China’s Refineries Create Worldwide Glut While Independents Buck Beijing’s Control

China’s Refineries Create Worldwide Glut While Independents Buck Beijing’s Control

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In its most recent analysis of China’s oil and gas industry, updated in April, the US Energy Information Agency (EIA) said that China’s installed crude refining capacity is over 11 million barrels per day (bbl/d), doubling since 2000, while its goal is to augment crude oil refining capacity by around 3 million bbl/d to reach 14 million bbl/d by 2015, the end of the country’s 12th Five Year Plan.

China’s goal to keep increasing its refining capacity has an impact not only within China, but (as is usually the case with China’s oil and gas dynamics in the past decade) also globally.

Perhaps the most conspicuous impact of Beijing’s refining goals is an impending glut of refined petroleum products worldwide. Late last year the International Energy Agency (IEA) addressed this issue, stating that global oil demand could rise to 95.7 million bbl/d by 2017, but refining sector expansion will likely take global refining capacity to 100.5 million bbl/d for the same period. The IEA said that China would account for more than 40% of global refining capacity in the next five years, a figure matching China’s recent emergence as a global energy player.

Likewise, in its June report the IEA said the world is heading for a glut of refined products as new Asian and Middle Eastern refineries increase oil processing in a move likely to force less advanced competitors in developed countries to close. The IEA said it expected 9.5 million bbl/d of new crude distillation capacity, representing more than a tenth of global demand, to come on stream in 2013-2015, substantially more than the forecast increase in crude production capacity and global demand forecast.

“While Europe’s economic woes are taking a toll on demand, there are mounting signs that China’s oil use, like its economy, may have shifted to lower gear. Slower growth in demand than in-runs could lead to product stock builds, while shorter than expected larger refining volumes would undermine refining margins,” the agency said.

However, the last thing refiners need are lower profit margins, particularly China’s refiners. Due to China’s National Development and Reform Commission (NDRC) which controls the price of fuel products sold domestically, China’s three state-owned national oil companies (NOCs) often suffer low profit margins and are forced to make it up by exporting more refined products overseas.

A worldwide glut of refined products could cut into these profits from exports as well. Lower profits margins from overseas operations mixed with weak refining margins at home could force China’s NOCs to borrow even more money than current debt levels to finance overseas deals and acquisitions. The past eight years have seen Chinese NOCs spend $200 billion on foreign acquisitions and joint ventures, with an unhealthy mix of debt to equity ratios starting to plague China’s oil majors.

Another problem for China’s refining sector, which is controlled by two NOCs, Sinopec (the second largest refiner in the world) and CNPC, which account for 46% and 31% of China’s refining capacity respectively, are independent refiners and what many call teapot refiners because of their small size. Though small in size, their numbers are surprising. Argus Media reported in an April study that there are around 155 independent refineries spread across China, and about half haven’t been legally indentified by Beijing.

Since China’s three oil majors monopolize the country’s refining sector, it has created a type of backlash for Beijing. First, these smaller independents are limited in what kind of feedstock they can use at their refineries but often find ways around Beijing’s top down control.

In fact, private oil companies in China are not usually permitted to import crude oil directly, but have to rely on state-owned companies for their supplies. The only crude private Chinese companies can import is heavy crude, which is harder to refine and yield less profitable refined products. Lighter crude is more valuable since it yields higher value lighter products such as gasoline, jet fuel and diesel.

Teapots and independents, ranging from 40,000-bbl/d capacity to 120,000-bbl/d capacity, account for 16% of China’s total refining capacity, the EIA says. Argus Media however places that number even higher, claiming that China’s independent refineries account for a “surprisingly large 21% of national refining capacity.”

But Beijing not only limits the quantity and type of crude independents and teapots can import but is trying to weed out the less productive ones in an effort to achieve economies of scale. In 2011, the NDRC issued guidelines that would eliminate refineries smaller than 40,000 bbl/d by the end of this year. However the independents, in true Chinese fashion, are not going down quietly. Several of these refineries, instead of shutting down, have expanded capacity or consolidated with larger firms.

Bucking control from Beijing

On top of that, these refineries often have the backing of provincial governments that do not want to lose local jobs, perks, nor revenue that these refineries generate. It’s a problem that government planners in Beijing have faced for centuries. From obstinate warlords in far flung western provinces bucking orders from the Qing dynasty to the same provincial power bases resisting top down government reform from the short lived KMT-Nationalist government in Beijing to the current day Chinese Communist Party (CCP) controlled government, ruling the Middle Kingdom from Beijing often proves a complicated and futile undertaking.

However, even if China’s refining sector is over-heating and contributing to a global refining glut, its independents are also making a positive impact domestically. Since the country’s independent refiners account for around 20% of national refining capacity this means that they provide a valuable service providing China with motor fuels and other products.

Argus said that the country’s independent refiners are essential to product supply in China and have a very large impact on imports of fuel oil as well as consumption of domestic crude and have a significant role on the Chinese domestic market.

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