Commodities 2022: Consolidation in store as China shows independent refiners iron fist

China's independent refining sector is expected to consolidate further in 2022 as Beijing's pledge to maintain supervision to ensure operational and tax discipline would see integrated refining capacities increasingly replacing smaller players that are scattered across northern part of the country.

The expected decision by China to deny five of its independent refineries crude import quotas in the first round of allocations is a confirmation that the independent refiners are set to face the toughest crackdown since the sector was liberalized and was given access to imported crude in 2015.

Analysts told S&P Global Platts that integrated refining capacities have started to replace the small and scattered ones in the refining sector, as the country steps up efforts in phasing out less efficient refining capacities and replace them with relatively more modern, integrated and petrochemical-oriented capacity.

Before 2021, independent refiners have been finding ways to use policy loopholes. But since last year, the government has started to tighten supervision by launching investigations on the sector's operations, taxation compliance and environmental responsibility.

Beijing has set a target to cap the country's refining capacity at 100 million mt/year in 2025.

Beijing in 2022 took the first strong step by removing five independent refineries from the list of refiners eligible for crude import quotas in the first round of allocations.

"Removing them from the first batch of quota allocation means that these refineries are unlikely to import even a drop of crude with their own quota in 2022 until the second batch of allocation when they will look to meet the requirements for quotas, and it is a warning to quota trade which is illegal," a Beijing-based analyst said.

The refineries left out in the first batch are Haiyou Petrochemical, Qingyuan Petrochemical, Qingyishan Petrochemical, Wonfull Petrochemical and Beifang Asphalt, which together had a combined crude import quota ceiling of 21.4 million mt/year in 2021.

Other than Beifang Asphalt in Liaoning province, the remaining four operating plants have been absent from the list since the second batch of allocation for 2021 in late June.

As a result, the refiners are only left with the option of buying domestically produced crudes, imported crude barrels from the domestic market as well as importing fuel oil and bitumen blends.

"This would boost their feedstock costs, compared with their peers, hurting their competitiveness," a Singapore-based analyst said.

Moreover, quotas awarded to the state-owned ChemChina also saw a 29% decline to 8.56 million mt from the same round of last year, which was attributed to operation faults found in 2021.

"We expect more progress to be made on the collection of consumption taxes at the pump, some resolution of tax practices, and stricter policies aimed at shutting small and aged refineries permanently," S&P Global Platts Analytics said in a report dated Dec. 16.

Integrated plants

In contrast, greenfield integrated refiners are set to gain more than 35 million mt/year of additional quotas in 2022, with the 36 million mt/year new refining capacity in Zhejiang Petroleum & Chemical and Shenghong Petrochemical starting operations.

Currently, ZPC is running its 40 million mt/year plant at about 80% of the nameplate capacity, while the 16 million mt Shenghong plans to startup in late-January.

Their increased crude throughput would largely more than offset the reduction in runs at their relatively smaller independent peers, which are set to gain relatively lower volume of quotas this year, compared with last year.

Moreover, three independent refineries which shut in 2021, were also absent from the first batch of allocation for 2022, compared to 2021.

These refineries, with a combined capacity of 8 million mt/year, had been allowed to crack a total 7 million mt/year of imported crude oil, and are set to transfer their quota to the under-construction integrated 20 million mt/year Yulong Petrochemical in Shandong province, sources said.

In 2022, three more of such independent refineries, with a combined refining capacity of 7.4 million mt/year, are likely to shut and in turn transfer their crude import quotas amounting to 4.56 million mt/year, Platts data showed.

Since 2020, a total of 10 small Shandong-based independent refineries have been set to shut their 2.8 million mt/year capacity to transfer 13 million mt/year crude import quota to the upcoming Yulong Petrochemical.

In China, refineries built and operated by state-owned companies -- CNOOC, PetroChina, Sinochem and Sinopec -- do not need quotas to import crude. All other refineries, including independents and those owned and operated by state-owned companies such as ChemChina and Norinco, require quotas.

Less oil, more petrochemicals

The phasing out of capacity is happening at refiners which are entirely oil products-oriented refiners, while the integrated refineries are being built keeping in mind a bigger petrochemicals portfolio.

"The shift is in line with China's development plan and product rebalancing," a Hong Kong-based analyst said.

China's transportation fuels demand is expected to fall over coming years as EVs expand their market share, while railways and waterways continue to replace road transportation.

This would lead to combined consumption of gasoline, gasoil and jet fuel peaking at about 390 million mt/year around 2025 and fall to 60 million mt/year by 2060, according to a report released by China National Petroleum Corporation's Economics & Technology Research Institute on Dec. 26.

A growing petrochemicals market is seen as a sector that would help to support China's oil demand, despite fears of slowing consumption of transportation fuels.

In addition, Beijing has set its eyes to minimize oil product exports to control emissions. As a result, it has slashed the country's export quotas allocation by 56% on the year in the first batch for 2022.