May 23, 2018 / 9:43 AM / 3 months ago

China's independent refiners embrace old friend fuel oil as taxes, rising crude, bite margins

BEIJING (Reuters) - China’s independent oil refiners are once again using fuel oil to feed their plants as stricter tax enforcement and rising crude oil prices have squeezed their margins.

These independent refiners, nicknamed teapots, buy nearly one-fifth of China’s crude imports and any reduction in their crude purchases would cap demand in what is now the world’s biggest oil importer.

Two independent refiners based in the eastern province of Shandong, home to most of China’s teapots, have each bought an 80,000 ton cargo of straight-run fuel oil (SRFO) cargo, together totaling about 1.02 million barrels, for April and May delivery, according to three traders with knowledge of the deals.

One cargo is arriving from Abu Dhabi and the other from Singapore, said one of the sources, an executive with a western trader involved in the supply talks.

The independents had primarily used straight-run fuel oil, the residue left after crude oil has been initially distilled in a refinery, as a feedstock for their plants since it cost less than crude oil and was taxed less. However, in 2014, the Chinese government raised taxes on fuel oil imports. But, that was followed in 2015 by teapots winning licenses to import crude.

Straight-run fuel oil consumption slumped as the refiners bought crude oil, which yielded a higher volume of higher-value products such as gasoline and diesel than the SRFO when processed and boosted profit margins for the teapots. China remained a large buyer of so-called cracked fuel oil as fuel for ships. [O/CHINA3]

However, starting on March 1, Beijing enacted new tax rules that more rigidly enforced on the teapots the collection of a $38 per barrel gasoline consumption tax and $29 per barrel tax on diesel.

Combined with a recent surge in crude oil prices to their highest since 2014, the higher tax collection has crushed the independent’s margins. That has prompted the renewed interest in lower-priced fuel oil.

To view a graphic on China's crude oil imports, click: reut.rs/2KJ2tuv

“Buying SRFO may not necessarily save tax cost as the buyer needs to pay up-front the (fuel oil) consumption tax, but obviously plants are exploring the old trade as the government’s tax stick is really a hard one this time,” said the oil trading executive.

Processing the SRFO does have an added tax benefit, however. The independents can deduct the tax of about $31 per barrel paid on their fuel oil imports from the consumption tax they are required to collect on their gasoline and diesel sales, said an official with an independent plant seeking fuel oil.

“Processing fuel oil gives better margins than (refining) crude oil as plants can get tax deducted (when selling refined fuel) later,” the official said.

The source, who declined to be named as he is not authorized to talk to press, added that his plant expected margins to be negative if they only processed crude oil.

The lower margins have resulted in the teapots cutting their run rates.

In early May, the independent refiners operated at only 63 percent of their processing capacity, the lowest since February during the Lunar New Year break, according to a weekly survey of 38 plants by Shandong-based consultancy Sublime China Information. Planned maintenance was also a factor, said Gao Lei, an analyst with Sublime.

“We’ve seen less impact (from the tax measures) on import volumes as state-run plants increase runs, but more on teapot margins,” said Seng-Yick Tee, of consultancy SIA Energy,

“They are definitely making less money now than before.”

To view a graphic on China’s teapot refinery runs rate, click: reut.rs/2GGnvaR

Additional reporting by Roslan Khasawaneh and Florence Tan in Singapore; Editing by Christian Schmollinger

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