China's second state crude reserve auction may include ESPO: sources

China is inching closer to release more crude from state reserves to absorb the shock from surging global prices amid expectations that the second set of auctions could potentially include at least 1 million mt (7.3 million barrels) of ESPO, trading and refining sources said Nov. 22-23.

The possibility of China releasing more crude to ease the supply situation in the domestic market comes amid hints from the US that it could coordinate a release from strategic reserves with Japan, China, India and other countries at a time when OPEC and its allies are sticking to their policy of increasing crude output by 400,000 b/d.

Market participants expect bidding interest from independent refiners as ESPO crude -- a favorite among independent refiners -- would likely be offered for the first time.

In the first auction conducted on Sept. 24, Middle Eastern Oman, Upper Zakum, Qatar Marine, Murban and Forties from the North Sea were offered.

"There have been talks about the possibility of ESPO being released in the second set of state reserve auctions. The total volume would equal around 10-14 cargoes of 100,000 mt each. This will be quite attractive for independent refineries," a source in Shandong said.

Independent refineries in Shandong have been the major buyers for ESPO as it is suitable for producing low vapor gasoil during the winter season.

ESPO imports by independent refineries amounted to 19.57 million mt in the January-October period, about 42.6% higher than Malaysian blended crudes and bitumen blend, which occupied the second spot, S&P Global Platts data showed.

Market players are closely watching out for any announcement about the release from China's National Food and Strategic Reserves Administration, as any new auction could further weaken the ESPO spot market.

This month, premiums for the ESPO grade slipped sharply as buying interest from China's private refiners turned bearish for January-loading barrels.

Differentials for the grade have slipped from premiums of around $6.40/b on Nov. 15 to $4/b to Platts front-month Dubai crude assessments in spot tenders issued by Russia's Surgutneftegaz in the Nov. 15-19 week, Platts data showed.

Hurdles to overcome

Independent refiners told Platts that some of them had registered for NFSRA's auction system, such as Zibo-based Chambroad. Independent refiners are allowed to participate once they pay deposits for the auctions. NFSRA requires Yuan 40/b ($6.26/b) of deposit for attending auctions.

However, crude import quota availability, cash deposit for participating in the auction and logistics are some of the barriers for the small-sized independent refineries.

"The key is that independent refineries should have enough quotas and need to pay all the cargo value in cash once they win the bid. This is not something that is preferred by them," an analyst in Shandong said.

State crude reserves are stored in China's bonded storage. Independent refineries are required to use their crude import quotas to bring in the barrels to the domestic plants.

Most of the refineries have fixed crude imports for the year, which they normally use up by the end of the year, leaving little unused quota for the anticipated auctions in the coming weeks, refiners said

"If we still need quotas to purchase those crudes, why should we bother buying those crudes that have been stored for quite a long time, as the crudes might be layering?" said a Dongying-based independent refinery source.

NFSRA allows auction winners to keep the barrels in the state reserve storage tank for 60 days after the sale contract is signed, suggesting that independent refineries have a choice to store the barrels by paying a daily rent of Yuan 0.3/cu m until next year when they can use crude import quota for 2022.

A bigger cargo will lead to higher deposit, which would also weaken independent refineries' bidding interest, sources said.

In the first set of auctions on Sept. 24, a cargo of 2.95 million barrels of Murban failed to attract bids as all participants said the Yuan 118 million deposit would hurt their cash flow, despite the amount being refundable.

Logistic costs a worry

Sources said that it is likely that the administration is going to release the state barrels in Zhoushan in Zhejiang province, in addition to Dalian in Liaoning province.

They said that independent refineries in Shandong would have to pay more to ship the barrels back to Shandong province, making it less competitive compared with purchases by refineries near the designated state reserve sites.

The two winners of the first set of auctions -- PetroChina Dalian Petrochemical and Hengli Petrochemical (Dalian) -- have pipelines connected to tanks where the barrels are stored in Dalian, requiring no additional shipping cost.

Zhejiang Petroleum & Chemical in Zhoushan could have an edge in winning a bid in the second round as it was recently awarded 12 million mt of crude import quotas for rest of 2021, a refinery source said.

Meanwhile, Norinco's Huajin refinery in Panjin city, Liaoning province, is also keen to bid if barrels are offered at the Dalian site.

"If prices are competitive and crude grades are suitable, buying interest will be strong", a source with Huajin said.