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China Sets the Stage for a Sustainable Oil Refining Sector

Beijing's refining sector policies may have been riddled with contradictions in 2017, but the government did lay the groundwork for a more balanced and sustainable growth path for the industry.

While on one hand, the government tried to curb excess refining capacity and put a lid on oil product exports, on the other, new refinery projects were approved and independent refiners were empowered to boost operating rates, creating a supply glut in the domestic market. These, not surprisingly, led to a lack of clarity on Beijing's plans for its refining sector.

In 2018, however, export and import controls have been eased. Instead, the government has strengthened its environmental and tax regulations and is using them to weed out inefficiencies in the sector and remove excess capacity.

A Beijing-based policy observer said that he was not surprised at the way 2017 had panned out. It was, after all, the year of the National Congress of the Communist Party of China, which is held every five years.

"This is in line with regulators' working cycle... tighten controls and slow down the pace of reform every five years when the national party congress is held, then hasten the pace once the party leadership for the next five years is announced at the congress," he said.

The 19th Chinese Communist Party Congress held in October last year strengthened President Xi Jinping's grip on the country, indicating continuity in policy changes.

Two key policy announcements were made in January, which if implemented successfully, will have far-reaching implications for the refining industry.

Tighter Monitoring of Refiners

The National Development and Reform Commission, China's top economic planner said in January that refiners that fail to meet industry guidelines that were unveiled last year would be punished. The NDRC is working with nine national government bodies including the Ministry of Commerce, the Ministry of Environmental Protection, and the State Administration of Taxation on this.

The NDRC inked a memorandum of understanding with 20 government entities in 2017 and revealed the scope of their work and specific measures last month.

In keeping with President Xi's focus on cleaning up the environment and the industry, the guidelines focus on capacity expansions, taxation, safety and environmental issues, and refinery emissions.

Curbing energy consumption, improving efficiency and setting up more environmentally friendly industries and factories have become key requirements not only when approving new projects, but for existing companies too.

The NDRC has asked provincial governments to investigate refineries and those flouting the guidelines will be given until early August to rectify their shortcomings. Those who still fail to meet the guidelines will face fines, suspensions, forced shutdowns and/or legal action.

The government plans to shut refineries with a capacity of under 2 million mt/year (40,000 b/d). Any capacity expansions that have taken place without the required approvals will also be forced to shut.

Refiners are also expected to raise investment in their plants to upgrade the products output, and promote safety and environmental protection.

All these measures will help the government achieve its twin objectives of removing excess inefficient capacity and curbing pollution.

Overhaul of Taxation Rules

Independent refiners and blenders in China have been using loopholes in the consumption tax rules to avoid tariffs entirely or only pay partial taxes. As independent refineries are more inefficient than state-owned refineries, being able to avoid paying the tax has been critical to their profits.

In January, the State Administration of Taxation announced tighter regulations for oil products consumption tax reporting that will come into effect on March 1.

The new regulations will require refiners, blenders and retailers to use a special tax reporting system to allow local authorities to collect a consumption tax on oil products by monitoring the whole transaction chain of the product -- from producers to end-users.

This will take away the cost advantage enjoyed by blenders and independent refiners and make some of them economically unviable.

The new rules are expected to make it easier for the government to deregulate oil product prices.

Under the oil product pricing mechanism in place since March 2013, the NDRC sets the ceiling for the retail price of gasoline and gasoil every 10 working days in line with international crude price fluctuations, unless the resulting price change is less than Yuan 50/mt or under exceptional circumstances.

Sources involved in the pricing mechanism said that the biggest hindrance to having a more market-oriented pricing method that reflects domestic fundamentals was the evasion of consumption tax by independent refiners made the market price too low for these companies. So the new rules should facilitate changes in the product pricing mechanism, they added.

The State Council in October 2015 announced a plan to set up market-oriented pricing mechanism for all commodities by 2020, including the liberalization of gasoline and gasoil prices at an appropriate time.

But "there is no mature plan about how to generate a benchmark for domestic product pricing and who should be releasing the benchmark," said a central government official with knowledge about the matter.

"With 2020 approaching, we need to at least have some adjustment to the current mechanism, such as increase the adjustment frequency or change the basket of crude oils," the official added.