CHINA INDEPENDENT OIL REFINERIES: Refiners' shift to sanctioned Iranian crude gives world breathing space

This feature is the second of a five-part series on China's small independent refiners. Read the first part here.

S&P Global Commodity Insights made its first visit to these refiners in 2012 when they were little known, and barring a break during the COVID-19 lockdown, our team visited the refiners every year from 2014 until 2019. We resumed our visit in the summer of this year, during which we spent five days visiting Qingdao, Dongying, Binzhou, and Zibo, meeting senior officials with nine independent refineries, four trading houses, and the Qingdao port authority.

These trips have allowed us to capture the rise in their influence and sway over the international and domestic oil markets in their heydays to a more recent turn in fortunes as the government disavows them in favor of larger, integrated plants.

The small Shandong-based independent refineries in this series include privately owned plants with capacities between 40,000 b/d – 214,000 b/d and exclude those under the state-owned ChemChina and the large integrated refining and petrochemical complexes.

The next feature will be published on Sept. 13.

Chinese independent refiners' strategic shift to crudes laced with sanctions may have raised eyebrows, but the switch to cheaper Iranian barrels -- the most competitive among the sanctioned basket -- has played a key role in smoothing oil flow in the Shandong market.

Shandong refineries now import nearly all of their total feedstock requirements -- comprising 2.47 million b/d of crude oil and fuel oil -- from sanctioned-hit Russia, Iran and Venezuela, the countries that found few crude takers globally in January-July.

As a result, the independent sector is no more competing for cargoes from other oil suppliers and playing a vital role in freeing up those volumes for other importers and helping keep a lid on world prices.

Moreover, "competition among the sanctioned resources has led to cheaper and better Iranian cargo inflows to gradually surpass those from Russia. This trend is likely to extend in the foreseeable future. Because the sanction on Iranian crudes is not very likely to be lifted in a year, capping the price, neither tighter supervision from US [is expected to get tighter], keeping the flow," said a trader with a state-owned oil company.

Iranian crude exports are likely to make modest gains as the country commits to higher production, while its exports, mainly to China, are set to reach 1.59 million b/d in Q4, S&P Global Commodity Insights said in a monthly report dated Aug. 31.

S&P Global data showed that these independent refineries imported 957,000 million b/d of Iran-origin crudes in July, 44% higher than their Russian crude inflows of 665,000 b/d in the same period.

The sharp increase in Iranian inflows by the small-sized independent refiners have made Iran one of the top four crude suppliers to China. The volume was just below the third supplier Iraq, which sent 1.28 million b/d shipments to China in July, as per calculations based on data from S&P Global and Chinese customs.

Iranian volumes are not reflected in China's General Administration of Customs data as most of the Iranian barrels are reported as crudes from Malaysia, UAE or Oman.

Lower price

"When the spread between Russian Urals and Iranian Light is wider than $5/b, independent refiners prefer to take the barrels from Iran," said a trader with PetroChina International, which supplies Russian crudes to the sector.

As of Sept. 5, Iranian Light was offered at a discount of around $13-$13.5/b against ICE Brent on DES basis in Shandong, while Iranian Heavy was at a discount of $17-$18/b. In comparison, offers for Urals were at discounts of $1-$2/b against ICE Brent while ESPO offers were at premiums of 50-60 cents/b, according to market sources.

"The independent refining sector has been the most important one for Iran ramping up supplies. The suppliers offer good services and are willing to absorb independent refiners' rising costs, such as additional import administration fees, rent for storage and even taxes," said a Qingdao-based trader, referring to Iranian supplies.

China is the only country among Iran's traditional customers that continues to purchase considerable volumes of oil from it, despite Iran saying it has found new markets, such as Venezuela, which is taking mostly Iranian gas condensates.

Iranian crude export volumes have been rising in recent months. The producer's crude outflows rebounded to a 50-month high of 1.7 million b/d in May from the low of 257,400 b/d in February 2020, according to S&P Global Commodities at Sea.

Iran is hoping to step up its crude oil production to 3.4 million b/d by Sept. 22 from about 3.2 million b/d on Aug. 22, against its oil production capacity of 3.8 million b/d, according to Iranian oil minister Javan Owji, as the country reports a significant growth in exports.

Better quality

Independent refiners said specifications of Iranian crudes were relatively more suitable for their facilities than Russian crudes.

"Iranian crudes have only one shortage, and that is higher sulfur content, compared with Russian barrels. But Russian crudes have a few issues," a Zibo-based refining source said.

Iranian crude appears to be a suitable alternative to Russian Urals. Iranian Light, one of Iran's leading export grades, has a relatively similar medium sour specification to Urals, with an API gravity of 33.6 and 1.46% sulfur content, compared with Urals' 31.7 API and 1.19% sulfur content.

But Russian Urals has relatively higher content of metals, carbon residue and chlorine, which are considered too high to produce gasoline and gasoil for Euro-6 equivalent fuels while corrode.

"It corrodes facilities and makes the color of gasoil unstable," the second Zibo-based refining source said.

These refiners process Iranian Light and Iranian Heavy directly in their crude distillation units, refining sources said. But the low asphalt yield, at about 20%, prevents Iranian Heavy from replacing Venezuelan heavy barrels as feedstock for asphalt production. Iranian Heavy grade is a heavy sour crude with an API gravity of 29.6 and sulfur content of 2.24%.

However, four refineries in Shandong's independent sector have stayed away from Iranian feedstocks, according to local traders and refiners. They were Lijin Petrochemical, Kenli Petrochemical, Chamboard Petrochemical and Yatong Petrochemical, located in Dongying and Zibo cities.

"We have to keep away from Iranian barrels as we use some technology provided by US companies," a source with Lijin Petrochemical said.

Russian barrels

Russian barrels have been one of the top feedstock choices for the small-sized independent refiners, even before Beijing gave them the green signal to use imported crude in 2015.

Russian straight run M100 fuel oil had been the refiners' preferred feedstock, ahead ofother crude grades that made their way into the country. Shandong independent refiners favored the Far Eastern Russian ESPO Blend as their initial crude choice due to the short voyage, Aframax-size and high gasoil yield, with the preference expanding to other Russian grades including Urals, Sokol and Sakhalin Blend.

Over the last two years, the evolving geopolitics and global trade flows have altered the palate of those independent refiners, who are now bringing in plentiful Russian feedstocks following their feedstock diversification over 2017-2021.

"It is interesting that we started with ESPO and currently we return to ESPO after trying different grades of crudes all around the world," a Zibo-based refining source said.

Competition

But seaborne Russian ESPO Blend crude is starting to attract buyers in India -- a trend that could intensify competition between the top two Asian oil importers.

In addition to Russia's production cuts, Russian grades are becoming less competitive than Iranian ones in the Shandong market, despite ESPO remaining the top sweet crude for independent refineries as prices of the barrels from West Africa are high.

"Indians' buying power is strong. They always make quick decisions and buy a few cargoes per month for, such as a quarter, in a deal. It's very difficult to compete. The Chinese state-run companies sometimes are willing to make bulk deal but take longer time to make decisions," the Qingdao-based trader said.

"ESPO was competitive when its discount was deeper than $8/b. It even hit a discount of $9.5/b against ICE Brent earlier this year, but those days have gone," the trader added.

Outlets of Venezuelan crudes are wider as the treasury department's Office of Foreign Assets Control in November last year issued the Venezuela General License 41, which allowed Chevron to drill in Venezuela and, sell and export the oil and petroleum products produced via joint ventures to the US. Chevron's exports to the US resumed in January.

Along with a strict clearance process for bitumen blend in Qingdao, imports of feedstocks produced from Venezuela to the independent refineries fell 29% on the year to 420,000 b/d in July, S&P Global data showed.

Venezuelan heavy crudes -- Merey 16, Boscan, Hamaca and DCO -- are usually blended in Malaysian waters and declared as bitumen blend, which is used as feedstock for asphalt production. The independent refiners also import straight run 380 CST fuel oil as feedstock.