INSIGHT: China base oils exports unlikely to gain traction on recovering regional supply

SINGAPORE (ICIS)–China base oils refineries were mostly running at high rates of 90% of capacity or more in the first half of 2021 as demand recovered.

China’s relative success in keeping COVID-19 infections under control had prompted refiners to resume normal production after operating rates at most Group I, II and III units were either shutdown or were cut to 20-30% of capacity from February to March last year amid strict lockdown restrictions.

Tight supply and firmer prices of Group I and Group II import cargoes from other Asian regions resulted in lesser monthly import volumes in the first half of 2021 compared to pre-pandemic levels in the first half of 2019, according to China import statistics.

If we were to compare imports in H1 2021 with that in H1 2020, March and April 2021 volumes were much higher than that in the same period in the prior year, but the opposite was true in the subsequent months of May and June when base oils prices hit multi-year highs, at a time when China domestic supply for some base oils grades was in surplus.

China base oils imports from July to September 2020 were significantly higher than the same period in 2019 because of competitively priced regional cargoes. Other northeast Asia and southeast Asian countries were under varying degrees of lockdowns when the COVID-19 situation outside China worsened.

China has always been a huge net importer of base oils, and exports very limited quantities despite its massive production capacity, which is largely due to unfavourable tax regimes for exporters.

China’s base oils exports prior to 2021, which are mainly Group I and II cargoes exported by state-owned refiner Sinopec to Singapore for its own downstream captive use, constitutes only a minute fraction of the country’s combined Group I and II nameplate capacity of 9m tonnes/year, according to the ICIS Supply and Demand Database.

Interestingly, base oils export volumes from China increased significantly from May to July this year as compared to the same period in previous years, albeit August export volumes dropped by more than half from July, based on China export statistics, which were not unexpected following the retreat in Asian Group I and II prices since August.

The surge in export volumes could be attributed to a separate state-owned refiner’s exports of Group I SN150 and SN400 cargoes to southeast Asia as the refiner took advantage of higher international prices, especially for SN500 (similar to SN400) grade, over domestic prices, and also to clear stock due to a build-up in inventory.

At least one other Chinese independent refiner has also started exporting Group II 150N cargoes to southeast Asia, India and the Middle East in recent months, whereby exports to the Middle East from China were virtually non-existent until 2021.

However, with overall import prices of both Group I and II having declined rapidly since August, it is unlikely that China will continue to export as much cargoes as they did from May to July.

China base oils refineries were mostly running normally at close to full capacity in the first half of 2021, which coincided with production cuts and facility shutdowns in Japan, South Korea and southeast Asia.

When regional production gradually recovered from around mid-2021 onwards, the additional supply was partially offset by some Chinese refineries scheduled turnarounds in the second half of 2021.

Mainland China base oils refinery shutdowns, 2021

WILL CHINA START TO EXTPORT IN A BIG WAY?
The proliferation of Group II and III start-ups and expansions in China in 2019 has caused worsening overcapacity with combined nameplate capacity for the two grades having increased by a 68% to around 7.5m tonnes/year in just 2019 alone, according to the ICIS Supply and Demand Database.

Unless the Chinese authorities do something to facilitate exports, local base oils production levels will come under threat if prices were to fall to a level whereby it makes more economic sense to produce more gasoil rather than base oils, just like what we had witnessed during pre-pandemic times in 2019. Refineries are able to easily switch between producing either more base oils or gasoil.

The following chart shows the spread between gasoil FOB Singapore prices and Group II 150N free on board (FOB) NE Asia spot prices. While base oils margins have remained healthy throughout the year, refiners’ incentive to produce base oils rather than gasoil has subsided due to strengthening crude and gasoil prices.

Chinese refiner Hainan Handi’s new 400,000 tonne/year Group II+ unit is slated to come on-stream in Q4 2021 but cargoes produced here are unlikely to find their way out of the country

The refiner was supposed to start-up another 600,000 tonne/year Group III unit at the site but it is unclear when exactly or whether the unit will ever start-up because of financial constraints, a company source said.

This is despite that the local raw material used in the production of Group III material exported from the site will not be subjected to tax as it is situated in a special economic zone, the source said, but did not clarify why its Group II+ cargoes will not get the same treatment.

In other words, Group III exports from the new unit will be treated as if they are produced using imported raw material whereby tax rebates will be given when downstream products made from the raw material are exported. This is known as re-processing trade in China and it applies to most petrochemical products, with only the amount of tax rebate being different.

Based in China’s southernmost province of Hainan Island, the refiner has an existing 300,000 tonne/year Group II unit located in another part of the island which is not within the special economic zone.

Additional contribution from Whitney Shi

Insight by Matthew Chong