ANALYSIS-China sharpens axe to cull "teapot" refiners

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Friday April 29, 2011 02:44:10 AM GMT

By Fayen Wong and Judy Hua

BEIJING, April 29 (Reuters) - China's state-owned oil companies can cover any shortages of refined fuel products under plans to shut small refiners known as "teapots" that make up 10 to 15 percent of the country's capacity, though fuel oil imports would fall sharply.

China's economic planning agency, the National Development and Reform Commission, this week brushed up a 2005 plan to cull the smallest oil refineries, along with other economic restructuring goals. [ID:nLDE73P0GU]

" Any shutdown of teapot refineries will lead to a decline in fuel oil imports because fuel oil is an important raw material to them," said Jin Yun, a senior oil market researcher with state-oil firm CNPC, parent of PetroChina , adding that 80 to 90 percent of the smaller refiners could be shut and cause shortages of refined products in some areas.

"Teapot refineries act as a swing player in China's refined oil product market, especially when the domestic supply of oil products is tight. If teapot refineries are closed, it will have a negative impact on fuel supply."

The government is taking aim at crude distillation units (CDUs) that process 40,000 barrels per day (bpd) or less, planning to phase them out by 2013. That threshold is far below the plants run by state oil giants Sinopec Corp and PetroChina , none of which face closure.

EXPANDING CAPACITY

China's top 10 independent oil refineries had 39 million tonnes or 780,000 barrels per day (bpd) of refining capacity in 2010, a recent report by consultancy C1 Energy showed, most run off fuel oil imports as only state-owned companies are licensed to import crude oil. But most independents are much smaller.[ID:nTOE6BS02E]

Total refining capacity in China, the world's second largest oil consumer, stood at around 10 million bpd at the end of 2010, exceeding total apparent oil demand of some 8.65 million bpd, as calculated by Reuters based on official data.

But China will likely add about 3.02 million bpd of new refining capacity between 2011 and 2015 in a refinery building boom to fuel its robust economic growth, industry officials and Chinese media have said.

DEFENCE

But teapots won't shut easily, relying on a double defence against the planned government cull.

The first is line of resistance is safety in numbers and the prospect of a shortage of fuel supplies. Their reserve position against Beijing's edict will be to take refuge in local politics, analysts said.

"I doubt if teapot refineries will phase out their CDUs according to this rule because they are shielded by local governments," said Dai Jiaquan, a senior oil market researcher with CNPC.

Many teapots managed to evade Beijing's previous dragnet by appealing to local officials.

"The new threshold is nothing special," said an executive at a 10,000 bpd teapot in the eastern province of Shandong, which is still operating, but on a wafer-thin profit margin. "Every region has its own policies and there will be ways out there to meet requirements."

Another Shandong teapot executive, whose two crude oil units can process 30,000 bpd in total, is equally unfazed.

"It's unrealistic and we are not too worried about it," he said. "There were quite a few privately-owned small refineries, and some of them have grown to bigger ones."

His plant will soon close for a major overhaul, a lucky break given that fuel oil costs are outstripping gasoline and diesel price rises set by the government.

But that convenient exit from the market, a step being taken by many teapots, may stiffen Beijing's resolve.

Almost all the teapots in the southern province of Guangdong have closed and output in Shandong, where the larger plants are located, is down to 20-30 percent as operators extend maintenance outages, traders said last week.

Although the teapots can win today's battle, or at least evade it, the government may still win the war as state-owned refining capacity swamps the market, freeing the government from any reliance on teapot supply.

"We expect China's refining capacity to be a glut in five years, even if you factor in the elimination of some outdated teapot capacity," said Dai, the CNPC researcher.

COAL EXAMPLE

The central government's determination to get the upper hand on the teapots, even if that means adding to market turmoil, is also evident from its management of the coal sector.

It has shut thousands of small coal mines in the past few years, forcing the huge coal mining nation to become a major coal importer in 2009 and 2010.

China's coal balance may be slowly turning the corner, with growing supply from bigger mines set to offset the loss of output from the myriad small mines and new rail projects easing logistical hurdles that prevented shipments to inland power plants.

"There is always a worry that there would be an oversupply of coal in the medium term and demand is a big factor. Aside from that, the raft of rail capacity that is expected to come online in around 2013 could also mark a big turning point for the market," said Geng Zhicheng, a senior researcher at the Energy Research Institute, part of the NDRC. (Reporting by Jim Bai, Judy Hua and Fayen Wong; Writing by Tom Miles and Fayen Wong; Editing by Ed Lane)

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