With Teapot Quotas Set to Fall, Some Eye Fuel Oil

The noose is tightening around the necks of China’s independent refiners, which have been important drivers of Chinese crude demand growth in recent years. Crude import quotas for China’s independent refiners are likely to be cut in the second half of the year. They are also facing a punitive new tax on bitumen mixes and other government measures to clamp down on their activity. As a result of these pressures, some of the independents are being forced to import straight-run fuel oil, which is less than ideal as refinery feedstock. A Chinese refiner source said Beijing's overarching aim is to shutter older, less efficient independent refineries, reduce their emissions, shrink China's glut of oil products glut and limit the threat to China's major national oil companies (NOCs) from what some see as a source of unfair competition. The government could cut independents' crude import quotas by 200,000-300,000 barrels per day in the second half of this year, with the second round of quotas likely to be issued by July, according to consultancy FGE. This would be equivalent to 6% to 9% of independents' 2020 crude imports of 3.43 million b/d, according to Chinese consultancy JLC and Chinese customs data. Under-the-Radar Deals As things currently stand, small independent "teapot" refineries without crude import quotas are only allowed to process domestic crude, but some have been illicitly buying excess quotas from other independents at $3-$4 per barrel, FGE noted. Some independents that want to import more crude than allowed under their quotas also buy imported crude from Chinese majors like PetroChina or buy other independents' unused import quotas. This trading of import quotas has been "very common in the past five years," said a Chinese analyst, who also referred to it as a "gray area." There is an expectation within the industry that independents involved in this kind of activity will be punished with cuts in their second-half import quotas, the analyst added. A significant number of independents could be affected, said two Chinese refiner sources. But a crude trading analyst is less convinced: "I doubt they will cut all the teapots who were trading quotas. Maybe [they will] just punish a few extreme cases to make an example." Meanwhile, independents are already feeling serious pressures from a raft of recent government moves to clamp down on multiple loopholes they have been using to import crude (IOD May28'21). The National Development and Reform Commission (NDRC) has launched investigations into independents' use of import quotas and the resale of imported crude by five state-owned companies (IOD Jun.3'21). The government also reportedly told PetroChina Fuel Oil in April that it must stop reselling imported crude to half a dozen independents. Huge Tax on Bitumen Mixes In an earlier move, the government slapped a new tax of 1.20 yuan per liter -- equivalent to $29.70/bbl -- on imports of bitumen mixes that starts on Jun. 12. Some independents have been importing sanctioned crude -- mostly from Venezuela -- as bitumen mixes, a maneuver that enables them to pocket steep price discounts while circumventing the limits on their crude imports (IOD May18'21). China imported 332,000 b/d of bitumen mixes in the first quarter of this year and all of that is likely to disappear going forward as a result of the new tax. So far, some independents have already used up 70% of their import quotas during the first half of 2020, with only 30% left for the second half, according to Chinese information provider Longzhong Information. Some independents are closer to running out of quotas and so -- faced with the loss of multiple sources of imported crude -- some have turned to buying straight-run fuel oil (SRFO) instead, said Chinese and other market sources. At least four independents -- Dongming, Shandong Haike, Shandong Dongfang Hualong and Chambroad -- have bought SRFO, said a Chinese refiner source and an Asian market source. But SRFO is not an ideal feedstock because it tends to produce smaller amounts of high-value distillates than crude oil, which is why most independents abandoned SRFO once they were granted crude import quotas. But as their access to crude has declined and is expected to fall even further going forward, independents have only two options left -- either process SRFO as a substitute, or cut throughput volumes, said a trader who markets to them. Freddie Yap, Singapore