Podcast: China's petrochemical refiners are making their presence felt way beyond the country's borders. How will this impact global supply, demand, and trade balances? Will global operating rates be reduced?
Textile giants Rongsheng and Hengli have shaken up China's cozy, state-dominated oil market this year with the addition of close to 1mn b/d of new crude distillation capacity and vast, integrated downstream complexes. Petrochemical products, rather than conventional road fuels, are the driving force for this new breed of private sector refiner. And more are on their way.
- Argus Toluene, Xylenes and Isomers/PET
- Argus US LPG and Petrochemical Feedstocks
- White paper: Assessing the impact of sustainability on virgin polyolefin demand
Tom: Hello, and thank you very much for joining us for the latest in our series of podcasts, "China Connection." I'm Tom Reed, VP for China Crude and Products. I head our oil analysis and pricing for the Chinese market.
Chuck: And I'm Chuck Venezia, Senior Vice President for the Petrochemical sector for Argus.
Tom: And today we are discussing the advent of petrochemical refineries in China, refineries that have been built to produce mainly petrochemical feedstocks. Just a bit of background here, these two big new private sector firms, Rongsheng and Hengli, have each opened massive, shiny new 400,000 b/d refineries in China this year. Hengli at Changxing in Northeast Dalian and Rongsheng at Zhoushan in Zhejiang Province on the East coast. For those unfamiliar with Chinese geography, Dalian is up by China's land border with North Korea and Zhoushan is an island across the Hangzhou Bay from Shanghai. And the opening of these two massive new refineries by chemical companies is shaking up China's downstream market. But China is a net exporter of the core refinery products, gasoline, diesel, and jet. So, building refineries doesn't sound like a purely commercial decision. Is it political? What's behind it? How will it affect the makeup of China's petrochemical product imports?
Chuck: And clearly, the driver here for Rongsheng and Hengli, who as Tom mentioned, are chemical companies, they are the world's largest producers of purified terephthalic acid, known as PTA, which is the main precursor to make polyester, polyester for clothing and PET bottles. And each of them were importing massive amounts of paraxylene, paraxylene being the main raw material to make PTA. And paraxylene comes from the refining of oil. And really the alternate value for paraxylene or its precursors would be to blend into gasoline to increase octane. So, when looking to take a step upstream in terms of reverse or vertical integration, they've quickly found themselves not just becoming paraxylene producers, but in fact becoming refiners of crude to begin with, which of course, is quite complex and it involves all kinds of co-products and byproducts. And as many know, the refining of oil, the primary driver there, as Tom has mentioned, is to produce motor fuels. So, we're reversing this where the petrochemicals become the strategic product and we look to optimize or maybe even limit the amount of motor fuels produced.
So, just as an order of magnitude and to show the numbers aren't so massive in terms of global PX demand or paraxylene demand. Back in 2010, the global demand for PX was around 30 million tons for the year, of which Chinese demand was about a third or 9.8 million tons. And then last year in 2018, global demand had increased to 43.5 million tons, but of which now China was consuming 25 million of those 43.5 million tons. So, you can see that China is consuming more than half of the global PX demand and yet their production or their capacity to produce PX was far below that. And as a result, China imported last year nearly 16 million tons of PX or about a third of the global production was actually shipped into China by producers who are in the Middle East or the primary sources are from Northeast Asia, Japan, Korea, Taiwan, and then Southeast Asia as well.
Tom: And presumably then, the creation of so much petrochemical feedstock production capacity is going to have a pretty major impact on global supply-demand and trade balances.
Chuck: And margins, of course, as well because no one wants to shut down their unit just to accommodate the new Chinese production. And what remains to be seen is global operating rates for these PX units will be reduced to maybe unsustainable levels. And as margins come down, they'll be down for everyone, but the most efficient suppliers or producers will be the ones that survive. And in the case of Hengli and Rongsheng, low feedstock costs, if you're driving down the cost of paraxylene, you take the benefit on the polyester side because now you have very competitive or very low-priced feedstock.
Tom: This is a real win for them. One wonders why they didn't think of doing this sooner. Who will be first against the wall in terms of paraxylene producers? I mean, are any areas, in particular, looking weak?
Chuck: Well, clearly anyone who's not integrated downstream into PTA, which many of those Northeast Asian producers are not, will be strategically challenged. And how do they react? Do they look at somehow producing more gasoline for instance, because they're not able to achieve the values into chemicals? That could be an option. Or do they reduce capacity by shutting down a unit here and a unit there? I think the answer is all of the above. Then it will be fairly choppy between now and then. The U.S. has already shut down one of its units. Chevron in Pascagoula shut down its paraxylene production capacity earlier this year, and so we could actually see the U.S. become more and more of an importer of PX whereas 10 years ago, we were a very large exporter.
Tom: That's a really interesting point actually. Looking at it from a refining economics point of view, if you were trying to diversify your revenue stream, for example, you probably wouldn't want to increase your gasoline production. And gasoline margins in Europe are barely breaking even, they're about $4 a barrel. In China, gasoline crack spreads are actually negative. So, fine, they're self-sufficient in the paraxylene they need for weaving, but are they just... the refiners themselves, Hengli and Changxing, are they now just soaking up losses from the sales of their transport fuels? I think they may be initially, but they're not just giving their gasoline away, obviously, these refineries were conceived as viable commercial concerns. Hengli anticipates profits, I think, of around 12 billion Yuan per year from its Changxing refinery giving a payback period on that investment of around five years. And each company, interestingly enough, has a distinct marketing strategy for their transport fuel.
Rongsheng is trying to build itself into a retail brand around Shanghai and the Zhejiang area. And Hengli is trying to muscle into the wholesale market on a national level, so it's gonna be selling products across China. And in that respect, as we were discussing earlier, in fact, Rongsheng appears to have an advantage because where it's located on the East Coast of China, that region is net short still of transport fuels, but Hengli in the Northeast, that's a very competitive refining environment. It's a latecomer to an already pretty saturated market: PetroChina, a state-owned oil giant, is a huge refiner up in Northeast China with its own oil fields, so a ready-made source of low-cost crude. And it's also very close to the independent sector refining hub in Shandong Province, which is the largest concentration of refineries in China. So, I think there are definite challenges for them on the road fuel front, even if it sounds like they're going to be pretty competitively placed further downstream in the paraxylene market.
Chuck: Well, and beyond paraxylene, they are looking at...to maximize paraxylene, not to get too technical, but you wanna split the naphtha into two different qualities and the high N+A, or the heavier naphtha is what yields the most paraxylene per ton of feed. But then you're left with a lighter paraffinic naphtha, which is not particularly good to blend into gasoline. And so, therefore, both are building ethylene steam crackers using that naphtha and then taking the ethylene down into polyethylene plastics. Not strategic markets for these two players necessarily, but China also has massive deficits in terms of meeting its domestic polyethylene demand. China is the largest importer of polyethylene and polypropylene. So, these projects will help offset some of that as well. But I'm concerned, you mentioned about the road fuels and if they are making retail gasoline, one needs octane, and it's precisely the precursors to the paraxylene that are needed, you have to buy those away from the chemical sector in order to blend up to the appropriate octane level. Is there a chance that they might be able to export fuels products or is that left to maybe some of the other established refining players in China?
Tom: Well, that's one of the peculiarities of the Chinese market. As private sector companies, neither Rongsheng nor Hengli are allowed currently to export transport fuels. That's a legacy concern of the Chinese government to ensure energy self-sufficiency downstream to make sure there's adequate supply on the domestic market of those fuels. So, that is a real impediment for them. And when they ramp up production of gasoline, diesel, and jet, they are driving down domestic prices and they are essentially forcing product into the seaborne market produced by other refineries. So, in that respect, the emergence of Hengli in Northeast China on PetroChina's doorstep has created a huge new sense of competition for PetroChina in particular. And I think certainly when you look at their recent financial data, it's quite clear that they are struggling to adapt to the new environment in which it's essentially export or die, because these new, massive refineries are crushing margins inside China.
I think globally it's increasingly a competitive environment for road fuels. China is already a net exporter of over 1mn b/d combined of gasoline, diesel, and jet. It's the fastest-growing exporter of those fuels in the world. But over-supply is also percolating through into the seaborne market: Indian diesel exports are rising; everyone is trying to desperately seek out net short regions and they're having to ship product further and further overseas. And we're seeing a situation emerge now in China where these refineries are importing crude perhaps from Latin America and they're exporting finished products to those same markets from which they took the crude. It's a tricky arbitrage, one would imagine.
Chuck: And going back specifically to the Hengli and Rongsheng projects, it's interesting to note, again, going to an order of magnitude or perspective, Hengli is producing or has capacity to produce 4.5 million tons of paraxylene. And in phase one, Rongsheng will have capacity to produce 4 million tons. And I know those are just large numbers, but again, bear in mind that last year, global demand was 43.5 million. So, effectively, these two plants, they could account for 20% of global demand. Just these two projects themselves to give you an idea of just how massive they are and how impactful they can be. Impactful or disruptive, it remains to be seen.
Tom: A sign it doesn't do things by halves. Although that said, one of the interesting things they have done is essentially halved their transport fuel yields. So, where in a conventional refinery, your combined output of gasoline, diesel, and jet, those core products, might be in the region of 80%, when you look at these new refineries, they've really cut that back down to 40% or 50%. And there are new petrochemical refineries springing up, and it'll be very interesting to see how disruptive those are to the petrochemical market. But in the conventional refining market, they are, I think under pressure to do even more to reduce their exposure to already weakened gasoline and diesel markets. I mean, Shenghong — this new textile company who's starting up another massive new conventional refinery designed to produce petrochemical products in 2021, I think — they've managed to reduce that combined yield to around 30%. They've reduced that from an original blueprint.
Chuck: It's remarkable, but just a note of caution, there have been other petrochemical and refinery projects built recently in Saudi Arabia and in Malaysia, in particular, with established engineering and established chemical and refining companies. And they've had trouble meeting the targeted dates for startup and it's one thing to be mechanically complete, it's another thing to be operationally complete. But both Hengli and Rongsheng have amazed me at how fast they were able to complete these projects. And by all reports so far, they are producing very, very effectively, but it does remain to be seen why these particular projects are able to run whereas the Aramco projects in Malaysia and in Rabigh in Saudi Arabia have had much greater problems.
Tom: It sounds like in terms of their paraxylene production, they are going to be among the most competitive in the world. They have these strategies to cope with oversupplied markets and refined fuels, but there is certainly an element of political support which has enabled them to get ahead of the pack, I guess. And suddenly in China, Prime Minister Li Keqiang visited the Hengli plant shortly after it came on stream in July, and Zhejiang, the local government there is a staunch backer of Rongsheng's project. And Zhoushan is the site of a national government initiative creating oil trading and logistics hub. Beijing wants Zhoushan to overtake Singapore as a bunkering location and it's one of the INE crude futures exchanges, registered storage location. So, both of these locations in China do enjoy a lot of political support, and there are benefits to that which I think do allow them to whittle down the lead times for these mega projects.
Chuck: Exactly. And there are projects downstream as well to add additional PTA capacity to consume much of this additional paraxylene, but there will be some lag effect as well. But to the extent that both of these firms and these projects are integrated, they stand to benefit by either profiting on the PTA and the polyester, the downstream or upstream on PX depending on market conditions.
So, thank you for joining us today, and it'll be interesting to follow all of these developments because there still are so many moving parts. And you can follow this on the petroleum side with China Petroleum, the publication in which Tom edits out of London or some of our petrochemical reports. We do daily assessments on the paraxylene markets as well as monthly outlooks, which include global price forecasts. And we have databases which show supply, demand, and trade flows, etc. And then also please tune in for future episodes of the "China Connection." And we thank you for your time and attention.