions that may conflict with our own interests.
 
It is possible that the current or future activities of our ultimate controlling shareholder, Sinopec Group Company, or its affiliates in or with certain countries that are the subject of economic sanctions under relevant U.S. laws could result in negative media and investor attention to us and possible imposition of sanctions on Sinopec Group Company, which could materially and adversely affect our shareholders.
 
Sinopec Group Company undertakes, from time to time and without our involvement, overseas investments and operations in the oil and gas industry, including exploration and production of oil and gas, refining and Liquefied Natural Gas or LNG, and chemical projects.  Sinopec Group Company’s overseas asset portfolio includes oil and gas development projects in Iran, Sudan and Syria, which countries are targets of U.S. sanctions administrated by OFAC and by the U.S. Department of State. We cannot predict the interpretation or implementation of government policy at the U.S. federal, state or local levels with respect to any current or future activities by Sinopec Group Company or its affiliates in countries or with individuals or entities that are the subject of U.S. sanctions.  Similarly, we cannot predict whether U.S. sanctions will be further tightened, or the impact that such actions may have on Sinopec Group Company.  It is possible that the United States could subject Sinopec Group Company to sanctions due to these activities.  Certain U.S. state and local governments and colleges have restrictions on the investment of public funds or endowment funds, respectively, in companies that are members of corporate groups with activities in certain countries that are the subject of U.S. sanctions. These investors may not wish to invest, and may divest their investment, in us because of our relationship with Sinopec Group Company and its investments and activities in those OFAC sanctioned countries. It is possible that, as a result of activities by Sinopec Group Company or its affiliates in countries that are the subject of U.S. sanctions, we may be subject to negative media or investor attention, which may distract management, consume internal resources and affect investors’ perception of our company.
 
Further, the Iran Sanctions Act, as amended, and other U.S. laws and Executive Orders, authorize the imposition of sanctions on companies that engage in certain activities in and with Iran, especially in Iran’s energy sector. It is possible that Sinopec Group Company or its affiliates engage in activities that are targeted for sanctions by U.S. laws. It is possible that the U.S. government would determine, and in the event that the U.S. government so determines, that Sinopec Group Company or an entity it owns or controls, had engaged in any such activities and if the most extreme sanction, blocking, was applied to Sinopec Group Company’s property, including controlled subsidiaries, Sinopec Group Company could be prohibited from engaging in business activities in the United States or with U.S. individuals or entities, and U.S. transactions in our securities and distributions to U.S. individuals and entities with respect to our securities could also be prohibited.
 
Risks Relating to the PRC
 
The PRC governmental authorities, from time to time, audit or inspect our ultimate controlling shareholder. We cannot predict the effect of their outcome on our reputation, our business and financial condition as well as the trading prices of our ADSs and H shares.
 
The PRC governmental authorities, from time to time, perform audits, inspections, inquiries or similar actions on state-owned companies, such as Sinopec Group Company, our ultimate controlling shareholder. We cannot predict the outcome of such actions of governmental authorities. If, as a result of such audits, inspections or inquiries, (i) material irregularities are found within Sinopec Group Company or us or (ii) Sinopec Group Company or we become the target of any negative publicity, there may be a material adverse effect on our reputation, our business and financial condition as well as the trading prices of our ADSs and H shares.
 
Government regulations may limit our activities and affect our business operations.
 
The PRC government, though gradually liberalizing its regulations on entry into the petroleum and petrochemical industry, continues to exercise certain controls over the petroleum and petrochemical industry in China. These control
 

 
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mechanisms include granting the licenses to explore and produce crude oil and natural gas, granting the licenses to market and distribute crude oil and refined petroleum products, regulating the upper limit of the retail prices for gasoline and diesel; collecting special oil income levies, deciding import and export quotas and procedures, setting safety, environmental and quality standards, and formulating policies to save energy and reduce emission; meanwhile, there could be potential changes to macroeconomic and industry policies such as further improvement of pricing mechanism of petroleum products, reforming and improvement of pricing mechanism of natural gas, and reforming in resource tax and environmental tax, which could impact our production and operations. Such control mechanisms may have material effects on our operations and profitability.
 
On the other hand, the PRC government has been gradually relaxing the control over imports of crude oil and refined oil products, which may result in refining overcapacity in China and intensify competition among refining companies in China. Such relaxation of the import control may have material and adverse effects on our refining margin, including procurement cost of imported crude oil and lower prices of refined oil products.
 
Our business operations may be adversely affected by present or future environmental regulations.
 
As an integrated petroleum and petrochemical company, we are subject to extensive environmental protection laws and regulations in China. These laws and regulations permit:
 
 
·
the imposition of fees for the discharge of waste substances;
 
 
·
the levy of fines and payments for damages for serious environmental offenses; and
 
 
·
the government, at its discretion, to close any facility which fails to comply with orders and require it to correct or stop operations causing environmental damage.
 
Our production activities produce substantial amounts of liquid, gas and solid waste materials. In addition, our production facilities require operating permits that are subject to renewal, modification and revocation. We have established a system to treat waste materials to prevent and reduce pollution. However, the PRC government has moved, and may move further, toward more rigorous enforcement of applicable laws, and toward the adoption of more stringent environmental standards, which, in turn, would require us to incur additional expenditures on environmental matters.
 
Some of our development plans require compliance with state policies and governmental regulation
 
We are currently engaged in a number of construction, renovation and expansion projects. Some of our large construction, renovation and expansion projects are subject to governmental confirmation and registration. The timing and cost of completion of these projects will depend on numerous factors, including when we can receive the required confirmation and registration from relevant PRC government authorities and the general economic condition in China. If any of our key projects required for our future growth are not confirmed or registered, or not confirmed or registered in a timely manner, our results of operations and financial condition could be adversely impacted.
 
Government control of currency conversion and exchange rate fluctuation may adversely affect our operations and financial results.
 
We receive a significant majority of our revenues in Renminbi. A portion of such revenues will need to be converted into other currencies to meet our foreign currency needs, which include, among other things:
 
 
·
import of crude oil and other materials;
 
 
·
debt service on foreign currency-denominated debt;
 
 
·
purchases of imported equipment;
 
 
·
payment of the principals and interests of bonds issued overseas; and
 
 
·
payment of any cash dividends declared in respect of the H shares (including ADS).
 
The existing foreign exchange regulations have significantly reduced government foreign exchange controls for transactions under the current account, including trade and service related foreign exchange transactions and payment of dividends.  Foreign exchange transactions under the capital account, including principal payments in respect of foreign
 

 
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currency-denominated obligations, continue to be subject to significant foreign exchange controls and require the approval of the State Administration of Foreign Exchange. These limitations could affect our ability to obtain foreign exchange through debt or equity financing, or to obtain foreign exchange.  The PRC government has stated publicly that it intends to make the Renminbi freely convertible in the future. However, we cannot predict whether the PRC government will continue its existing foreign exchange policy and when the PRC government will allow free conversion of Renminbi.
 
The exchange rate of the Renminbi against the U.S. dollar and other foreign currencies fluctuates and is affected by, among other things, the changes in the PRC’s and international political and economic conditions.  On July 21, 2005, the PRC government introduced a floating exchange rate system to allow the value of the Renminbi to fluctuate within a regulated band based on market supply and demand and by reference to a basket of foreign currencies. Since 2005, the value of the Renminbi has appreciated significantly against the U.S. dollar. Fluctuations in the exchange rate of the Renminbi against the U.S. dollars and certain other foreign currencies may materially and adversely affect our oil and gas business, financial condition and results of operations.
 
Risks relating to enforcement of shareholder rights; Mandatory arbitration.
 
Currently, the primary sources of shareholder rights are our articles of association, the PRC Company Law and the Listing Rules of the Hong Kong Stock Exchange, which, among other things, impose certain standards of conduct, fairness and disclosure on us, our directors and our controlling shareholder. In general, their provisions for protection of shareholder’s rights and access to information are different from those applicable to companies incorporated in the United States, the United Kingdom and other Western countries. In addition, the mechanism for enforcement of rights under the corporate framework to which we are subject may also be relatively undeveloped and untested. To our knowledge, there has not been any published report of judicial enforcement in the PRC by H share shareholders of their rights under constituent documents of joint stock limited companies or the PRC Company Law or in the application or interpretation of the PRC or Hong Kong regulatory provisions applicable to PRC joint stock limited companies. We cannot guarantee that our shareholders will enjoy protections that they may be entitled in other jurisdictions.
 
China does not have treaties providing for the reciprocal recognition and enforcement of judgments of courts with the United States, the United Kingdom or most other Western countries, and therefore recognition and enforcement in China of judgments of a court in any of these jurisdictions in relation to any matter not subject to a binding arbitration provision may not be assured. Our articles of association as well as the Listing Rules of the Hong Kong Stock Exchange provide that most disputes between holders of H shares and us, our directors, supervisors, officers or holders of domestic shares, arising out of the articles of association or the PRC Company Law concerning the affairs of our company, are to be resolved through arbitration by arbitration organizations in Hong Kong or the PRC, rather than through a court of law. On June 18, 1999, an arrangement was made between Hong Kong and the PRC for the mutual enforcement of arbitral awards. This new arrangement was approved by the Supreme People’s Court of the PRC and the Hong Kong Legislative Council, and became effective on February 1, 2000. We are uncertain as to the outcome of any action brought in China to enforce an arbitral award granted to shareholders.
 
Our auditor, like other independent registered public accounting firms operating in China, is not permitted to be subject to inspection by Public Company Accounting Oversight Board, and as such, investors may be deprived of the benefits of such inspection
 
Our independent registered public accounting firm that issues the audit reports included in our annual reports filed with the SEC, as an auditor of companies that are traded publicly in the United States and a firm registered with the Public Company Accounting Oversight Board, or PCAOB, is required by the laws of the United States to undergo regular inspections by PCAOB to assess its compliance with the laws of the United States and professional standards. Because our auditor is located in China, a jurisdiction where PCAOB is currently unable to conduct inspections without the approval of the PRC authorities, our auditor, like other independent registered public accounting firms, is currently not inspected by PCAOB.
 
Inspections of other firms that PCAOB has conducted outside of China have identified deficiencies in those firms’ audit procedures and quality control procedures, which may be addressed as part of the inspection process to improve future audit quality. The lack of PCAOB inspections in China may prevent PCAOB from regularly evaluating our auditor’s audits and quality control procedures. The inability of PCAOB to conduct inspections of auditors in China makes it more difficult to evaluate the effectiveness of our auditor’s audit procedures or quality control procedures. As a result, investors may be deprived of the benefits of PCAOB inspections.
 

 
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Proceedings instituted recently by the SEC against five PRC-based accounting firms, including our independent registered public accounting firm, could result in our financial statements being determined to not be in compliance with the requirements of the Exchange Act.
 
In December 2012, the SEC brought administrative proceedings against five accounting firms, including our independent registered public accounting firm, in China, alleging that they had refused to provide audit work papers and other documents related to certain other China-based companies under investigation by the SEC for potential accounting fraud. On January 22, 2014, an initial administrative law decision was issued, censuring these accounting firms and suspending four of the five firms from practicing before the SEC for a period of six months. The decision is neither final nor legally effective unless and until reviewed and approved by the SEC. The accounting firms have the ability to appeal and the four firms which are subject to the six month suspension from practicing before the SEC have indicated that they will appeal. The sanction will not become effective until after a full appeal process is concluded and a final decision is issued by the SEC. The accounting firms can also further appeal the final decision of the SEC through the federal appellate courts. We are not involved in the proceedings brought by the SEC against the accounting firms. However, our independent registered public accounting firm is one of the four accounting firms subject to the six month suspension from practicing before the SEC in the initial administrative law decision. We may therefore be adversely affected by the outcome of the proceedings, along with other U.S.-listed companies audited by these accounting firms.
 
On May 24, 2013, the PCAOB announced that it had entered into a Memorandum of Understanding on Enforcement Cooperation with the China Securities Regulatory Commission, or the CSRC, and the Ministry of Finance which establishes a cooperative framework between the parties for the production and exchange of audit documents relevant to investigations in the United States and China. However, it is not clear how these recent developments could affect the SEC's final decision in the case against the five accounting firms or any subsequent appeal to courts that the accounting firms may initiate. Therefore, it is difficult to determine the final outcome of the administrative proceedings and the potential consequences thereof.
 
If our independent registered public accounting firm were denied the ability to practice before the SEC and we were unable to timely find another registered public accounting firm to audit and issue an opinion on our financial statements, our financial statements could be determined to not be in compliance with the requirements of the Exchange Act. Such a determination could ultimately lead to delisting of our ADSs from the New York Stock Exchange or deregistration from the SEC, or both, which would substantially reduce or effectively terminate the trading of our ADSs in the United States.
 
ITEM 4. 
INFORMATION ON THE COMPANY
 
A.         HISTORY AND DEVELOPMENT OF THE COMPANY
 
Our legal and commercial name is China Petroleum & Chemical Corporation. Our head office is located at 22 Chaoyangmen North Street, Chaoyang District, Beijing 100728, the People’s Republic of China, our telephone number is (8610) 5996-0028 and our fax number is (8610) 5996-0386. We have appointed our representative office in the United States, located at 410 Park Avenue, 6/F, New York, NY 10022, USA (telephone number: (212) 759-5085; fax number: (212) 759-6882) as our agent for service of processes for actions brought under the U.S. securities laws.
 
We were established as a joint stock limited company on February 25, 2000 under the Company Law of the PRC with Sinopec Group Company as the sole shareholder at our inception. Our principal businesses consist of petroleum and petrochemical businesses transferred to us by Sinopec Group Company pursuant to a reorganization agreement.  Such businesses include:
 
 
·
exploration for, development, production and marketing of crude oil and natural gas;
 
 
·
refining of crude oil and marketing and distribution of refined petroleum products, including transportation, storage, trading, import and export of petroleum products; and
 
 
·
production and sales of petrochemical products.
 
Sinopec Group Company’s continuing activities consist, among other things, of:
 
 
·
exploring and developing oil and gas reserves overseas;
 

 
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·
operating certain petrochemical facilities and small capacity refineries;
 
 
·
providing geophysical exploration, and well drilling, survey, logging and downhole operational services;
 
 
·
manufacturing production equipment and providing equipment maintenance services;
 
 
·
providing construction services;
 
 
·
providing utilities, such as electricity and water; and
 
 
·
providing other operational services including transportation services.
 
Sinopec Group Company transferred the businesses to us either by transferring its equity holdings in subsidiaries or by transferring their assets and liabilities. Sinopec Group Company also agreed in the reorganization agreement to transfer to us its exploration and production licenses and all rights and obligations under the agreements in connection with its core businesses transferred to us. The employees relating to these assets were also transferred to us.
 
In order to expand our core businesses, prevent competition between us and members of Sinopec Group and reduce related party transactions, between 2001 and 2009 we have acquired Sinopec National Star Petroleum Company, Sinopec Group Maoming Petrochemical Company, Tahe Oilfield Petrochemical Factory and Xi’an Petrochemical Main Factory, certain Petrochemical and Catalyst Assets, certain Refinery Plants and certain service stations, certain Oil Production Plants, Sinopec Hainan and certain downhole operation assets, 100% equity interest of Sinopec Qingdao Petrochemical Company Limited and certain other assets relating to exploration and production, refining and marketing and distribution segments and assets of certain research institutes from Sinopec Group Company. We have also sold and disposed of certain auxiliary assets and chemical assets. In addition, we completed the privatization of Beijing Yanshan Petrochemical Co., Ltd. and Sinopec Zhenhai Refinery and Chemicals Co., Ltd. and the tender offers for the acquisition of publicly-held A-shares of four subsidiaries formerly listed on stock exchanges in China, namely Sinopec Qilu Petrochemical Co., Ltd., Sinopec Yangzi Petrochemical Co., Ltd., Sinopec Zhongyuan Petroleum Co., Ltd., and Shengli Oil Field Dynamic Co., Ltd.
 
On March 3, 2010, the warrants issued by us in 2008 matured, of which 188,292 warrants had been exercised and converted into 88,774 shares, providing funding of approximately RMB 1.7 million to us.
 
In 2010, we acquired a 55% equity interest of SSI, from Sinopec Overseas Oil & Gas Limited, a subsidiary of Sinopec Group Company, for a cash consideration of US$1.678 billion. SSI owns a 50% interest in Angola Block 18.
 
In 2011, we issued RMB 23 billion convertible bonds which are convertible into our A shares. As of December 31, 2013, our A shares increased by 117,873,188 shares as a result of the exercise of conversion rights by some holders of our convertible bonds. As of April 11, 2014, an aggregate of 348,021,943 A shares have been converted from these convertible bonds.
 
In 2012, we received from Sinopec Group Company an undertaking to avoid its competition with us.  For details, please refer to the descriptions under “Item 7. Major Shareholders and Related Party Transactions – A. Major Shareholders”.
 
On February 14, 2013, we completed a placing of an aggregate of 2,845,234,000 new H shares at a price of HK$8.45 per share. The net proceeds from such placing are approximately HK$23.97 billion.
 
In 2013, Sinopec International Petroleum E&P Hongkong Overseas Limited, a joint venture owned by Sinopec Group Company and us on a 50:50 basis, acquired from Sinopec Group Company (i) 50% interest in Caspian Investment Resources Ltd. (“CIR”), (ii) 49% interest in Taihu Limited (“Taihu”), and (iii) 50% interest in Mansarovar Energy Colombia Ltd. (“Mansarovar”), for a cash consideration of US$2.711 billion in the aggregate. Each of CIR, Taihu and Mansarovar is engaged in oil and gas exploration, development and production business, with CIR based in Kazakhstan, Taihu in Russia and Mansarovar in Colombia.
 
On February 19, 2014, our board of directors unanimously approved a proposal to restructure our marketing and distribution business and to diversify the ownership of this segment by way of introducing social and private capital investments. The shareholding percentage for social and private investors will be determined according to the market conditions. Our board of directors authorized our Chairman, for so long as the aggregate shareholding percentage of social and private investors does not exceed 30%, to determine the investors, their respective shareholding percentages and the terms and conditions of their participation in the marketing and distribution segment
 

 
17

 

and to organize the implementation of the plans for such participation. As of April 1, 2014, our ownership, management and control of the assets in the marketing and distribution segment have been transferred to Sinopec Sales Co., Ltd, one of our wholly owned subsidiaries.
 
B.         BUSINESS OVERVIEW
 
Exploration and Production
 
Overview
 
We currently explore for, develop and produce crude oil and natural gas in a number of areas in China and overseas. As of December 31, 2013, we held 195 production licenses in China, with an aggregate acreage of 22,563 square kilometers and with terms ranging from 10 to 80 years. Our production licenses may be renewed upon our application at least 30 days prior to the expiration date, which are renewable for unlimited times. During the term of our production license, we pay an annual production license fee of RMB 1,000 per square kilometer.
 
As of December 31, 2013, we held 293 exploration licenses in China for various blocks in which we engaged in exploration activities, with an aggregate acreage of approximately 983,680 square kilometers and with the maximum term of 7 years. Our exploration licenses may be renewed upon our application at least 30 days prior to the expiration date, with each renewal for a maximum two-year term. We are obligated to make an annual minimum exploration investment in each of the exploration blocks which we obtained the exploration licenses. We are also obligated to pay an annual exploration license fee ranging from RMB 100 to RMB 500 per square kilometer. Under the PRC laws and regulations, however, we are entitled for reduction and exemption of exploration license fee for exploration in the western region, northeast region and offshore of China.
 
As of December 31, 2013, our overseas subsidiary held 2 production licenses, with an aggregate acreage of 322.57 square kilometers. It currently does not have exploration licenses. Our overseas equity-accounted investments held 70 production licenses, with an aggregate acreage of 3,779.33 square kilometers, and 6 exploration licenses.
 
Properties
 
We currently operate 16 oil and gas production fields in China, each of which consists of many oil and gas producing fields and blocks.
 
Shengli production field is our most important crude oil production field. It consists of 70 producing blocks of various sizes extending over an area of 2,564 square kilometers in northern Shandong province, all of which are our net developed acreage. Most of Shengli’s blocks are located in the Jiyang trough with various oil producing layers. In 2013, Shengli production field produced 197 million barrels of crude oil and 17.66 billion cubic feet of natural gas, with an average daily production of 548 thousand BOE.
 
As of December 31, 2013, the total acreage of our oil and gas producing fields and blocks in China was 8,902 square kilometers, including 6,388 square kilometers of developed acreage, all of which were net developed acreage; and 2,514 square kilometers of gross undeveloped acreage, all of which were net undeveloped acreage.
 
As of December 31, 2013, the total acreage of our oil and gas producing fields and blocks of our overseas subsidiary was 140.5 square kilometers, including 110.0 square kilometers of developed acreage, of which 31.8 square kilometers were net developed acreage; and 30.5 square kilometers of gross undeveloped acreage, of which 8.8 square kilometers were net undeveloped acreage.
 
As of December 31, 2013, the total acreage of our oil and gas producing fields and blocks of our overseas equity-accounted investments was 1,738.5 square kilometers, including 1,591.9 square kilometers of developed acreage, of which 656.5 square kilometers were net developed acreage; and 146.6 square kilometers of gross undeveloped acreage, of which 46.1 square kilometers were net undeveloped acreage.
 
Oil and Natural Gas Reserves
 
As of December 31, 2013, our estimated proved reserves of crude oil and natural gas in China were 3,855 million BOE (including 2,773 million barrels of crude oil and 6,493 billion cubic feet of natural gas), and our estimated proved reserves of crude oil and natural gas outside of China, which included a share of the estimated proved reserves of our equity-accounted
 

 
18

 

investments, were 362 million BOE. Our estimated proved reserves do not include additional quantities recoverable beyond the term of the relevant production licenses, or that may result from extensions of currently proved areas, or from application of improved recovery processes not yet tested and determined to be economical. Since the end of 2013, we have made significant progress in the exploration and development of shale gas field in Fuling, Sichuan province, which may result in significant increase in our proved reserves in the near future.
 
The following tables set forth our proved developed and undeveloped crude oil and natural gas reserves by region as of December 31, 2013.

Crude Oil Proved Reserves
As of December 31, 2013
 
(in millions of barrels)
Developed
 
Subsidiaries
 
China
 
Shengli
1,944
Others
557
Overseas(1)
61
Subtotal
2,562
Equity-accounted investments
 
Overseas(2)
259
Subtotal
259
Total Developed
2,821
Undeveloped
 
Subsidiaries
 
China
 
Shengli
110
Others
162
Overseas(1)
7
Subtotal
279
Equity-accounted investments
 
Overseas(2)
30
Subtotal
30
Total Undeveloped
309
Total Proved Reserves
3,130
 
Natural Gas Proved Reserves
As of December 31, 2013
 
(in billions of cubic feet)
Developed
 
Subsidiaries
 
China
 
Puguang
2,939
Others
2,842
Overseas(1)
-
Subtotal
5,781
Equity-accounted investments
 
Overseas(2)
24
Subtotal
24
Total Developed
5,805
Undeveloped
 
Subsidiaries
 
China
 
Puguang
-
Others
712
Overseas(1)
-
Subtotal
712
Equity-accounted investments
 
Overseas(2)
3
Subtotal
3
Total Undeveloped
715
Total Proved Reserves
6,520
 
______________________
(1) In 2010, we acquired from Sinopec Group Company part of its interests in Angola Block 18. The proved reserves amount is the net reserves amount of SSI after deducting the government’s amount-sharing. We hold a 55% equity interests in SSI.
(2) In 2013, a joint venture owned by Sinopec Group Company and us on a 50:50 basis acquired from Sinopec Group Company (i) 50% interest in CIR, (ii) 49% interest in Taihu, and (iii) 50% interest in Mansarovar. The proved reserves amount reflects the joint venture's shares in CIR, Taihu and Mansarovar.
 

 
19

 
 

As of December 31, 2013, approximately 309 million barrels of our crude oil proved reserves and 715 billion cubic feet of our natural gas proved reserves were classified as proved undeveloped reserves in China and overseas, among which approximately 11.65 million barrels of our crude oil proved reserves and 0.105 billion cubic feet of our natural gas proved reserves in China were classified as proved undeveloped reserves for more than five years, due to international factors. These reserves are mostly located in the Shanghai branch.
 
During 2013, a total of 1,014 wells were drilled by us in China and 8 wells were drilled overseas. We converted 96 million barrels of proved undeveloped crude oil reserves and 851 billion cubic feet of proved undeveloped natural gas reserves into proved developed reserves in 2013. Total capital expenditure incurred in converting proved undeveloped reserves into proved developed reserves amounted to RMB 22.204 billion, including RMB 19.583 billion and RMB 2.621 billion incurred in connection with our operations in China and overseas, respectively, in 2013.

We manage our reserves estimation through a two-tier management system. Our Oil and Natural Gas Reserves Management Committee, or the RMC, at our headquarters level oversees the overall reserves estimation process and reviews the reserves estimation of our company. Each of our Branches has a reserves management committee that manages the reserves estimation process and reviews the reserves estimation report at the branches level.

Our RMC is chaired by Mr. Wang Zhigang, one of our senior vice presidents, and is co-led by our deputy chief geologist and our director general of our exploration and production segment. Mr. Wang holds a Ph.D. degree in geology from Geology and Geo-physics Research Institute of the China Academy of Science and has over 30 years of experience in oil and gas industry. Our RMC also consists of 31 other members who are senior management members in charge of exploration and development activities at production bureau level. A majority of our RMC members hold doctor’s or master’s degrees and our RMC members have an average of 20 years of technical experience in relevant industry fields, such as geology, engineering and economics.

Our reserves estimation is guided by procedural manuals and technical guidance. Initial collection and compilation of reserves information are conducted by different working divisions, including exploration, development, financial and legal divisions, at production bureau level. Exploration and development divisions collectively prepare the initial report on reserves estimation. Together with technical experts, reserves management committees at production bureau level then review to ensure the qualitative and quantitative compliance with technical guidance and accuracy and reasonableness of the reserves estimation. At headquarter level, the RMC is primarily responsible for the management and coordination of the reserves estimation process, review and approval of annual changes and results in reserves estimation and disclosure of our proved reserves. We also engage outside consultants who assist us to be in compliance with the U.S. Securities and Exchange Commission rules and regulations. Our reserves estimation process is further facilitated by a specialized reserves database which is improved and updated periodically.

Oil and Natural Gas Production
 
In 2013, we produced an average of 1,153 thousand BOE per day in China, of which approximately 73.86% was crude oil and 26.14% was natural gas. We produced an average of 69 thousand BOE per day overseas, all of which was crude oil. The following tables set forth our average daily production of crude oil and natural gas sold for the years ended December 31, 2011, 2012 and 2013. The production of crude oil includes condensate.


   
Year Ended December 31,
 
   
2011
   
2012
   
2013
 
   
(in thousands of barrels)
 
Average Daily Crude Oil Production
                 
China
                 
Shengli
    532       536       540  
Others
    299       304       312  
Overseas
                       
Subsidiary(1)      
    50       59       59  
Equity-accounted investments
    -       -       10
(2)
Total Crude Oil Production
    881       899       921  
 

 

 
20

 


   
Year Ended December 31,
 
   
2011
   
2012
   
2013
 
   
(in millions of cubic feet)
 
Average Daily Natural Gas Production
                 
China
                 
Puguang
    586       732       784  
Others                                                                    
    830       905       1024  
Overseas
    -       -       -  
Total Natural Gas Production
    1,416       1,637       1,808  
______________________
(1) The average daily production of our overseas subsidiary is the net production of SSI after deducting the government’s sharing of production. We hold 55% equity interest of SSI.
(2) The average daily production of our equity-accounted investments reflects our shares of the production in CIR, Taihu and Mansarovar, starting from our acquisition in 2013 of (i) 50% interest in CIR, (ii) 49% interest in Taihu, and (iii) 50% interest in Mansarovar, through a joint venture owned by Sinopec Group Company and us.

Lifting Cost & Realized Prices
 
The following table sets forth our average lifting costs per BOE of crude oil produced, average sales prices per barrel of crude oil and average sales prices per thousand cubic meters of natural gas for the years ended December 31, 2011, 2012 and 2013.

   
Weighted
Average
   
China
   
Overseas(1)
 
   
(RMB)
 
For the year ended December 31, 2013
                 
Average petroleum lifting cost per BOE
    112.56       113.63       91.27  
Average realized sales price
                       
Per barrel of crude oil
    590.86       584.35       671.17  
Per thousand cubic meters of natural gas
    1,359.23       1,359.23       -  
For the year ended December 31, 2012
                       
Average petroleum lifting cost per BOE
    110.64       111.47       92.55  
Average realized sales price
                       
Per barrel of crude oil
    632.51       625.79       704.17  
Per thousand cubic meters of natural gas
    1,291.65       1,291.65       -  
For the year ended December 31, 2011
                       
Average petroleum lifting cost per BOE
    103.86       104.89       81.64  
Average realized sales price
                       
Per barrel of crude oil
    636.61       632.03       707.70  
Per thousand cubic meters of natural gas
    1,284.02       1,284.02       -  
_______________________
(1) The exchange rates we used for overseas data in this table was the average exchange rates for each year ended December 31, 2011, 2012 and 2013, which were RMB 6.4588 to US$1.00, RMB 6.3125 to US$1.00, and RMB 6.1928 to US$ 1.00, respectively.

Exploration and Development Activities
 
In 2013, we increased our oil and gas reserves by exploring resources in our five important exploration areas for our upstream business activities. We made remarkable progresses in our exploration of unconventional oil and gas resources. We made a number of technological breakthroughs and achieved satisfactory trial development results in our exploration of the Fuling marine-facies shale gas field, laying a solid foundation for our shale gas development. In 2013, we made two dimensional seismic exploration of 14,654 kilometers, three dimensional seismic exploration of 11,534 square kilometers, and drill footage of 1,875 kilometers. In 2013, we added 313 million barrels to our proved oil reserves in China, achieving an oil reserve replacement ratio of more than 100%. We also acquired overseas upstream assets from Sinopec Group Company, which significantly increased our overseas oil and gas assets. In addition, we enhanced the recovery rate in mature fields and effectively curbed the growth in lifting costs. We made intensive efforts in the natural gas market by increasing sales volumes to meet consumption demand.
 

The following table sets forth the numbers of our exploratory and development wells, including a breakdown of productive wells and dry wells we drilled during the years ended December 31, 2011, 2012 and 2013.

   
Total
   
China
   
Overseas
 
         
Shengli
   
Others
   
Subsidiary
   
Equity-accounted investments
 
For the year ended December 31, 2013
                             
Exploratory
                             
Productive
    350       112       238       -       -  


 
21

 


Dry
    352       96       256       -       -  
Development
                                       
Productive
    4,513       2,490       2,016       5       2  
Dry
    83       39       44       -       -  
For the year ended December 31, 2012
                                       
Exploratory
                                       
Productive
    329       101       228       -       -  
Dry
    682       89       593       -       -  
Development
                                       
Productive
    3,583       2,047       1,532       4       -  
Dry
    35       6       29       -       -  
For the year ended December 31, 2011
                                       
Exploratory
                                       
Productive
    321       112       209       -       -  
Dry
    504       124       380       -       -  
Development
                                       
Productive
    3,333       1,839       1,494       -       -  
Dry
    23       5       18       -       -  

The following table sets forth the number of wells being drilled by us as of December 31, 2013, as compared to December 31, 2012:

    As of December 31,  
   
2012
   
2013
 
   
Gross
   
Net
   
Gross
   
Net
 
China
                       
Shengli
    86       86       93       93  
Others
    199       199       174       174  
Overseas
                               
Subsidiary
    4       1       1       -  
Equity-accounted investments
    -       -       1       -  
Total Wells Drilling
    289       286       269       267  

The following table sets forth our number of productive wells for crude oil and natural gas as of December 31, 2013, as compared to December 31, 2012:

   
As of December 31,
 
   
2012
   
2013
 
Productive Wells for Crude Oil
 
Gross
   
Net
   
Gross
   
Net
 
China
                       
Shengli
    30,082       30,082       28,844       28,844  
Others
    16,165       16,165       17,281       17,281  
Overseas
                               
Subsidiary
    21       7       23       7  
Equity-accounted investments            
    -       -       1,604       468  
Total
    46,268       46,254       47,752       46,600  
 
 
   
As of December 31,
 
   
2012
   
2013
 
Productive Wells for Natural Gas
 
Gross
   
Net
   
Gross
   
Net
 
China
                       
Puguang
    53       53       53       53  
Others
    3,794       3,776       4,179       4,159  
Overseas
    -       -       -       -  
Total
    3,847       3,829       4,232       4,212  


 
22

 


Refining
 
Overview
 
In 2013, our refinery throughputs were approximately 232 million tonnes. We produce a full range of refined petroleum products. The following table sets forth our production of our principal refined petroleum products for the years ended December 31, 2011, 2012 and 2013.
 
   
Year Ended December 31,
 
   
2011
   
2012
   
2013
 
   
(in million tonnes)
 
Gasoline
    37.10       40.55       45.56  
Diesel
    77.17       77.39       77.40  
Kerosene and jet guel
    13.73       15.01       17.43  
Light chemical feedstock
    37.38       36.33       37.97  
Liquefied petroleum gas
    9.47       9.92       10.56  
Fuel oil
    2.54       2.38       3.17  

Gasoline and diesel are our largest revenue producing products, and are sold mostly through our marketing and distribution segment through both wholesale and retail channels. We use most of our production of chemical feedstock as feedstock for our own chemical operations. Most of our refined petroleum products were sold in China to a wide variety of industrial and agricultural customers, and a small amount are exported.
 
Refining Facilities
 
Currently we operate 34 refineries in China. As of December 31, 2013, our total primary distillation capacity of crude oil was 282 million tonnes per annum.
 
The following table sets forth our total primary distillation capacity per annum of crude oil and refinery throughputs as of and for the years ended December 31, 2011, 2012 and 2013.
 
   
As of and for the Year Ended December 31,
 
   
2011
   
2012
   
2013
 
Primary distillation capacity of crude oil (million tonnes per annum)
    247.10       260.90       282.20  
Refinery throughputs (million tonnes)
    217.37       221.31       231.95  
_______________________
Notes:
(1) The primary distillation capacity and refinery throughputs of joint ventures are 100% included in our statistics.
(2) When calculating refinery throughputs, conversion from tonnes to barrels are made at a rate of one tonne to 7.35 barrels.
 

In 2013, measured by the total output from our refineries, our gasoline yield was 19.64%, diesel yield was 33.37%, kerosene yield was 7.52%, and light chemical feedstock yield was 16.37%. Other products include lubricant, liquefied petroleum gas, solvent, asphalt, petroleum coke, paraffin and fuel oil. For the years ended December 31, 2011, 2012 and 2013, our overall yield for all refined petroleum products at our refineries was 95.09%, 95.15% and 94.82% , respectively.
 
The following table sets forth the primary distillation capacity per annum as of December 31, 2013 of each of our refineries with the primary distillation capacity of 8 million tonnes or more per annum.
 
Refinery
 
Primary Distillation Capacity
as of December 31, 2013
   
(in million tonnes per annum)
Zhenhai
 
23.80
Maoming
 
23.50
Jinling
 
21.00
Shanghai
 
16.00


 
23

 


Qilu
 
14.00
Fujian
 
14.00
Tianjin
 
13.80
Yanshan
 
13.50
Guangzhou
 
13.20
Gaoqiao
 
13.00
Qingdao
 
12.00
Changling
 
11.50
Yangzi
 
9.50
Hainan
 
9.20
Luoyang
 
8.00
Wuhan
 
8.00
Anqing
 
8.00
 
In 2013, our primary distillation capacity of crude oil increased by 21.3 million tonnes per annum, which included an increase of 8.5 million tonnes per annum in the distillation capacity of sour crude. In addition, in 2013, our hydro-refining capacity increased by 20.7 million tonnes per annum. The revamping projects for a number of refining facilities to improve refined petroleum product quality were also completed and put into operation.
 
Source of crude oil
 
In 2013, approximately 81.81% of the crude oil required for our refinery business was sourced from international suppliers.
 
Marketing and Sales of Refined Petroleum Products
 
Overview
 
We operate the largest sales and distribution network for refined petroleum products in China. In 2013, we distributed and sold approximately 165.42 million tonnes of gasoline, diesel, jet fuel and kerosene.  Most of the refined petroleum products sold by us are produced internally. In 2013, approximately 77.9% of our gasoline sales volume and approximately 79.2% of our diesel sales volumes were produced internally.
 
The table below sets forth a summary of key data in the marketing and sales of refined petroleum products in the years of 2011, 2012 and 2013.
 
   
2011
   
2012
   
2013
 
Total sales volume of refined petroleum products
(in million tonnes)
    162.32       173.15       179.99  
Domestic sales volume of refined petroleum products
(in million tonnes)
    151.16       158.99       165.42  
Retail
    100.24       107.85       113.73  
Direct Sales
    33.22       33.25       33.49  
Wholesale
    17.70       17.89       18.20  
Average annual throughput of service stations (in tonnes per station)
    3,330       3,498       3,707  


 
24

 


   
As of December 31,
 
   
2011
   
2012
   
2013
 
Total number of service stations under Sinopec brand
    30,121       30,836       30,536  
Self-operated service stations
    30,106       30,823       30,523  
 
Retail
 
All of our retail sales are made through a network of service stations and petroleum shops operated under the Sinopec brand. Through this unified network we are more able to implement consistent pricing policies, maintain both product and service quality standards and more efficiently deploy our retail network.
 
In 2013, we sold approximately 113.73 million tonnes of gasoline, diesel and kerosene through our retail network, representing approximately 68.8% of our total domestic gasoline, diesel, jet fuel and kerosene sales volume. Our retail network mainly consists of service stations that are wholly-owned and operated by us, and jointly-owned and generally operated or leased by us, all of which are operated under the Sinopec brand. We also franchised the Sinopec brand to third parties services stations. As of December 31, 2013, we had 13 franchised service stations that are owned and operated by third parties. In 2013, the average annual throughput of our service stations increased by 5.97% from 2012, and we have further strengthened our leading position in our principal market, and further improved our brand awareness and customer loyalty.
 
Direct Sales

In 2013, we sold approximately 33.49 million tonnes of refined petroleum products, including 2.67 million tonnes of gasoline, 28.74 million tonnes of diesel and 2.08 million tonnes of kerosene, through direct sales to domestic commercial customers such as industrial enterprises, hotels, restaurants and agricultural producers.
 
Wholesale
 
In 2013, we sold approximately 18.2 million tonnes of gasoline, diesel, kerosene and jet fuel through wholesale channels, representing approximately 11.0% of our total domestic sales volume of gasoline, diesel, kerosene and jet fuel. Our wholesale sales include sales to large commercial or industrial customers and independent distributors as well as sales to certain long-term customers such as railway, airlines, shipping and public utilities.
 
Through our wholesale centers, we operate 395 storage facilities with a total capacity of approximately 15.7 million cubic meters, substantially all of which are wholly-owned by us. Our wholesale centers are connected to our refineries by railway, waterway and, in some cases, by pipelines. We also own some dedicated railways, oil wharfs and oil barges, as well as a number of rail tankers and oil trucks.
 
Chemicals
 
Overview
 
We are the largest petrochemicals producer in China. We produce a full range of petrochemical products including intermediate petrochemicals, synthetic resins, synthetic fiber monomers and polymers, synthetic fibers, synthetic rubber and chemical fertilizers. Synthetic resins, synthetic fibers, synthetic rubber, chemical fertilizers and some intermediate petrochemicals comprise a significant majority of our external sales. Synthetic fiber monomers and polymers and intermediate petrochemicals, on the other hand, are mostly internally consumed as feedstock for the production of other chemical products. Our chemical operations are integrated with our refining businesses, which supply a significant portion of our chemical feedstock such as naphtha. Because of strong domestic demand, most of our petrochemical products are sold in China’s domestic market.
 
Products
 
Intermediate Petrochemicals
 
We are the largest ethylene producer in China. Our rated ethylene capacity as of December 31, 2013 was 10.18 million tonnes per annum. In 2013, we produced 9.98 million tonnes of ethylene. Nearly all of our olefins production is used as feedstock for our petrochemical operations.
 

 
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We produce aromatics mainly in the forms of benzene and para-xylene, which are used primarily as feedstock for purified terephthalic acid, or PTA, the preferred raw material for polyester. We are the largest aromatics producer in China.
 
Chemicals extracted from olefins and aromatics are mainly used to produce synthetic resins, synthetic rubber and synthetic fibers, as well as intermediate petrochemicals.
 
The following table sets forth our rated capacity per annum, production volume and major plants of production as of or for the year ended December 31, 2013 for our principal intermediate petrochemical products.
 
 
Our Rated
Capacity
 
Our
Production
 
 
Major Plants of Production
 
(thousand tonnes per annum)
 
(thousand tonnes)
   
Ethylene
10,180
 
9,980
 
Yanshan, Shanghai, Yangzi, Qilu, Maoming, Guangzhou, Tianjin, Zhongyuan, SECCO*, BASF-YPC*, Fujian*, Zhongsha (Tianjing)*, Zhenhai and Sino-Korean (Wuhan)*
Propylene
9,155
 
8,462
 
Yanshan, Shanghai, Yangzi, Qilu, Maoming, Guangzhou, Tianjin, Zhongyuan, SECCO*, BASF-YPC*, Gaoqiao, Anqing, Jinan, Jingmen, Fujian*, Zhongsha (Tianjing)*, Zhenhai and Sino-Korean (Wuhan)*
Benzene
5,056
 
3,745
 
Yanshan, Shanghai, Yangzi, Qilu, Guangzhou, Zhenhai, Tianjin, Luoyang, SECCO* and BASF-YPC*
Styrene
2,099
 
2,084
 
Yanshan, Qilu, Guangzhou, Maoming, SECCO* and Zhenhai
Para-xylene
4,779
 
4,478
 
Shanghai, Yangzi, Qilu, Tianjin, Luoyang and Fujian*
Phenol
608
 
597
 
Yanshan and Gaoqiao
_______________________
* Joint ventures, of which the production capacities and outputs are 100% included in our statistics.

Synthetic Resins
 
We are the largest producer of polyethylene, polypropylene and polystyrene and supplier of major synthetic resins products in China.
 
The following table sets forth our rated capacity per annum, production volumes and major plants of production for each of our principal synthetic resins as of or for the year ended December 31, 2013.
 
 
Our Rated
Capacity
 
Our
Production
 
Major Plants of Production
 
(thousand tonnes
per annum)
 
(thousand
tonnes)
   
Polyethylene
6,889
 
6,597
 
Yanshan, Shanghai, Yangzi, Qilu, Maoming, Guangzhou, Tianjin, Zhongyuan, SECCO*, BASF-YPC*, Fujian*, Zhongsha (Tianjing)*, Zhenhai and Sino-Korean (Wuhan)*
Polypropylene
6,155
 
5,733
 
Yanshan, Shanghai, Yangzi, Qilu, Guangzhou, Maoming, Tianjin, Zhongyuan, SECCO*,  Jingmen, Fujian*, Zhongsha (Tianjing)*, Zhenhai and Sino-Korean (Wuhan)*
Polyvinyl chloride
600
 
308
 
Qilu
Polystyrene
750
 
665
 
Yanshan, Qilu, Maoming, Guangzhou and SECCO*
Acrylonitrile butadiene styrene
200
 
121
 
Gaoqiao


 
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_______________________
* Joint ventures, of which the production capacities and outputs are 100% included in our statistics.

Synthetic Fiber Monomers and Polymers
 
Our principal synthetic fiber monomers and polymers are purified terephthalic acid, ethylene glycol, acrylonitrile, caprolactam, polyester, polyethylene glycol and polyamide fiber. Based on our 2013 production, we are the largest producer of ethylene glycol and caprolactam in China.  Most of our production of synthetic fiber monomers and polymers are used as feedstock for synthetic fibers.
 
The following table sets forth our rated capacity per annum, our production volume and major plants of production as of or for the year ended December 31, 2013 for each type of our principal synthetic fiber monomers and polymers.
 
 
Our Rated
Capacity
 
Our
Production
 
Major Plants of Production
 
(thousand tonnes per annum)
 
(thousand tonnes)
   
Purified terephthalic acid
3,119
 
2,947
 
Shanghai, Yangzi, Yizheng, Tianjin and Luoyang
Ethylene glycol
2,579
 
2,018
 
Yanshan, Shanghai, Yangzi, Tianjin, Maoming, BASF-YPC*, Zhongsha (Tianjing)* and Zhenhai
Acrylonitrile
680
 
703
 
Shanghai, Anqing, Qilu and SECCO*
Caprolactam
660
 
549
 
Shijiazhuang and Baling
Polyester
3,168
 
2,858
 
Shanghai, Yizheng, Tianjin and Luoyang
_______________________
* Joint ventures, of which the production capacities and outputs are 100% included in our statistics.

Synthetic Fibers
 
We are the largest producer of acrylic fibers in China. Our principal synthetic fiber products are polyester fiber and acrylic fiber.
 
The following table sets forth our rated capacity per annum, production volume and major plants of production for each type of our principal synthetic fibers as of or for the year ended December 31, 2013.
 
 
Our Rated
Capacity
 
Our
Production
 
Major Plants of Production
 
(thousand tonnes
per annum)
 
(thousand
tonnes)
   
Polyester fiber
1,328
 
1,093
 
Yizheng, Shanghai, Tianjin and Luoyang
Acrylic fiber
265
 
293
 
Shanghai, Anqing and Qilu

Synthetic Rubbers
 
Our principal synthetic rubbers are cis-polybutadiene rubber, styrene butadiene rubber, or SBR, styrene butadiene-styrene thermoplastic elastomer and isobutadiene isoprene rubber, or IIR. Based on our 2013 production, we are the largest producer of SBR and cis-polybutadiene rubber in China.
 
The following table sets forth our rated capacity per annum, production volume and major plants of production as of or for the year ended December 31, 2013 for each of our principal synthetic rubbers.
 
 
Our Rated
Capacity
 
Our
Production
 
Major Plants of Operation
 
(thousand tonnes
per annum)
 
(thousand
tonnes)
   
Cis-polybutadiene rubber
540
 
405
 
Yanshan, Qilu, Maoming and Gaoqiao
Styrene butadiene rubber
430
 
410
 
Yanshan, Qilu, Maoming and Gaoqiao and Yangzi


 
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Styrene-butadiene-styrene thermoplastic elastomers
140
 
108
 
 
Yanshan and Maoming
Isobutylene isoprene rubber
45
 
35
 
Yanshan
Isoprene rubber
30
 
2
 
Yanshan

Synthetic Ammonia and Urea
 
We produce synthetic ammonia and urea. Our synthetic ammonia is used to manufacture urea, caprolactam and acrylic nitrile.
 
The major companies of our production for chemical fertilizers for the year ended December 31, 2013 were Sinopec Anqing Company, Sinopec Baling Company and Sinopec Hubei Chemical Fertilizer Company.
 
Marketing and Sales of Petrochemicals
 
Most of our sales revenue come from China. Price and volume of petrochemical sales are primarily market driven. The southern and eastern regions in China, where most of our petrochemical plants are located, constitute the major petrochemical market in China. Our proximity to the major petrochemical market gives us a geographic advantage over our competitors.
 
Our principal sales and distribution channels consist of direct sales to end-users, most of which are large- and medium-sized manufacturing enterprises, and sales to distributors. We also provided after-sale services to our customers, including technical support. We continuously strive to improve our product mix and enhance our product quality to meet market needs.
 
Competition
 
Refining and Marketing of Refined Petroleum Products
 
Market participants compete primarily on the basis of wide-established sales network and logistics system, quality of products and service, efficiency of operations including proximity to customers, awareness of brand name and price. While we constantly face competition from other market participants, we believe that we have a competitive advantage in our principal market against our competitors.
 
Chemicals
 
We compete with domestic and foreign chemicals producers in the chemicals market.  We believe our proximity to customers has given us significant geographical advantages. Most of our petrochemical production facilities are located in the eastern and southern regions in China, an area which has experienced higher economic growth rates in China in the past thirty years. Proximity of our production facilities to our markets has given us an advantage over our competitors in terms of easy access to our customers, resulting in lower transportation costs, more reliable delivery of products and better service to customers.
 
Patents and Trademarks
 
In 2013, we were granted 2,388 patents in China and overseas. As of December 31, 2013, we owned a total of 11,569 patents in China and overseas.
 
Business Operations Relating to Iran Threat Reduction and Syria Human Rights Act of 2012
 
In 2013, we sourced a small amount of crude oil from Iran, and such amount represented 2.95% of our total refinery throughputs. In addition, we engaged in a small amount of trading activities with an Iranian company with net profit of approximately $3.41 million.

Based on feedback to our inquiries to Sinopec Group Company, our controlling shareholder, Sinopec Group Company, directly or indirectly through its affiliates, engaged in a small amount of business activities in Iran such as providing engineering support and designs. Sales revenue from these business activities accounted for 0.0015% of its total unaudited sales revenue. In 2013, no profits were generated from these business activities.
 

 
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Since we have performance obligations under our Iran-related contracts, we are legally required to continue our performance of part of Iran related contracts in 2014.

Regulatory Matters
 
Overview
 
China’s petroleum and petrochemical industry has seen significant liberalization in the past ten years. However, the exploration, production, marketing and distribution of crude oil and natural gas, as well as the production, marketing and distribution of certain refined petroleum products are still subject to regulation of many government agencies including:

National Development and Reform Commission (“NDRC”)

The NDRC is responsible for formulating and implementing key policies in respect of petroleum and petrochemical industry, including:

 
·
Formulating guidance plan for annual production, import and export amount of crude oil, natural gas and petroleum products nationwide based on its forecast on macro-economic conditions in China;
 
 
·
Setting the pricing policy for refined oil products; and
 
 
·
Approving certain domestic and overseas resource investment projects which are subject to NDRC’s approval as required by the Catalogue of Investment Projects Approved by the Government (2013).
 
The Ministry of Commerce (“MOFCOM”)

MOFCOM is responsible for examining and approving production sharing contracts, Sino-foreign equity joint venture contracts and Sino-foreign cooperation joint venture contracts for oil and gas development within the PRC. It is also responsible to issue quotas and licenses for import and export of crude oil and refined oil products.

In November 2010, we were approved by four Ministries including MOFCOM to become one of the first trial enterprises to cooperate with international business partners and develop coal bed methane  resources (MOFCOM Circular 984[2010]).

Ministry of Land and Resources (“MLR”)

The MLR is responsible for issuing the licenses that are required to explore and produce crude oil and natural gas in China.

Regulation of Exploration and Production
 
Exploration and Production Rights
 
The PRC Constitution provides that all mineral and oil resources belong to the state. In 1986, the Standing Committee of the National People’s Congress passed the Mineral Resources Law which authorizes the Ministry of Land and Resources, or the MLR, to exercise administrative authority over the exploration and production of the mineral and oil resources within the PRC, including its territorial waters. The Mineral Resources Law and its supplementary regulations provide the basic legal framework under which exploration licenses and production licenses are granted. The MLR has the authority to grant exploration licenses and production licenses on a competitive bidding or other basis it considers appropriate. Applicants for these licenses must be companies approved by the State Council to engage in oil and gas exploration and production activities.  Currently, only we, PetroChina, China National Offshore Oil Corporation (CNOOC) and Yanchang Petroleum Group Ltd. have received such exploration licenses and production licenses in oil and gas industry. In addition, pursuant to the Regulation on the Administration of Geological Survey Qualifications promulgated by the State Council, which became effective from July 1, 2008, any entity engaging in geological survey activities shall obtain a geological survey qualification certificate. Oil and natural gas survey qualifications, among others, shall be examined, approved and granted by the MLR.
 

 
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Applicants for exploration licenses must first submit applications to the MLR with respect to blocks in which they intend to engage in exploration activities. The holder of an exploration license is obligated to make an annual minimum exploration investment and pay annual exploration license fees, ranging from RMB 100 to RMB 500 per square kilometer, relating to the exploration blocks in respect of which the license is issued. The maximum term of an exploration license is 7 years. The exploration license may be renewed upon application by the holder at least 30 days prior to expiration date, with each renewal for a maximum two-year term.
 
At the exploration stage, an applicant can also apply for a progressive exploration and production license that allows the holder to test and develop reserves not yet fully proved. The progressive exploration and production license has a maximum term of 15 years. When the reserves become proved for a block, the holder must apply for a full production license in order to undertake production.
 
The MLR issues full production licenses to applicants on the basis of the reserve reports approved by relevant authorities. The maximum term of a full production license is 30 years unless a special dispensation is given by the State Council. Due to a special dispensation granted to us by the State Council, the maximum term of our full production licenses is 80 years. The full production license is renewable upon application by the holder at least 30 days prior to expiration of the original term. A holder of the full production license has to pay an annual full production right usage fee of RMB 1,000 per square kilometer.
 
Exploration and production licenses do not grant the holders the right to enter upon any land for the purpose of exploration and production. Holders of exploration and production licenses must separately obtain the right to use the land covered by the licenses, and if permissible under applicable laws, current owners of the rights to use such land may transfer or lease the land to the license holder.
 
Incentives for Shale Gas Development
 
China National Energy Administration issued the Shale Gas Industry Policy (the “Policy”) on October 22, 2013, which classifies shale gas as a “national strategic new industry” and calls for more fiscal support for exploration and development of shale gas. In particular, subsidies should be given directly to a shale gas production company according to the amount of its shale gas development and utilization. Local governments are also encouraged to provide subsidies to shale gas production companies, with the subsidy amount to be determined by local fiscal authorities. The Policy provides that compensatory fee for mineral resources and/or license fee for shale gas exploration enterprises will be reduced or exempted, and tariffs can be exempted on the import of certain equipment which cannot be produced domestically. In addition, the government intends to develop and issue regulations on tax incentive policies relating to resource tax, value added tax and income tax for shale gas exploration and development.
 
Price Controls on Crude Oil
 
According to the Measures for Administration of Petroleum Products Price (Trial) issued by the NDRC on March 26, 2013, the crude oil price shall be determined by the enterprises on their own accord, by reference to the international market price. The price for supplying crude oil by us and CNPC to each other shall be determined by both the parties upon consultation in accordance with the principle that the cost for transporting domestic crude oil to the refinery is equivalent to the cost for importing crude oil from international market to the refinery. The price for providing crude oil by us and the CNPC to local refineries shall be determined in reference to the supply prices between the two corporations. The price of crude oil produced by CNOOC or other enterprises shall be determined on their own accord by reference to the international market price.
 
Price Controls on Natural Gas
 

 
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On June 28, 2013, NDRC released the Circular on Adjustment of the Price of Natural Gas. Pursuant to the circular, prices of natural gas will be linked to the prices of alternative energy, and the prices will be determined at city gates by the market (i.e., by natural gas suppliers and consumers themselves), subject to a ceiling price set by the government. The natural gas prices are subject to slight increase, but caps are set for the prices increase. Price of natural gas used to make fertilizer shall be increased by no more than RMB 0.25 per cubic meter and prices of other non-residential natural gas shall be increased by no more than RMB 0.4 per cubic meter. Gas prices for residential users will remain unchanged.
 
Regulation of Refining and Marketing of Refined Petroleum Products
 
Price Controls on Gasoline, Diesel and Jet Fuels
 
The PRC government continues to exercise control over the prices of gasoline, diesel and jet fuels.
 
On March 26, 2013, the NDRC announced adjustments to the existing refined oil pricing mechanism, which include, among other things, (i) shortening of monitoring period for adjusting oil product prices from 22 working days to 10 working days; (ii) eliminating the 4% upward or downward fluctuation as a trigger for adjustment of oil product prices; (iii) adjusting the composition of benchmarked crude oil as a reference  for domestic oil product prices. In the cases of changes such as significant increase in domestic CPI or significant fluctuations of crude oil price, NDRC may issue additional procedural guidelines, such as implementing ad hoc suspension, delay or narrowing of price adjustment upon the approval by the State Council.
 
The ex-factory price of the jet fuels (standard) will be determined by the buyers and the sellers, subject to a limit of no more than the import parity price in the Singapore market. The NDRC will regularly release the import parity price for jet fuels in the Singapore market.
 
On September 16, 2013, a Circular of Relevant Opinions on Pricing Policies for Upgrading Oil Product Quality was promulgated by the NDRC. The Circular provides that the prices of gasoline and diesel products shall be increased if the quality of such products is upgraded. For gasoline and diesel products that are upgraded to GB IV standards, their prices shall be raised by RMB 290 per tonne and RMB 370 per tonne, respectively; for gasoline and diesel products that are upgraded from GB IV to GB V standards, their prices shall be raised by RMB 170 per tonne and RMB 160 per tonne, respectively. Prices for regular diesel shall be benchmarked against automobile diesel with same specfication.
 
Regulation of Crude Oil and Refined Petroleum Products Market
 
On December 4, 2006, Ministry of Commerce of the PRC promulgated the “Administrative Rules for Crude Oil Market” and “Administrative Rules for Refined Petroleum Products  Market” to open the wholesale market of crude oil and refined petroleum products to new market entrants, respectively. The rapid entrance of foreign enterprises into Chinese petroleum, chemical and other related business will change the current horizon of crude oil resorce, as well as petroleum and chemical products market.
 
Investment
 
Under the State Council’s Decision on Investment System Reform, investments without the use of government funds are only subject to a licensing system or a registration system, as the case may be. Under the current system, only significant projects and the projects of restrictive nature are subject to approval so as to maintain social and public interests, and all other projects of any investment scale are only subject to a registration system.
 
 
 
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On December 2, 2013, the State Council issued the Catalogue of Investment Projects Requiring Government Approval (2013) (“2013 Catalogue”). Under the 2013 Catalogue, NDRC approval will only be required for overseas investment projects larger than US$1 billion in size or concerning sensitive countries or regions or sensitive industries. All other projects, including those by enterprises directly administered by the SASAC and local enterprises with an investment size over US$3 billion, will require only a filing with the NDRC or NDRC’s local branches. In addition, when establishing and operating enterprises abroad, Chinese investors will be required to apply for MOFCOM approval if sensitive countries or regions or sensitive industries are involved. For other projects, Chinese investors will need to submit a filing with MOFCOM or MOFCOM’s local branches.
 
Pursuant to the Anti-Monopoly Law of the PRC which became effective on August 1, 2008, when market concentration by business carriers through merger, acquisition of control through shares or assets acquisition, or acquisition of control or the ability to exercise decisive influence over other business carriers by contract or by other means reaches a threshold of declaration level prescribed by the State Council, the business carriers shall declare in advance to the Anti-monopoly Law enforcement agency, otherwise, the business carriers shall not implement such market concentration.
 
Taxation, Fees and Royalty
 
Companies which operate petroleum and petrochemical businesses in China are subject to a variety of taxes, fees and royalties.
 
Effective from January 1, 2009, China has adjusted the consumption tax rates of the refined oil and other refined oil products under the country’s refined oil tax reform plan.
 
On October 28, 2011, the Rules for Implementation of Interim Regulations of the Resource Tax was promulgated by the Ministry of Finance and State Administration of Taxation,  under which the implementation of resources taxes reform will cover oil and gas enterprises at nationwide since November 1, 2011. Any person who is involved in production of crude oil and natural gas, and is qualified to pay resources taxes, shall pay 5% of the price of crude oil or natural gas as the resource taxes. Qualified taxes payers may enjoy an exemption or reduction of resources taxes.
 
Effective from November 1, 2011, The Ministry of Finance increased the threshold of the special oil income levy to US$55 per barrel, and a five-level progressive rate will still be applicable to special oil income levy collection based on the sale prices, which is calculated and paid monthly.
 
Applicable tax, fees and royalties on refined petroleum products and other refined oil products generally payable by us or by other companies in similar industries are shown below.
 
Tax Item
 
Tax Base
 
Tax Rate
 
Enterprise income tax
 
Taxable income
 
25% effective from January 1, 2008.
         
Value-added tax
 
Revenue
 
13% for liquefied petroleum gas, natural gas, and low density polyethylene for production of agricultural film and fertilizers and 17% for other items. We generally charge value-added tax to our customers at the time of settlement on top of the selling prices of our products on behalf of the taxation authority. We may directly claim refund from the value-added tax collected from our customers for value-added tax that we paid for (i) purchasing materials consumed during the production process; and (ii) charges paid for drilling and other engineering services.
         


 
32

 


Consumption tax
 
Aggregate volume sold or self-consumed
 
RMB 1.0 per liter for gasoline, naphtha, solvent oil and lubricant; RMB 0.8 per liter for diesel, jet fuel and fuel oil. The consumption tax for naphtha for the production of ethylene and aromatic products will be taxed first but refunded later. The consumption tax for naphtha  which is produced internally for the production of ethylene and aromatic products and those listed in direct supply scheme of State Administration of Taxation will be exempted. Consumption tax on jet fuel is currently exempted.
         
Import tariff
 
CIF China price
 
5% for gasoline, 6% for diesel, 9% for jet kerosene and 6% for fuel oil. Beginning on July 1, 2011, the applicable tax rates for gasoline, fuel oil, diesel and jet kerosene are 1%, 1%, 0% and 0%, respectively.
         
Resource tax
 
Aggregate volume sold or self-consumed
 
Effective from November 1, 2011, for domestic production of crude oil and natural gas, the applicable tax rate is 5% of the sales revenue, exemption or deduction may apply if qualified.
         
Compensatory fee for mineral resources
 
Revenue of crude oil and natural gas
 
1%
         
Exploration license fee
 
Area
 
RMB 100 to RMB 500 per square kilometer per annum.
         
Production license fee
 
Area
 
RMB 1,000 per square kilometer per annum.
         
Royalty fee(1)
 
Production volume
 
Progressive rate of 0-12.5% for crude oil and 0-3% for natural gas.
         
City construction tax
 
Total amount of value-added tax, consumption tax and business tax
 
1%, 5% and 7%.
         
Education Surcharge and local education surcharge
 
Total amount of value-added tax, consumption tax and business tax
 
3% and 2%.
         
Special Oil Income Levy
 
Any revenue derived from sale of domestically produced crude oil when the realized crude oil price exceeds US$55 per barrel.
 
Progressive rate of 20% to 40% for revenues derived from crude oil with realized price in excess of US$55 per barrel.
__________
(1)
Sino-foreign oil and gas exploration and development cooperative projects whose contracts were signed prior to November 1, 2011 and have not yet expired are still subject to royalty fee, and the project companies of those cooperative projects are not subject to any other resource taxes or fees. Sino-foreign oil and gas exploration cooperative projects whose contracts are signed after November 1, 2011 are not subject to royalty fee, but are subject to resource taxes.

C.         ORGANIZATIONAL STRUCTURE
 
For a description of our relationship with Sinopec Group Company, see “Item 4. Information on the Company ¾ A. History and Development of the Company” and “Item 7. Major Shareholders and Related Party Transactions.” For a description of our significant subsidiaries, see Note 34 to our consolidated financial statements.
 
D.         PROPERTY, PLANT AND EQUIPMENT
 
We own substantially all of our properties, plants and equipment relating to our business activities.
 

 
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See “Item 4. Information on the Company ¾ B. Business Overview” for description of our property, plant and equipment.
 
Environmental Matters
 
We are subject to various national environmental laws and regulations and also environmental regulations promulgated by the local governments in whose jurisdictions we have operations. For example, national regulations promulgated by the central government set discharge standards for emissions into air and water. They also set forth schedules of discharge fees for various waste substances. These schedules usually provide for discharge fee increases for each incremental amount of discharge up to a certain level. Above a certain level, the central regulations permit the local government to order any of our facilities to cure certain behavior causing environmental damage and subject to the central government’s approval, the local government may also issue orders to close any of our facilities that fail to comply with the existing regulations. In addition, we have incurred capital expenditure specifically in compliance with the various environmental protection objectives set by the PRC government for the petroleum and chemical industry, to promote energy saving and environmental protection in China.
 
Each of our production subsidiaries has implemented policies to control its pollutant emissions and discharge and to oversee compliance with the PRC environmental regulations. In January 2013, we integrated our environmental protection functions such as low-carbon development strategy and energy-saving mission by setting up a new department named Energy Management and Environmental Protection Department. The main functions of this new department are environmental management functions such as energy saving, emission reduction, environmental protection, water saving, comprehensive utilization of resources and clean production.
 
Our production facilities have their own facilities to treat waste water, solid waste and waste gases on site. Waste water first goes through preliminary treatment at our own waste water treatment facilities. Thereafter, the water is sent to nearby waste water treatment centers operated either by us or by Sinopec Group for further treatment. All solid waste materials generated by our production facilities are buried at disposal sites or burned in furnaces either operated by us or by Sinopec Group. Waste gases are generally treated and burned in furnaces before dissipation and the ash is disposed in accordance with our solid waste disposal procedures.
 
Environmental regulations also require companies to file an environmental impact report to the environmental bureau for approval before undertaking any construction of a new production facility or any major expansion or renovation of an existing production facility. Such an undertaking will not be permitted to operate until the environmental bureau has performed an inspection and is satisfied that environmentally sound equipment has been installed for the facility.
 
We believe our environmental protection systems and facilities are adequate for us to comply with current applicable national and local environmental protection regulations. The PRC government, however, may impose stricter regulations which require additional expenditure on compliance with environmental regulations.
 
Our environmental protection expenditures were approximately RMB 4.2 billion in 2011, RMB 4.8 billion in 2012, and RMB 5.2 billion in 2013.
 
Insurance
 
In respect of our refining, petrochemical production, and marketing and sales operations, we currently maintain with Sinopec Group Company, under the terms of its Safety Production Insurance Fund (“SPI Fund”), approximately RMB 650.3 billion of coverage on our property and plants and approximately RMB 109.3 billion of coverage on our inventory. In 2013, we paid an insurance premium of approximately RMB 2.6 billion to Sinopec Group Company for such coverage.  Transportation vehicles and products in transit are not covered by Sinopec Group Company and we maintain insurance policies for those assets with insurance companies in the PRC.
 
The insurance coverage under SPI Fund applies to all domestic enterprises controlled by Sinopec Group Company under regulations published by the Ministry of Finance. We believe that, in the event of a major accident, we will be able to recover most of our losses from insurance proceeds paid under the SPI Fund or by insurance companies.
 
Pursuant to an approval of the Ministry of Finance, Sinopec Group Company entered into an agreement with China People’s Insurance Company on January 29, 2002 to purchase a property and casualty policy which would also cover our assets. The policy provides for an annual maximum cumulative claim amount of RMB 4.0 billion and a maximum of RMB 2.36 billion per occurrence.
 

 
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On November 22, 2013, our Donghuang II pipeline located in Qingdao Economic and Technological Development Zone ruptured, resulting in oil leakage into the covered municipal drainage trench. The municipal drainage trench exploded and caused severe casualties and injuries to the surrounding pedestrians, residents and rescue team. The accident caused 62 deaths and 136 injuries and a direct economic loss of RMB 751.7 million, according to the investigation report issued by the State Council investigation team. We were responsible for paying our portion of required compensation to third parties. Our payments would be funded mainly from our Safe Production Insurance Fund that have been accumulated in the past years, as well as claims under the business catastrophe insurance policy that we maintained with a third-party commercial insurance company.
 
ITEM 4A
 UNRESOLVED STAFF COMMENTS
 
None.
 
ITEM 5.   
OPERATING AND FINANCIAL REVIEW AND PROSPECTS
 
A.         GENERAL
 
The following discussion and analysis should be read in conjunction with our audited consolidated financial statements. Our consolidated financial statements have been prepared in accordance with IFRS. Certain financial information presented in this section is derived from our audited consolidated financial statements. Unless otherwise indicated, all financial data presented on a consolidated basis or by segment, are presented net of inter-segment transactions (i.e., inter-segment and other intercompany transactions have been eliminated).
 
Critical Accounting Policies
 
Our reported consolidated financial condition and consolidated results of operations are sensitive to accounting methods, assumptions and estimates that underlie the preparation of our financial statements.  We base our assumptions and estimates on historical experience and on various other assumptions that we believe to be reasonable and which form the basis for making judgments about matters that are not readily apparent from other sources.  On an on-going basis, our management evaluates its estimates.  Actual results may differ from those estimates as facts, circumstances and conditions change.
 
The selection of critical accounting policies, the judgments and other uncertainties affecting application of those policies and the sensitivity of reported results to changes in conditions and assumptions are factors to be considered when reviewing our financial statements.  Our principal accounting policies are set forth in Note 2 to the consolidated financial statements.  We believe the following critical accounting policies involve the most significant judgments and estimates used in the preparation of our financial statements.
 
Oil and gas properties and reserves
 
The accounting for our upstream oil and gas activities is subject to special accounting rules that are unique to the oil and gas business.  There are two methods to account for oil and gas business activities, the successful efforts method and the full cost method.  We have elected to use the successful efforts method.
 
The successful efforts method reflects the volatility that is inherent in exploring for mineral resources in that costs of unsuccessful exploratory efforts are charged to expense as they are incurred.  These costs primarily include dry hole costs, seismic costs and other exploratory costs.  Under the full cost method, these costs are capitalized and written-off (depreciation) over time.
 
Engineering estimates of our oil and gas reserves are inherently imprecise and represent only approximate amounts because of the subjective judgments involved in developing such information.  There are authoritative guidelines regarding the engineering criteria that have to be met before estimated oil and gas reserves can be designated as “proved”.  Proved and proved developed reserves estimates are updated at least annually and take into account recent production and technical information about each field.  In addition, as prices and cost levels change from year to year, the estimate of
 

 
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proved and proved developed reserves also changes.  This change is considered a change in estimate for accounting purposes and is reflected on a prospective basis in related depreciation rates.
 
Future dismantlement costs for oil and gas properties are estimated with reference to engineering estimates after taking into consideration the anticipated method of dismantlement required in accordance with industry practices in similar geographic area, including estimation of economic life of oil and gas properties, technology and price level.  The present values of these estimated future dismantlement costs are capitalized as oil and gas properties with equivalent amounts recognized as provision for dismantlement costs.
 
Despite the inherent imprecision in these engineering estimates, these estimates are used in determining depreciation expense, impairment expense and future dismantlement costs, and in disclosing the supplemental standardized measure of discounted future net cash flows relating to proved oil and gas properties.  Depreciation rates are determined based on estimated proved developed reserve quantities (the denominator) and capitalized costs of producing properties (the numerator).  Producing properties’ capitalized costs are amortized based on the units of oil or gas produced.  Therefore, assuming all other variables are held constant, an increase in estimated proved developed reserves decreases our depreciation, depletion and amortization expense.  Also, estimated reserves are often used to calculate future cash flows from our oil and gas operations, which serve as an indicator of fair value in determining whether a property is impaired or not. The larger the estimated reserves, the less likely the property is impaired.  There have been no significant changes to the original reserve estimates during any of the three years ended December 31, 2011, 2012 and 2013.
 
Impairment for long-lived assets
 
If circumstances indicate that the net book value of a long-lived asset, including oil and gas properties, may not be recoverable, the asset may be “impaired”, and an impairment loss may be recognized.  The carrying amounts of long-lived assets are reviewed periodically in order to assess whether the recoverable amounts have declined below the carrying amounts. For goodwill, the recoverable amount is estimated annually. These assets are tested for impairment whenever events or changes in circumstances indicate that their recorded carrying amounts may not be recoverable. When such a decline has occurred, the carrying amount is reduced to recoverable amount. The recoverable amount is the greater of the net selling price and the value in use.  It is difficult to precisely estimate selling price because quoted market prices for our assets or cash-generating units are not readily available. In determining the value in use, expected cash flows generated by the asset or the cash-generating unit are discounted to their present value, which requires significant judgment relating to level of sales volume, selling price and amount of operating costs. We use all readily available information in determining an amount that is a reasonable approximation of recoverable amount, including estimates based on reasonable and supportable assumptions and projections of reserve quantities, sales volume, selling price and amount of operating costs.
 
Impairment losses recognized for each of the three years ended December 31, 2011, 2012 and 2013 in our statement of income on long-lived assets are summarized as follows:
 
   
Year ended December 31,
 
   
2011
   
2012
   
2013
 
   
(RMB in millions)
 
Exploration and production
    2,153       1,006       2,523  
Refining
    78       -       88  
Marketing and distribution
    269       8       35  
Chemicals
    308       -       -  
Corporate and others
    1       -       15  
Total
    2,809       1,014       2,661  

Depreciation
 
Property, plant and equipment (other than oil and gas properties) are depreciated on a straight-line basis over the estimated useful lives of the assets, after taking into account the estimated residual value. We review the estimated useful lives of the assets regularly in order to determine the amount of depreciation expense to be recorded during any reporting period. The useful lives are based on our historical experience with similar assets and take into account anticipated technological changes. The depreciation expense for future periods is adjusted if there are significant changes from previous estimates.  There have been no changes to the estimated useful lives and residual values during each of the three years ended December 31, 2011, 2012 and 2013.
 

 
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Impairment of accounts receivable for bad and doubtful debts
 
We estimate impairment of accounts receivable for bad and doubtful debts resulting from the inability of our customers to make the required payments. We base our estimates on the aging of our accounts receivable balance, customer credit-worthiness, and historical write-off experience. If the financial condition of our customers were to deteriorate, actual write-offs would be higher than estimated.  The changes in the impairment losses for bad and doubtful accounts are as follows:
 
   
Year ended December 31,
 
 
 
2011