What factors constitute the cost of coal-derived oil products? Tax impact analysis

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With the continuous development of the economy, China's demand for oil is increasing steadily. In the composition of China’s available reserves of energy and mineral resources, coal accounts for 97%, while oil and gas account for less than 3%. With the continuous adjustment of the energy consumption structure, it is expected that by 2030, the share of oil and gas in energy demand will exceed 30%, and the degree of dependence on imports will continue to rise. Supporting 30% of energy consumption through oil and gas with a 3% share of energy resources in the overall energy mix is neither safe nor sustainable. Cleaning up the use of coal and developing coal-based oil and gas alternatives are strategic choices for ensuring China’s energy supply. Coal-to-oil technology was developed in the early 20th century, and it is mainly divided into direct liquefaction and indirect liquefaction based on the methods used. Direct liquefaction can directly convert coal into refined oil or petroleum products ； Indirect liquefaction involves first gasifying coal under heat and pressure, and then producing refined oil or petroleum products after liquefaction and hydrogenation stabilization. After introducing this technology in our country, and following years of research on related technical processes, as well as the pilot operations of coal-to-oil projects carried out by companies such as Shenhua Group and Yitai Group, the coal-to-oil technology has gradually matured, and the prospects for such projects have become clearer. Since the second half of 2014 to the present, affected by falling international oil prices, the profit margins in China’s coal-to-oil industry have narrowed. Coupled with the country’s economy entering a new normal and a slowdown in energy consumption, corporate profitability and their ability to invest and raise funds have declined, putting the coal-to-oil industry in a difficult situation. The emerging industry of coal-to-oil emerged when international oil prices were high, as profit margins were substantial and the tax system had little impact; however, when international oil prices fell, this industry could no longer afford high taxes. Simply applying the tax policies of oil refining enterprises fails to exert the necessary fiscal and tax regulatory effect, which is detrimental to the healthy development of the coal-to-oil industry. Based on the enterprise data obtained through field research, this paper analyzes in detail the cost structure of coal-based oil products as well as the composition of taxes and fees, and discusses the impact of these taxes and fees on coal-based oil enterprises. 1. Overview of the current status of the coal-to-oil industry As of the end of October 2016, 9 coal-to-oil projects were in operation across the country. These included Shenhua Ordos’ 180,000-ton indirect liquefaction coal-to-oil project, Shenhua Ordos’ 1.08 million-ton direct liquefaction coal-to-oil project, Yitai’s 160,000-ton indirect liquefaction coal-to-oil project, Lu’an’s 160,000-ton indirect liquefaction coal-to-oil project, Jinneng Tianxi’s 100,000-ton synthetic oil production project, Yunnan Xianfeng’s 200,000-ton coal-based methanol to gasoline project, Yankuang Yulin’s 1.1 million-ton indirect coal-to-oil project, Yanjiang Yulin Coal Chemical’s 150,000-ton syngas-to-oil project, and Shenhua Ningmei Dong’s 4 million-ton indirect coal-to-oil project (Table 1). These 9 projects will involve a total investment of 119.42 billion yuan, with a production capacity of 7.15 million tons per year. http://img.yf116.cn/image/img/20170811/92333255380.jpg There are 6 projects under construction for coal-to-oil production, with a total capacity of 7.9 million tons (Table 2); 3 projects are planned to be built, with a capacity of 10.5 million tons. http://img.yf116.cn/image/img/20170811/93473262755.jpg The \"13th Five-Year Plan for Energy Development\" states that during this period, the coal-to-oil production capacity is expected to reach around 13 million tons. As of the end of January 2017, the total coal-to-oil production capacity in China’s areas that met the requirements for development during the 13th Five-Year Plan period – including projects that were already in operation, under construction, or had received approval for construction – reached 28.68 million tons, far exceeding the production capacity target set out in that plan. “The provisions regarding the development of coal chemical industry in the \"Plan\" can be summarized into four points: controlling production capacity, upgrading demonstration projects, advancing technologies, and identifying key areas for development – these also represent the future direction for coal-to-oil projects in our country. Judging from the current market situation of coal-to-oil enterprises, these companies do not possess the necessary financial capacity; in the author’s view, adjusting taxes and fees to promote industrial upgrading is a viable approach. 2 Analysis of the composition of the consumption tax on refined oil The consumption tax on refined oil refers to the tax paid by consumers when using seven types of refined oil, namely gasoline, diesel, naphtha, solvent oil, aviation kerosene, lubricating oil, and fuel oil. The imposition of consumption tax takes into account the rational use of resources, environmental protection, and the prevention of excessive consumption. The current consumption tax policy is formulated based on China’s resource characteristics of having limited oil reserves, and it is designed for petroleum refining enterprises, focusing primarily on crude oil. Based on fluctuations in international crude oil prices, the consumption tax on refined petroleum products will also be adjusted accordingly. During periods of high oil prices, this helps to **stabilize the prices of refined petroleum products and thus stabilize** the economy, preventing economic downturns; in such cases, the consumption tax is reduced ； During low oil prices, **to prevent excessive consumption and environmental pollution, the consumption tax is appropriately increased. The price of refined oil is linked to the price of crude oil; therefore, oil refining companies can maintain a certain profit margin under any circumstances, and adjustments in consumption tax have little impact on their profits. However, when structural changes occur in the refined oil market, the consumption tax on refined oils does not apply to other types of oil derived from sources other than crude oil. For example, the profits of coal-to-oil companies are entirely influenced by the domestic pricing mechanism for refined oils and the adjustments to the consumption tax. When international oil prices are high, these companies earn high profits while paying low consumption taxes; whereas when international oil prices are low, their profits are low and they still have to bear high consumption taxes, which makes it difficult for them to survive. **The consumption tax policy is not applicable to the normal development of the coal-to-oil industry. Since the decline in international crude oil prices in the second half of 2014, China has raised the consumption tax on refined oil products three times in a row. The unit tax rate for consumption taxes on gasoline, naphtha, solvent oil, and lubricants has been raised from 1 yuan/L to 1.52 yuan/L, an increase of 0.52 yuan/L, representing a surge of 52%. The unit tax rate for consumption taxes on diesel, aviation kerosene, and fuel oil has been raised from 0.8 yuan/L to 1.2 yuan/L, an increase of 0.4 yuan/L, representing a 50% rise. It is understandable to raise the consumption tax on refined oil products during periods of low oil prices, in order to curb excessive oil consumption and promote environmental protection, energy conservation and emission reduction, as well as energy substitution. However, as an emerging industry for the clean utilization of coal and as a model sector tasked with ensuring **energy security, it is unreasonable for coal-to-oil to be \"harmed\" by high taxes. In the past two years, international oil prices have remained below $60 per barrel, and this trend is set to continue. However, the break-even point recognized by the industry is around $60 per barrel, which makes reforms related to taxation and finance in the field of coal-to-oil production urgent. The Political Consultative Conference of the Ningxia Autonomous Region took the lead in submitting a proposal to **the relevant ministries and commissions titled \"Proposal on Introducing Tax Policies Related to Coal-based Oil Products to Promote the Clean and Efficient Utilization of Coal,\" recommending that a specific consumption tax be established for the coal-based oil products industry. The «Proposal» suggests exempting consumption tax when crude oil prices fall below a certain level; once crude oil prices rise, a tiered taxation policy could be implemented based on the overall profitability of the coal-to-oil industry, in order to enhance its market adaptability. 3. Case analysis of the costs of indirect and direct liquefaction of coal to oil. Based on the data collected through research, the author takes Company S, which uses direct liquefaction for converting coal to oil, and Company Y, which uses indirect liquefaction, as examples to analyze their costs. These two companies have been operating at full capacity for many years and are in good financial condition, making them suitable subjects for analyzing the costs associated with coal-to-oil conversion. The products of these two companies are mainly coal-derived diesel, liquefied petroleum gas, naphtha, liquid paraffin, and stabilized light hydrocarbons; the articles analyze these products by converting them all to oil equivalent tons. 3.1 Composition of the costs for coal-to-oil production The costs associated with coal-to-oil products include production costs, selling costs, administrative costs, tax and fee costs, financial costs, and others. In this text, production costs refer only to raw coal and fuel coal; water and electricity expenses as well as employee wages and depreciation are included under financial costs and others. Tax and fee costs include consumption tax. Enterprise S’s total cost for that year was 6 billion yuan, of which production costs, selling costs, administrative costs, tax and fee costs, financial expenses, and other costs accounted for 30%, 1%, 11.8%, 17.2%, and 40% respectively. Of the 2.4 billion yuan in tax and fee costs, 1.81 billion yuan is value-added tax, accounting for 30.2% of the total cost. Enterprise Y’s total cost for that year was 972 million yuan, of which production costs, selling costs, administrative costs, tax and fee costs, financial expenses, and other costs accounted for 13%, 0.04%, 16.7%, 64.8%, and 5.1% respectively. The tax and fee costs include 30 million yuan in consumption tax, accounting for 3% of the total costs. The raw materials and financial costs required for production are shown in Tables 3 and 4. It was calculated that the unit cost for Product X at Company S for that year was 5,445 yuan per ton, while at Company Y it was 5,451 yuan per ton (Table 5). http://img.yf116.cn/image/img/20170811/96423280280.jpg http://img.yf116.cn/image/img/20170811/97163283670.jpg 3.2 Operating Revenue: Enterprise S’s total revenue from product sales for that year was 5.6 billion yuan. Of this, 270,000 tons of naphtha were sold, generating sales revenue of 1.269 billion yuan ； 730,000 tons of diesel were sold, generating sales revenue of 3.72 billion yuan ； 102,000 tons of liquefied petroleum gas, with sales revenue of 385 million yuan (Table 6). http://img.yf116.cn/image/img/20170811/99233296362.jpg Yie’s total product sales revenue for that year was 1.14 billion yuan, allowing the company to remain in a profitable state. Of this, 9,787 tons of liquefied petroleum gas were sold, generating sales revenue of 46.158 million yuan ； Diesel: 7,309 tons, sales revenue: 48.13 million yuan ； 108,000 tons of liquid paraffin, with sales revenue of 747.79 million yuan ； 48,000 tons of stable light hydrocarbons were produced, with sales revenue amounting to 256.91 million yuan (Table 7). http://img.yf116.cn/image/img/20170811/910533305363.jpg The diesel oil equivalent is close to that of standard oil products. When compared with the diesel prices for that year, Company S was operating at a loss (Figure 1). The company’s main products – diesel, naphtha, and liquefied petroleum gas – are subject to high consumption taxes, which account for 30.2% of its total annual costs; among these, the consumption tax on liquefied petroleum gas constitutes as much as 56.9% of its selling price. Company Y turned a profit that year, demonstrating the flexibility of the indirect liquefaction coal-to-oil process. Its main products are liquid paraffin and stabilized light hydrocarbons, which allow it to avoid high consumption taxes on refined oil; these taxes account for only 3% of its total annual costs. 3.3 Cost Changes From the perspective of **energy security and the use of ‘coal-to-oil’ as a substitute for traditional crude oil**, this section analyzes only the cost structure of Company S after the exemption from consumption tax. After excluding consumption tax, the total annual cost for that year was 4.19 billion yuan. The cost per ton of oil products decreased by 1,643 yuan/t, resulting in a cost of only 3,802 yuan/t. At current market prices, this leaves a very large profit margin (Figure 2). http://img.yf116.cn/image/img/20170811/913233320339.jpg 3.4 Impact on the industry: Considering that the profits resulting from exemption from consumption tax might be too substantial, the author believes that as the coal-to-oil industry develops and the external environment changes, fiscal and tax policies will also be improved gradually, with corresponding adjustments being made, such as reinstating consumption tax related to coal-to-oil production or introducing additional relevant taxes. The 13th Five-Year Plan for Energy Development states that during this period, the coal-to-oil production capacity is expected to reach around 13 million tons. As of January 2017, the total coal-to-oil production capacity in China for projects that were already in operation, under construction, or had received approval for development – and located in areas meeting the requirements set out in the 13th Five-Year Plan – reached 28.68 million tons, which is more than twice the planned capacity. In the near future, coal-to-oil companies should focus on improving product quality and addressing environmental concerns, while also ensuring profitability. In fact, in recent years China’s coal-to-oil industry has achieved many advancements in terms of quality, such as vehicle fuels that meet standards exceeding National V, as well as special military fuels for aviation and naval use. There are also coal-derived diesel fuels with characteristics of ultra-low sulfur content, low aromatic compounds, and a high cetane number. These products can **reduce the emission of pollutants such as sulfur dioxide, nitrogen oxides, hydrocarbons, and particulates**, aligning with the trends of high-tech development and cleaner utilization of coal. However, insufficient funding hinders further research and development; adjusting consumption tax policies could help companies overcome this challenge. During difficult times in the coal-to-oil industry, many coal chemical enterprises reduced their investment in environmental protection facilities in order to cut costs, which had an adverse impact on the surrounding environment. As an emerging industry focused on the clean use of coal, it faced criticism. When profit margins are high, it is necessary to increase investment in environmental protection and improve management practices, so as to set a good example for the clean utilization of coal. Coal-to-oil enterprises should earnestly comply with the requirements of the 13th Five-Year Plan for Energy Development, focus on future development, and start by advancing the clean use of coal and the research and development of high-tech products in order to enhance the sustainable competitiveness of the industry. 4 Summary and Recommendations 1) China is rich in coal resources, but relatively deficient in oil and gas resources. A high dependence on foreign oil and gas is neither safe nor sustainable. Developing coal-to-oil as a supplement to conventional oil and gas is a strategic choice for ensuring China’s energy supply. On this basis, coal-to-oil enterprises possess a certain level of market competitiveness, which enables them to absorb excess coal production capacity as well as to develop clean utilization methods for coal resources, thereby promoting the transformation and upgrading of the coal industry. 2) As of the end of January 2017, the total coal-to-oil production capacity in China’s areas that met the construction requirements for the 13th Five-Year Plan – including projects that were already in operation, under construction, or had received approval for construction – reached 28.68 million tons, far exceeding the production capacity target set out in that plan. **A scientific set of entry standards should be established at this level to strictly control environmental issues, and fiscal and tax policies should be gradually improved in line with the characteristics of the industry, with corresponding dynamic adjustments made. 3) Under the current international oil prices, high consumption taxes hinder the development of coal-to-oil enterprises; if these taxes are adjusted, the industry will experience a significant turning point. Coal-to-oil enterprises should, on the basis of profitability, accelerate their transition from a focus on volume to one on higher quality products, increase investment in high-tech products and environmental protection measures, so as to better promote the healthy and stable development of this strategic emerging industry.