There is a widespread concern in the world regarding China’s decelerating economic growth. The slowdown, if it continues, threatens economic activity almost everywhere. Growth in Germany, for example, has already cooled due to its exports of high-quality machinery to China dropping precipitously.
Those in the oil market also worry about China. The country’s economic growth has been a key driver of global crude oil consumption. Indeed, China accounts for one-third of the International Energy Agency’s projected 2019 increase in world oil use.
Weak Chinese economic growth is not the end of the oil market’s prospective ills, however. Few recognize the additional trouble on tap from the Chinese independent refiners affectionately known as “teapots.” The danger occurs because lower oil demand growth in China comes just when independent refining capacity there is rising. The capacity growth has been financed primarily by debt, most likely supplied by China’s alternative lenders. As demand slows, these refiners will turn to international markets, dumping products in Singapore, the Americas, or Europe to earn hard cash. In doing so, they could plunge the global refining industry into a serious recession and drive crude prices down sharply.
This will not be the first time that refineries in Asia caused a crisis in the oil sector. In 1997, Korean refiners did the same during the Asian financial collapse. That incident is described in the December 1997 Oil Market Intelligence (OMI). The report begins by noting that Korean refiners had begun to seek exports markets before the crisis hit “mostly to employ 620,000 b/d of new refining capacity that came on stream since late 1966.” The effort intensified as domestic consumption collapsed:
But once the won started its second descent in two years—it dropped over 94% against the dollar between July 1 and December 10 , much of it in early December—the push to export became more desperate because the five big refiners could not recoup in domestic product prices the staggering dollar price of crude oil feedstock. (“Economic Crisis Spills Over onto Oil Markets,” Oil Market Intelligence, December 1997, p. 11.)
The article noted that Korean refiners were trying to sell products to China, Taiwan, and Japan. It added that Korea’s exports to China rose fourfold between January and October, while its share of the Chinese gasoil import market went from seven to twenty-six percent. The Asian refining center in Singapore lost market share, falling from seventy-five to twenty-six percent.
The OMI report also observed ominously that “shippers and traders report that Korean refiners are lowering prices to meet their need to expand that share.”
The gasoil market suffered significantly. The OMI editors explained that Korea’s use was declining (consumption dropped one hundred fifty thousand barrels per day, or thirty-three percent, in December 1997 from December 1996), causing refiners to push gasoil to China. Those sales pressured margins at refineries in Singapore. The editors added, “If its [Korea’s] five refiners can keep importing crude oil—and the government is now talking of using foreign exchange reserves to finance crude purchases and overcome private credit squeezes—it is likely to keep pumping out the product to its neighbors.”
Looking back twenty years, one sees this is what happened. Figure 1 traces the price of gasoil and premium gasoline in Singapore by month from January 1997 to December 1999. Spot gasoil prices plunged from a peak of $32.50 per barrel in December 1996 to a low of $13.80 in October 1998. Distillate cracks measured against spot Dubai crude dropped from $9 per barrel in December 1996 to zero in 1999.
Arbitrage carried the impact of the Korean fire sale across the globe. Gasoil prices fell fifty-eight percent in Singapore from December 1996 to October 1998. In the US Gulf Coast market, they declined fifty-eight percent from December 1996 to February 1999. In Europe, the decline was fifty-one percent.
Korea’s fire sale of products precipitated a crude price decrease. As I have written often, product prices often lead crude prices. This was the case in the Asian crisis. Energy Intelligence Group data show that the netback on Dubai crude at Singapore declined from $23 per barrel in December 1996 to $9 in February 1999. Spot crude prices followed, as did prices for export contracts linked to spot crude prices.
Chinese independent refiners may be emulating the action of Korean refiners in 1997 and 1998. The Wall Street Journal warned on January 23 that the economic slowdown in China could curb Chinese gasoline consumption, which would “mean a flood of exports to the rest of Asia.” The WSJ author, Kevin Kingsbury, added that regional refining margins could be pressured.
Kingsbury explained that the economic slowdown would reduce growth in China’s oil consumption as refining capacity there increased:
Nomura forecasts demand growth of 0.5% this year, slowing from an estimated 4% last year. At the same time, Chinese refineries will increase production capacity by some 6%, according to Fitch Solutions.
He also noted that export quotas for gasoline, jet fuel, and fuel oil rose thirty-five percent last year. Further increases are expected for 2019 “so Chinese refiners can maintain production.”
In this regard, a January 24 report from Bloomberg is concerning. In it, Jack Wittels wrote that “a fleet of giant newly built oil tankers is gearing up to ship diesel out of East Asia.” Five new tankers are positioned off China’s coast, each with a capacity of two million barrels. Two additional tankers will shortly join the “armada.” Four of the parked vessels are already loaded or loading. The products will likely move to Europe, where margins are high.
These will not be the last shipments from China. In past economic downturns, the decrease in petroleum product consumption has lagged the falloff in economic activity. For example, the December 1997 OMI began its discussion of problems in Asia with this observation: “a few short months ago it seemed that Asia’s economic woes were unlikely to affect oil demand in a major way, and that the financial crisis could be contained in Thailand, Malaysia, Indonesia and the Philippines.” The article then continued ruefully, “Neither proposition looks valid anymore.”
The increased exports from China will reduce refining margins across the globe just as margins are being squeezed by a gasoline surplus and as refiners get ready to meet the IMO 2020 standard. This situation could have serious impacts on US and European refiners. Profits could come under intense pressure, particularly at firms that have been boosting product exports from the United States to Europe and the Americas.
Attention must stay riveted on China for the rest of 2019. The volume of product exports from its refineries will keep rising if its economy continues to falter, as many believe it will. The country’s problems, and problems for the world refining industry, will be compounded if the United States and China cannot resolve their trade war.
In this regard, further news on Wednesday, January 29, was ominous. Platts reported that China’s refiners are looking beyond Asia to boost exports. In 2018, Chinese gasoline exports rose twelve percent from 2017 and gasoil exports seven percent. There could be much larger increases in 2019 as more refining capacity comes on stream, especially if China’s domestic consumption stays the same or decreases.