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China's teapots are filling up

Chinese authorities are giving independent refiners greater freedom to source their own supplies of crude oil

Until recently, China's Hengli Petrochemical was a little-known manufacturer of chemical fibres. But in May, the group, based in the Port of Dalian in northern China, leapt into prominence when the commerce ministry gave it approval to import 400,000 barrels a day of crude oil, the biggest-ever quota for a privately-owned "teapot" refinery.

Overnight, the decision made Hengli an important buyer of Saudi Arabian crude oil. The first shipment, reportedly 2m spot barrels of medium crude, was being loaded in June and fed into Hengli's new refinery for trial runs. Clearly, the quota is directly connected to the refinery, which has a capacity of 400,000 b/d and is designed to process Saudi medium and heavy crude grades.

The windfall throws a spotlight on China's broader refining industry. On top of Hengli's imminent increase in production, two other companies are buying in more crude to feed into new refineries. Hangzhou-based Zhejiang Rongsheng, another privately-owned petrochemical group, is due to start up the first phase of a $24bn, 800,000-b/d plant in the eastern city of Zhoushan in late 2018. Around the same time, China National Petroleum Corporation's 100,000-b/d expansion of the Huabei refinery in the north will come on stream.

Combined, the three new refineries will boost China's production by nearly 10%. That's a big step up. But China's independent refiners have been quietly increasing their share of the country's downstream capacity in the past few years. By mid-2017, the 121 independents accounted for about 4.4m b/d—or just under a quarter of overall capacity—notes the Oxford Institute for Energy Studies (OIES). And that percentage is rising all the time. In a direct recognition of their growing sophistication, the state-owned giants have been forming alliances with them.

Sidestepping middleman

Hengli's coup marks the latest high point in the independent refiners' trajectory. Until three or four years ago, the teapots couldn't access crude oil directly and had to rely on more expensive imported fuel oil as feedstock. "[That] included 180-CST low-sulphur fuel oil from Asian markets, 380-CST fuel oil from Venezuela, or M-100 fuel oil from Russia," the institute reported. This was mostly processed into diesel for farm machinery.

It was only in 2015 that two teapots won approval to import crude directly, bypassing the state-owned middleman for the first time. After that, direct-import quotas were handed out more freely. By the end of 2016, according to the OIES, the National Development and Reform Commission had granted 19 independents the right to process 1.46m b/d of imported crude. Roughly half of this was in the form of "quotas", or the maximum volume of imported crude the independents were permitted to process in a given year, rather than "licences". These allow the independents to import directly from the international market. In 2016, 13 refiners received licences.

The more relaxed import regime meant that, by 2016, the independents accounted for most of China's incremental crude buying.

But why has Hengli been chosen for a record-breaking import quota? Over the years it has become an internationally significant petrochemical conglomerate with a 2017 net profit of $268m, up 45.7% year-on-year. Hengli ranks 268th in the Fortune Global 500 and boasts the biggest purified terephthalic acid (PTA) plant in the world, enough to put the group in the running for bonus imports.

Also, Hengli was astute enough to form an alliance with state-owned Sinochem. In June the companies opened a joint-venture trading office in Singapore that will buy crude for the refinery and sell its production offshore. The office could be a landmark for China's petrochemical oil and gas exports into Asia, especially as new, highly sophisticated refineries start up production in late-2018.

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