China's Most-Wooed Oil Buyers Are Being Shunned

(Bloomberg) -- They were once the toast of the oil town, courted by everyone from OPEC producer Saudi Arabia to energy giant BP Plc and top independent trader Vitol Group. Not so much anymore.

Instead, China’s independent refiners -- whose purchases helped soak up a global oil glut -- are reducing imports, cutting operations, being shunned by sellers and getting throttled by the taxman. At least one has gone bust. A near 50 percent rally in crude over the past year and a drop in the local currency, making dollar-denominated raw materials costlier, hasn’t helped either.

The turmoil roiling the refiners, known as teapots, risks curbing shipments to No. 1 importer China and may prove another hurdle for a further gain in global prices. As the Organization of Petroleum Exporting Countries boosts output to fill potential supply gaps due to disruptions, a slowdown in demand from Asia -- the world’s biggest oil-consuming region -- could threaten the market’s balance.

China's Most-Wooed Oil Buyers Are Being Shunned

“Some teapots will have huge operating losses and some may even be wiped out from the market as they cut refining rates amid higher tax costs,” said Harry Liu, a Beijing-based consultant with IHS Markit Ltd. “Crude imports have already dropped in June to about 8 million barrels a day, which we think will become the new norm for China’s imports going forward.”

Still, it’s unlikely all teapots will be affected equally. The companies run the gamut from relatively big, cash-rich firms boasting a processing capacity of over 300,000 barrels a day, to small outfits that operate a single plant with daily capacity of less than 50,000 barrels. The refiners that run larger, more sophisticated facilities rivaling state-owned giants may be better shielded from the issues racking the industry.

Tax Bills

While a drive by Xi Jinping’s administration to revamp the Chinese economy had helped thrust the teapots into the spotlight about three years ago, another government policy is slamming the breaks on their growth. As the president expands his anti-corruption campaign and seeks to curb financial risks, credit is getting harder to come by at a time when the economy is weakening.

The teapots also face higher tax bills after authorities closed a loophole that had allowed them to declare fuels such as gasoline and diesel -- which are subject to a levy -- as other oil products that don’t attract a consumption tax.

Almost 40 percent of the processors -- who make up about a third of China’s total refining capacity -- may currently be running at a loss, said Pang Guanglian, Beijing-based senior economist at the China Petroleum and Chemical Industry Federation, whose members include state-run companies as well as teapots. “With oil prices rising so fast this year, independent refiners bear huge costs of taxes.”

Brent crude, the benchmark for more than half the world’s oil, was trading at $73.50 a barrel on Wednesday, about 42 percent higher than a year earlier.

Crude Imports

Imports by refiners in Shandong -- the Chinese province where most of the teapots are clustered -- fell by 350,000 barrels a day in June versus a month earlier, according to Cinda Securities. July volumes may further drop by the same amount due to lower demand from independent processors, it said. Crude stockpiles in the region, meanwhile, remain high after hitting a record in May.

However, according to Shanghai-based commodities researcher ICIS China, imports may pick up in the third quarter, with the start up of some new mega refineries.

China's Most-Wooed Oil Buyers Are Being Shunned

“By all accounts it sounds like the tax changes combined with the credit crunch is really starting to hurt the teapots,” said Michal Meidan, an analyst with industry consultant Energy Aspects Ltd. “It’s a combination though of the new tax system, limited political support, a squeeze by the majors to buy less product output and not just the tax change.”

While international traders remain wary of doing business with smaller teapots as banks raise the cost of financing transactions with the firms, China’s state-run refining giants such as Sinopec and PetroChina Co. may stand to benefit the most from the woes of the independent refiners, according to a Bloomberg survey of 5 participants in the nation’s oil market.

Chinese state-owned companies can also gain from offtake agreements that allow using fuel from teapots as collateral, and the sale of relatively cheap domestic crudes including Penglai that are sought after by the refiners.

Operating rates at independent refineries in Shandong province fell below 54 percent of capacity in July, the lowest level in almost two years, according to data from industry researcher SCI99. Run rates reached a high of over 70 percent late last year, before the government-initiated tax reforms kicked in during March 2018.

On whether the companies face an existential crisis, Energy Aspects’s Meidan said, “My main caution would be that they’ve survived in the past. But it does feel different this time.”

©2018 Bloomberg L.P.