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Smoke and Mirrors in China’s Oil Statistics
Jianjun Tu, The Jamestown Foundation, China Brief
In recent years, oil product shortages in China have frequently caught the attention of the world. In August 2005, China’s southern manufacturing heartland of Guandong was plagued by closed service stations, fuel rationing and hours-long gas queues, and authorities were forced to send thousands of police to petrol stations in Guangzhou to prevent massive social unrest as drivers scrambled to fill their tanks (Wall Street Journal, August 19, 2005). In May 2006, a diesel shortage hit Guangdong again and lasted for half a month until a 270,000 ton emergency stock of gasoline and diesel fuel were allocated to the local market by China National Petroleum Corporation (CNPC) and China Petroleum and Chemical Corporation (Sinopec) (Xinhua News Agency, May 23, 2006). Since then, not only has the frequency of oil shortages increased, but also the geographic coverage of such events, extending to Beijing, Shanghai, Yunnan, Xian, and Henan (International Herald Tribune, October 31, 2007 Henan Business Daily, October 30, 2007 China Daily, March 29). On May 12, a magnitude 8.0-earthquake struck southwest China with its epicenter at Wenchuan County in Sichuan province. The death toll so far has exceeded 40,000 with 248,000 injured and 32,000 missing. To speed its unprecedented disaster relief efforts, Beijing had to drain its strategic oil reserves (Xinhua News Agency, May 20). The constraint on China’s petroleum infrastructure by the earthquake coupled with China’s recent stockpiling of diesel fuel ahead of the 2008 Beijing Olympics Games have unsurprisingly raised anxiety about the stability of the international oil market (Wall Street Journal, May 19).
After China replaced Japan as the world’s second-largest oil-consuming nation in 2002, major Chinese national oil companies have not only strengthened their domestic dominance but also successfully expanded their international presence. After CNPC, China’s largest oil producer, returned to the Shanghai A-share stock market in November 2007, PetroChina, the listed arm of CNPC, edged ExxonMobil and was ranked first amongst the world’s top 50 energy companies (Reuters, January 23). Similarly, China’s posted crude oil distillation capacity overtook Russia as the world’s second-largest in 2006, and Sinopec is currently the world’s third-largest oil refiner in terms of production capacity . Even China National Offshore Oil Corporation (CNOOC), the smallest of China’s three oil majors, almost doubled its annual petroleum production between 2000 and 2007, ranking seventh on Forbes’ “Asia’s Fabulous 50 Companies” list in terms of market value . Moreover, spikes in oil prices in recent years have stimulated a worldwide investment frenzy in the petroleum industry crude oil supply and refining capacity have generally balanced the growth in demand well in the world market. Given the strong performance of major Chinese national oil companies, the sufficient oil supply in the international market, China’s chronic oil shortage raises a legitimate question: what is wrong with China’s oil industry?
Driving Force Underlying China’s Chronic Oil Shortage
When oil shortages make headlines, price regulation by the Chinese central government has usually been identified as the primary underlying driving force. Before Deng Xiaoping opened China to the outside world in 1979, the Chinese economy was largely centrally controlled and planned in one-, five- and occasionally ten- and twelve-year time horizons. Since then, the once tightly controlled energy sector is now much more decentralized and market-oriented. When China’s current pricing framework for crude oil and oil products was first introduced in 1998, it was intended to allow the prices of both crude oil and oil products to track international fluctuation. The aim was to progressively remove the government from the pricing process, to integrate China’s oil markets with international markets, to provide clear commercial incentives for oil companies and to send correct signals to consumers . The outcome so far, however, is far from encouraging. In order to maintain the incentive for exploration and production of oil within China and import crude from the international market, domestic crude oil prices have been allowed to follow international levels. In comparison, after the 1998 reform, pricing policy for oil products has been further changed. In November 2001, the powerful National Development and Reform Commission (NDRC) set the price of processed oil based on the average price of oil products in the Singapore, Rotterdam and New York markets, and the government will only adjust the price of oil products once the international price rises above an eight percent threshold (Xinhua New Agency, October 31, 2007). Yet the relatively free market approach soon started to crumble as crude oil prices rose above $40 per barrel in 2004. To protect consumers from high energy prices and retard surging inflation pressure—which is an increasing headache for China’s decision makers because of its serious impact on social stability—NDRC has constantly maintained domestic oil product prices significantly lower than international levels in recent years.
Historically, Beijing always needed to subsidize at least one of its national oil companies when oil prices were tightly regulated. As CNPC, Sinopec and CNOOC had focused mainly on onshore oil and gas exploration and production downstream activities such as refining and distribution and offshore petroleum exploration and production, respectively, none of these companies had the ability to subsidize price regulation related financial losses with profits from other parts of its business operations. In 1998, when Beijing reorganized most state-owned oil and gas assets and made CNPC and Sinopec into two vertically integrated firms, one objective of restructuring these companies was to reduce the heavy financial burden of subsidy by the government. As a result of the 1998 restructuring, the rationale of NDRC’s oil product price control may seem reasonable—the current financial losses incurred in the downstream refining operations of the CNPC and Sinopec could be covered by the windfall profits from each company’s upstream production. In reality, however, behavior of the major players in China’s oil industry did not meet Beijing’s expectations. While China’s national oil companies did not hesitate to stifle domestic competition from their non-state rivals, these publicly traded monopolies are still inclined to observe the corporate economic bottom line of profit maximization whenever possible. Both CNPC and Sinopec were reportedly unwilling to fully utilize their refining capacity to meet domestic demand when oil product prices were not high enough to cover their production costs, and they have allegedly manipulated oil shortage events through product stockpiling, shutting down refinery capacity and increasing export of oil products (Sohu.com, August 16, 2005 Xinhua News Agency August, 13, 2007).
Moreover, all Chinese national oil companies—including CNOOC, a new entrant to China’s downstream industry—have managed to delay the construction progress of either their Greenfield refinery addition or Brownfield capacity expansion in recent years . To make the situation worse, oil imports by Guangdong, the province hardest hit by oil shortage, decreased 18 percent in 2007 on a year over year basis, and oil exports from Guangdong increased sharply by 47 percent during the same period (Xinhua News Agency, March 24). Facing enormous political pressure, Sinopec eventually cut its oil exports and stepped up production to supply the market in May 2006, and CNPC quickly followed suit and shipped more oil from its northeastern refineries to South China with the intention to break into Sinopec’s turf (Xinhua News Agency, May 17, 2006). Yet the Chinese government’s application of soft pressure toward major national oil companies has failed to solve the chronic oil shortage across China, as there exist other important factors in the market that are far more difficult to control by government regulations.
Distortions in China’s Oil Industry
Unlike China’s mismanaged coal mining industry—which was historically plagued by as many as 100,000 small township and village enterprises in 1991, a low technological level and appalling safety record —China’s oil industry has many fewer players. This is especially evident in the upstream exploration and production part of the industry, which is still cornered by CNPC, Sinopec and CNOOC. Nevertheless, after nearly three decades of economic reform, Chinese private enterprises have made inroads into the oil industry in downstream activities such as oil refining and distribution. International oil companies also have a modest presence in China, particularly in offshore exploration and production.
There are three types of petroleum refineries in China. The first is state-owned refineries including joint ventures with foreign companies. Currently, Sinopec runs about 26 refineries with an annual crude capacity of 160 million tons per annum (Mt/annum). In comparison, CNPC operates about 24 refineries with a crude capacity of 120 Mt/annum. The capacity of West Pacific Petrochemical Corp.-Dalian, the first joint venture refinery in China, is 10 Mt/annum . The second type is local and private refineries (LPRs). As early as 2005, the aggregate crude capacity of Chinese LPRs reached 80 Mt/annum. The crude capacity in Shangdong, Guangdong and Shaanxi alone exceed 45, 15, and 10 Mt/annum, respectively (Economic Information Daily, March 31 International Financial Daily, September 19, 2005). Access to refinery feedstocks is currently the most pressing issue for Chinese LPRs. For instance, local refineries in Shangdong have only been assigned 1.69 Mt/annum of the crude oil quota by the central government, and only processed 7.2 Mt of crude oil and 16 Mt of heavy fuel oil (HFO) in 2007, or a 52 percent capacity utilization rate (China Stock Network, April 28 Economic Information Daily, March 31). The third type is numerous illegal teapot refineries, which often process either crude stolen from state oil companies or heavily polluting feedstocks such as recycled fuel oil or waste tires. By the end of 2000, China had reportedly closed more than 6,000 such facilities, but how many teapot refineries are still illegally operating remains an open question .
To meet its surging oil demand, China plans to add more than 90 Mt/annum crude refining capacity during the 11th five-year planning period (2005-2010), which will be primarily fulfilled by investment from either national oil companies or joint ventures with international majors . While the Chinese government keeps shutting down illegal teapot refineries due to their notorious environmental and safety records, Beijing’s attitude toward LPRs is also quite hostile. Before 1998, there were about 193 local refineries in China. In May 1999, Beijing ordered the closure of most local refineries, and only allowed 82 to remain operating, which includes 19 belonging to CNPC and Sinopec . In the wake of the oil price spike in the early 2000s, the once profitable petroleum refining sector suffered ever-increasing deficits due to price regulation on oil products, so both CNPC and Sinopec were able to close their inefficient small refineries in early 2000s. Yet unlike developed countries such as the United States, Beijing has not developed a fair revenue sharing framework between the central and local governments. Local governments generally benefit much less from national oil companies than from local enterprises. As a result, many LPRs that were ordered for closure have managed to survive under the protection of local authorities. Nevertheless, these survivors and new refinery entrants often need to hide the nature of their business with misleading names such as “asphalt plant” (Liqing Chang), “solvent manufacturer” (Rongji Chang) and “lubricant company” (Runhuayou Gongsi).
The uncertain legal status of LPRs has seriously distorted the statistical reporting of China’s oil industry. While crude distillation capacity of Chinese LPRs has exceeded 100 Mt/annum, only one such facility—Yanan Refinery at Luochuan—was covered by Oil & Gas Journal’s annual worldwide refinery survey so far . Even Chinese statistical agencies were unable to provide accurate data regarding these facilities, so the actual capacity of China’s petroleum refining industry has been constantly underreported in recent years. Moreover, Chinese LPRs not only are currently unable to secure sufficient crude oil supply from domestic upstream producers, but also are not allowed to freely import crude oil from the international market. While HFO is not subject to Beijing’s import restrictions, most Chinese LPRs are forced to process imported straight-run fuel oil. As a result, China’s HFO imports grew quickly by 64 percent since 2002, reaching 31.4 Mt in 2006 . Under the tightly controlled Chinese oil market, LPRs’ relentless request to secure their feedstock supply has presented some unique challenges to regulators as a significant portion of feedstock processed by LPRs came from several “underground” channels. First, LPR operations have stimulated oil-related criminal activities. For instance, more than 1 Mt of crude oil stolen from the Shengli oilfield is sold to adjacent refineries annually. Second, importing crude oil as HFO has become popular amongst LPRs. It is estimated that more than 10 Mt of crude oil is imported into the Chinese market through this channel each year. Third, the crude oil quota may be obtained from national oil companies by paying premium and bribe .
Unlike their state-owned rivals who have a political obligation to meet domestic demand, Chinese LPRs operate according to market rules. When the price of oil products is deemed too low, LPRs could entirely shut down their refining operations. As the coordination between national oil companies and LPRs is poor, the operation strategy of LPRs would add complexity into national oil companies’ efforts to stabilize the market. Moreover, in China’s National Energy Balance Tables, HFO credited to LPRs as refining feedstock has been mistakenly allocated as energy consumption by the industrial sector. The aforementioned statistical distortion coupled with the fact that part of China’s transport fuels have already been misreported under other end-use sectors make the forecast of China’s oil demand a much more difficult challenge than it otherwise should be. When this researcher modeled China’s energy and environmental trajectory between 2005 and 2050 to provide input to the G8 Gleneagles dialogue on climate change mitigation in 2008, he needed to reallocate 95 percent of gasoline and 35 percent of diesel in China’s industrial, construction and service sectors, 100 percent of gasoline and 95 percent of diesel in the residential sector, and 100 percent of gasoline in the agricultural sector back as transport fuels to correct the statistical distortion .
Similar to oil shortages, oil smuggling is another chronic pain haunting China’s energy sector. In the 1990s, when prices of oil products in China were maintained artificially high in favor of domestic refiners, smuggling diesel into China was rampant. After the Xiamen Yuanhua Smuggling Case was uncovered, 40 Mt of diesel was reportedly illegally shipped into one Chinese port alone between 1994 and 1998 (Hong Kong Commercial Daily, September 13, 2000). Since then, unofficial oil imports are still thought to have been as high as 20 Mt/annum in the early 2000s . In recent years, smuggling oil products out of China has rebounded strongly due to NDRC’s price regulation on oil products. To counter the rampant oil smuggling, Beijing has an urgent need to eliminate the very incentives it has created. While the current price regulation on oil products has effectively lowered refinery capacity utilization of Chinese LPRs, before Beijing corrects such price distortion, it needs to proactively solve the crude oil supply issue haunting Chinese LPRs. Otherwise, a strong incentive will be created to stimulate smuggling crude oil into the domestic market, with a detrimental impact on China’s national energy statistical accounting.
Beijing’s price control of oil product is the primary driver underlying recent oil shortages, and the hostile regulatory environment imposed on LPRs has certainly compounded the situation. Chinese decision makers have long wished to reign in the chaotic oil industry in an environment of falling energy prices, but increasingly elevated oil prices in recent years suggest that Beijing may need to correct the very price distortion it has created even when oil prices are still high. Otherwise, the misleading price signals will undoubtedly compromise China’s energy conservation efforts. Moreover, with Chinese LPRs’ relentless quest to justify their existence with large scale expansion , Beijing can no longer run an energy policy that is so hostile toward its private oil enterprises. As the stakes involved are high, both the enormous investment made by the private sector and the relationship between central and local governments should be carefully taken into calculation. Ideally, Beijing could create a fair regulatory environment under which long-anticipated healthy competition could be introduced amongst players in China’s oil industry otherwise, a prolonged chaos in this strategically important sector may undermine the great economic achievement of the past three decades.
1. U.S. Energy Information Administration Oil & Gas Journal
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