OREANDA-NEWS. August 04, 2014. Moody's Investors Service says that while refining capacity growth is outpacing demand growth in China, it expects China National Petroleum Corporation (CNPC, Aa3 stable) and China Petroleum and Chemical Corporation (Sinopec, Aa3 stable) will maintain their strong credit quality.

"CNPC and Sinopec are both large state-owned companies that benefit from strong market positions, profitable exploration and production businesses, and very high levels of government support," says Kai Hu, a Moody's Vice President and Senior Credit Officer.

Hu was speaking on Moody's just-released report "Sinopec and CNPC Can Manage Challenges from Overcapacity in China's Refining Sector".

According to the Moody's report, the growing supply-demand imbalance has reduced refinery utilization rates. China's overall refining capacity utilization rate in 2013, defined as total crude oil processed divided by primary distillation capacity, dropped to around 77% from 81%-82% in 2010-2012.

Such decline will likely pressure the profitability of CNPC's and Sinopec's refining segments by reducing their ability to absorb the high fixed costs, particularly depreciation, of the refining businesses.

However, Moody's views that the Chinese government's policy on the pricing of refined oil products should limit this pressure. Specifically, the Chinese government's control over pricing prevents refiners from undercutting each other on price.

As such, Moody's believes CNPC, Sinopec and Chinese refiners broadly are in a better position than companies in other oversupplied industries, such as steel and coal mining, which are suffering from very weak profitability or even losses because prices have dropped sharply.

"Additionally, the government's move last year to link refined product prices more closely to crude oil prices has strengthened CNPC's and Sinopec's refining segment profit margins, providing a buffer against declining utilization rates," adds Hu.

CNPC's and Sinopec's size -- together accounting for around three quarters of China's refining capacity -- also allows them to manage the country's overall supply of refined oil products.

Specifically, Moody's expects both companies will slow their pace of new refinery projects and continue adjusting their product mixes in response to end-user demand. They are also increasing their export volumes to alleviate the supply build up.

Furthermore, even if the financial performances of CNPC's and Sinopec's refining businesses deteriorate, which Moody's does not expect, the effect on the companies' overall credit quality will be limited.

Both companies have in the past maintained strong credit metrics even when their refining segments were losing money. Their upstream exploration and production businesses continued to generate large profits, while their retail and marketing segments produced stable profits.