China and IMO 2020
Shippers and refiners have been actively preparing for the IMO transition and engaged in a lively debate on how it would play out, and since the second half of 2019, making active preparations for it. Chinese refiners, however, seem to have been less preoccupied with it than their Western peers. This may seem surprising given that China holds the world’s second largest refining capacity behind the US, is home to six of the 10 largest container ports globally, and is an early adopter of tighter shipping fuel emission standards domestically.
One key reason is that China’s domestic bunker market is small relative to its refining capacity and to other Asian hubs. At 20 Mt, it is about 2.5 time smaller than bunkering volumes at the port of Singapore alone (about 50 Mt). Of this 20 Mt, domestic bunkering account for 6-7Mt and bonded bunkering represents an additional 13 Mt. Yet the domestic tax system, which adds both consumer and value added taxes to bunker fuels, even for bonded sales, makes refinery based bunker fuels uncompetitive. It leaves blenders, who generally import about 90% of the material, mainly from Singapore and Malaysia, to dominate supplies.
However, this may be changing. IMO 2020 presents an opportunity for refiners, and the government’s efforts to promote China as a bunkering hub on par with Singapore is heralding a change. China’s state-owned refiners started gearing up to produce very light sulphur fuel oil (VLSFO) in 2019, having announced plans to produce close to 20 Mt of VLSFO in 2020. Expectations that the government will offer tax rebates on VLSFO exports have boosted refiners’ enthusiasm for the fuel while the Free Trade Zone (FTZs) at Zhoushan port, where the government has relaxed restrictions on imports of marine fuels and blendstocks, is also supporting the nascent market. Eventually, China will be able to supply the full volume of compliant bunkers in its ports without imports. And even though refiners can also produce compliant marine gasoil (MGO), the high consumption tax levied on it and restrictive export quotas suggest it will struggle to compete with VLSFO. At the same time, higher VLSFO output will require some refiners to shift their crude slate to sweeter crudes, which are currently commanding a premium, and squeeze production of clean products. With excess refining capacity and weakening gasoline demand growth, these adjustments are unlikely to be a problem for China’s refining system and over time Chinese refiners will likely emerge as growing suppliers of low-sulphur bunker fuels.
Yet even though the immediate focus is on VLSFO, the government’s medium- and long-term plans emphasise LNG in shipping. Use of LNG for bunkering in China’s inland waterways has been part of government plans to switch to low sulphur fuels since 2013, but the lack of LNG vessels as well as refuelling and bunkering infrastructure has limited its growth, with shipping estimated to account for 1.5 bcm of China’s 280 bcm of natural gas demand in 2018. With a stronger policy focus from the government announced in late 2018, aiming to develop LNG in shipping through 2025, the state-owned oil and gas companies as well as shippers are increasingly setting their sights on LNG in shipping for both domestic and international bunkering. These developments in China’s bunkering market are set to weigh on diesel use, benefitting fuel oil in the near term, and LNG, at the margins, from 2025. At the same time, the state-owned oil and gas majors are set to recapture market share from blenders as they develop supplies of both VLSFO and LNG.