The Chinese economy will slow further in 2016. The correction in the real estate markets, and government pledges to curb overcapacity, will weigh on heavy industry. But consumption and services will continue to drive growth, albeit at a slower pace than in 2015. At the same time, further steps to liberalise financial markets will generate volatility in the main Chinese indices. China’s currency will also witness greater volatility in both directions. While the Chinese economy is far from a hard landing, market confidence is wavering.
Yet, the impacts of economic rebalancing on oil demand have been clear for some time: Diesel demand growth will be flat—at best, and most likely, down y/y given the sharp slowdown in heavy industries and the coal sector—while gasoline consumption will increase by 8% y/y. But even as demand growth slows gradually, crude imports will continue to surge.
This is because of rising demand for crude from China’s teapot refiners. In 2015, 11 independent ‘teapot’ refineries had been granted approval to import a total 0.98 mb/d of crude oil. In 2016, the teapots’ crude import quota volumes will be as high as 1.5-1.8 mb/d, adding 1-1.2 mb/d to China’s already hefty crude demand once adjusted for the volume of imported crude they were already receiving from state-owned traders and port constraints.
For the global crude market this will not only mean higher Chinese demand, but also a change in buying patterns, as independent refiners will opt for more diverse crude grades. Most teapots need to secure small cargos in a relatively short timeframe due to credit constraints and their limited access to port facilities (e.g. they are not connected by pipeline to the docks in Shandong that allow them to offload big vessels, implying greater reliance on pipeline crude such as ESPO). Moreover, they cannot hedge against volatility in the oil markets and will therefore opt for Russian crude grades or local Asian grades that are cheaper, faster and easier to deliver.
The independents will increase run rates—which have traditionally hovered around 30-40%—to as high as 50-60%. But state-owned refiners are unlikely to cut their throughput significantly as they will want to fend off competition from the independents and protect market share.
Higher run rates will also be supported by strong margins, at least for as long as global oil prices stay below $40 per barrel, due to changes to China’s domestic product pricing mechanism. Chinese refiners will defy economic rationale and keep importing and producing. But given weak domestic demand, the oversupply in the Chinese domestic market, especially for diesel, will lead to record high exports of products, weighing on Asian product prices. That said, the overall amount of product exports awarded to independents is unlikely to be higher than 0.15 mb/d in 2016. The key limiting factor will be the logistical capacity to export as only a few of these teapots are close to ports, limiting the number of teapots that will be eligible.
Global crude markets will also find support from the ongoing buying binge to fill up the SPR. In 2015, China likely filled nearly 140-150 mb of crude across their SPR, state-owned and private commercial storage. We expect 2016 to see a similar 150 mb build even though some slippage into 2017 is likely. And even if there are further delays to the SPR sites, there will be new private storage companies that will make tanks available to the government.