China - the great moderation
China's teapot refiners have enjoyed cheap oil prices. But the country's breakneck pace of demand growth will not return in 2017
China's GDP growth has been slowing, but we still expect expansion of 6.8% and 6.7% in 2016 and 2017, respectively. The country's goods and services sector will remain the economic driving force but the weaker oil price has done little to stimulate domestic demand while inflicting a raft of negative effects on Chinese oil producers.
In response, 2016 saw three key developments in China's oil sector: falling production, rising imports and, importantly, a growing role for the country's independent refineries, the so-called teapots.
The market, meanwhile, remained transfixed by China's Strategic Petroleum Reserve (SPR) and the potential for its capacity to increase in 2016. That said, we believe China has filled much of its available SPR capacity in the near term, meaning demand for crude will weaken in the next 12 months.
While major refiners have seen capacity-expansion projects delayed or, in some instances, shelved entirely, the teapots are cementing their position as a major player in the global market.
Independent refinery utilisation rates increased throughout 2016 on the back of Beijing's liberalisation of the downstream market. In the short term, we expect this to yield a rise of 150,000-200,000 b/d in Chinese imports.
China's developing oil infrastructure is providing the groundwork for future processing and storage growth. Although the country's refining capacity had fallen by over 10m tonnes a year (about 200,000 b/d) by the end of 2015, we expect China will have addressed this deficit by the end of 2016. Indeed, although 21m t/y of capacity is to be closed permanently, China plans to add new capacity totalling 30m t/y. Such initiatives also coincide with policies concerning overcapacity across many industries, whereby inefficient, high-emission plants are being shut down.
Further ahead, authorities in Shandong - the epicentre of the independents' refining sector - are targetting increased teapot utilisation rates of around 60% in 2017, with a goal of 75% in 2020.
Should they meet the 2020 target, it would correspond to a 300,000-b/d increase in crude oil imports. Indeed, nine refineries are expected to share increased imports of up to 0.627m b/d, bringing total teapot capacity to 1.94m b/d - an increase that on its own roughly equals the country's total teapot refinery capacity at the end of 2014 (0.75m b/d). However, there are some risks to the crude oil import growth expected by teapots as Chinese authorities are clamping down on tax benefits enjoyed by the sector in importing crude.
While these downstream shifts have taken place, the domestic upstream has faltered. China, the world's fourth-largest oil producer, has lost about 470,000 b/d in production capacity since its June 2015 peak. Along with the US, the two countries have been the biggest contributors to the decline in non-Opec supply. The country's three major producers - Sinopec, China National Petroleum Company (CNPC), and China National Offshore Oil Corporation (Cnooc) - responded to the weaker oil price in 2016 by cutting capex by over $7bn, equivalent to a drop of about 14% from 2015. We don't see capex rising in the mid-term - in fact, further cuts can be expected in 2017 if oil prices fail to recover.
The upstream picture has been pretty ugly. Sinopec's domestic crude output fell by 13% in the first half of the year compared with the same period in 2015. That amounted to a drop of 105,000 b/d, to 0.705m b/d, and involved the closure of the company's four worst-performing sites in the mature Shengli field, in Shandong province. Output from CNPC-operated Daqing - China's largest oilfield - fell in 2015 for the first time in seven years.
Fortunately for China, these losses didn't happen during a time of record-busting demand growth.
Nonetheless, the upstream slowdown has forced the country to increase its crude imports. Chinese refiners processed an average of 10.69m b/d of crude in the first half of 2016, 250,000 b/d more than in same period of 2015, driven by both stronger margins earlier this year and the thirst of the teapots. A side-effect of this is that China also increased gasoline output. With product-export quotas for teapots rising, we expect their export business to increase from its present level of 3%, even if Beijing's recent tax clampdown on these independents has the effect of lessening their - and thus China's - oil imports in the short-term.
On top of the refiners' appetite, China's SPR stockpiling has been a major contributor to crude imports. According to its 13th five-year plan (2016-20), China will complete the SPR's second phase of construction and consequently begin work on further sites before 2020.
The latest data released by China's National Bureau of Statistics indicated that the country had deposited 233m barrels in the SPR by the start of 2016 with close to 140m in phase-two development. China also has an estimated total commercial storage capacity of 315m barrels, plus another 62.9m barrels of storage this year. Another 31.5m-63m barrels is expected to be added from 2017.
In the second half of 2015, Chinese data showed 90m barrels of unexplained imports - most of which we believe went straight into the strategic reserves, with some being added to commercial storage facilities. Given the first half of 2016 saw an import excess of around 0.8m b/d, we calculate that China stored a further 140m barrels in either the SPR or commercial storage.
All of this is confusing - and reading through the Chinese data is not easy. But the main point is this: we believe China met most of its SPR needs over the past 18 months. As a result, we forecast that China's year-on-year net crude imports will grow more slowly in 2017.
China has lost about 470,000 b/d in production capacity since its June 2015 peak
Actual demand is also a culprit. This has flattened, following annualised contractions during two months in the first half of 2016. Overall demand growth (including changes in inventories) has been sliding: in the first half of 2015, it rose, year-on-year, by 5.4%. In the first half of 2016, the figure was just 0.7%. We expect oil and oil-product demand growth will have fallen even further in Q3 2016 due to flooding, which hindered both the industrial and construction sectors, as well as weaker demand from the transport segment.
Manufacturing weakness has led to some contraction in industrial oil demand for oil products excluding gasoline and jet kerosene. Fuel oil demand has slowed.
What's more, diesel demand has been suffering sharp year-on-year contractions since August 2015.
Given diesel's correlation to construction activity - due, for example, to the transportation of raw materials - further decline in construction rates (like total floor space under construction) will in turn further dampen diesel demand.
The gasoline picture is more mixed. Gasoline demand growth has also slowed in 2016: total passenger-kilometres travelled on highways declined during the first half of 2016. But robust car sales growth - particularly for high-consuming SUVs - might still translate into rising gasoline demand, provided infrastructure developments maintain their pace. The growing second-hand car market in smaller Chinese cities is prolonging the use of inefficient vehicles, so should help future gasoline demand too.
Meanwhile, total air-passenger-kilometres growth has also been falling, though we expect jet kerosene demand growth to remain strong, thanks to the expansion of Chinese airport capacity.
The country's five-year plan includes building 50 airports by 2020 and almost doubling the number of airport facilities, to about 400 by 2030. Indeed, one of the most significant projects is the planned $11bn spend on a second airport in Chengdu, which will address the rising demand for air travel in the southwest.
Still, as demand for both industrial fuels and oil products is slowing, we expect total oil-products demand in China to rise by 104,000 b/d for all of 2016. In 2015, the figure was 320,000 b/d. By 2017, however, we believe the phase of weak growth in fuel oil demand will fade.
With this in mind, for 2017 we forecast a 208,000 b/d year-on-year rise in apparent demand for oil products.
And, given our expectations for growth in car sales and air travel we think gasoline and jet kerosene demand will hold steady, if not strengthen. All told, in terms of oil products, China will consume 2% more in 2017 than in 2016.
This article is part of Outlook 2017, our annual book looking at energy market trends for the year ahead. To purchase a copy, click here