Chinese refiners to flood the market
Chinese exports from its refinery overcapacity to increase Asian market disruption
Asian refining margins may in the short-term look better than in some regions, most notably Europe. But the structural trend in China suggests this may be the briefest of respites.
High Chinese economic growth rates may soon be a thing of the past. And China's ageing and more affluent population will see a transition in its economy, with consumer spending and services displacing energy-hungry industries such as manufacturing and construction. In short, there is a "disconnect" between Chinese oil imports for refining and its domestic needs for product, says Caroline Bain, chief commodities economist at consultancy Capital Economics in London.
The Chinese have "overestimated future demand" amid the "euphoria" of previously high growth rates, with the country's predictions also failing to take into account the growth of electric vehicles, Bain says. Crude imports will lead to ever higher refinery throughputs than the country itself will consume, meaning constituent growth of products exports into other Asian markets, she adds.
According to research from bank Nomura in February this year, the oversupply of domestic refined products in China is set to increase through to 2020. It predicts increases of 9pc and 13pc in Chinese refining capacity this year and next, respectively.
Some smaller Asian countries such as Cambodia and the Philippines may benefit from excess Chinese refining capacity, Bain says. But countries with their own significant refining industries will face a greater challenge. "The fact that they are trying to export so much will put downward pressure on product prices in Asia," she says, negatively affecting the refining industries in Singapore, South Korea and Malaysia.
And refining companies in Japan and India could be "up in arms" about cheap Chinese exports, she says. India has a long history of sector-based tariffs, such as in rubber, and there could be a protectionist response, Bain warns.
In 2018, China was the fourth-largest refined products exporter in the Asia-Pacific region, behind South Korea, Japan and India. And Asia was the largest contributor to global refining capacity growth last year, largely driven by China and India, according to consultancy McKinsey.
Four major Chinese refining projects are slated for 2019—Sinopec-Kuwait, Yihong, Hengli and Zhoushan—with a total capacity of 65mn t/yr. Seven further projects are scheduled to start in 2020, with total capacity of 102mn t/yr, according to Nomura.
China as a net product exporter is not new in itself, says Stefano Zehnder, global vice president at Icis Consulting in Milan, Italy. But the current export of Chinese refined products is not large compared to internal demand, with the surplus at 10-15pc of domestic requirements, he says.
"The fact that they are trying to export so much will put downward pressure on product prices in Asia" — Bain, Capital Economics
There could be factors that temper a glut of excess Chinese middle distillate production. Transport fuels may incrementally become more of a co-product, rather than the focus, in newer Chinese refineries, adds Zehnder. One of the Chinese 'big three' oil firms, Sinopec, predicts that petrochemical feedstock—light ends such as naphtha, propane and butane—will become the major refining product by 2050, displacing transport fuels.
New rules on marine fuel being adopted by the International Maritime Organisation (IMO) from 2020 should also offer some support for Asian refining margins. Excess middle distillate can be used to produce marine gasoil (MGO) or blended to reduce the sulphur level in fuel oil down to the new 0.5pc limit.
But the size of the refining investments China has made ensures some level of excess products in the international market, says Zehnder. "This will not be good for Asia[n refiners]," he warns. India is likely to contribute to ongoing over-capacity—the country's refining capacity will grow at an average rate of 5.3pc pa to 2023, according to consultancy GlobalData.
China's refiners may bear some of the pain themselves. Operating rates in some of its refineries are between 70pc and 80pc, much lower than in the US, says Zehnder. According to Sinopec, in 2018 the average refinery capacity in China was only 87,000bl/d, just half of the global average level.
Many smaller, less efficient Chinese refineries could be subject to rationalisation. Japanese refineries have already started rationalisation and will focus on more specific products, Zehnder says. Two of Japan's largest refiners, Idemitsu Kosan and Show Shell Sekiyu, merged this year.
According to a Sinopec presentation in March, China will create 4.32mn bl/d of new capacity but also phase out 2.1mn bl/d of "backward" capacity before 2025, when total capacity will stand at 18.8mn bl/d. The new capacity will be more concentrated and integrated, and be more involved in the export market, Sinopec says.
But that capacity may struggle to find a market in the long term. The Icis base case is for the increase in China's gasoline demand to plateau around 2030. It will then decline, with the speed being determined by the pace of automotive electrification.
And Bain is negative on the long-term outlook for overall Chinese growth, arguing that the economy is undergoing a "structural slowdown" and the country has reached the "limits of its economic development model." In the 2019 edition of the BP Energy Outlook, the largest revisions for projected energy consumption in 2040 were in China, with the forecast now 7pc lower than that made in 2018. By the mid 2020s, BP says, India will surpass China as the world's largest growth market, accounting for over a quarter of growth in global energy demand.
4.32mn bl/d — planned new refining capacity
Stimulus measures by the authorities will do no more than stabilise the economy, rather than reignite it as in previous cycles, Bain says. Chinese growth in the 2020s will average about 3pc pa, falling to 1.5pc pa in the 2030s, Capital Economics predicts. Bain sees no signs of a return to previously high GDP growth rates and sees growth at 2pc pa in ten years' time. In the medium term, Charles Robertson, chief economist at investment firm Renaissance Capital, is even more pessimistic. He predicts a 2pc decline in Chinese GDP in 2023, which he says will trigger a global recession.
Beijing continues to suck in oil even as its economic horizon clouds. Saudi Arabia's crude shipments to China have doubled in the last year—although some of that will be taking up slack from reduced Iranian imports—while the second-batch quotas for non-state crude imports issued by China's ministry of commerce in July show a sharp jump to 56.85mn t, from 11.91mn t a year earlier.
As a result, the refined products surplus looks likely to increase. China's large refineries in coastal areas will target international, as well as domestic, markets in future, according to Sinopec. "China will flood the market," Bain says.
But the consequent impact on Asian products will mean Chinese refineries needing to curtail exports that are no longer profitable, she says, predicting at least a decade of refining capacity unable to be run at maximum rates due to demand-side constraints.