The amount of crude oil China holds in storage became a pertinent question this month when freight rates to Asia
reached record highs, discouraging flows on key supply routes from the Middle East and the United States.
Were China’s inventories sufficient to withstand declines in imports? Would refineries have to slow down?
The timing was tough. Storage tanks were already draining before the spike in freight rates.
China’s crude inventories fell by 7.4% between the end of August and early October, sinking to the lowest level so far in 2019, according to Ursa measurements.
Ursa measures global crude inventories using imagery from satellite radar.
Strong refinery demand has exerted downward pressure on stocks for months after the start-up of two mega-refineries and diminished supply from Saudi Arabia after the September-14 attacks.
We highlighted the impact these new facilities are having on Chinese crude demand in an earlier blog.
Crude imports have increased, but couldn’t keep pace, resulting in lower stocks even before freight rates exploded.
The culprit? US sanctions on Iran and Venezuela removed some 300 oil tankers (3% of global fleet) from the market.
The nail-in-the-coffin came September 25 when the US Department of Treasury imposed Iran-related sanctions on subsidiaries of COSCO, the Chinese shipping behemoth.
This month saw freight rates to Asia hit all-time highs. The Arab Gulf-Far East VLCC rate was assessed at a record $65.53/mt October 14, while the WAF- Far East Suezmax rate was assessed at a record $88.8/mt.
And even though rates have eased, relatively high transportation costs remain in place at a time when China badly needs more oil.
In May, Hengli Petrochemical launched its 400,000 barrel a day refinery in the port city of Dalian, followed by the Rongsheng refinery in Zhoushan, which is still ramping up.
At an Argus-hosted conference in Geneva last week, a speaker estimated that 2019 Chinese refinery runs will average 600,000 bpd more than a year ago.
And more planned refineries are expected to come online over the next few years.
The good news is that, despite the large draws recently, China’s inventories remain solid as a percentage of capacity.
For the week ending October 17, for example, we measured China’s inventories at 61% of capacity. That’s almost equal to the average level -- 62% -- from January 2018 to present.
Commercial stocks at three major storage sites (Zhoushan, Dalian & Ningbo) were above 50% of capacity.
While more refineries means more crude demand, another factor is margins which determine how hard facilities run.
This gets back to the issue of high shipping costs hurting margins, particularly for a refiner like Sinopec (Asia’s largest), which mostly transacts in the spot freight market.
The outlook for Asian refining margins has soured as a result of higher freight rates.
And in the background, there are questions about the strength of the Chinese economy and how structural shifts are impacting oil demand.
China’s automobile sales have fallen, keeping a lid on gasoline demand, though government-fueled infrastructure spending has helped on the diesel side.
For privately-owned refineries, a longstanding wish has been the ability to tap markets outside China. So far, only state-owned refineries can export fuel under a quota system.
Hengli Petrochemical already submitted a fuel export application with the government.
This week saw a possible first step towards winning approval when China’s civil aviation authority reportedly told Hengli it could supply jet fuel for commercial use.
Selling overseas would create a new outlet helping absorb the growing supply of refined products from China.
Going back to the original point, the operations of Chinese refineries will depend on crude imports and the size of a buffer (i.e. inventories) capable of withstanding any supply hiccups.
That’s not some hypothetical scenario either.
Consider the events over the last six weeks that rocked the oil market.
First, a major attack on Saudi Arabia’s oil infrastructure and then an unprecedented jump in freight rates to Asia.
We’ll keep an eye on China’s crude inventories and keep you updated here. Keep reading!