Declining demand and a weakening economy in China has meant that demand for oil products has declined. Refinery utilization rates have declined and the gross refinery margins (GRMs) are pulled down by the sluggish economy.

China refinery

Major refineries like PetroChina Company Limited (ADR) (NYSE:PTR) (SHA:601857) and China Petroleum & Chemical Corp (ADR) (NYSE:SNP) (HKG:0386) (Sinopec) have been suffering the impact of declining margins. Throughout 2011 and 2012, the Chinese integrated companies have been suffering hefty negative margins in their refinery business segment. This was during a time when oil prices were relatively stable, so the foremost impact on the companies’ profitability had come from decreased domestic demand.

Figure 1: Annual refinery margins in Petro China and Sinopec, 2008 to 2012

china's refinery
Source: Company Filings

China’s gross refinery margins improved

However, Platts reported that downstream margins have improved considerably since last year due to improvements in pricing mechanisms in the country. The pricing authority, National Development and Reform Commission (NDRC), has introduced a new mechanism this March that has allowed domestic oil prices to closely track the international prices of the same products.

However, the major cause of concern for refiners is still the slow economic growth in the country. According to Platts, China’s apparent oil demand growth in the first seven months of the year rose 4.2 percent YoY to average 9.86 million barrels per day (mmbpd). “In particular, refiners point to gas-oil demand, which makes up the largest slate in China’s oil product mix, as being weak,” says Platts.

Refineries have been operating below optimum levels and refinery utilization rates have been disappointing at best. “Refining capacity expansions in China have been largely on track this year although the country’s relatively weaker growth in oil demand could delay some projects and result in lower utilization rates. Up to 1.3 million b/d of additional refinery capacity had been expected to come on stream in China during 2012 and 2013,” reports Platts.

A survey of twenty of China’s largest refineries conducted by Platts showed that the average refinery utilization fell from 83 percent last year to 80 percent between January to August 2013.

Shifts in economy affects oil

The economic environment of China has been unpredictable in recent months and the brunt of this issue has fallen on the oil refineries. Sinopec refinery throughput rose 5.2 percent YoY to 4.69 million bpd in the first half of 2013. The company booked an operating profit of CNY 213 million in the refining segment in this period, versus a CNY 18.5 billion loss in the first half of 2013. The chunk of profits for Sinopec’s refinery came in the first quarter, with the company returning to a CNY 2 billion loss in the second quarter.

Platts reported that “the average realized price for Sinopec’s major oil products fell, with gasoil prices sliding 4.1 percent YoY to CNY 7,031 per metric tonne (mt), kerosene prices falling 5.4 percent YoY to CNY 6,195 per mt, and gasoline prices slipping 3.3 percent YoY to CNY 8,450 per mt.”

Since petrochemicals chiefly fuel the modern economy, not only is the economic slowdown an indication of poor performance in the downstream sector, but the reduced profitability of the oil and gas segment as a whole is a warning for a slowing economy itself. Hence, many analysts feel that the reduced margins in the oil downstream sector is a sign that China is not on the path to recovery as yet.