China's teapots eat into crude glut, but build Asian fuel surplus

By Florence Tan and Chen Aizhu

SINGAPORE/BEIJING (Reuters) - Newly licensed Chinese oil importers are taking advantage of low crude prices and healthy domestic product margins, snapping up hundreds of thousands of barrels a day of a global surplus but also adding to China's swelling fuel exports.

Armed with quotas that could make up a fifth of total Chinese crude imports this year, the independent refiners, nicknamed "teapots", are seeking barrels from Asia, the Middle East, Europe and South America, and are prepared to pay top premiums to secure deliveries out to April.

Despite the troubles of a private refiner that failed to secure financing for two import cargoes in December, there has been little let up from the new pool of buyers. Last year, the independents, alongside Beijing's stockpiling programme, helped grow China's crude imports by 8.8 percent, or 543,000 barrels per day (bpd).

"As long as oil remains under $40, margins will be supportive of crude buying," said Michal Meidan of consultancy Energy Aspects.

"But even if margins start to get squeezed a little, they will still import and seek tax breaks from local officials."

After Beijing started granting quotas in July 2015, independents bought close to 8 million tonnes of crude between September and December, a rough rate of 500,000 bpd over the four months, according to estimates by Thomson Reuters Oil Research and Forecasts and an executive at one teapot refiner.

With over 1 million bpd in quotas finally approved so far, teapots are set to step up purchases further this year, as most won permits only towards the end of 2015 or in early 2016.

Sources at the independents said they are testing out a variety of grades for their plants, which typically have small capacities and basic crude distillation equipment that most easily handle light, sweet oils.

China's total crude imports this month may reach 7.68 million bpd, near a record hit in December and marking another challenge to the United States as the world's top crude buyer, according to Thomson Reuters Oil Research and Forecasts.

The teapots' preference for smaller-sized cargoes due to port constraints helped push Russia up China's supplier list to the No.2 spot after Saudi Arabia, with Russian volumes surpassing those of the Saudis for four months in 2015.

The independents' demand for ESPO blend crude, the key Russian grade for Asia, has pushed up its premium for cargoes loading in March to the highest since May 2014.

ROBUST MARGINS

The teapots' buying was supported by Beijing's recent move to freeze domestic pump prices when benchmark crude prices go under $40, effectively locking in processing margins as Brent and U.S. oil hold near 12-year lows.

To capture healthy margins and replenish inventories ahead of the Lunar New Year break that starts on Feb. 8, teapots have cranked up output to near full-tilt, according to sources at three plants based in eastern Shandong province.

Until the middle of last year, many struggled to operate even at 30-40 percent of capacity due to poor margins and their inability to import crude.

Cargoes have been booked through April loadings, the sources said, with the high number of enquires likely extending far into the second quarter.

Still, with fuel stocks rising and factory activity contracting in the world's second-largest economy, weak domestic demand - especially for diesel - may force companies to export more and eventually cap crude throughput.

State refiners have already been exporting fuels at record amounts, but a lack of export infrastructure is hampering teapots' efforts despite winning government export permits.

"On average the operating rates have gone up, but the question is where will their exports go? They have the other problem of finding markets," IHS' analyst Victor Shum said.

(Reporting by Florence Tan in SINGAPORE and Chen Aizhu in BEIJING; Editing by Tom Hogue)