China still thirsty
Forget the rumours, Chinese imports of oil – for refining and strategic storage – are rising again
China's teapot refineries are unexpectedly playing a bigger role in crude imports as the country continues to top up its Strategic Petroleum Reserve (SPR) faster than expected.
Combining the unexpected burst of activity by these independents with large-scale buying by the state-owned oil giants, analysts expect China to remain an important net importer of crude throughout 2017, despite the firming of oil prices since the Opec deal.
Armed with new import licences issued by the National Energy Administration (NEA), in the first six months of 2016 the teapots on average imported a combined 3.23m tonnes of crude a month (about 0.78m barrels a day), roughly double the volumes of 2015. The refineries are tapping additional storage facilities that became available after the NEA encouraged private tank owners to lease them out for the purposes of building up the reserve.
Boosted by the teapots, in the first nine months of 2016 crude imports averaged around 31m tonnes a month, compared with last year's 28m tonnes, according to figures from Reuters. Demand by the smaller refineries is helping plug the domestic supply gap as well as topping up the reserve.
Speculation last year that the authorities called a temporary halt to the filling of the reserve now looks to be wrong as storage capacity continues to increase. Two dedicated underground sites at Huizhou and Jinzhou are now taking crude while a 3m-cubic-metre-capacity site at Aochan will eventually be able to hold 19m barrels. Also, according to Beijing-based oil analyst Patricia Tao, from energy consultancy Icis, storage tanks at Dushanzi and Lanzhou are only half full, and two sites at Tianjin and Qingdao have almost reached capacity.
The explosion of storage capacity, with more likely on the way, has confounded China-watchers' earlier predictions about the state of the reserve
Saudi Arabia's Aramco is stepping into this breach. The firm is boosting its own storage capacity in Okinawa, Japan, so that the teapot refineries, as well as other Asian buyers, can access crude more easily. The Saudi Arabian group may also establish capacity within China after signing a memorandum of understanding with Beijing in early 2016 to examine the feasibility of doing so. Other oil exporters in the Middle East are also said to be looking at ways of supplying China's smaller importers by installing their own infrastructure in the region.
The explosion of storage capacity, with more likely on the way, has confounded China-watchers' earlier predictions about the state of the reserve. By mid-2016, estimates Bernstein's Hong Kong-based Neil Beveridge, China was already ahead of its targets. There were 369m barrels of crude in storage, equivalent to 51 days' import cover. And because the ultimate goal of 90 days' cover requires 0.8bn barrels, Beveridge estimates China will get there within the next two or three years instead of by 2020.
Clearly, this augurs well for imports. "We expect China will continue to take advantage of third-party storage, which has allowed the filling [of the reserve] to be greater than we or most others expected," he concludes.
The only question mark is whether there's a trigger point in crude prices that determines whether both state-owned and independent refiners choose to buy - or not. Until the Opec deal was struck in November, it was thought that $45/b was roughly the swing price around which China bought crude for its reserve. Although the NEA doesn't provide figures, Beveridge estimated in a late-2016 report that China's oil production has a breakeven price of $37-50/b. This implies that prices above $50/b would deter buying for the reserve.
But the reserve has been growing steadily despite recent price hikes, just as it did in 2015 when Brent crude topped $59/b. Looking ahead, chief executive of London-based wealth manager Sun Global Investments, Mehir Kapadia, expects the price to settle at around $60/b in the second quarter of this year, provided the Opec deal sticks. If it does, that would answer a few questions about China's appetite for imports.
However Chinese buyers may have already signed contracts at highly favourable prices with nationally owned oil companies, for instance Iran. Trading sources estimate that Sinopec and China National Petroleum Corporation (CNPC), among other Chinese buyers, will lift 5%-7% more barrels of Iranian crude in 2017 than they did last year after rolling over annual supply agreements with Iran's state firm Nioc.
Although no prices have been disclosed for these agreements, it's reasonable to assume they are similar to those applying before the Opec deal. Iran, which has won an exemption from the agreed production cuts, may even raise output slightly.
It's been to Sinopec's and CNPC's advantage that that they ignored the sanctions imposed on Iran because of its nuclear programme and stuck with their respective long-term development contracts for Iran's Yadavaran and North Azadegan fields when other nations felt obliged to pull out. Both fields came to full production during 2016 and are pumping at around 160,000 b/d.
7% - the expected 2016 drop in Chinese oil production
As China's upstream industry, the largest in the Asia-Pacific, heads into 2017, analysts are expressing concerns about the relative collapse in capex by state-owned companies in response to low prices. Cnooc was typical in cutting its capex budget in 2016 by nearly 21% compared with 2015, down to 1.67bn yuan [$1.69bn] so that, as the country's third-largest oil company reported, it could "cope with the low oil-price environment." Cnooc specialises in offshore production.
Inevitably, one result was a fall in domestic production. Sinopec's output of oil and gas in the first nine months of 2016, for example, declined by more than 8% to 322m barrels. In this, crude was the loser, with output declining by 12.5%.
Overall, China's National Energy Administration expects production to have fallen by nearly 7% when the full 2016 figures are in. This would mark the steepest drop in 30 years. As Bernstein's Beveridge points out, "no other large oil-producing country in the world is experiencing this level of production decline". China's output in 2015 rose 1.5% to 4.3m b/d, according to BP.
One related important cause for concern is the age of China's major oilfields, most of which have been in production for more than half a century and require hefty doses of capex to keep them functioning efficiently.
The overall picture shows that China will have increased imports again in 2016. When the year's numbers are in, Icis's Tao expects them to show that total crude imports were around 376m tonnes (about 7.55m b/d), up nearly 12% on 2015. That's more than was expected and has encouraged analysts to raise their figures for 2017.
According to a report issued in mid-January by S&P Global Platts, and based on Chinese government data, domestic demand is on the rise. It hit 11.44m b/d a day in November, the second highest level on record. Refinery runs were put at 11.54m b/d, implying a 7.8% increase year-on-year.
Platts sees no respite for the refineries. "Gasoil demand is expected to pick up with the restart of industrial activity [following the new year] as well as the spring farming season in south China," explains senior analysist Song Yen Ling.
In short, nobody's predicting that China will need less oil to fire its industry in 2017 at a time when production is down. With the economy still growing at nearly 7%, that clearly implies rising imports of crude.