CHINA INDEPENDENT OIL REFINERIES: Refiners succumb to vagaries in Chinese policymaking

This feature is the first 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. 6.

Chinese independent refiners from Shandong first visited Singapore in 2016 amid much pomp and glory -- China's oil demand was growing at a brisk pace, the oil market was oversupplied, and with a combined crude oil buying capacity of over 2 million b/d, these refiners were courted by every trading house and supplier worth their salt.

As Zhang Guifen, vice general manager at Hengyuan Petrochemical, told S&P Global Commodity Insights then: "All kinds of princes from producing countries across the world are coming here to offer us barrels."

Seven years on, the same refiners are conspicuous by their absence. They are not even expected at APPEC 2023, S&P Global's flagship oil and energy conference to be held in Singapore Sept. 4-6.

"We have not done any business with Western trading firms for nearly a year and don't have a strong reason to go to Singapore," a Zibo-based refiner said, a sentiment echoed by his counterparts in Dongying and Binzhou.

Similarly, the S&P Global team did not see any Western traders during their Shandong trip this summer, when in the past it was common to run into them in meeting rooms or on banquet tables hosted by the independent refineries.

Their absence can be explained by a significant shift in their crude buying strategy. From importing 123 crude grades from 38 countries in 2020, these refiners currently rely almost entirely on Russia, Iran, and Venezuela -- suppliers facing a host of sanctions.

Between January and July 2023, 99% of their crude imports -- around 2.5 million b/d -- came from Russia, Venezuela and Iran.

Their focus on sanctioned crudes has drawn Western trading houses away and even encouraged them to pull investments out of Shandong, with Mercuria divesting its stake in a crude storage facility in Dongjiakou.

The independent refineries' trading desks in Singapore have also become insignificant, as banks in the city-state do not provide financial services to sanctioned barrels.

"We only have some financial staff in Singapore, and it runs OK under supervision from Shandong. I visited in May, just for some administration work," a Dongying-based refining official said.

There are more than 10 independent refineries with trading desks in Singapore, but most of them have cut down operations to just one or two staff running the office, according to refinery sources.

Beijing's shifting policies

To understand the reason behind such a drastic reduction in the crude basket, one only has to look so far as Beijing's shifting policies towards the oil sector.

In 2015, when these refiners were first allowed to import crude oil, Beijing's policy focus was to keep the product market well-supplied and inject vitality into the market with competition for state-owned refiners. But that policy gradually changed focus toward supply-side reform and industry upgrades, tightening the noose around tax evasion and violation of environmental rules and regulations.

To survive and make profits amid these shifting policies, these small independent refineries have been forced to rely on discounted crudes to compete against their state-owned and private integrated peers.

Thanks to their small size and almost no exposure to the overseas market since they are no longer allowed to export products, these refineries are in a better position to navigate the sanctions environment and enjoy the low prices of sanctioned crudes by using unique ways of procurement, different from the regular ones settled in US dollars on FOB basis.

The use of sanctioned crudes allowed these refiners to make up to Yuan 1,500/mt ($28/b) in profit in March this year. Margins have come down to Yuan 1,000/mt more recently due to rising Russian crude prices, according to several independent refiners. But, in comparison, state-owned Sinopec's gross profit stood at Yuan 354/mt in the first six months of 2023, down 33.6% on the year, according to the company's interim report. Most of Sinopec's refineries are designed to process Middle Eastern crudes.

The independent refiners may not be dealing with Western trading houses anymore in foreseeable future, but are certainly putting to use the trading knowledge accumulated over the period of doing business with them.

Their top priorities for crudes with suitable specifications are: competitive prices to keep their margins profitable, Aframax-sized cargoes for flexibility, ICE Brent as the pricing basis for transparency, and crudes to be bought on a DES Shandong basis for minimum logistics and insurance risk.

Navigate sanctions

Most of the sanctioned barrels are settled in Yuan and are paid for via telegraphic transfer, while local Chinese banks have also started to issue letters of credit to finance the cargoes, according to refinery sources.

Russian feedstocks are mainly supplied by state-owned trading companies PetroChina, Zhenhua, CNOOC and Russian firms such as Lukoil.

As Iranian and Venezuelan crudes are under secondary sanctions, these cargoes are usually blended in the waters of Malaysia, Kuwait, or the UAE, and traded by Chinese private trading companies. These private trading houses are run by local traders in Shandong, who are constantly opening new firms after shutting old ones over short periods to avoid sanction risks.

In the first seven months of the year, at least 52 such trading companies showed up in S&P Global's database of feedstock imports for independent refineries, supplying a combined 34.44 million mt of feedstock from Iran and Venezuela.

"The barrels are sold by the same set of traders, who keep changing their company names," a Dongying-based refiner said.

These cargoes sometimes were bought with onshore US dollars via local banks in Yiwu city, China's small ware manufacturing and trading hub in Zhejiang province, according to traders and refiners in Shandong.

"The dollars are circulated in China as the suppliers would use the money for merchandise they send back home," a Qingdao-based trader said, adding that the circulation is smooth despite secondary sanctions.