Analysis: China’s independent refiners to slow crude imports in H2 as tax reforms pinch

Tax reforms force independent refiners to cut runs, as losses pile up
Increase in crude import quota of 31% over 2017 to remain underutilized
Lower crude demand to ease pressure on crude markets, change flows

Singapore — The growth in crude oil demand from China’s independent refiners is expected to take a hit in 2018 as tighter tax regulations take hold, forcing them to cut utilization rates, lower throughput and eventually trim crude purchases.

This threatens China’s overall crude imports and ultimately global oil demand growth, as independent refiners pretty much propelled the surge in China’s oil demand for the last couple of years, accounting for 85% of the country’s incremental crude imports in 2017 alone.

Lower crude procurement will impact trade flows, as the independents secured crude from a variety of sources including Latin America, Russia, West Africa and the Middle East. This will be partly offset by lesser availability of Venezuelan crudes for Chinese refiners by nearly half due to the country’s political situation.

Independent refiners were allowed to buy Venezuela’s Merey and Boscan crudes through state-run CNPC under the government’s oil-for-loan deals. They bought a total of 12.3 million mt of these crudes from CNPC last year, and around 4.96 million mt of Merey and 357,000 mt of Boscan crudes in the first six months of 2018.

Under the new tax system implemented since March 1, the independent refiners are no longer able to avoid paying consumption tax on sales of refined products, which had inflated their profits and given them an edge over their state-run counterparts.

Beijing’s policy to tighten control over the independent refining sector through regulations, such as tax compliance, has clearly proved effective. There is no scalable way for refiners to skirt the new system, effectively curbing their crude appetite.

UNUTILIZED IMPORT QUOTAS

China’s crude import quotas were key to the rise of independent refiners, allowing them to switch feedstock from fuel oil to crude, and impact global oil markets. Last week, Beijing boosted quotas for 2018, raising the year-to-date allocation to 129.23 million mt, about 31.4% higher than the 98.34 million mt awarded to 33 independent refineries for the whole of 2017. They have used 49.4% of the quota in the first half of 2018, S&P Global Platts’ data showed.

However, the higher quotas are futile.

“I don’t think the independent refiners will use up crude oil quota this year. We expected around 20 million mt of surplus,” a Beijing-based analyst said.

This is reflected in the sharp drop in the black market price of the quota. Quota holders are not allowed to sell their quotas to refiners who don’t have them, but the trade happens on the black market nonetheless.

The black market price fell to Yuan 50/mt recently from a peak of Yuan 200/mt in H2 2017, when quota availability was tight, suggesting quotas are not scarce anymore, a source based in Shandong province, where most independents are located, said.

“It looks like everyone has [sufficient] quotas. Some refineries have more than enough,” the Shandong-based trader said, adding that the active quota trade witnessed last year would not emerge this year.

Moreover, crude imports by independents have been on a downward trend, hitting a 20-month low of 5.78 million mt in June, amid a record high inventory level of 5.42 million mt at major ports in Shandong.

BLEAK FUTURE

China’s independent refiners have seen their average utilization rates surge to a historical high of 70% at end-2017, on the back of crude import quotas. They made sure that existing quotas were always fully utilized, in order to keep import quotas coming the following year.

Some refiners like Luqing Petrochemical, Chamboard Petrochemical and Wonfull Petrochemical had doubled their primary capacity in the last two years.

However, full utilization is now uncertain.

“Refining is a business. If processing crude results in losses now, it is unwise to take more crude just for securing quotas for the coming year,” a Guangzhou-based trader said.

Even a Dongying-based independent refinery, which is more competitive than its peers due to an in-house transportation arm and more than a hundred retail outlets, is struggling.

“Due to higher tax costs, we lost about Yuan 100/mt for selling oil products produced from imported crude oil recently, while last year we earned about Yuan 500-600/mt profit,” a source at the refinery said.

“As a result, we have cut our throughput in our two plants to 16,000 mt/month from the previous 25,000 mt/month,” the source added.

— Oceana Zhou with Staff, [email protected]

— Eric Yep, [email protected]

— Edited by Norazlina Jumaat, [email protected]

Source: S&P Global Platts