Potential reforms to China's light-cycle oil (LCO) tax and import regime are starting to disrupt trade flows and premiums for cargoes from suppliers such as South Korea and India.
China could extend its oil product consumption taxes to cover LCO as early as May, traders said. China's biggest refiner state-controlled Sinopec this month repeated calls for the consumption tax to be imposed on imported LCO, which is used for diesel blending. Imports of this product are currently exempt from the hefty consumption taxes that are applied to road transportation fuels, reducing the competitiveness of domestic refinery output.
Premiums for LCO cargoes from major exporter South Korea have fallen in reaction to the possible tax changes. Premiums have dropped to $2-3/bl to Singapore spot assessments of gasoil for end-April loading cargoes, down from as high as $6-7/bl earlier this month and premiums of $3-5/bl for March cargoes, said traders.
South Korea is the top supplier of LCO to China with shipments of 195,000 b/d in 2020, up by 75pc on a year earlier, according to Chinese customs data. This accounted for 63pc of China's total LCO imports, which rose by 82pc to 310,000 b/d last year.
South Korea's April LCO exports are so far on course to hit 180,000-200,000 b/d, or 18-20 300,000 bl medium-range cargoes, according to market estimates. This is down from 22-25 such cargoes in March because of lower prices and refinery turnarounds.
South Korean refiners typically blend 500ppm sulphur gasoil with other components to produce blended LCO. China then blends the imported LCO with kerosine to produce bunker fuels or high-sulphur gasoil.
LCO imports rose sharply last year thanks to strong diesel demand and a weak jet fuel market that encouraged blenders to step up output of cheaper, blended gasoil.
LCO is exempt from Chinese consumption taxes because it can be used as a feedstock for petrochemicals, which benefit from government import incentives.
But traders say this could soon change. Tax reforms have been mooted for years — the prospect of blending components becoming subject to the consumption tax first raised concerns among some market participants in 2017. But the government may be serious about imposing the tax, amid a crackdown on tax evasion and a stronger focus on the environment.
Taxes represent as much as 40pc of the retail price of road fuels in China. These comprise a consumption tax of 2,110 yuan/t ($39/bl) for gasoline and Yn1,411/t ($29/bl) for diesel, 17pc value-added tax (VAT), an urban construction tax and education surcharges. Applying a consumption tax to LCO at a similar level to diesel would make it unprofitable to import LCO into China, traders said.
Indian trade
China's LCO demand draws in supplies from as far afield as India, albeit indirectly. LCO cargoes from Indian refiners are bought by trading firms and shipped to southeast Asia, where they can be exported on to China tax-free using the Form E tax exemption granted to supplies originating from the Association of Southeast Asian Nations (Asean) region.
China's LCO imports from Asean more than doubled to 106,000 b/d last year from 48,300 b/d in 2019. Imports from India were recorded at a nominal 1 kg.
Recent high premiums for imports of blended LCO cargoes to China have encouraged one private-sector Indian refiner to offer gasoil with unusually high aromatics content since February, said market participants. The refiner has offered two 500,000-650,000 bl Long Range 1 cargoes of gasoil with minimum aromatics content of 50pc and 8ppm sulphur.
Suppliers can blend these cargoes with other components to produce blended LCO for shipment to China. LCO cargoes typically have minimum aromatics content of 50pc, compared to minimum 10-15pc for standard diesel.
India's biggest state-controlled refiner IOC started offering combined cargoes of LCO and high-speed diesel in July last year and has since offered cargoes for loading from Paradip on India's east coast every month. It last sold a spot combined cargo for mid-April loading at a mid-single-digit premium to the average of Mideast Gulf spot 10ppm gasoil assessments.
But a more stringent import regime in China may curb the trade. Chinese customs authorities have begun stricter inspections on cargo origins, which may make it tougher to obtain Form E certificates, market participants said.
The prospect of a customs crackdown and a consumption tax could kill the LCO trade, they added, although some traders said importers would find new ways to avoid tariffs.
