Surging oil, Russian crude woes pull down China independent refiners' runs

A growing number of independent refineries in China's Shandong province are resorting to throughput cuts as crude oil's steep surge above $100/b is starting to take a toll on refining margins, while the escalating Russia-Ukraine conflict squeezes access to risk-free and cheap Russian crudes.

The developments could potentially add to oil products supply shortage in China in March and April when many refiners would undergo maintenance, capping the country's oil products exports, refinery sources told S&P Global Commodity Insights March 8.

The average utilization rate of independent refineries in Shandong, which had fallen below 70% in January, has not seen a strong revival despite Beijing Olympics having ended in February. The Olympics had led the government to impose emissions curbs and other regulations.

At least three independent refineries having a combined capacity of 9.3 million mt/year in Shandong had instead cut their crude throughput even more due to weakening margins as of March 7, a market source said.

Their runs could have fallen to about 58% in the week of March 7-11 from 60% in the previous week, according to local information provider JLC.

China's independent refineries have a combined capacity of about 159 million mt/year, accounting for close to 17% of the country's total refining capacity.

"More refineries are likely to cut throughputs or shut for maintenance in the coming weeks, as we actually have not booked sufficient feedstocks for March delivery," said an independent refinery source.

Feedstock imports for the independent refineries fell 19.6% month on month to a four-month low of 13.17 million mt in February, latest data compiled by S&P Global showed March 8, suggesting limited availability of inventories for sustaining normal operations.

Cost rises, margin narrows

"Procurement costs have soared following rocketing crude prices over the past weeks due to the Russia-Ukraine conflict," a second refining source said.

With international crude prices rising to nearly $130/b on March 7 from $90/b in early-February, independent refineries now need to pay about 44% more to purchase the same barrel of crude. This would be a huge burden for them, adding to the pain created by tightened tax collection measures by Beijing, according to the sources.

Crude oil futures jumped in Asia trade March 7, with ICE front-month Brent rallying $21.02 to $139.13/b and NYMEX front-month crude reaching its highest level since 2008 to $130.50/b, as the US consider a ban on Russian oil imports.

Under China's current oil products pricing mechanism, Beijing sets caps on retail gasoline and gasoil prices every 10 working days in line with international crude prices, when they are in a range of $40-$130/b.

If crude rises above $130/b, the government typically maintains or limits increments of the retail prices' upper ceiling in a bid to control inflation.

This means refiners' margins would tighten as crude prices rise above $130/b unless the government provides subsidy or cut taxes.

"International crude prices are more likely to stay at high levels at least for a few weeks, as we can't expect the war to end soon, while additional supplies from Iran or Venezuela will take months to return," a Beijing-based analyst said.

Access to Russian crudes

Unlike their state-owned peers having term contracts with Russian suppliers, stable pipeline or shipping agreements, and strong financing support, independent refineries are dependent on spot cargoes and keep looking for cheaper cargoes.

"We only consider Russian cargoes on a DES basis. But there are very few such offers in the market. As the war is still on, sanctions can get escalated any time. Therefore, traders are not willing to take the entire risk on their shoulders to deliver the cargoes," a Dongying-based refiner said.

Traders' recent offers for Russia's Urals grade were at a premium of $3-$4/b against ICE Brent on a DES Shandong basis. However, they have failed to attract any interest, according to sources.

"The price actually is not very low. They are only a few dollars below similar grades from other origins. But the financing costs for those cargoes are high," one refiner from Dongying said.

Johan Sverdrup, a similar grade from Norway, was traded at ICE Brent plus $7.20-$7.30/b DES Shandong in the week ended March 5, sources said.

They added that local banks were cautious in opening letters of credit for Russian crudes.

Some independent refineries have to switch to pay via telegraphic transfer for their March-onward cargoes, which would increase their financial costs significantly as it is almost like shelling out cash to sustain their cash flow.

"This adds further burden to independent refineries, which have been struggling to pay taxes," a Shandong-based source said.

Chinese Foreign Minister Wang Yi said March 7 during the country's legislative session that it will retain its strategic partnership with Russia despite the international community's response to the conflict.