China's independent teapot refineries in eastern Shandong province have significantly expanded their capacities in the last few years ahead of an end-2013 deadline set by the government to eliminate smaller plants.
In an effort to cool overheated growth and promote efficient use of resources in the sector, Beijing had mandated the closure of small plants in the independent refining sector in the last few years.
It originally wanted teapot refineries with under 1 million mt/year (20,082 b/d) of topping capacity to shut by the end of 2011, but intensified this in March of the same year by decreeing further consolidation, mandating the closure of refineries with crude distillation capacity under 2 million mt/year by the end of 2013.
Beijing also said at the time that it would restrict building of new refineries with crude throughput of less than 10 million mt/year, catalytic crackers and hydrocrackers of under 1.5 million mt/year, reformers of less than 1 million mt/year, and steam crackers of under 800,000 mt/year capacity.
Two years later, the reality is that most of these units that were earmarked to be suspended have expanded in order to stay open.
DOUBLING OF CAPACITY
According to data from Beijing-based information provider JYD Commodities Hub, teapot refiners' crude distillation capacity in eastern Shandong province, where most of the facilities are concentrated, is currently at 112 million mt/year, double the 56 million mt/year in 2009.
The bulk of the growth came after 2010 when capacity jumped from 61.4 million mt/year to 103.5 million mt/year by the end of 2012.
Going forward, overall capacity is expected to rise to 130 million mt/year after 2014.
The teapot refineries now account for 16.2% of China's total refining capacity, up from 9.7% in 2008 and 14% in 2011, according to JYD.
As of this year, the refiners in Shandong had total catalytic cracking capacity of 43.77 million mt/year, up 57.3% from 2009, while coking plant capacity surged 84% to 39.95 million mt/year. Hydrogenation capacity more than doubled to 46.1 million mt/year over the same period while reforming capacity rose 92% to 4.8 million mt/year. SUPPORT FROM BANKS, BIG REFINERS
The refineries started expanding a few years ago, when the government's regulations were first announced. It was then much easier to procure bank loans for new investments and upgrades, some sources said. The majority of lenders are small to medium-sized domestic banks such as Pingan Bank and Minsheng Bank.
In the last few years, state-owned oil companies have also started alliances with many refiners in Shandong as a way to expand their market share and increase their overall distillation capacity in east China.
While the majority of teapot refineries have traditionally used imported fuel oil as feedstock because of limited accessibility to crude supplies, relationships with the Chinese majors has allowed them access to some crude as well as financial support.
More than half of China National Offshore Oil Corp.'s total refinery throughput comes from teapot refineries it has acquired since 2008 in Shandong and neighboring Jiangsu province.
In 2010 PetroChina took a 50% stake in Shandong Dongming Petrochemical, one of the largest teapot refiners with 12 million mt/year of capacity, including a promise to supply crude oil to it.
State-owned oil trader Sinochem also currently controls around 5 million mt/year of teapot refining capacity in Shandong, according to JYD. FINANCIAL WOES
But there are many others who struggle to come up with the capital for refinery upgrades, particularly in recent years.
"Many think of expansion but it's difficult to get loans from the banks now as China has tightened the monetary policy. Also, the refining margin is not very good this year due to higher cost of feedstock and lower prices of refined products, which has discouraged expansion," said a source at Dongying Mingyuan Petrochemical, which has a crude distillation capacity of 150,000 mt/year and operates mainly using its fluid catalytic cracker and cokers.
Even then, sources said refineries that fail to reach the required 2 million mt/year capacity target would likely still remain operational. This is because the teapot sector contributes significantly to provincial revenue and provides jobs to much of the local population and therefore gets very strong backing from the local government.
"It will be difficult to eliminate small refineries with a capacity of even 300,000 mt/year, let alone those with 1 million mt/year capacities, as they will receive strong support from the government," said a source at Tianhong Petrochemical, which has a 1.5 million mt/year CDU and is building another 3.5 million mt/year CDU, along with a 500,000 mt/year gasoline hydrotreater, both of which will come on stream by mid 2014. RUNNING LOW VERSUS SHUTTING DOWN
Teapot refiners have historically suffered from poor margins due to their relatively less sophisticated units producing lower-quality products, as well as lack of access to crude oil, forcing them to turn to more expensive imported fuel oil as feedstock. In addition, domestic oil product price controls imposed by the government routinely depress profits. Their utilization rates have therefore hovered at 35% to 40%, much lower than state-owned refiners' utilization rate of around 80%.
Many, however, still continue to operate rather than suspending operations.
"They need to continue to run in order to generate cash flow, which impacts their bank loan repayments. Even if they shut due to negative margins, the cost of restarting is also very high. So teapot refineries would rather run at low rates than totally shut down," a trader said.
In addition, the local government may sometimes offer tax breaks, which can be the deciding factor between a loss-making and profit-making facility, said a source at Shandong Changyi Petrochemical.
