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Aug 19, 2013 | 10:16 GMT

China's Plans for Oil Reform

(STR/AFP/Getty Images)

China is reportedly considering expanding access to crude oil imports in 2014, a move that would be key to its ability to implement broader reforms in the country's oil industry. Historically, the government had provided quotas of imported crude to China's three state-owned oil giants. But this trend began to shift in late 2012, when state-owned chemical company ChemChina was granted an annual quota of 10 million tons of crude, or roughly 200,000 barrels per day. According to a government document leaked recently to Reuters, several private refineries may soon receive quotas of a similar size.

This shift in policy would serve two primary purposes: First, China is attempting to shutter many of the country's small private refineries while boosting production at larger independent facilities. Beijing has struggled in its pursuit of such goals in the past, but giving the larger refineries access to imported crude would make it increasingly difficult for the smaller ones to survive. Second, the government hopes that supporting the large private plants would introduce a degree of controlled competition in the Chinese oil and natural gas sector, where reform is critical to Beijing's achieving its broader economic goals.

Since the late 1990s, the Chinese government has been seeking to restructure and consolidate control over major industries — especially coal, steel, oil and natural gas — under state-owned conglomerates, and the continuation of this strategy was part of China's five-year plan for 2010 through 2015. For example, state-owned mining companies Shenhua Group and China Coal Energy Co. are attempting to consolidate their control over the coal industry from the mine to the power plant. Beijing is also trying to increase the share of the 10 largest steel producers from the current level of about 40 percent to 60 percent by 2015 and 70 percent by 2020. The government has a similar plan for the refining sector.

In the 1980s, Beijing broke up the country's oil and gas industry into three parts, giving China Petroleum & Chemical Corp. (or Sinopec) control over refining, China National Petroleum Corp. control over onshore production and China National Offshore Oil Corp. control over offshore production. In the late 1990s, Beijing forced Sinopec to sell several of its refineries in the north to China National Petroleum Corp. in exchange for several of the latter's southern oil fields, essentially creating two vertically integrated national oil companies with distinct geographic areas of control.

More recently, however, Beijing has been pushing the two companies to compete directly with one another outside their regions of dominance. For example, China National Petroleum Corp. operates a joint venture refinery in southern Guangdong province with Venezuelan state-owned firm Petroleos de Venezuela, and Sinopec is building a large refinery in the northern Hebei province to boost its market share in Beijing. To further increase competition among the dominant state-owned firms, China National Offshore Oil Corp. has also been integrating vertically since the opening of its first refinery in Guangdong province in 2009. Still, the introduction of market dynamics to the sector has been a slow process. 

Outside of the three dominant firms, about 3 million barrels per day — roughly one-fifth of the country's total refining capacity — is refined in private facilities known as "teapots." Most of these independent refineries are small, though some can process up to 240,000 barrels per day, and the majority of the teapots operate in Shandong and Guangdong provinces. Beijing is attempting to close the smaller teapots while promoting the larger ones in hopes that they will compete with the state-owned majors. In a sense, Beijing is trying to introduce competition from two directions — both internally among the state-owned firms and externally with large, consolidated independent refining companies.

As a part of this effort, China announced plans to close refineries with capacities of less than 40,000 barrels per day by the end of 2013. Historically, the teapots have played a balancing role in China's domestic markets, since state-owned companies are subject to Beijing's political strategies and thus do not respond to market pressures as quickly as the independent refineries. Now, the government is giving the state-owned firms more freedom to react to market forces; in May, Beijing introduced a new pricing mechanism allowing refiners to adjust rates more quickly in response to changes in global oil prices.

Local Resistance

Beijing's ability to effectively enforce its energy policies is in question. The government has attempted to reduce teapot refining several times in the past, with only limited success. To avoid being shut down, many smaller refineries are trying to increase capacity beyond the threshold of 40,000 barrels per day by the end of the year — a trend that runs counter to Beijing's goal of controlling growth in refining capacity.

Moreover, Beijing's efforts are being resisted by municipal and regional governments, which rely on local refineries for employment and tax revenues. Even if a smaller teapot is acquired by one of the state-owned companies instead of being closed altogether, the local administration overseeing it would still lose the ability to tax it. Beijing has had success in consolidating upstream sectors in the past, but downstream sectors are more similar to mining and other industrial sectors where operations are tightly linked to local governments.
The recent leaks about fuel quotas thus indicate that Beijing is attempting to use market mechanisms to implement its energy policies. With limited access to crude oil, many independent refiners rely on imported fuel oil or other more expensive crude products. Teapots have remained profitable only because of their increased efficiency and ability to better respond to market competition. Beijing's attempts to boost competition among the state-owned firms and the recent pricing reforms have weakened the teapots' advantages, forcing them to reduce production. If the government indeed allows some larger independent refineries to access imports in 2014, competition for the majors will increase. Meanwhile, the smaller teapots without access to cheaper crude will struggle to compete, even if they avoid closure by boosting capacity beyond 40,000 barrels per day.

The central government is unlikely to achieve its goals completely. The smuggling of crude oil, where teapots import crude by labeling it as fuel oil, is common, and Beijing's ability to overcome the political difficulties of forcing refineries to close is unclear. Nonetheless, the increase in quotas would support China's efforts to reform the vital sector — and reform is indeed necessary for the country to succeed in rebalancing its economy overall.

China's Plans for Oil Reform
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