China’s emergence as diesel exporter dampens Asian refining margins

By Jessica Jaganathan

SINGAPORE, Feb 23 (Reuters) -- China's emergence as a major oil product exporter is depressing oil refining margins across Asia as favorable domestic fuel policies encourage Chinese refiners to keep output high and flood regional markets with surplus supplies.

The surge in Chinese shipments has been felt the most in the diesel market, where benchmark Asian margins recently slumped to 6-year lows following an almost 80% jump in Chinese exports in 2015.

The world's No. 2 diesel producer had until last year been only a modest exporter of the fuel, as the country's large mining, power generation and trucking industries used up most of its diesel output.

But as China's industrial engine slowed, refinery run rates remained high to meet still strong demand for gasoline and jet fuel, used for transport. That led to a surplus of diesel that was steered on to regional markets with increased aggression over the course of 2015.

Average monthly exports over the second half of 2015 were 865,000 tons, compared to 329,000 tons per month over the first half.

"As independent refineries in China have increased access to crude, this positively affects their run rates. In turn every additional barrel in the already oversupplied middle-distillates market has a negative effect on the gasoil margins," said David Wech, managing director of research institute JBC Energy.

Additional export quotas for independent refineries along with export-linked incentives for refineries owned by state-owned oil giant Sinopec are expected to lead to higher shipments in 2016. January exports eased back from December levels, but were more than 10 times higher than the same month in 2015.

China's net surplus of diesel could more than double to 220,000 bpd -- or about 10.8 million tons in 2018 from 100,000 bpd in 2015, Wech said.

"The sizable diesel supply glut created by an upsurge in Chinese exports of diesel ...(will) remain intact, leading diesel prices in Asia to underperform diesel prices in Europe and North America over 2016 to 2020," said BMI Research's Asia oil analyst Peter Lee.

While China's increased exports have slashed Asian diesel margins - from roughly $16/bbl a year ago to around $10 now - the impact has been partly offset by tumbling oil prices, which have kept other refiners profitable.

Chinese refiners have also been protected by a domestic floor price that is above international rates and provides a buffer for competitively priced exports.

On a monthly basis, China has already overtaken Japan and Taiwan to become Asia's fourth-largest diesel exporter after South Korea, Singapore and India.

China accounted for 12% of Asian diesel exports in the month of December, 2015, up from just 4% nine months earlier, according to trade data and a Reuters analysis of ship loadings in the region.

South Korean and Japanese refiners say they are confident of holding their own in Asia where long-term demand is expected to catch up with the supply surplus, but concede that Chinese refiners have an advantage in new markets.

"We haven't lost any market share to the Chinese but in terms of expanding our business, it's more difficult especially in the Southeast Asian market," a source with a South Korean refiner said.

"Their domestic fuel pricing system is very favorable for them so they can secure huge margins, which means they can offer the diesel cargoes at cheaper prices, which are difficult for us to compete with."

Globally, China is expected to become the world's eighth biggest diesel exporter by 2018, up from 20th place in 2015, JBC's Wech said.

Its top exports are to Singapore, as Chinese refiners take a bigger position in the Asian benchmark pricing system and store diesel in the region's trading hub, but its reach extends as far as Africa and Argentina.

New refineries in China are also able to meet more stringent specifications required by developed countries such as Australia, where the closure of ageing refineries has boosted import demand.

"I think the immediate attraction for them is Australia and maybe to some extent Africa, but I'm sure they will want to expand their reach to Europe and the United States," said a source with a Japanese refiner.