China’s teapot refineries keep brewing

China has unexpectedly raised crude import quotas for its independent ‘teapot’ refiners, allocating additional product export quotas, normally issued quarterly, for the rest of 2017 and increasing 2018 import quotas by 1.1mn b/d to 2.9mn b/d, according to Bank of America Merrill Lynch.

The analyst also reports that petroleum product imbalances in China are set to become more pronounced, adding near-term downside risks to refining margins. It says: ‘As China’s oil demand growth accelerated since 2009, so did investment in refining. Between 2008 and 2014, Chinese refiners added an average of 700,000 b/d of net crude distillation (CDU) capacity per annum, outpacing end user demand growth. This year, net CDU capacity is set to expand at the strongest rate in five years. In part, this expansion in capacity has turned China into the world’s largest crude oil importer, with many barrels now feeding into teapot refineries. These independent refiners were granted crude oil import quotas in mid-2015 and are still expanding capacity. The net result is a sharp pick-up in refinery throughput and rising product imbalances in China. In turn, this mismatch has pushed up domestic product inventories and spurred export growth, putting pressure on the wider Asian market.’

However, BofA Merrill Lynch believes global refining capacity is likely to stay structurally tight in the medium-term, and regards any drop in margins as a buying opportunity.

Given the latest expansion in quotas, petroleum product imbalances in China are likely to remain as much a feature in 2018 as they were in 2017, even if run increases by teapots are likely to be somewhat slower, notes BofA Merrill Lynch. ‘This implies that Asian, and by extension European, refining margins, could face temporary downsize. In particular, margins could suffer if China eventually decides to sharply increase petroleum product export quotas for 2018. Distillates are likely to be most negatively affected given China’s strong diesel bias in its refinery base.’