Haijiang Wang
Energy Security Analysis Inc.
Washington, D.C.
China's refining system is undergoing a major overhaul. (48899 bytes) New refineries are being built as existing ones are upgraded and expanded.
Most of the new construction is in China's booming southern and eastern coastal regions, where there is easy access to domestic and export demand.
The country's crude-distillation capacity will be sufficient, while capacity of upgrading units remains insufficient. Secondary units will continue to fall short of meeting increasing demand for middle distillates.
The success of refineries funded completely or partially by non-Chinese companies will depend in part on Chinese government policy. There will be demand for products from third-party processing facilities, but hard currency is necessary for the investors to repatriate profits and for China Petrochemical Corp. (Sinopec) to bid on the products from such facilities.
These refineries may need yuan to pay workers, taxes, and the like, but crude purchases will be made in hard currency, making it necessary for most sales also to be in hard currency.
The limited convertibility of Chinese currency constitutes a major central control over the country's entire economy. This control can be affected by limiting product exchange participants and the volumes to be traded. Such a limitation, however, will reduce access of non-Chinese companies to China's markets, and is not likely to occur in the next 10 years.
CAPACITY
China is one of the fastest growing countries in terms of new refining capacity. More than 180,000 b/d has been added each year for the last 5 years, but capacity utilization has fallen.
By the beginning of 1993, Chinese refining capacity was 3.2 million b/d, ranking China fourth in national crude capacity, after the U.S., Russia, and Japan. Of this total, Sinopec, the world's fourth largest refiner, holds 2.96 million b/d (148 million metric tons/year), or 92% of China's capacity.
In the 1980s, China's refining capacity grew slightly more than half as fast as the economy and just over 25% as fast as industrial output. Atmospheric distillation capacity increased from 2.3 million b/d in 1988 to 3.2 million b/d in 1993.
As Table 1 (17425 bytes) shows, China's fluid catalytic cracking (FCC) capacity is relatively high at about 900,000 b/d. This is slightly greater than Japan's 700,000 b/d of FCC capacity.
Cracking capacity also is fairly high relative to crude distillation capacity - 35% in China, compared with an average 18% in Asia. China also operates more coking capacity than any other Asian country.
All existing refineries in the country have been designed and constructed by Chinese firms, although a few processing units have been licensed from international licensers. Most of the refineries were built between the late 1960s and early 1980s.
Overall technical conditions are relatively inferior, by international standards, even though technical refitting and modernization has continued.
Chinese researchers recently have developed new refining processes, such as a fluid catalytic cracking unit (FCCU) yielding greater than 50% light olefins. Another Chinese technology combines catalytic cracking and aromatics extraction in one unit. The latter process can raise the yield of gaseous and liquid products by 1.2% while improving product quality.
The concentration of demand growth in light products-middle distillates in particular-has forced heavy investments in cracking capacity to meet domestic demand, reduce light diesel imports, and reduce fuel oil yields.
About 40 FCC units are in operation at Sinopec refineries. According to the company, China's FCC units are approaching the world technical standards of the late 1980s.
Catalytic reforming is another refining process in which China has made great progress in recent years, after importing modern technology from abroad. If the country moves toward eliminating lead in gasoline, catalytic reforming capacity additions can be expected to continues.
Hydrocracking has a relatively small role in China's refining system, although the country has increased efforts to develop hydroprocessing technology domestically because of the high cost of importing such technology.
Chinese refineries also have added secondary processing capacity at existing refineries, resulting in great yield changes for light products. New construction has focused on:
- Hydrocrackers, for the production of diesel and kerosine (at the Daqing, Fushun, Maoming, Nanjing, and Shanghai refineries)
- Alkylation units, for the octane enhancement of gasoline (at Shanghai, Tianjin, Zhejiang, Qilu, Fushun, and other smaller refineries)
- Catalytic crackers, for processing heavy fuel oil fractions.
REFINING
The volume of crude oil refined in China has increased roughly 5%/year since 1985. Last year was the first year since the early 1960s that China's refinery throughput showed no growth from the previous year.
In 1994, China processed 2.64 million b/d of crude, a 0.4% decrease over 1993. In addition, 1994 third-party crude processing averaged about 24,000 b/d, falling from a peak of 60,000 b/d in 1993.
Of all the crude refined in China, about 85% was processed by Sinopec refineries in 1993 and 1994. The rest was processed by other relatively small refineries operated by China National Petroleum Corp. (CNPC) and local governments.
The efficiency of Chinese refineries has improved significantly during the past 5 years. Overall refining utilization fell from 93% in 1988 to 83% in 1994.
China's refining industry also is focusing on the development and efficient operation of technologies for secondary processes, separation, and utilization of refinery gases, and on the formulation and production of advanced refining catalysts and additives, among other areas.
Increasing operational efficiency at existing refineries is a critical issue. Almost all Chinese refineries were built to process domestic crude, which is typically heavy, waxy, and sweet.
The supply of domestic crude is increasingly insufficient to meet domestic demand, however, so more crude will have to be imported. In fact, Sinopec has completed crude deals for at least 80,000 b/d with Saudi Arabia, Kuwait, and the U.A.E. Deliveries are to begin this year.
Most Chinese refineries cannot handle sour crude, like most Middle Eastern grades, because of the metallurgical limitations of the process units. Most of China's existing distillation towers were built with untempered steel, which limits the sulfur content of the crudes they can refine without experiencing corrosion problems.
As a stopgap, refineries may install front-end crude desulfurization units. But that is very expensive, so many complexes eventually will have to be rebuilt.
Furthermore, topping units usually are combined directly with vacuum units in Chinese refineries. Increasing the gravity of the crude being processed will result in less material being sent to the vacuum distillation unit, leaving vacuum capacity under-utilized. Because the heat exchanger systems of the atmospheric and vacuum units are linked, this may cause operational problems.
All told, the cost of modifications to enable processing sour crudes may make replacement a more attractive alternative.
There has been little improvement in Chinese product quality in the last 20 years, especially in motor gasoline and diesel oil. Processes such as isomerization and etherification have not been introduced on a large scale, but reforming capacity has increased.
China's sulfur content limits in transportation fuels are:
- Gasoline No. 97, 0.15 wt % or less
- Gasoline No. 93, 0.15 wt % or less
- Gasoline No. 90, 0.15 wt % or less
- Gasoline No. 70, 0.15 wt % or less
- Light diesel super grade, 0.2 wt % or less
- Normal grade diesel, 1.0 wt %.
China's refining industry has an intelligent and qualified research and development team. In the past, they have focused their attention on domestic crude, and notable results were achieved. Now they are starting to work on processing more foreign crudes.
Meanwhile, China intends to negotiate with international licensers for advanced technologies. It is believed that technical improvement will be an important aspect in the development of Sinopec's existing refineries in the next decade.
As Table 2 (69315 bytes) illustrates, for the most part, China's refineries are located near oil fields in northern and northeastern China, as well as in Shandong province (map). Only a few refineries are scattered in the various other provinces, according to local consumption.
This system has resulted in overcapacity in northern and northeastern China and a lack of large refineries in the vast southwestern areas. In addition, the refineries in the inland provinces usually have relatively small capacities and operate at lower utilization rates.
This distribution of refineries has left the southern coastal provinces, which are seeing the most growth in economic, power, and oil demand, with few large-scale refineries.
Table 2 (69315 bytes) also shows that most Chinese refineries are small - none are larger than 200,000 b/d. Only four refineries - Fushun, Qilu, Gaoqiao, and Maoming - have capacities greater than 150,000 b/d. This is one explanation for the low energy efficiency and productivity common in Chinese refineries.
CAPACITY EXPANSION
Construction of new refineries around the world is limited by the required investment and constrained by tough environmental regulations, especially in industrialized countries. A new, fully upgraded refinery with about 200,000 b/d of distillation capacity requires an investment of more than $2 billion.
Given current shrinking refining margins, only a few major companies or state corporations can be expected to attempt to construct such facilities. China is at the top of that list.
The rapid growth rate of petroleum product consumption and the drain on foreign exchange created by exporting crude and importing products are forcing China's energy policy to shift toward expanding domestic refining capacity. By refining domestic crude instead of exporting it, hard currency is saved and self-sufficiency is improved.
The number of proposed new joint venture refineries in China has grown. The highest growth rates are seen in southern China, where smaller refineries are the norm and economic growth is causing oil demand to increase fastest.
A number of new refineries and upgrading projects are under construction in coastal areas, and more are under study. Before the prospects for Chinese refinery construction are addressed, however, the procedures required to build a new refinery in China should be described.
REFINERY PLANNING
The process for building a new refinery or expanding an existing one still is strongly influenced by the central planning system in China.
The first step is indicating the intention to build a refinery and conducting a feasibility study, with the consent of the provincial government. Next, a more detailed study is performed by the Chinese initiator or initiators, or by a collaboration between Chinese and foreign parties.
The normal feasibility study in China requires disclosure of: the source or sources of funds, equity distribution, total cost, cash flow, payback period for loans, local infrastructure requirements, technology used compared to the current world standard, market potential for petroleum and petrochemical sales, environmental impact, staff training, and other details.
Because of the huge investment required for a refinery, the completed feasibility study for the new refinery is submitted to the State Planning Commission (SPC). The SPC, in turn, asks either China International Engineering Consulting Corp., a de facto subsidiary of the SPC, or the Petrochemical Planning & Engineering Institute, a Sinopec subsidiary, to examine the feasibility study.
The Petrochemical Planning & Engineering Institute heads a team that includes experts from relevant central and local organizations such as banks, trading companies, the provincial government, and the appropriate environmental agency. The final report from this team will be submitted to the SPC.
If the project is approved, the proposed project is fully permitted. Without the SPC's approval, no new capacity may be built and no existing capacity may be expanded.
China has adopted three strategies in developing its domestic refining sector:
- Debottlenecking and revamping existing facilities
- Building grassroots refineries near existing plants
- Building new refineries in emerging consuming centers.
For all these plans, China expects foreign equity participation.
CONSTRUCTION
The projects listed in Table 3 (33414 bytes) are worth keeping and eye on, even though some of them may not materialize. Other refineries have been Proposed (such as Zhanjiang's 70,000 b/d plant and Zhuhai's 50,000 b/d plant, both in Guangdong province) but less information is available about them.
An outline agreement has been signed with Iran for the study of a refinery project, although no site has been selected. In addition, Japanese and Taiwanese companies continue to show interest in China's petrochemical sector.
Besides new refineries, some existing refineries are scheduled to be modernized and revamped. Many of these expansion plans include such processes as reforming, FCC, hydrocracking, and alkylation.
In some instances, it makes more sense to upgrade existing facilities or integrate new development with existing infrastructures. This approach to refinery expansion can be achieved more easily than constructing grassroots refineries, largely because of cost.
Seven of Sinopec's refineries lie either in coastal areas or inland near access to river transportation. The company plans to revamp and expand these plants to a capacity of 200,000 b/d each by 2000.2
Sinopec hopes to include foreign companies in these expansion projects and is negotiating with foreign oil firms to expand the refining capacity of its four major refineries in Dalian, Fujian, Zhenhai, and Maoming. Each of these plants will be expanded by roughly 100,000 b/d.
Guangzhou General Petrochemical Plant in Guangdong province also is on the expansion list, but no further information on project details has been released.
CNPC is upgrading three of its refineries in northern Xinjiang to meet rising production from the Tarim basin. Debottlenecking and upgrading will increase capacities at Karamay (now 40,500 b/d), Dushanzi (now 71,000 b/d), and Zepu (now 10,000 b/d) by 20,000 b/d each by December.
Sinopec also has begun a major revamp of its refinery network, capacity debottlenecking, and desulfurization facility construction at the major refineries of coastal China.
Many of China's proposed refineries are in the south-Guangdong and Guangxi provinces-where three new refineries with a total of 380,000 b/d capacity will more than double the current regional capacity. Current proposals, however, also will have a significant impact on eastern China-Shandong, Shanghai, and Zhejiang provinces-with three proposed facilities totaling 420,000 b/d of capacity, or 70% of current regional capacity.
There have been a few proposed refinery projects in the crude-producing areas of the north and west, and only one in the northeast, near the Shengli field. In crude producing areas such as Daqing and Shengli, officials are particularly eager to diversify and add value to crude production as their aging oil fields begin to decline.
As northern and northeastern China already have sufficient refining capacity, investors have shown that they prefer to invest in the consuming regions to avoid extra transportation costs and uncertainties created by China's infrastructure. Locating in a southern coastal province assures access to growing domestic markets and international crude and products markets.
Because of cash shortages in both Chinese currency and foreign exchange in all levels of government and in Sinopec, foreign capital will be needed for new refineries in the foreseeable future. Sinopec's financial resources are significant, however, and should be perfectly adequate to meet the company's commitments in joint venture projects.
joint venture refineries have more operational and financial flexibility than do domestic refineries. For example, joint venture plants can import crude and export refined products without permits. If they like, part of the output can be channeled into China's domestic market, but limited currency convertibility is an obstacle to these sales.
Coastal refinery construction is premised on export markets that can pay for the capital and foreign exchange costs of a refinery, as well as its crude supplies.
THIRD-PARTY PROCESSING
Because of slow growth in domestic crude production, the share of imported crude in Chinese refinery throughput has increased. Use of imported crude was 2.7% of the crude slate in 1990, 9.2% in 1992, 11.9%, in 1993, and 9.5% in 1994 (Table 4)(20202 bytes).
With continuing robust demand, this share is expected to be 10%, or more for the next 5 years.
China has spare refining capacity for third-party processing because, in the past, every refinery lobbied central planners for more capacity than necessary to get a larger quota of crude from the central government. Consequently, most refineries have operated below capacity.
Third-party processing was initiated domestically in 1988, when some provinces were given permission by the central government to buy a certain amount of crude, with no restrictions on origin. After that, a number of coastal refineries were approved to accept foreign clients for third-party processing. These third parties comprise firms from Hong Kong and other Asian countries.
Current Chinese policy is more open and any refinery with excess capacity is encouraged to do such business, so long as it has suitable facilities to receive crude and handle products.
After 1990, China started to reduce expensive product imports by allowing third-party processing in its coastal refineries. Only 6 of 40 refineries in China are located along the eastern and southern coast, where they have the opportunity to accept these third-party processing arrangements because they are closer to international markets. These refineries are in Dalian, Zhenhai, Maoming, Nanjing, Fujian, and Shanghai.
The bulk of imported sweet crude is from Indonesia, Malaysia, and more recently Viet Nam, although some crude still is exported to Singapore for refining, the products from which are then imported. Not all products refined by third-party processors are re-exported - many are sold in China.
In most third-party processing arrangements, China buys some of the products that are in short supply domestically, such as kerosine, gas oil, and fuel oil. China's open policy toward foreign processing is the result of underutilized refining capacity and slow increases in crude production.
The primary advantage of this policy stems from short shipping distances between China and other Asian countries. The short shipping distances offset higher processing fees in China relative to Singapore. For example, processing in Maoming in Guangdong province costs more than $2.00/bbl, while the term fees for processing in Singapore vary between $1.50 and $1.80/bbl.
Contract length for third-party processing usually is 1 year. Several varieties of crude have been involved, but most are low-sulfur grades such as Southeast Asian and Omani crudes. Maoming is the only refinery that can handle sour crude.
In 1993, the Zhenghai refinery had the largest volume of third-party processing - 24,000 b/d. Other coastal refineries such Maoming, Fujian, and Dalian had the balance.
At present, the Zhenghai refinery on the eastern coast takes nearly half of all third-party processing. The Dalian refinery processes about a quarter of the national total. Other refineries are taking only small volumes for trial.
Despite the absence of third-party processing data from 1988 to 1991, the author infers that the volume was very small because crude import volumes were low for that period.
Third-party processing has increased in recent years. The data in Table 4 (20202 bytes) show that third-party processing was 38,000 b/d in 1992 and 60,000 b/d in 1993, but declined to 24,000 b/d in 1994 (excluding processing for domestic clients). Third-party processing as a percentage of total refinery runs remained small.
These processing arrangements recently have lost some of their appeal. The ability to sell more products was reduced when 1994 import restrictions went into place. Most products refined via third-party agreements must be reexported-only a limited volume may be sold in Chinese markets.
Significant third-party processing volumes should persist for some time, as long as there is spare capacity in some of the larger coastal refineries. But these arrangements must contend with high product prices and low crude prices on the international market, and with competition from Singapore and other Asian refining centers.
At present, the third-parties involved in these agreements are from a number of regions, but most are based in Hong Kong. As long as there are no refineries in Hong Kong, demand for third-party processing will continue.
But if labor and utility costs increase significantly in China, in addition to relatively high refinery energy consumption and low efficiency, the profitability of third-party processing will decline.
As joint venture refineries enter service, they may displace some third-party processing because they will have the freedom to sell into Chinese markets (observing the valid regulations on prices and distribution systems set by the central government), and because of their higher efficiency.
REFINING POLICY
Three layers of decision-making affect the oil sector in China: the political system, macroeconomic policy, and oil policy. In China, oil policy is a function of macroeconomic policy, which is related to larger political issues.
The government still "makes" the oil market, if not directly, then through price controls and trade restrictions, or at least through supervision and guidance. And although liberalization programs will affect the oil industry, Energy Security Analysis Inc. (ESAI) does not see the industry achieving substantial deregulation over the next 5-10 years. Indeed, ESAI believes the oil sector will be one of the last sectors to be liberalized.
Of course, the government does have an incentive to encourage upgrading units, if only to limit the cost of imports and produce higher-value fuels. And China's present level of complexity already is one of the highest in Asia. But, as with other Asian countries, matching product supply with demand is only one of the goals of government energy policy.
In 1993, a year of great oil market freedom in China, increasing product price decontrol and unrestricted oil business licenses boosted product trade flow domestically. This increase resulted in the establishment of three separate petroleum exchanges, and private petroleum retailers mushroomed.
Also in 1993, principal product imports (gasoline, diesel, kerosine, and fuel oil) were not licensed exclusively to any company. Many oil outsiders acquired import licenses and rushed into the import business to profit from the price differentials between the domestic and international markets.
The decontrol of petroleum prices and distribution met the demand increases in the emerging coastal market. But decontrol also created chaos in the oil market because of an inadequate legal system. In addition' inflation soared in 1993, in part, as a result of liberalized oil prices.
In 1994, the trend was reversed and the decentralized oil market was "recontrolled" by Beijing. Regulated refinery and retail prices squeezed the profit margins of private gas stations and led petroleum exchanges to close.
The authority to distribute refined products was assigned solely to Sinopec, thereby prohibiting any reselling of products. Principal products could be imported only by a licensed company, and only three companies - Sinochem, ChinaOil, and Unipec - were granted licenses.
As a result, the oil market in 1994 was sluggish. The oil import ban and reduction of import quotas restricted the volume of product imports in 1994. Inflexibility in oil allocation blocked product flow between regions, as well as crude flow among refineries.
The southern refineries could not receive adequate crude supplies from the central government to produce sufficient products, while surplus products stockpiled in the north could not be shipped to the south because of a transportation bottleneck. Therefore, total petroleum product demand showed virtually no growth in 1994, compared to about a 300,000 b/d increase in 1993.
In 1994, refinery operations provided a good example of how the downstream industry works under a centrally planned economy.
"Excessive" product imports at the end of 1993-caused by a big spread between Chinese and world market prices and by the 1993 practice of decentralized import licenses-led to ample product inventories in the first half of 1994. The tightening of policy governing oil distribution in May 1994 restricted demand in the fast-growing areas of southern and eastern China.
In 1994, the central government also took back crude allocation authority, part of which had been assigned to oil producers in 1993. In other words, in 1993, crude producers could sell refineries' crude output above their production quotas at market prices.
Under such a recentralized allocation system, Beijing provided crude proportionally to refineries based on their capacities, But when the central planners saw high inventories, they cut the crude supply of every refinery equally, regardless of the demand situation faced by particular refineries.
This inflexible crude allocation caused refineries in the east and south to receive inadequate crude supplies to meet burgeoning regional demand, while product inventories in the northeast, where demand growth was relatively low, remained high. As a result, national refinery runs in 1994 were held in check for the first time in 30 years.
In 1993 and early 1994, due to the booming oil market, foreign oil companies were rushing to plan joint venture refineries in China. Following the central government's "re-regulation," however, negotiations were halted and investors stepped back to wait for China's oil market to adjust.
Currently, many, if not most, of the joint venture refinery projects that held such promise in 1993 and the first half of 1994 have been shelved. The growing realization of the difficulties of investing and working in China only add to many companies' reluctance to invest the huge sums of money necessary to build grassroots refineries.
CHANGE
What are the prospects for changes in China's refining sector? Two important factors stand out:
- Sinopec and the provincial governments, because they are directly aware of the gaps between supply and demand in certain regions, have more motivation than the central government to expand existing refineries and build new ones. Unfortunately however, under a centrally planned economy, they have no ability to influence the macroeconomic and investment environment.
A tough economic environment only weakens their bargaining power in joint venture negotiation. After Deng's departure, however, if provincial governments grasp more decision-making power from the central government, the provinces could enjoy more freedom to decide on needed refinery projects and begin construction quickly.
- Self-sufficiency objectives in refining are very important to the government, and this concern will force China to adopt a more flexible policy toward foreign investment when the central government has inadequate capital.
If China's refinery expansion is delayed, the Chinese economy will require more product imports to meet demand increases. But if this were to occur, there still would be stringent limitations on product imports.
The government will place a great priority on minimizing product imports, especially if the world oil price is high and China suffers a large trade deficit. As product imports creep up, however, policy makers will realize that self-sufficiency is a goal that China will need foreign assistance to reach. This could change the government's attitude and lessen the restrictions and red tape that foreign refiners now face.
In summary, the desire to avoid inflation through a tight macroeconomic policy makes it even more likely that the government will maintain its current oil policy through 1995. Nevertheless, real change in the oil industry and market may happen in the longer term, if a peaceful political transition after Deng's departure ushers in a more free market economy and increased oil demand.
But for the foreseeable future, whoever assumes political leadership is very likely to place stability above all other objectives in order to overcome the uncertainty and potential power vacuum that may follow Deng's death.
ACKNOWLEDGMENT
The author would like to thank George Beranek and Raoul Leblanc for their assistance.
REFERENCES
- China Petrochemical Corp. annual report, 1993, P. 30.
- "Moving Towards the New Century: Reports from Guangzhou General Petrochemical Plant," People's Daily (overseas edition), Sept. 7, 1994, P. 2.
BIBLIOGRAPHY
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