Chinese Refiners Crude Buy Could Hurt Fuel Oil
China is poised to allow more private companies to directly import oil, a move that will have only a marginal impact on crude markets but may have a disproportionate impact on fuel oil prices.
The vast majority of China's crude imports come via the two state giants, PetroChina (PCCYF) and Sinopec , which account for about 90 percent of the imports of the world's second-largest oil user.
Last year, China dipped its toes into deregulation by allowing some smaller, independent refiners to have import quotas of their own.
The total amount of crude that may be allowed under new licences hasn't been revealed, but government documents last year suggested that at least 10 million tonnes more could be granted.
This would be in addition to the 10 million tonnes given last year to China National Chemical Corp (ChemChina), owner of China's largest chain of standalone refineries.
If a total of 20 million tonnes is granted, this would equate to about 400,000 barrels per day (bpd) of crude.
This doesn't mean that China's crude imports would necessarily rise by the same amount, with much depending on domestic demand and the profitability of refining.
If oil product consumption in China is soft, it tends to be the private refiners, sometimes known as teapots, that cut runs as they lack the financial resources of the two state majors.
Even if an additional 10 million tonnes of crude import licences are granted - and all this oil is imported - it would raise imports only about 3 percent to 6.33 million bpd, based on a first-half intake level of 6.13 million bpd.
This isn't enough to make a marked difference to crude prices in Asia, but it would help to keep an upward bias.
Where the real difference is likely to be felt is in fuel oil prices, especially if the additional crude imports are offset by a corresponding decrease in fuel oil shipments.
Teapot refiners tend to use heavy fuel oil as a feedstock as they aren't allowed to buy crude directly.
If crude import licences are granted to teapot refiners, particularly those in Shandong province, the likelihood is that fuel oil imports will drop.
The decision to grant an import licence to ChemChina has already resulted in lower fuel oil imports.
China brought in 360,800 bpd of fuel oil in the first half of 2014, down 29 percent over the same period last year, according to customs data.
May's imports of 1.124 million tonnes of fuel oil was the lowest monthly total since February 2010, and overall China's fuel oil imports have been declining since the end of 2012.
FUEL OIL DISCOUNT WIDENS
This has shown up in regional pricing, with the discount of Singapore 180-centistoke fuel oil to Dubai crude showing a widening trend since the beginning of 2012.
For a brief period at the start of 2012, fuel oil commanded a small premium to Dubai crude, peaking at 81 cents a barrel on Jan. 27 of that year.
It has since trended lower, with the discount reaching $14.39 a barrel on June 19 this year, the lowest since August a year ago, when it touched $14.92.
It has since narrowed to $12.02 on Aug. 1, but this is likely a reflection of tighter supply due to summer demand in the Middle East, where fuel oil is used to generate electricity.
Once summer demand dissipates, supplies into the Asian market will likely increase, and this may coincide with decreased buying by Chinese teapot refiners, assuming additional crude import licences are granted.
What appears to be occurring is a structural shift in fuel oil demand, although Chinese authorities will probably tread cautiously in reforming the nation's energy markets.
The authorities are in favour of increased competition in the refining sector to counter the concentration of power in the hands of PetroChina and Sinopec.
While it will take time, it's likely that more refiners and traders will eventually be allowed into the market, a process that will result in more substitution of crude for fuel oil.
By Clyde Russell
