Chinese refiners look outward as domestic market saturated: Fuel for Thought

The dramatic transformation that China’s vast refining landscape has undergone in the last year is rewriting the market dynamics for oil trade flows in Asia.

With the deregulation of the sector and the emergence of a swathe of independent refineries on the eastern coast, the country has been flooded — more than in any previous year — by an overwhelming supply of oil products.

And to battle an oversupply situation at home, China has been aggressively shipping out products to such an extent that it has flooded regional markets in Asia.

Transport fuel exports are now at their highest level on record. Gasoline outflows have jumped 78% while gasoil exports are up 183% over the first three quarters of the year.

That means that in a typical month, China is sending out the equivalent of around 35 medium-range cargoes of gasoil and more than 20 MR gasoline cargoes, up from 17 and 14, respectively, during the whole of 2015.

Gasoline and gasoil exports are expected to remain at more than 1 million mt/month in November and December each following the end of heavy refinery maintenance in the third quarter. China will likely surpass South Korea as the second largest exporter of gasoline in Asia this year, behind India.

The message to the market is clear: China is now a major refining hub in Asia, alongside traditional exporters such as South Korea and India. This is a change from the de facto strategy of aiming to be balanced for major oil products.

There are two main reasons for this.

With the global oil market looking to remain oversupplied for a long period of time, China has fewer worries of pushing up prices with its growing appetite for crude. Indeed one could argue that China is one of the few bright spots on the demand side.

A second reason is that China’s refining sector has turned from being dominated by an oligopolistic few to one with increased competition from independent, non-government affiliated companies, meaning it is now difficult to make a concerted effort to keep the domestic market balanced.

Why blink first?

China’s crude intake has jumped by more than 900,000 b/d over January to September, with independent refiners in Shandong raising their runs by 600,000 b/d year on year.

This has created a glut in the domestic market, with smaller independent refineries leveraging their flexible distribution systems using a combination of road, rail and some pipelines to send oil products all around the country.

The question then is why aren’t state-owned refiners cutting back on their runs?

The simple answer is similar to OPEC’s conundrum regarding oil production that nobody wants to be the first to reduce their runs and cede market share to rivals.

Refiners would rather keep utilization rates high to bring down unit costs through economies of scale and export excess supplies, even if poor regional cracks make it uneconomical to export incremental barrels of oil products.

“Exports can only go up, not down,” notes one Chinese refining source ominously.

With Asia becoming the dumping ground for products, the key then is to find other markets.

Data collected by Platts China Oil Analytics shows that beginning this year, a few gasoline cargoes from China have been sent to the Middle East and as far away as the US while gasoil has been sent to the Americas, including Peru.

Peru has been a landing spot for Chinese polymers for several years and it looks like oil products may follow the same path.

Over the years Chinese state-owned companies have become not just suppliers of crude and products into China but also developed sophisticated trading subsidiaries to raise revenues and achieve profit targets.

This is complemented by a global refining and storage footprint. PetroChina, with refineries in Europe and Sinopec with storage in the Americas, for example, enables them to send cargoes from one region to another within their own systems, even when the conventional arbitrage is not open.

So while Asia is critically short of crude oil, it appears that China has joined the ranks of other Asian refining stalwarts, which take the view that as long as there is a margin to be made made processing crude and exporting oil products they will do it.

The sea change that China’s refining industry has witnessed this year is just the beginning of a trend. Just as China has mastered mass production and left shuttered factories in its wake, the same could happen in the refining sector.