Argus Live: Volatility to persist in Chinese oil market

A persistent resurgence of Covid-19 infections will continue to drive uncertainty in the short term in China, even as new refinery openings are expected support the country's oil demand in 2021, delegates said at the Argus Crude Live virtual conference.

The emergence of big private-sector refineries and their impact on the industry could also exacerbate volatility this year, according to speakers at a panel discussion about the Asia-Pacific crude market in a post-Covid-19 world. The discussion was held under Chatham House rules, which prohibit media from quoting participants.

Asian oil demand led by China will likely return to normal in the second half of 2021, participants said. But China is undergoing another Covid-19 wave despite the rollout of its coronavirus vaccine, with more than 600 cases in its northern Hebei province in December, resulting in additional lockdowns across some northern cities, according to one delegate.

"China's approach to containing the spread of the coronavirus by locking down entire cities has been proven to work but translates into a hard hit on oil demand. There will likely be a pull-back in demand in China this quarter. Chinese companies traditionally buy crude for March-April delivery with the lunar new year coming up but that will be constrained now, leaving refiners with a lot of unprocessed stock since imports in January-February, particularly to Shandong province, were high. That will have a ripple effect on the country's oil demand over the course of the year," a speaker said.

Chinese oil demand growth may be more modest in 2021 compared with previous years. "We've seen demand growth of 11pc in 2020 compared with 2019. When you think of those kind of growth rates, it's likely that Chinese growth rates will moderate in 2021. It's quite hard to sustain the kind of demand growth that we saw last year, which was largely driven by new refinery openings. And we have some refinery openings happening this year and that is going to drive demand possibly more than the vaccine in China," the speaker told the conference.

Crude flows to China's big private-sector refineries are poised to rise after its commerce ministry said it plans to award 1,781.2mn bl in import quotas for 2021, a 21pc year-on-year increase. "The government granted more quotas to big refineries, like Rongsheng, whose new 400,000 b/d refinery has been in commission since the end of 2020. This year, new units will get their import quotas and for the whole year, the main increment will be from these big refineries compared with small refineries in Shandong," the delegate said. New units include Shenghong Petrochemical's 320,000 b/d refinery in Jiangsu province, which aims to come on stream in August and is likely to be granted import quotas in the following batches.

China's ability to absorb surplus supply in 2020, partly because of these import quotas, saw huge volumes of crude traded on a delivered basis in the country in the second quarter. But import restrictions, coupled with price controls, could create big swings in demand. Refiners could be incentivised to burn through their quotas in a falling market as seen last year when government price controls kept domestic refining margins above international levels while crude prices fell. "I don't see the quota system changing, in fact, it has been expanded this year to accommodate the start of new refineries like Shenghong. And the government is also talking about launching product futures without the accompanying talk of dropping price controls at the retail level. So there is this desire to control markets in a way that does exacerbate volatility on a global scale," a speaker said.

Speakers at the event agreed that smaller independent refiners will face more challenges compared with large integrated refineries with the ability to absorb and convert cheap petrochemical feedstocks into profit. "Smaller refiners are adding downstream chemical units in a kind of piecemeal fashion, which I think could leave them struggling. We've seen real growth in the number paraxylene and ethylene units that are being built in China by companies that do not actually have the ability to convert it all the way down the value chain into that pair of trousers. That does leave a lot of these would-be petrochemical refiners in China with a bit of an exposure because they are competing with very integrated companies," according to one speaker.

"I have a nasty suspicion that a lot of that is going to end in tears because those refineries are still very exposed to road fuel markets. Road fuel accounts for 70pc of a traditional refinery output and with demand being as volatile as it is and overcapacity building in the petrochemical market, 2021 could be a bit of a rocky year for some of these refineries," he said.

By Yvette Choo