On Friday, 22 October 2021, China's ministry of commerce released an unprecedented 5th batch of crude import quotas.
This has allowed the country’s independent refiners to resume purchases of December-arriving crude and triggered a flurry of spot-market deals.
In this episode of The Crude Report, our vice presidents James Gooder and Tom Reed review the latest round of allocations and the effect these quotas have on global trade.
James Gooder: Hello, and welcome back to The Crude Report. This is a podcast series from Argus Media, covering events and issues in global crude oil markets. My name is James Gooder, I'm a VP for Crude at Argus Media based in London. And I'm very pleased to welcome back our VP for China Crude and Products, Tom Reed.
Tom Reed: Hi, James.
James: Hi, Tom. Good to be with you. Well, China's back in the news. Is it ever out of the news?
Tom: Oh, China.
James: And this week, it seems to be that the issue is that long-awaited crude imports quotas are finally being assigned. You know, what is being imported into China has a huge impact on crude markets everywhere else. So perhaps you can, first of all, tell us why is this long-awaited? What's new, and what's been the impact of the delay?
Tom: Yeah, no, I mean, it has been keeping the market, I think it's fair to say, on tenterhooks for some time. The government's been doling out this year's import quotas for independent refiners piecemeal rather than handing out a huge majority of import right at the start of the year as it used to a large extent. This goes back to its unhappiness, the government's unhappiness, with the discovery that quite a few refiners, for example, if they had refinery turnarounds, if the refinery shut, they would resell or trade these import rights, which the government sees as being a privilege rather than a right.
So it's pretty upset about that. And as a result, it's pretty much staggered the release of the last of this year's expected import quotas over three issuances. There was one in August which was quite significant, and then there have actually been two this month. And I think it's fair to say that this demonstration of bureaucratic power that the government has just kind of gone in for, really did put the wind up the market.
In the past, you'd see independent refiners in China buy crude three or maybe four months ahead of delivery. And this year, there's been a lot more prompt buying, a lot more refiners buying closer to delivery simply because a lot of them no longer had any certainty about their future ability to actually import those cargos, to clear those cargoes through Chinese customs.
James: Right. It's a real kind of hand-to-mouth approach.
Tom: Yeah, yeah, absolutely. And in particular, there was a lot of uncertainty over quotas which were expected to be allocated to a firm called Rongsheng. This runs China's biggest refinery, it's an 800,000 b/d refinery called ZPC in Zhejiang province on the East Coast. That level of uncertainty had a particular impact on sour crude markets because Rongsheng has always tended to be a very, very visible presence on the Mideast Gulf sour crude spot markets. You know, buyers were like buying up Basrah Light, Upper Zakum in these monthly spot tenders. And then between July and October, it essentially vanished from the Mideast Gulf market and was forced, because it was running out of import rights, to cut runs at its refinery, and to cut crude buying, and that has caused considerable alarm.
But it came back into the market earlier this month and began buying crude for December delivery, even though it didn't yet have any quotas. But I think a lot of people did think, ah, maybe things are returning to normal. And they now have, I think, to a large extent.
James: Given the delays that we've seen so far, just in terms of the volumes, how do this year's imports compare to previous years? I mean, obviously, last year was a bit of an outlier, but how are the imports looking?
Tom: Just thinking literally about Chinese crude imports, obviously, this year they are running year to date far, far lower in January to September than they were. So far year to date we're down about 600,000 b/d, it's averaging about 10.4mn b/d a day. October is looking like it's going to be another weak month for imports. According to our surveys, October imports are going to be the lowest so far this year, and probably the lowest since July 2019. A lot of that is down to the reluctance of independent refiners to buy crude, which they might not be able to land.
James: That makes sense. Yeah, exactly. So, but perhaps now that some of that uncertainty has been cleared up, we will see a bit of an uptick in spot market activity in buying, right?
Tom: Yeah, and we are starting to see that already, and I think a lot of suppliers are rubbing their hands in glee right now.
James: I bet they are. So, I mean, you've told us a bit about Rongsheng which is interesting, have there been any other changes or any other surprises in the list of refiners that have been granted import quotas by the Ministry of Commerce this time?
Tom: There haven't really been any significant changes I would say. You know, a handful of the refiners which had admitted to trading quotas earlier this year, last year, maybe didn't get any in the later batches awarded this year. But those are pretty small in the scheme of things. The really significant absence from that list in early October when the latest batch came out was Rongsheng, it's a huge textile producer with very, very strong political support from the local government where it's refinery's done. And for a long time, Rongsheng was held up as this kind of poster child for a new model of highly integrated petrochemical-focused refinery in China.
But then today, we're recording this, obviously, on the 25th, it's going to go out a few days later, it did get a quota and a large one too. Today, Rongsheng actually announced that it's received its quota that's equivalent to 240,000 b/d over the full year, or nearly 90mn bls. So the market has today gone up quite a lot as a result of that.
James: Wow. Are they likely to be able to use all of that quota?
Tom: No. And I think there's still some discussion about whether they'll be allowed to carry some of that volume over into 2022, because we're already seeing a lot of January 2022 cargoes trading in the market, and so it would make sense for some of that volume to spill over into next year.
Historically though, the government has been quite strict that if you apply for 400,000 barrels a day of crude import rights in a given year, you have to use them in that year, and it's use them or lose them. If you don't use them up, then the following year you will get awarded a smaller import allowance. But I think given the lateness of the day, it was probably rather unreasonable to expect Rongsheng to go into the spot market and buy 90mn barrels of crude for delivery in China before December. I think there's probably going to be a bit of leeway around that.
James: That could have caused a certain amount of turmoil. Interesting. So, I mean, you've talked a little bit about the boosting spot market activity, suppliers kind of circling this newly re-emerged opportunity. But can you tell us a little bit more about the impact on the market itself, just in terms of the prices and how significant this is in the broader demand picture in China and the wider region?
Tom: It is pretty significant because not least, China is experiencing its own version currently of a squeeze in diesel markets. And a lot of that is because independent refiners both in Shandong, up in Liaoning where you've got another cluster of independent buyers, and Rongsheng down in Zhejiang province have been cutting runs, so they don't have the import rights to sustain throughput levels at the sort of rates we saw earlier this year. On top of that, we're seeing a lot of incremental demand spill over from the power generation market where a lot of factories have had to buy diesel in the market.
Like I said, there's a shortage of product supply in China. And I think allowing independent refiners greater access to crude imports is going to help remedy that. And we're now in a situation where the Chinese government, having appeared very reluctant to continue to give private sector firms import rights. And I stress the word appear here because it's far from fair that Beijing ever really was genuinely reluctant to continue to give import rights to refiners. It's actually given out more import rights now this year than it did in 2020. This year, so far, it's handed out 3.8mn b/d of import rights. Last year, it handed out 3.7mn b/d.
That difference is small, but I think it is significant. Certainly, in terms of market sentiment, I think it does send quite a powerful signal to the market. And I think it's likely to be very supportive to prices in an already red-hot market at the moment.
James: Well, exactly. I mean, it is a very hot market, prices are as high as they have been in three years at least and before that, that peak in 2018 was anomalous too, and before that, we hadn't seen anything like this for the decade previous.
So, well, I mean, I'm thinking about the kind of crudes that are most in-demand over there now. You've talked about some of the sour Mideast crudes being picked up by Rongsheng and so on. But it's quite a wide Brent/Dubai spread at the moment, and relatively high freight rates too, so it's quite difficult to bring Atlantic Basin crudes profitably into East Asia and China at the moment. So that's potentially kind of choking off one source of supply and keeping that Mideast sour market supply. But what kind of crudes are you seeing kind of coming into the market, this kind of spot market right now?
Tom: Yeah. I mean, that is an absolutely fascinating central point, isn't it, at the moment? I mean, because of, you know, and it's a seasonal thing because of the very, very high cost of gas, we're seeing hydrotreating costs go up for refiners. It's costing a lot more to refine, to desulphurise those sour barrels. And that is proving very supportive of the sweet grades which independent refiners in China broadly favour.
And the strongest price response we've seen so far in the market, the DES market, is ESPO Blend, a light, sweet Russian grade which really sits on the doorstep of China, of Shandong Province in particular, and Shandong is of course the home to the majority of Chinese independent refiners.
Premiums to Brent for ESPO Blend on a delivered China — DES — basis, they've shot up by $1 in the last month. And typically when independent refiners buy more crude, it'll tend to be ESPO Blend, or Tupi from Brazil, or Johan Sverdrup.
But I think, and this kind of goes back to what we started talking about, because of the delays relating to the release of this year's quotas, we've seen a lot of that demand shift from the long-haul grades, from Brazil, from Norway, into short-haul grades like ESPO blend which you can take delivery of relatively rapidly in China, and I think that's going to be essential to increasing supply of diesel.
To your other point, the cost of delivering crude to China is very high because of the EFS, because of rising freight rates. But just to refer back to that diesel shortage that I mentioned, refining margins in China now are incredibly strong, and perfectly capable, I think, of supporting those kinds of arbitrage economics.
James: That's interesting. I mean, just again, to think back to 2008, those of us who've been around for a while, I mean, the reason that we had those very high crude prices, of course, that was the time when crude topped $147/bl, was exactly because of a shortage of low sulfur diesel, and there's very wide crack spreads for that kind of product. So perhaps this is something of a rerun of that.
Tom: Well, I mean, that is really interesting. That is very paradoxical. It's kind of ironic, isn't it? I mean, those kinds of level of diesel cracks that we saw then, that was a result of China's industrialisation years, rapid growth. And here, the diesel shortage that they're experiencing in China is in many ways a reaction to its kind of attempt to de-industrialise, to reduce its emissions, and that's why they've got these electricity shortages.
James: Fascinating. Well, Tom, we'll wrap it up there, but thanks ever so much for joining us.
Tom: My pleasure.
James: And, of course, you can read all about this in the very next edition of Argus China Petroleum, which, Tom, will be coming out very soon, right?
Tom: Yep. Yep. Be out on Thursday.
James: And, of course, don't forget that you can also get daily prices and news analysis for internationally traded crude streams, so have a look at the Argus Crude service at argusmedia.com. Thanks so much everyone for listening, and do please join us again on the next episode of The Crude Report.