After a rise, must come a fall. Chinese refinery runs in June 2017 reached the second highest level on record, jumping to 11.21 mmbpd, up from 10.98 mmbpd in May 2017 and up 2.3% y-o-y. Two of the highest monthly output statistics have occurred in the last nine months, the absolute highest being 11.26 mmbpd in December 2016. That’s a lot of fuel products sloshing around China, as the country moves into peak summer demand.
Possibly a little too much. Oil markets were roiled earlier this week as China announced its July production numbers. Output fell to 10.71 mmbpd, down by 500,000 barrels from June though marginally higher y-o-y by 0.4%. In absolute terms, that’s still a massive amount of fuel products. But lack of growth always spooks traders, particularly when China is involved, and that sent Brent and WTI some US$2/b lower. There was talk about how Chinese demand is slowing down, driving bearish concerns that the global supply glut will grow.
There is probably a small kernel of truth in that. Chinese demand has been slowing down, in relative growth terms. But that’s largely because larger growth jumps are harder to come by at higher levels of development – the potential for double digit growth has passed on to India; but even a 2% jump in Chinese demand is still massive in absolute terms, requiring an additional 1 million tons per month – or four more VLCCs. What is actually happening in China, however, is the same problem happening globally – oversupply.
Looking over data from the first six months of 2017, the jumps in crude throughput are linked to a recent phenomenon of independent ‘teapot’ refiners. Allowed to import crude for the first time last year, these private players have been responsible for the recent sterling growth in Chinese output. In the months where new import quotas in 2017 were granted, Chinese throughput soared. In the months when there were jitters about the quotas being granted, throughput was flat. Chinese state refiners have largely kept their throughputs flat y-o-y; all the growth has been from the teapots this year.
Perhaps too much growth. Less driven by concerns of national balances and more on immediate profits, it produced a major oversupply of fuels in China. Many of the teapots are petrochemical players, more interested in the naphtha portion of refining production, but still produce great amounts of gasoline and diesel in the process. Inventories reached record levels and even strong demand entering summer could not sap that. Much of this had been anticipated by the state refiners – they announced in June that some 10% of capacity will be shut down for maintenance in Q3, a necessary move to trim the overhang. Teapot production, however, may very well continue to max. Which is why the state refiners are also waging a war on two fronts with the independents – commercially, through a retail price war for market share that began in May, and institutionally, by lobbying the Chinese Politiburo to impose controls on the teapots as well as investigate them for tax and financial irregularities.
In many ways, this is the growing pains of the Chinese market developing. The teapots were allowed to flourish in China’s attempt to introduce competition in the refining industry. In a free market, this is what happens. Without the overarching national concerns that PetroChina and Sinopec face, the teapots’ approach to the industry to maximise profits. This development is symptomatic of nothing more than the Chinese refining industry adjusted to a new equilibrium. That’s the trouble with the free market sometimes – it will correct itself, but oftentimes it takes a little pain to get there. Even if that little pain is more drag on global crude prices.
P.S. for continuity of investments in the energy industry, making the right choices are key for future success. Read more about Scenario planning and the so what question a recent blog post by Henk Krijnen. Henk Krijnen will be in Kuala Lumpur this October 2017, presenting a very timely “Masterclass on Scenario Planning for Decision Making in the Energy Industry”. Find out more https://goo.gl/tauq5x. If you are too busy during this period, check out our training series on “Training to Navigate Uncertainty in Oil & Gas”