A new Chinese tax on esoteric oil products poses a challenge for heavy sour crude, particularly from Venezuela.
In this episode of The Crude Report, vice president Tom Reed and senior contributing editor Patricia Garip discuss how Beijing’s new import tax threatens to orphan 400,000 b/d of Venezuelan crude that has been a lifeline for Caracas since the US imposed sanctions in 2019.
Tom Reed: Hello and welcome to The Crude Report, a podcast series on global crude oil markets by Argus Media. I'm Tom Reed, vice president of China crude and products from London, and joining me for this podcast is Patricia Garip, senior contributing editor based in Santiago, Chile.
I'm back this week to discuss China's recent announcement about the new consumption taxes on intermediate refined products, including mixed aromatics, light cycle oil, and diluted bitumen. This last one, diluted bitumen, is actually the product category through which China's independent refiners import Venezuelan’s heavy sour Merey crude grade that's coveted by the refiners for its bitumen-rich quality, suitable for making asphalt.
While there are other heavy sour barrels in the market, Canada's Cold Lake or Iraq's Basrah Heavy, the Venezuelan crude tends to give China the best bang for their buck. And that's because US sanctions force Venezuela state-owned PDVSA to sell its crude at heavily-discounted prices using intermediaries, ship-to-ship transfers, and trading routes via Malaysia, relabeling it and blending it to get that crude into the Chinese market. No other destination accounts for more of Venezuela's oil exports.
This new tax of 1.20 Yn/litre, or around $30/bl, on diluted bitumen taking effect from the 12th of June basically wipes out the margins on the Venezuelan crude sales into China.
So, if the Venezuelan crude feedstock is so cheap, why would China impose a tax on it? The new taxes appear to be a way for China's state-owned refiner, Sinopec and others, to squeeze out the independent refiners that have poached so much domestic market share in recent years, forcing the state-owned refiners to export their surplus motor fuel.
It's worth bearing in mind that the independent refiners are subject to crude import quotas, which is why they import the Venezuelan crude as product instead. They could reclassify Venezuelan crude, but it really is crude, but then their import quotas won't give them much leeway to import their usual baseload feedstocks. There's some question as to whether the Chinese government might consider expanding the import quotas to allow independent refiners to keep on buying Venezuelan crude, but that would probably fly in the face of what the more influential state-owned refiners want, which is to push them out of the market. So, Patricia, what does this mean for Venezuela? What does this tax mean?
China: Heavy sour crude imports
Patricia Garip: So, as you mentioned, Tom, the Venezuelan government relies on the Chinese market to absorb most of its crude exports. While the actual figures bounce around, we're talking about some 400,000b/d, if not more, that goes into China. In response to US sanctions on Venezuela, Chinese companies moved away from directly lifting Venezuelan oil around August 2019. And since then, Merey, that's a 16° API blend derived from the Orinoco heavy oil belt, makes its way into Shandong province via intermediaries and transshipments.
For decades, before the US imposed oil sanctions on Venezuela in early 2019, most of Venezuela's oil went to US refiners, including PDVSA's own US refining subsidiary, Citgo. For a period after the sanctions, a chunk of Venezuela's oil exports went to India and the EU through crude for diesel swaps, under an exception to the sanctions on humanitarian grounds.
Basically, India's reliance and EU companies Repsol and Eni we're lifting Venezuelan crude in exchange for diesel or to cover past debts. Now, the US closed off that diesel exception toward the end of 2020, rendering Venezuela even more dependent on the Chinese market, and the obscure intermediaries it sometimes uses to get it there. So, the new tax deals a real blow to Venezuela and its national oil company, PDVSA.
Tom: So, what is PDVSA doing to try and navigate this?
Patricia: So, the new Chinese tax took PDVSA and the Venezuelan government by surprise. Remember, China has long been one of Venezuela's key international patrons, so Venezuelan officials expressed a sense of betrayal over this. For now, PDVSA is trying to overcome terminal glitches and crude contamination issues to try to load as much oil as it can before the tax takes effect. Even though the cargos won't arrive in China by then, the hope in Caracas is that China will grandfather in those cargoes, while it seeks to persuade Beijing to loosen the independent refiner's crude import quotas to keep the channel open.
There's another angle to this as well, Tom. Venezuela still owes China more than $10bn in oil-backed debt. If Venezuela can't export oil to China or if volumes are sharply reduced, it's going to take a lot longer for Venezuela to service that debt. And in the meantime, interest is accumulating.
Tom: Sounds like Venezuela is in a bit of a pickle?
Patricia:Yeah, that's right, Tom. And the timing is super sensitive for the government of President Nicolas Maduro, who the US sanctions by the way are designed to force out. Maduro, whether the US put a maximum pressure campaign of the previous US administration, the US supported political opposition in Caracas is pretty divided and dispirited right now. The two sides are flirting with a new round of negotiations to try to break the political stalemate.
While Maduro looked to have the advantage heading into the talks, this narrowing of Venezuela's oil export options suddenly makes them look more vulnerable and could force him to make concessions. We've seen Caracas extend some olive branches in recent months, such as moving some jailed Citgo executives into house arrest, allowing the World Food Programme to operate, and bringing two opposition figures onto the national electoral board. But Maduro hasn't made any moves to hold credible early presidential elections, liberate political prisoners, or allow a free press, which according to Maduro's opponents would signal substantive progress toward restoring democracy. Having said this, Maduro has muddled through for years with support from China, Russia, Iran, Turkey, and, of course, its close political ally, Cuba. So, if history is any guide, he could overcome this latest challenge too.
Tom: The next question, obviously, is what does this mean for US policy and for Maduro's domestic opponents?
Patricia: Well, it's interesting to see how this seemingly esoteric tax on blendstocks in China poses a big test for Maduro, pressuring his government to an extent that years of US sanctions never really did. US officials sense an opportunity, and Maduro's fractured opponents are hoping the pressure unwittingly imposed by China will give them more of an edge heading into those talks.
While Venezuela is not a top US foreign policy priority right now, some in Washington do see a chance for a breakthrough if Maduro is backed into a corner. But all sides will have to make compromises to break the stalemate, and that means Maduro's opponents might need to consider some form of power-sharing. It's worth stressing, we don't think China's new taxes were designed to force Maduro's hand, but as an unintended consequence, that's precisely what could happen.
Tom: No real quiet, and I imagine a large part of their thinking was, you know, the idea that putting taxes on heavy sour crude imports actually has an environmental benefit. And of course, China is topping up its environmental targets currently. On the other hand I, of course, don't see China reversing course on these taxes to allow Venezuela to continue placing its barrels in Shandong because that's probably not a priority for Beijing either. The government seemed to have more interest in lending a hand to the state-owned refiners than keeping the spigot open for Venezuelan crude, and the independent refiners that benefit from it.
Well, I think that's all we have time for, for now. But thank you so much for that fascinating insight into the unintended consequences of these tax changes on the other side of the world. To stay close to the Chinese crude market, the world's largest crude oil buyer, consider subscribing to our Argus China Petroleum service. And if you're more in need of Latin America crude oil and refined product coverage, consider subscribing to Argus Latin Markets. You can find more information on these services at www.argusmedia.com. Thanks for tuning in. And we look forward to you joining us on the next episode of The Crude Report.