CHINA INDEPENDENT OIL REFINERIES: Yulong set to alter competitive landscape in Shandong

This feature is the fourth of a five-part series on China's small independent refiners.

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. 27.

China's Shandong is set to witness increased competition in the independent refining sector, as the 400,000 b/d Yulong refining and petrochemical complex completes construction by end-2023, putting the spotlight back on how small-sized refiners in the province can remain profitable despite challenges.

With bigger financial muscle, stronger credibility among international suppliers, provincial government backing, and locational advantage, Yulong is bringing back the "small vs big" debate that the sector has seen since it was liberalized in mid-2015, while also raising the question: Can small, standalone refiners survive under the shadow of large, integrated refiners?

"Most of the small independent refineries generated profit from tax evasion, which has been gradually blocked. They are now losing against the economies of scale of the mega plants," an official with the National Development and Reform Commission said.

"Yulong is the best solution. It consolidates the scattered small independent refineries in Shandong, maintains refining capacity in the province with economies of scale, advanced technology, and with support from the provincial government," a senior policy researcher with Sinopec said.

Officials with independent refineries, whom S&P Global Commodity Insights visited, expect the start-up of Yulong to cut their utilization rates but were happy with the current margins from processing sanctioned crudes and didn't regret their decision not to join Yulong.

Yulong's footprint will be quite substantial in front of a number of refiners with capacities ranging from 40,000-150,000 b/d scattered in the Shandong province, but this is not happening for the first time.

Integrated and government-supported refining and petrochemical giants in the private sector have mushroomed in China since 2018 when the 400,000 b/d Hengli Petrochemical, the 800,000 b/d Zhejiang Petroleum & Petrochemical and 320,000 b/d Shenghong Petrochemical started up one after another.

This is further reflected in the drop in the proportion of Shandong independent refiners' crude import quotas. They accounted for 33% of quotas over January-September 2023, compared with 67% in 2017. The annual import quota allocated to these refineries has fallen to 61.16 million mt for 2023, from 95.54 million mt for 2020, S&P Global data showed.

Location proximity

What makes Yulong unique is that it is located in Shandong province -- home to a bulk of China's independent refineries -- unlike the other large, integrated independent refineries that are in other provinces along the coast.

The Yuan 127.4-billion ($17.5 billion) Yulong refinery is a project developed by the provincial government with the private Nanshan Group owning 51% and state-owned Shandong Energy owning 46.1%. To maintain Shandong's competitiveness in the refining and petrochemical sector, the provincial government initiated the Yulong project in 2018 by consolidating 10 small independent refineries, phasing out their combined 558,000 b/d of capacity and taking over their 13 million mt/year of crude import quotas.

The second phase of the project is in the planning stage and could add another 400,000 b/d of refining capacity by further consolidating small refiners in the province, market sources said.

"The provincial government provides strong support to our operations -- from licenses and application approvals to financing," a source with Yulong said.

Petroleum and chemicals is the leading industry in Shandong, the country's third biggest GDP contributor. The refining landscape in the province comprises four Sinopec refineries, about 48 small and big independent refineries, and hundreds of chemical plants located in Dongying, Zibo, Weifang, and Heze.

Located on Yulong island in Yantai city, the Yulong plant also enjoys lower logistical costs with convenient shipping facilities. In contrast, the land-locked small refineries continue to rely on trucks for product transportation as most of them were built close to the aging onshore Shengli oil field.

"Yulong will completely restrict our product sales inland on top of the other mega plants [Hengli, ZPC, and Shenghong along the coast] which have been eating up our seaborne market share in southern China – the consumption center," said a Qingdao-based trader with an independent refinery.

Small is beautiful?

"Our small [size] actually gives us more flexibility, while old [plants] also enjoy a lower operating cost," a Dongying-based refining source said.

Thanks to their small size and almost no exposure to the overseas market, these refineries are in a better position to navigate the sanctions environment and rely on cheap sanctioned barrels for 99% of their feedstocks, allowing them to make up to Yuan 1,500/mt ($28/b) in profit in March this year, higher than most of the integrated refineries in China.

"For example, new means higher asset depreciation cost, it means higher recruitment cost to attract talent and higher sales cost as a newcomer in the market. These to some extent offset the new mega plants' economies of scale. Certainly, additional capacity will cut the average utilization rate in the sector and will lead us to make a loss sometimes, but it is not killing," the Dongying-based refining source added.

Some owners of the 10 mothballed refineries that make up Yulong expressed regret over missing the recent hefty margins from processing cheap crudes, as they had shut their facilities and transferred import quotas to Yulong.

"Compared to the mega plants, I prefer to work in a small refinery, where the decision-making chain is simple and straightforward and the boss is willing to take risks, making trades linked to market trends exciting," a procurement manager with a refinery in Zibo region said.

"The small independent refineries usually lack long-term development plans but they try everything to survive and make profits," a senior researcher with Sinopec said.

Local governments of the refining hubs, such as Dongying and Zibo, need small refineries for economic growth and job creation so these governments will help them survive at least for a few years, the researcher added.

The GDP per capita of Dongying -- home to 50% of Shandong's independent refineries -- was the largest in the province at Yuan 163,900 ($22,534) in 2022 and even higher than that of the first-tier city Guangzhou, official data showed.

"History of independent refineries tells us that none of the plants died from competition, but because they violated policies or rules," a Zibo-based refining source said, adding that most of the small plants will survive amid competition.

Independent refineries mothballed CDUs for Yulong

Unit: million mt/year

Source: S&P Global Commodity Insights