China's teapot growth
The expansion has been boosted by bigger import quotas and a buying alliance
China's "teapot" refineries will be much busier in 2018 than was widely expected because the government has increased its oil import quota by 55% compared with 2017. This figure has important implications for the wider market.
The new arrangements, announced by the commerce ministry in early November, allow non-state refineries to import 142.42m tonnes of crude this year, up from 2017's 91.73 tonnes. The independents won't get all of this, but on past performance they should pick up about two-thirds.
The quota, so much higher than expected, confirms the growing power of the teapots in China's drive for higher-quality refining, especially considering that Beijing cut their import allowances in 2017. There is, however, a sting in the tail. Companies that don't fill their quotas will be required to hand back unused permits and, presumably, lose their entitlement in 2019.
According to consultancy IHS Markit, the 2018 quota represents something of a bonanza for Russia and particularly Angola, which have been providing much of the crude to the independents. As Platts reports, in October Angola supplied marginally more crude to the independents than Russia, making it their top source. In total, Angola delivered 1.493m tonnes, up 7.5% from September, compared with Russia's 1.491m. It's unlikely that it will stay on top for long though—between January and October, Russia headed the list with volumes of 15m tonnes, up 124% on 2016. (The US made it into the top 10 for the first time.)
The latest quotas assure the teapots of a growing influence on imports of crude oil, as the latest stats show. In the first three quarters of 2017, imports jumped by 75% compared with 2016. Although they fell in October, to 57% compared with the equivalent month in 2016, that was probably because the teapots had exhausted their quotas. The implication is they would have imported more crude if they had been allowed.
The boost in quotas follows a big year for the independent refiners. Following a decision to form an independent purchasing alliance for crude, known as the "league", they are putting in place arrangements that promise to shake up the market. For example, the teapots' growing appetite for feedstock has already forced some of the biggest Japanese and South Korean refiners to chase up alternative sources. But the alliance could be good for Vietnam and Indonesian suppliers, which are already selling crude to the teapots.
The impetus for the establishment of the alliance came from Li Xiangping, chairman and chief executive of Dongming Petrochemical, biggest of the teapots with a capacity of 15m tonnes a year. According to Dongming, the initiative came about in early 2017 when Li approached Guo Shuging, then governor of Shandong and a champion of the teapots, seeking approval for the concept. His base argument was that the independents would be able to strike better deals with foreign sellers if they operated collectively.
142.42m t—Independent refiners' 2018 oil import quota
The 16-member alliance was formed quickly, in February, with the Dongming boss as president. Suppliers will be interested to see how the union affects import-purchasing strategies during 2018. Until now, the independents have bought mainly from suppliers who are prepared to offer more flexible deliveries, volumes and payment terms, rather than tie themselves into long-term contracts. This was partly because they didn't know what the following year's quota might be. Also, the overworked ports in the independents' main base of Shandong province couldn't guarantee long-term shipping arrangements.
But now, if the union combines to buy bigger volumes under joint contracts, that could change the game.
And that's the way it's looking. As the alliance reported, it "aims to establish a platform for the centralised procurement of imported crude oil, enhance bargaining power, reduce adverse competition and cut import costs in order to safe-guard the national interests and the industry". The alliance's statement makes it clear that reducing "adverse competition" means the teapots can now present a united front instead of being picked off by suppliers. The alliance refers to this as "disorderly bidding".
Centralised procurement could mark a turning point for the teapots as well as for the markets. Since Beijing first allowed them to import crude, two and a half years ago, they've purchased feedstock from wherever possible in a competitive scramble. As the Oxford Institute for Energy Studies (OIES) pointed out in a comprehensive mid-2017 report: "They have tapped into a wide variety of suppliers, impacting regional pricing dynamics and crude flows to China."
The independents operated through their own rapidly-acquired trading teams that were mostly lured from the state-owned traders such as China Oil, Unipec and Sinochem. They brought with them long-established contacts that got the teapots off to a flying start.
The establishment of the alliance shows how far the independents have come in a short time. Until a few years ago, even the bigger refiners relied on the state-owned companies to funnel surplus crude and fuel oil to them, with little certainty of supply.
The teapots are also showing a growing confidence of their place in China's oil and gas industry by expanding their capacity and improving the quality of their products. For instance, privately owned petrochemical group Zhejiang Rongsheng will reportedly start up a new 400,000-barrels-a-day refinery in China at the end of 2018, while Hengli Petrochemical will build another 400,000-b/d refinery in Dalian in the northeast. And in late December the Lihuayi Group, one of the biggest independents, began commissioning a mono-ethylene glycol plant with a capacity of 200,000 tonnes per year in the hotbed of Shandong.
Meantime, Dongming is leading the charge. According to its own statistics, at the end of 2016 it had assets of $4.56bn, with a primary processing capacity of 15m t/y. At the end of 2016, presumably with Beijing's approval, it acquired foreign shareholders in the form of two Qatari companies that spent about $5bn for a 49% stake. At least some of this money will be used to fund a liquefied natural gas terminal in Shandong.
Teapots can now present a united front instead of being picked off by suppliers
Dongming is also expanding into retail. As well as developing a 1,000-strong chain of petrol stations in six provinces, which would give the group a nationwide presence, it's selling to the other 6,000 outlets in the province. And like other teapots, Dongming is diversifying its product mix. At present, its main products include gasoline, diesel, liquefied petroleum gas, solvent oil, liquid paraffin, polypropylene, high-grade asphalt and rubber.
Overall, as OIES reports, China's 121 independent refiners account for an estimated 4.3m b/d of the country's overall downstream capacity, equivalent to just under a quarter. With remarkable speed the term "teapot", although it's likely to stick, has become a misnomer for some independents. "Many of the Shandong refiners have grown in scale and sophistication over time and, while they are still dubbed teapots, some of them are among the country's most complex petrochemical facilities," the OIES notes.
The teapots encounter problems with much of the imported crude oil, the main one being its low quality. Although high-sulphur crude, mainly from Venezuela, sells at heavy discounts to higher grades supplied by Angola and the Opec countries such as Saudi Arabia, it's more challenging to refine. Most of the teapots are designed for crudes with 1.5% sulphur content.
As Dongming, which buys mainly Venezuelan crude with 2.5-2.6% sulphur content, pointed out in late November, the sulphur and acid content of crude pumped up from ever deeper waters is "leading to serious corrosion of equipment and pipelines in some refining units, creating pressure over time on the safety of units". In their attempts to eradicate the problem, the independents are sharing their expertise at, for example, increasing insulation at vulnerable places.
It's yet another example of how the independents are joining forces in a way that looks certain to make them increasingly influential, not just in China but also in the wider region. Beijing clearly relies on them more and more to help meet official goals of higher-quality, lower-polluting fuel up to grade V as well as other products.
The teapots have a broader economic role to play, particularly in Shandong, where their presence has become crucial in keeping the ports, railway and other infrastructure busy. Beijing's steady adoption of public/private projects means it relies less on its state-owned oil and gas giants, some of which have fallen into disfavour in the current corruption crackdown. The independents offer a nimble and resourceful alternative. Although some of them have survived and profited through sleight-of-hand tax avoidance schemes, the government appears to have taken a much softer line in dealing with the offenders than was originally expected, probably because of their importance in the overall energy mix.