Impact of the Increasing RMB Exchange Rate Changes

Introduction

With the advent of the G20 Summit, the future change of the RMB exchange rate becomes the hot topic. In respect that China is characterized for the great amount of the exporting business which accounts for the large proportions of the Gross Domestic Product, the impact caused by the increasing RMB exchange rate will destroy the competency of the Chinese products. But to the petroleum industry in China, the increasing RMB exchange rate might give some positive impact on the Chinese national petroleum companies especially under the condition that the crude petroleum import increases every year. In order to find out the possible impact of the increasing RMB exchange rate on the Chinese national petroleum companies, this essay will firstly discuss the relationship between the operation of the Chinese national companies and the increasing RMB exchange rate. Following that, it will analyze the benefits and risks that might be caused by the increasing RMB exchange rate. Lastly, it will discuss the feasible measures that can be adopted to eliminate the negative impact given by the increasing RMB exchange rate. Since the major Chinese national petroleum companies are CNOOC, CPI and CNPC (Rice, 2010), these companies will be illustration used in the analysis of this essay.

Relationship between the operation of the Chinese national petroleum companies and the increasing RMB exchange rate

The value china of the petroleum business consists of the segments of petroleum prospecting, petroleum production, petroleum product refining, petroleum product processing, sales and distribution (Petrostrategies, 2010). In respect that China is not rich in the petroleum resource and has the difficulty in exploiting the petroleum, the emphasis of the Chinese oil companiesâA¢”šA¬A¢”žA¢ business is focused on the middle and lower reaches of the value chain such as the petroleum product refining and processing, sales and distribution (CNOOC, 2010; SINOPEC, 2010; CNPC, 2010). What is more, the rapid economic development boosts the great demand of the energy and the petroleum products. China has to rely on the increasing crude oil import to satisfy the increasing needs. As the state owned enterprises, most of the crude oil of the CNOOC, SINOPEC and CNPC is imported from the foreign countries such as the petroleum production companies in the Middle East. Therefore, the changes of the RMB exchange rate certainly influence the manufacturing costs of these national oil companies. If the RMB exchange rate is increased, the Chinese national companies will have the advantage in bringing on the costs expended in the upper reach of the petroleum value chain (Jin, 2010). In addition, even though the proportion of the petroleum prospecting and production is not as large as the other parts, the Chinese national petroleum companies still engage in the research and develop of these two segments of the business. Due to the intensive large capital required in the research and development as well as the introduction and cooperation with the international petroleum, the increasing RMB exchange rate does good to bringing down the cost caused by these activities.

In the overall perspectives, similar to the upper reach of the value chain, the activities of the petroleum sales and distribution in the lower chain also benefits from the increase of the RMB exchange rate. In terms of the international competition, after the final processing, the crude oil will be ultimately turned into the different types of chemical products. And some of these chemical products will be exported and sold in the international market. As the part of the overall product cost can be attributed from the cost of the crude oil, the decreasing crude oil cost caused by the increasing RMB exchange rate will be brought down accordingly (Peterson Institute for International Economics, 2010). Other things being equal, the increasing RMB exchange will result in the increase in the competency of these chemical products within the international market. However, the increasing RMB exchange rate acts like a double-edged sword on this issue. In the long term perspective, the increasing could increase the manufacturing and labor cost. In the end, the increasing cost would be equal to the cost saved, leading to the absence of the product competency caused by the increasing RMB exchange rate. At the same time, this product competency increased can also help the Chinese national petroleum companies prevent their market shares from losing to the internal petroleum companies within the domestic market.

However, as for the petroleum product refining and processing activities of the Chinese oil companies, the increasing RMB exchange rate does not have much influence. This is because that the cost of the petroleum product refining and processing activities is influenced by the internal management capability in a greater extent. Moreover, the refining and processing technique is relatively mature that the Chinese national petroleum companies do not need to seek the international collaboration in this field.

As it can be seen, due to the different relation between different parts of the Chinese national petroleum company value chain and the RMB exchange rate, the influence given by the increasing RMB exchange rate will be varied along of different segments of the petroleum value chain.

The benefits caused by the increasing RMB exchange rate

In light of the relationship analysis between the operation of Chinese national petroleum companies and the RMB exchange rate, it can be found out that the increasing RMB exchange rate brings more advantages than disadvantages to the competency of the Chinese national petroleum products. Besides, there are some other benefits brought to the development of the Chinese national petroleum. In terms of the corporate strategy realization, the increasing RMB exchange rate gives positive impact on the sustainable development of the Chinese national petroleum companies. Since the petroleum is the scarce but unsustainable resource and the research and development of the related production is at the great cost and time consuming, the increasing RMB exchange rate brings the advantages of bringing down the cost of technology introduction and international collaboration.

In terms of the actual petroleum operation, the strategy petroleum reserve is so important in the current days that the Chinese government implement this strategy via the action of the Chinese national petroleum companies. The strong purchasing power of the RMB favors the decrease of the petroleum bought from the foreign countries. Even though there might the belief that the this advantages might be eliminated in the long run, the petroleumâA¢”šA¬A¢”žA¢s attributes of being scarce but unsustainable makes it necessary and significant to reserve the petroleum. Furthermore, the increasing RMB is good for satisfying the great demand of petroleum caused by the rapid development of China, decreasing the chance of economic disturbance caused by lack of adequate petroleum.

The risks caused by the increasing RMB exchange rate

In respect that the Chinese national petroleum companies also have business operation with the international industrial counterparts and customers, the increasing RMB exchange also brings the risks to the operation of the Chinese national petroleum companies.

The major risk brought by the increasing RMB exchange rate lies in the accounting perspective. This accounting risk shows in two aspects. Firstly, some assets of the Chinese national petroleum companies are recorded in the foreign currency due to the convenience of international business operation. Switching the foreign currency to the national currency might cause the book loss in light of the increase of the RMB exchange rate (McKinnon, 2009). Take CNPC for example, CNPC buy the crude oil as its inventory. In year 1995, the exchange rate was 8.31 Yuan for one dollar and the price for each barrel of crude oil was 15 dollars which was equal to 124.65 Yuan on average (China National Petroleum Corporation, 2010). In year 2008, the RMB exchange rate was raised that the official exchange rate become 7.8 Yuan for one dollar and the price for each barrel of crude oil was 60 dollars which was equal to 468 Yuan on average. Ignoring the influence of the crude oil price changes, the increasing RMB exchange rate can make the company lose at least 6.12% if the crude oil was recorded in the value of US dollar. And the increasing crude oil price would enlarge the book loss. This typically demonstrates the exchange risk occurred in the accounting perspective. The size of the risk caused by the increasing RMB exchange rate will be varied in light of the currency used in the book keeping. Secondly, the Chinese national petroleum companies have affiliated agencies established in the international market and these business entities also have their own financial statements. Combining these financial statements into the financial report of the parent company will probably cause the book loss because of the exchange rate changes (Bradley & Moles, 2002).

Another risk caused by the increasing RMB exchange rate will be shown in the economic perspective (Ahmed & Omneya, 2007). This is the economic risk, which is the uncertainty lying in the changes of the interest rates, products, labor cost and the market demand. And the changes of the exchange rate are the ultimate cause of inducing these uncertainties. The increasing RMB exchange rate will bring up the price of the Chinese chemical products that are the one of main income sources relied by Chinese national petroleum companies. The increasing price will weaken the productâA¢”šA¬A¢”žA¢s competency, which results in the decreasing demand towards the Chinese chemical products. What is more, the lower demand of the lower downstream product might lead to the lower demand of the upstream material that is the crude oil (Commodities, 2010).

The last risk caused by the increasing RMB exchange rate will show in the perspective of the transaction exposure (Sohnke & Gordon, 2007). This is because that the Chinese national petroleum companies engage in many investment and financial activities all over the world. The contracts of these activities are signed without paying attention to the exchange rate changes over the contract term. In addition, these situations also occur in the international as to the oil and gas and the international engineering service collaboration. The variation of the exchange rate happening after signing the contracts or before finishing the account settlement might let these companies suffered from lose increasing or income decreasing. What is more, the Chinese national petroleum companies also engage in the business of foreign exchange trading which is aimed at decreasing its potential loss caused by the changes of the exchange rate. The uncertainties lied in the foreign exchange trading might bring the risk exposure caused by holding the foreign currency. In the recent years, the emphasis paid to the financial system and related regulation by the Chinese national petroleum companies such as CNPC and SINOPEC proves the fact that the risk exposure of foreign exchange trading can have huge impact on the financial performance of these companies (Chen, 2010).

The measures adopted to handle the risks caused by the changes of the increasing RMB exchange rate

In order to avoid the negative impact given by the risks caused by the increasing RMB exchange rate, there are two types of measures should be taken. One is taken in advance while the other is taken afterwards the issues.

In terms of the measures taken in advance, these measures mainly focus on adopting the measures to prevent the risks caused by the exchange rate when the company is signing the contracts. These measures are taken according to the willingness of the business entities. To be specially, the Chinese national petroleum companies should conduct analysis on the exchange rate. The Chinese national petroleum companies should adopt the flexibility of pricing about their products and service in light of the exchange rate by making good use of the information system. In making the tender, these companies should take the changes of the exchange rate into consideration. Furthermore, the company should choose the currency of denomination in a proper manner. These companies should choose the currency that has stable exchange rate or the trend of appreciation in recording the income while they should choose the currency that has the trend of depreciation in recording the expense. Besides, these companies should stick to the principle of carrying out the financing and spending by using the same type of currency so as to prevent themselves from the exchange rate risk. In addition, in collaborating with the international counterparts in terms of the petroleum or gas exploitation and engineering technology service, these companies should try their best to match the foreign exchange claims and debts in terms of currency type, size and time. Adjusting the types of currency used in debt obligation, bringing forward or defer the time period of repaying the debts are the major means to realize the match mentioned above. Lastly but not the least, these companies should learn to share the exchange rate risks with cooperation partners.

In terms of the measures taken afterwards, these measures refer to the practices to be taken only if the utilization of contracts fails in eliminating the influence caused by the exchange rate. First of all, making good use of the foreign trade financing tools helps the Chinese national petroleum companies to avoid the exchange rate risk. Besides, using these financing tools does good to improving the turnover rate of the corporate working capital and shorten the period of exchange settlement. Moreover, the Chinese national petroleum companies should use the derivatives such as futures and swaps to limit the changes of exchange rate within the acceptable scope so as to determine the income and cost in the future. This practice is widely used in CNOOC and help the company avoid the unnecessary book loss (Credit Suisse, 2010). There are several aspects that need special attention particularly the proportion of the hedge. The utilization of derivatives requires the mangers have strong understanding on these complicated financing tools. Otherwise, the risks of using these tools will be greatly excel the benefits brought by them. Hence, for realizing the purpose of reducing the risks caused by changes of the exchange rate, it is advisable for the Chinese national petroleum companies to use the simple financing tools such as ordinary option and forward.

Conclusion

By reviewing the possible impact of the increasing RMB exchange rate on the Chinese national petroleum companies, it can be found out that the influence given by the increasing RMB exchange rate will be varied along of different segments of the petroleum value chain. The increasing RMB exchange rate will bring the benefits that consist of short-term advantages in obtaining resources and long-term sustainable development to the Chinese national petroleum companies. However, this also brings the risks to the companies, which are shown the aspects of accounting, economics and transaction. In order to reduce the influence caused by these risks, two types of measures can be adopted. The measures to be taken in advance consist of proper analysis on exchange rate change, choosing suitable currency in exchange settlement, match between the foreign claim and obligation, sharing the exchange rate risk. The measures to be taken afterwards emphasize the importance of using suitable financing tools to engage in risk hedging.

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