Petrochemical Origin’s recommendation: A comprehensive analysis of independent refineries in Shandong!

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Independent refineries refer to those refineries that are not part of the state-owned enterprises such as CNPC, Sinopec, CNOOC, Sinochem Group, and China National Chemical Corporation. The initial capital for independent refineries comes from private or local state-owned funds, and their business model is self-production and self-sales. In February 2015, the **National Development and Reform Commission issued a notice on issues related to the management of imported crude oil**, easing regulations on crude oil resources; independent refineries were granted \"access permits\" for the first time to purchase crude oil from the market. Coupled with the loose global crude oil supply in recent years, the raw material supply issue that has plagued China’s independent refineries for decades has been largely resolved, leading to dramatic changes across the country’s entire refining industry. 1. The evolution of raw material supply for independent refineries in Shandong: As China’s economic system shifted from a planned economy to a market-oriented one, the pattern of raw material supply for independent refineries in Shandong underwent significant changes. The main raw materials used for processing went through three main stages: domestic crude oil, imported fuel oil, and imported crude oil. At present, the raw material supply for independent refineries in Shandong is based primarily on imported crude oil, with domestic crude oil playing a supplementary role. Phase 1: The 1970s–1990s, during which crude oil, as an important strategic resource, was under the control of **. At this stage, the raw materials processed by Shandong’s independent refineries mainly consisted of oil delivered to the fields, oil from scattered wells, and **the approved quota of Shengli crude oil; the quota for Shengli crude oil was less than 2 million tons. By the end of 1997, the country’s crude oil processing capacity was approximately 229 million tons per year; of this, independent refineries had a processing capacity of around 13.08 million tons per year, accounting for 5.7% of the total national crude oil processing capacity. The total amount of raw material processed each year was about 10 million tons. Phase 2: 2000–2014, using imported fuel oil as the main raw material for processing. As the refining capacity of independent refineries expands, domestically produced crude oil is no longer sufficient to meet production needs, forcing independent refineries in Shandong to seek alternative sources of raw materials. After China joined the World Trade Organization (WTO), quota management for the state-owned trade import of refined oil products (including fuel oil, gasoline, aviation kerosene, diesel, naphtha, and wax oil) was abolished in 2004, and it was replaced by a system of automatic licensing; straight-run fuel oil thus became the main raw material for independent refineries. Imported fuel oil has poor quality, with an API grade generally ranging from 10 to 20, and a high sulfur content; it is a heavy-grade feedstock that large refineries both at home and abroad \"refuse to process\". With a shortage of raw material supply, imported fuel oil has become the main raw material for independent refineries in Shandong, driving rapid expansion of the production capacity of processing units such as secondary catalysis and coking at local refineries. Phase three: After 2015, with imported crude oil as the main processing raw material. With the advancement of market-based reforms in China’s oil and gas sector, in February 2015, the **National Development and Reform Commission issued a notice regarding the management of imported crude oil**, and imported crude oil gradually became an important raw material for independent refineries. As of April 2017, there were 23 independent refineries across the country that had the right to import crude oil, with a total annual quota of 95.85 million tons. In Shandong province alone, 18 independent refineries had such rights, using a total quota of 60.85 million tons per year. Furthermore, central state-owned enterprises’ control or shareholding in independent refineries in Shandong has also provided these refineries with some crude oil resources. Currently, China National Chemical Group supplies 10 million tons of crude oil annually to its refineries, including Zhenhe, Changyi, and Huaxing ； Since 2005, CNPC has been working in partnership with independent refineries in Shandong. By 2016, the volume of crude oil supply contracts signed by CNPC with these independent refineries for Maré crude oil (i.e., Venezuelan crude oil) was nearly 10 million tons per year ； In addition to supplying its own refineries, CNOOC’s crude oil production also supplies over 10 million tons per year to independent refineries in Shandong. With the increase in the supply of imported crude oil as well as domestic crude oil, crude oil accounted for over 97% of the feedstock used by independent refineries in Shandong in 2016. The processing volume of straight-run fuel oil continued to decline due to high consumption taxes and low economic viability in its processing (see Figure 1). 2. Current status of raw material supply for independent refineries in Shandong In 2016, following the liberalization of access to imported crude oil, the total processing volume of independent refineries in Shandong increased. The sources of raw material supply became more diverse, thereby fully meeting the refineries’ requirements regarding both the quantity and quality of raw materials. Meanwhile, changes in the raw material supply landscape have led to significant changes in both the purchasing methods and transportation methods used by refineries. 2.1 The demand for raw materials has been largely met; the variety of processed products has increased, and their quality continues to improve. In 2016, independent refineries in Shandong processed a total of 73.829 million tons of raw materials. Of this amount, 40.767 million tons consisted of newly imported crude oil. The API gravity of the processed fuel oil was approximately 18, while its sulfur content was around 3%. As 59% of the total amount of imported crude oil (see Figure 2). It is worth noting that before the relaxation of restrictions on the import of crude oil, the Maré crude oil from Venezuela had always served as one of the raw materials used by independent refineries in Shandong, with China United Petroleum Co., Ltd., a subsidiary of PetroChina, being responsible for its import. At present, independent refineries in Shandong process more than 30 varieties of imported crude oil, which mainly come from the Middle East, Russia, Brazil, Venezuela, Southeast Asia and other regions (see Table 1). The demand for imported crude oil at independent refineries in Shandong shows clear diversity. As these refineries tried to use crude oil of different qualities for processing, and after repeated attempts to identify suitable types of crude oil, the advantages of crude oils such as ESPO crude, Oman crude, Cabinda crude, and Sadoun crude gradually became apparent. It is understood that in 2017, independent refineries in Shandong strengthened their cooperation with other oil-producing countries, including those in Europe and North America. In the future, there is a trend toward further diversification of the sources from which Shandong’s independent refineries import crude oil. The relaxation of restrictions on crude oil imports has led to a significant increase in the supply of raw materials for independent refineries in Shandong, resolving the raw material bottleneck that has plagued these refineries for years; as a result, their capacity utilization rates will also increase substantially. According to the latest statistics from Zhuochuang Information, after phasing out outdated production capacity, Shandong’s independent refineries that have been granted quotas for imported crude oil have retained a total refining capacity of 70.4 million tons per year. The total amount of crude oil they are allowed to use amounts to 60.85 million tons per year, which can meet 86.43% of their raw material needs (see Table 2). In addition to a significant increase in the supply volume of raw materials, their quality has also seen a notable improvement. Fuel oil is a heavy, high-sulfur, low-quality raw material; previously, the API grade of the fuel oil processed by independent refineries in Shandong was around 18, with a sulfur content of about 3%. With the gradual liberalization of imported crude oil, the trend toward lighter feedstocks for independent refineries in Shandong has become increasingly evident. At present, the API grade of imported crude oil processed by independent refineries in Shandong has risen to 30, while the sulfur content has dropped sharply to 0.5%. The trend toward lighter raw materials, coupled with the expansion of the industrial chains of independent refineries in Shandong, will further increase the demand for lightweight raw materials by these refineries in the future. Meanwhile, the evolution of the trade patterns in the global crude oil market has created favorable conditions for independent refineries in Shandong, as well as for the entire oil refining industry in China. The right to set prices has always been a problem affecting China’s crude oil procurement, and the country has also suffered huge economic losses as a result. China still does not have good control over crude oil pricing. The evolution of the crude oil market landscape for independent refiners has, at another level, increased the influence of Chinese independent refiners and even China itself over crude oil pricing. As is well known, the crude oil market was characterized by consistently high prices from 2011 to 2014; the development of unconventional oil and gas resources, including shale oil and gas in the United States, advanced significantly, with U.S. shale oil production rising at a rapid pace. The slowdown in global economic growth and the reduced growth in oil consumption have led to a severe imbalance in the global oil supply and demand balance. This surplus supply is not a short-term phenomenon; the growth rate of oil consumption cannot be significantly improved in the short term. Coupled with the gradual adoption of clean energy and the expansion of electric vehicles, the oil market will remain in a state of surplus supply for a long time. Furthermore, the large-scale increase in U.S. shale oil production has led to a continuous decline in the U.S. country’s dependence on imported crude oil, resulting in even a surplus supply of light crude oil. With the lifting of the U.S. ban on crude oil exports, the global oil supply and demand pattern will trend toward “multipolar supply and centralized demand”. The global oil market is accelerating its transition from a seller’s market to a buyer’s market. The Asia-Pacific region, particularly China, as a major driver of global oil demand, will gain greater bargaining power as a result, which will create a favorable external environment for the future development of independent refineries in Shandong. 2.2 Significant changes in the pricing method and procurement approach for raw materials: At independent refineries in Shandong, the raw materials have shifted from fuel oil to crude oil, which has led to significant changes in the methods used for pricing and purchasing these raw materials. Fuel oil is priced based on the Platts MOPS price; at the stage of importing fuel oil by independent refiners, they mainly purchase spot fuel oil from traders. The pricing formula for imported straight-run fuel oil is: ×1.17 + other charges (currently, the consumption tax on fuel oil is 1,218 yuan per ton). Independent refineries mostly purchase crude oil futures, and the price of imported crude oil is based on the Brent crude price, with adjustments made according to the quality of the oil. The formula for calculating the price of imported crude oil is: (Base price + Discount) × Exchange rate × 1.17 + Other factors. Currently, the methods for crude oil imports by independent refineries in Shandong include agency import and direct import. Before the policy changes, independent refineries in Shandong had little contact with international oil companies, resulting in a weak foundation for cooperation between the two sides. Currently, only a few refineries such as Dongming Petrochemical and Jingbo Petrochemical carry out independent procurement of raw materials; other refineries* are accustomed to importing crude oil through agent companies. It is understood that among the 18 independent refineries in Shandong that have been granted the right to import crude oil, 12 have signed agreements with CNPC for the agency import of crude oil. Some other independent refineries cooperate with large international oil companies such as Total, Mokoré, and Vidro to purchase crude oil. Independent refineries in Shandong import crude oil through agents, and depending on the crude oil discount, they have to pay an agency fee of 50–100 yuan per ton to the agent. In 2016, independent refineries in Shandong spent nearly 3 billion yuan on agency fees alone. To reduce raw material procurement costs, independent refineries in Shandong will be more inclined to import crude oil on their own in the future. 2.3 Changes in the methods of raw material transportation In 2016, independent refineries in Shandong saw a significant increase in their crude oil imports, with a large number of oil tankers arriving at the ports. Due to the limited capacity of the port facilities, including storage and pipeline systems, these tankers were sometimes forced to stay at sea for extended periods, resulting in substantial economic losses for the independent refineries. Currently, the raw material transportation for independent refineries in Shandong mainly relies on three methods: road transport, rail transport, and pipeline transport. Among them, road transport accounts for 60%, making it the most widely used mode of transportation ； Rail transport accounts for about 12%; it has significant advantages in terms of transportation costs and safety, but its efficiency is low and its utilization rate improves slowly ； Pipeline transportation accounts for 28%. The construction cost of pipelines is relatively high, and the approval process is rather complicated; it was not until 2010 that some of the larger independent refineries in Shandong began to work on building such pipelines. Currently, there are four long-distance pipelines in Shandong Province that serve independent refineries, namely the Ridong Pipeline, Huangwei Pipeline, Laichang Pipeline, and Yanzi Pipeline (see Table 3). Compared to other modes of transportation, pipeline transport results in lower losses and higher efficiency; over the same distance, its transportation cost is about 1/3 of that of road transport, making it the best option for reducing transportation costs. In the future, the focus for independent refineries in Shandong regarding raw material transportation will be to accelerate pipeline construction (see Table 4). On October 24, 2016, the Shandong Provincial Development and Reform Commission, the Economic and Information Technology Commission, and the Department of Transportation jointly issued the \"Provincial Plan for the Construction of Oil and Gas Transmission Facilities (2016–2020)\"), aiming to accelerate the development of oil and gas pipelines in Shandong Province. It is estimated that once all the planned oil pipelines are completed and put into use, they will solve the issue of transporting 60 million tons of crude oil per year for the independent refineries in Shandong, with annual transportation costs expected to be saved by around 5 billion yuan. 3. New changes in the production and operation of independent refineries in Shandong: The crude oil supply to these independent refineries has shifted from heavy fuel oil to high-quality crude oil, resulting in significant changes in their production and operation patterns as well as in their industrial structure. Refining capacity continues to grow, with the average operating load of the plants rising from 40% to around 60%; production and yields of refined oil and naphtha products have increased significantly. Additionally, the strategic focus of independent refineries is gradually shifting toward the chemical industry; chemical projects such as ethylene and PX (para-xylene) have been successively launched. 3.1 Production 3.1.1 Continuous expansion of refining capacity: Following the relaxation of restrictions on the use of imported crude oil, independent refineries need to replace their quotas for using crude oil by phasing out outdated production capacities. According to Zhuochuang’s statistics, since 2015, a total of 61.1 million tons per year of outdated production capacity has been phased out across the country (see Figure 3), accounting for approximately 8.2% of China’s primary processing capacity. Of this amount, Shandong Province eliminated 32.37 million tons per year, while other provinces and regions eliminated 28.73 million tons per year. One of the prerequisites for applying for the right to import crude oil is that the production capacity of a single atmospheric and vacuum distillation unit must be at least 2 million tons per year. To meet the application requirements, some refineries with relatively limited production capacity carried out renovations and expansions on their existing facilities, resulting in a situation in Shandong where independent refineries were expanding their capacity while simultaneously phasing out older facilities. By the end of 2016, the capacity of primary distillation and vacuum distillation units at independent refineries in Shandong was 163.05 million tons per year, an increase of 9.1% compared to the previous year; this capacity accounted for 20.86% of the total national capacity. However, there was little change in the capacity of secondary processing units such as catalytic cracking and delayed coking at these independent refineries (see Figure 4). At present, independent refineries in Shandong are no longer investing much capital and effort in the construction of atmospheric and vacuum distillation units; instead, their focus has shifted to units such as hydrogenation and reforming that help improve product quality. In the future, with the planning and construction of China’s seven major petrochemical industrial bases, as well as the gradual establishment of numerous large-scale private-sector refining projects in Zhoushan, Caofeidian, Lianyungang and other areas, the share of Shandong’s independent refineries in the country’s total refining capacity is likely to decline. It is estimated that by 2020, the capacity share of Shandong’s independent refineries could drop to around 18%. 3.1.2 Significant increase in unit startup load and product output Before 2015, due to insufficient raw material supply, the capacity utilization rate of atmospheric and vacuum distillation units at independent refineries in Shandong remained low for a long time. From 2011 to 2014, the capacity utilization rate of the atmospheric and vacuum distillation units at independent refineries in Shandong remained below 40%. During 2015–2016, after obtaining the right to import crude oil one after another, and thanks to an ample supply of raw materials, the capacity utilization rate of the atmospheric and vacuum distillation units at independent refineries in Shandong increased significantly (see Figure 5). Statistics show that at some refineries, the operating rate has exceeded 80%, with the average operating rate rising to over 60%. However, this remains below the average of 77% recorded by the three major state-owned oil companies. In the future, as raw material supply increases and outdated production capacity is phased out, independent refineries are expected to further raise their plant operating rates. The operating capacity of independent refineries in Shandong has increased significantly, leading to a sharp rise in the production of refined oil, naphtha, and other products. From 2012 to 2015, the average annual compound growth rate of gasoline production at independent refineries in Shandong was 20.93%, while the average annual compound growth rate for diesel production was 10.44%. After the relaxation of restrictions on the use of imported crude oil in 2016, the gasoline production of independent refineries in Shandong reached 23.208 million tons, an increase of 5.8704 million tons compared to the previous year, representing a growth rate of 33.86% ； Diesel production reached 39.59 million tons, an increase of 10.6864 million tons compared to the previous year, representing a growth rate of 36.97% (see Figure 6). In 2016, China’s apparent consumption of gasoline and diesel decreased by 4.1311 million tons compared to the previous year; the growth rate of gasoline consumption fell to 3.9%, a decrease of 6.9 percentage points from the previous year ； The growth rate of apparent diesel consumption declined to -4.99%. Meanwhile, the combined output of gasoline and diesel by independent refineries in Shandong surged by 16.5568 million tons year-on-year. The massive influx of refined oil products into the domestic market has had a significant impact on the traditional markets of the three major state-owned oil companies. 3.1.3 The structure of refined products and the quality of finished oils have been improved. After independent refineries in Shandong shifted from processing fuel oil to crude oil, the average API gravity of the feedstock rose to around 31, resulting in a significant increase in the yield of light oils among the refined products. The yield of refined products with high added value is close to 80%, which is much higher than the yield of fuel oil produced through processing ； Meanwhile, the yield of low-value-added products such as petroleum coke decreased significantly (see Table 5). Overall, the increased yield of light oils from the processing of crude oil by independent refineries directly boosts the total revenue from refinery products. Additionally, the sulfur content in the raw materials has decreased from 3% to around 0.5%. Combined with refineries’ refining and purification facilities, independent refineries can more easily control the sulfur content in refined oil during the processing stage. This has played a significant role in improving the quality of refined oil in China, and is in line with relevant environmental protection policies. At present, the gasoline products produced by independent refineries in Shandong have been upgraded to National V standards, while diesel is divided into regular National III diesel and National V diesel for use in vehicles. Some refineries began producing gasoline and diesel meeting the Beijing VI standards at the beginning of 2017, primarily for supply to the Beijing area. This shows that independent refineries are now comparable to the three major state-owned oil companies in terms of product quality and control of specifications. 3.2 In terms of operations, during periods of low oil prices, the overall refining profits of Chinese refineries processing imported crude oil remained favorable. During 2015–2016, the comprehensive refining profits of independent refineries in Shandong reached their highest level in nearly five years (see Figure 7). Dongying Yihua Yi achieved a monthly net profit of 300 million yuan in March 2016, marking a golden period for the development of independent refineries. Shandong’s independent refineries take advantage of the opportunities brought about by changes in raw materials by pursuing a diversified development strategy. Building on their existing refining operations, they expand their warehousing and logistics services, while accelerating the extension of their vertical industrial chains and the development of their horizontal distribution networks. 3.2.1 Acceleration of the integration of refining and chemical production: With the relaxation of restrictions on the use of imported crude oil, the raw material issues faced by independent refineries in Shandong have been significantly improved. To cope with changes in tax policies and to enhance their own industrial chains, these refineries have shifted from traditional oil refining operations to an integrated model that combines refining and chemical production. Firstly, when independent refineries use fuel oil as raw material, since both fuel oil and refined products are subject to consumption tax, in order to avoid double taxation on consumption tax, the consumption tax on refined products can be offset against the input fuel oil. Since no consumption tax is required for the production of chemical products, it is not possible to use such tax credits against those applied to fuel oil, which invisibly increases the cost of raw materials. As a result, independent refineries are at a disadvantage in competition with the three major state-owned oil companies in the chemical industry, which in turn reduces their enthusiasm to expand into this sector of the industrial chain. At present, independent refineries in Shandong mainly use crude oil as their raw material, and there is no issue related to tax deductions on raw materials. As a result, they are on the same starting level as the three major state-owned oil companies in terms of the production costs of chemical products, which provides a prerequisite for independent refineries to expand into the chemical industry. Secondly, the profitability of independent refineries in Shandong relies to a large extent on flexible tax deductions. To regulate the development of the refining industry, China’s **relevant authorities will surely step up tax oversight in the future, which will have a significant impact on the survival and development of independent refineries. It is reported that in 2016, the **tax authorities conducted surprise inspections of some independent refineries and collected substantial amounts of taxes and fees. Independent refineries are actively expanding their chemical industry operations on top of their refining activities, by investing in projects such as those related to ethylene and PX. This not only helps to reduce the operational risks associated with policy changes but also enhances the overall profitability of these enterprises, ensuring their stable and sustainable development. By 2020, the total production capacity of ethylene projects planned to be launched by independent refineries in Shandong (including those that produce ethylene through light hydrocarbon cracking and naphtha steam cracking) is set to exceed 5 million tons per year. These projects will be located in cities such as Heze, Zibo, Binzhou, Weifang, and Yantai, with the total investment in these projects potentially reaching over 60 billion yuan. Independent refineries have already begun formulating plans for the PX industry following naphtha reforming and extraction. Nearly 11 PX projects in cities such as Dongying, Weifang, Binzhou, Heze, and Rizhao in Shandong have applied to be included in the **plans, with a total production capacity of over 10 million tons per year; by then, the PX industry will become an important part of Shandong’s independent refinery industry chain. 3.2.2 The layout of the retail network at the point of sale has accelerated in the past two years; compared to the profits from oil refining, the retail profits from gas stations at the point of sale are quite substantial. In 2016, the average wholesale-retail price gap for gasoline at independent refineries in Shandong was 2,666 yuan per ton, with a maximum of 3,201 yuan per ton ； The average wholesale-retail price gap for diesel was 1,409 yuan per ton, with a maximum of 2,184 yuan per ton (see Figure 8). Even after deducting transportation costs, operating expenses, and discounts, the retail profit at retail gas stations remains quite substantial. While extending their industrial chains vertically, independent refineries in Shandong are also accelerating the development of their retail networks horizontally. By the end of 2016, there were approximately 97,100 gas stations across the country, of which 20,700 belonged to PetroChina, accounting for 21% of them ； Sinopec has 30,721 stations, accounting for 32% ； There are 45,679 other social gas stations, accounting for 47%. The number of gas stations owned by Shandong’s independent refineries is just over 500, accounting for 0.5% of the total in the country (see Table 6). According to statistics, the refined oil sold through gas stations by Sinopec accounts for nearly 70% of its total refined oil sales, whereas the amount of refined oil produced by independent refineries in Shandong and sold through their own gas stations represents only 1.45% of their total refined oil production. Currently, gas stations at refineries such as Jingbo Petrochemical, Wantong Petrochemical, and Dongming Petrochemical are developing rapidly, with other refineries also actively expanding their operations. Among them, Fuhai Group plans to develop 100 gas stations, while Alliance Petrochemical is also expanding the retail outlets for refinery products by partnering with private gas stations. In recent years, road planning in Shandong Province has become more sophisticated; the approval process for building new gas stations is strict, and the costs associated with acquiring or leasing gas stations are very high. The cost of acquiring gas stations in urban areas can run into tens of millions of yuan. Independent refineries in Shandong have thus missed the optimal period to establish a presence in the retail market. Against this backdrop, Zhongan Petroleum Company, controlled by Jingbo Petrochemical, was established. Its shareholders include the Shandong Oil Refining and Chemical Industry Association, as well as 22 independent refineries such as Hualian Petrochemical, Haike Chemical, Hengyuan Petrochemical, and Dongming Petrochemical. The plan is to integrate more than 6,000 private gas stations in Shandong to turn this brand into a platform for a \"local refined oil sales network,\" thereby addressing to some extent the issue of low market share held by these independent refineries in the retail sector. 4. Conclusion: After the liberalization of the rights to import crude oil, independent refineries in Shandong have achieved remarkable results in terms of production and operations. **The shift in policy toward independent refineries, along with the improvement in the raw material supply environment for refineries, has greatly boosted the production enthusiasm of independent refineries in Shandong. Currently, the demand from domestic downstream markets is growing at a limited pace. The increase in the market share of independent refineries in Shandong has severely impacted the traditional market shares of state-owned enterprises such as China National Petroleum Corporation and Sinopec. Looking at the development trends of China’s petrochemical industry, the competitiveness of private oil companies is continuously increasing. As the reforms in China’s oil and gas industry progress further, the degree of marketization in China’s petroleum sector will increase ainda more. Meanwhile, given the overall surplus in China’s refining capacity, the significant increase in the production of refined oil by independent refineries in Shandong will exacerbate the imbalance between supply and demand in the domestic gasoline and diesel markets. As a result, China’s exports of refined oil are likely to increase further in the future. In 2016, the production of gasoline and diesel by independent refineries in Shandong increased by 16.56 million tons compared to the previous year, while China’s net exports of gasoline and diesel rose by 11.513 million tons. The significant increase in China’s exports of refined oil products will have a profound impact on the supply and demand dynamics of refined oil products across Southeast Asia and the world as a whole. A representative from a South Korean oil company said that due to an increase in China’s exports of refined oil products, the price differential for oil cracking dropped by 50% at one point. Furthermore, as a major global commodity futures product, the relaxation of restrictions on the use of imported crude oil will enable independent refineries in Shandong to become more deeply involved in the global crude oil market. Previously, the refining profits of independent refineries in Shandong were largely determined by the market. Now, some of these refineries have begun to use financial instruments, such as futures contracts, for hedging purposes and even to lock in their refining profits, in order to avoid the risks associated with sharp fluctuations in market conditions. Independent refineries in Shandong are actively involved in crude oil futures trading, which will also create better internal conditions for the crude oil futures to be launched in China.