Spotlight on Shandong

Shandong province has been the Texas of China's oil refining sector for decades, having survived multiple government crackdowns and stiff competition from state-run refiners, to carve out their own niche in the global oil market.

But China's small independent refiners, nearly 80% of whom are in Shandong, may have found their biggest adversary yet -- the rise of a new class of greenfield mega-refineries along the coast of its adjacent provinces.

China's small independent refineries have driven a new trend in crude oil flows in 2019 -- record high imports of blended grades from Malaysia.

The trade flow in itself is unusual -- Malaysian oil production is on the decline, many of the blends contain grades from undisclosed origins and their suppliers are secretive about the exact composition.

The timing has also raised eyebrows -- it coincides with collapsing margins at Chinese independent refiners and the removal of favored Venezuelan and Iranian crudes from regular trading channels due to sanctions. New Malaysian blends are perfectly-timed substitutes to fill the gap.

Oil markets have not seen the last of Shandong's independent refiners.

They have a tenacious history of survival, and will battle it out both in the domestic and international markets as China's refining overcapacity is increasingly exported.

Traders expect China's growing product exports to underpin gasoline and gasoil trade flows in Asia, much like the emergence of refining hubs in Singapore and India did in the past.

China has gone from being a net fuel importer to one of the world's top ten refined product exporters in 2018.

Shandong's refiners currently face many uncertainties -- China's economic slowdown, stagnating fuel markets, the light-heavy differentials challenging global refiners and the (hopefully positive) impact of IMO 2020 on refining margins.

Their immediate concern, however, is maintaining government-sanctioned quotas that are their biggest asset but also their Achilles' heel -- unused quotas affect future quota allocations so they have to be fully used up, regardless of market conditions.

Shandong's independent refiners were the darling of oil suppliers for a few years, but some fear the market opportunity could shrink as capacity rationalization creeps in.

The rise of integrated petrochemical complexes already signals a change -- the independents were largely a spot market play, whereas the mega-refineries of Hengli Petrochemical (Dalian) and Zhejiang Petroleum & Chemical have long-term supply contracts with Middle East producers like Saudi Aramco.