A little heralded change to China's crude import rules may have a much greater impact on Asia's fuel oil market next year further depressing margins for the residue.
Industry sources said that China National Chemical Corporation may be granted a licence to directly import crude oil. If this happens, it may help break the stranglehold on China's crude import market held by the big three of PetroChina, Sinopec and CNOOC.
ChemChina may get a quota to bring in about 10 million tonnes of crude in 2013, equivalent to about 200,000 barrels per day. This would not be enough to meet all of ChemChina's needs, given it has about 500,000 barrels per day of refining capacity but similar to most teapots, it seldom runs its units at anything near capacity because of weak margins.
The teapots suffer from having to import fuel oil to use as feedstock or buy crude from the majors at higher prices, which depresses their profits and often leaves utilization rates languishing at less than 50%.
Teapots have a total refining capacity of about 2 million barrels per day or just under one fifth of China's total, so any move that allows them to boost their operating rate is significant. On the surface, it appears possible that ChemChina could replace about 200,000 barrels per day of fuel oil imports with crude.
According to JPMorgan's commodities research team, ChemChina's three biggest refineries will process about 80,000 barrels per day of offshore crude and 60,000 barrels per day of imported fuel oil in 2012. However, ChemChina may well choose to boost its run rates if it does get access to cheaper direct crude imports, so the chances are China's imports of crude will rise and those of fuel oil will decline.
The gain in crude imports won't be enough to significantly alter the overall supply demand balance but the impact could be more pronounced in the fuel oil market, given China's current status as a major buyer.
China's net imports of fuel oil have been easing recently but were still 259,493 barrels per day in October down 10.3% on the month. The 12 month moving average stood at 258,041 barrels per day in October, accounting for the bulk of the net product imports of 341,237 barrels per day over the period.
It's probably too much to assume that fuel oil imports will drop by the full 200,000 barrels per day quota under consideration for ChemChina, but even a decline in the region of 100,000 barrels per day would be felt in Asian product markets.
Fuel oil's discount to Dubai crude has been on a declining trend since June and stood at USD 11.47 per barrel on November 23rd 2012. The discount fell as low as 57 cents in June as fuel oil demand rose for power generation during summer in the Middle East and Western sanctions against Iran cut shipments of the residue to Asia.
Slower Chinese demand for fuel oil, particularly in August, when teapot refineries were struggling to make profits, also helped widen the discount to crude.
Any erosion in Chinese demand will put further pressure on the fuel oil crack, especially at a time when demand from other sources, such as the shipping industry is muted. And fuel oil isn't the only product that may be affected if ChemChina and perhaps other teapot refiners are allowed to directly source their own crude.
It's possible that increased refinery runs in China will increase the surplus of fuels, which could put pressure on the authorities to allow more exports of refined products.