China faces refinery consolidation challenge
A new mega-refinery is meant to concentrate rather than expand capacity. But it may not work out that way, and may have other knock-on effects
China has committed to a new 400,000bl/d mega-refinery in Shandong to be built by 2024. And it plans to shut down an even greater capacity of smaller, less-complicated independent facilities, the so-called ‘teapot’ refineries to make room for the new plant without adding to the country’s refined products glut.
But it remains to be seen if China can pull off this consolidation, or if at least some of the teapots marked for closure will cling on and lead to a capacity increase.
On the assumption that clean air is a major driver behind the decision, Steve Hanke, professor of applied economics at John Hopkins University in Baltimore, is optimistic. The move will, in his view, be “transformational” in terms of the Chinese refining industry’s sustainability.
“They realise they are killing themselves. They have to do it,” says Hanke. And he sees the level of compensation being offered to the teapots as a measure of the strength of China’s commitment. “There may be cost overruns, but the deadline will be met,” he predicts.
Others are less convinced. “Consolidation almost never goes to plan,” says Gabriel Collins, a research fellow at the Baker Institute for Public Policy at Rice University in Houston.
Chinese attempts to upgrade its production base in industries such as glass, steel and aluminium by replacing smaller, less-efficient plants with modern mega-factories have created increased, rather than simply modernised, capacity.
400,000bl/d – Capacity of planned refinery
“This is the latest iteration” of that pattern, Collins warns. “Those [additional refined product] barrels will head onto the export market, with a competitive sweet spot east of Suez.”
At an enterprise level, the biggest impact of this additional products supply is likely to be on South Korean refiners, which compete in the same Southeast Asian markets as China, predicts Collins.
But the country most affected could be Saudi Arabia, given its ambitions to grow its downstream presence both at home and also in other Asian refining and petrochemical hubs. This is particularly ironic, Collins notes, given that China remains Saudi Arabia’s biggest customer for crude.
In his view, Saudi Arabia may need to “have in mind” that China’s refined products surplus may grow as it weighs up its vertical integration capex. It may also “think even harder” about its own appetite to invest in the Chinese downstream.
Middle Eastern reset
China seems to have the stomach to re-imagine its relationship with Saudi Arabia. Beijing depends less on Saudi oil than South Korea or Japan. According to thinktank the ChinaMed Project, the value of China’s Saudi energy imports was less in 2019 than it was in 2012 or 2013. Dependent on whose figures one trusts, Russia has moved at least close to, if not above, Saudi Arabia as China’s biggest supplier of crude.
And a new proposal from Chinese oil companies to form a collective oil importing bloc could disrupt the trading relationship between China and the major oil exporting countries in the Middle East, according to Edward Bell, senior director, market economics at Dubai bank Emirates NBD. “By pooling purchases, China’s oil companies may be able to exert pressure on exporters for more favourable terms,” he suggests.
Middle Eastern oil exporters as a whole have a significant dependence, in Bell’s view, on China as a baseload consumer for their exports. Iraq is particularly exposed, with more than 25pc of its exports landing in China. But Saudi Arabia, alongside Kuwait, is not far behind, seeing c.23pc of its shipments end up in China.
The new facility is also slated to produce 3mn t/yr of ethylene. And, to some extent, the petchems feedstock output is as, if not more, important as the refined products. China needs ethylene in areas such as consumer electronics, packaging and textiles, as its economy relies more on consumption-driven growth in the coming decade.
According to consultancy McKinsey, China’s chemical industry expansion will provide more than half of the global growth rate over the next decade. But Collins is more pessimistic that the attempted pivot will pay off.
He fears that investment in new facilities to boost a move up the value chain is simply “juicing the market”. And when the infrastructure stimulus wears off, the impact of a resulting contraction in Chinese growth will be “disastrous” for the global economy.