China’s clean-energy planners take aim at its $7B high-sulfur oil market

Bloomberg News 3/18/2021
China is considering curbing its thirst for dirty oil by updating tax structures.
China is considering curbing its thirst for dirty oil by updating tax structures.

(Bloomberg) - One of the fastest-growing corners of China’s energy market is facing a potentially devastating blow as Xi Jinping’s government increases scrutiny of high-emission fuels.

Chinese regulators are considering a new tax on imports of so-called light-cycle oil, a low-quality petroleum product that’s blended into diesel and fuel oil, and have asked energy companies and government agencies to provide feedback on a draft plan, people with knowledge of the matter said. The levy could take effect as soon as the first half of 2021 if approved, the people said.

Taxing LCO imports would upend the economics of a market that ballooned to $7 billion last year from almost nothing in 2014. Demand has soared in part because LCO’s exemption from China’s fuel consumption tax means it can be used to make diesel and fuel oil at cheaper prices than those charged by state-owned Chinese refiners including Sinopec and PetroChina.

LCO imports -- mostly from South Korean suppliers like SK Innovation and GS Caltex -- hit a record in 2020 as China ramped up construction and industrial production to revive its Covid-battered economy, stoking demand for diesel and other fuels.

While Chinese refiners have long lobbied for an end to the LCO tax exemption, their pleas are gaining more traction after Xi vowed in September that China would become carbon neutral by 2060. Emissions from LCO consumption are larger than standard diesel products because of the oil’s higher sulfur content, density and carbon residue.

China’s Ministry of Finance and General Administration of Customs didn’t reply to faxed requests for comment.

LCO is currently exempt from fuel consumption tax because it’s considered a petrochemical feedstock, not a finished fuel. Extending taxes for gasoline and diesel to oil-products known as blendstocks -- such as LCO and mixed aromatics -- was proposed by a Sinopec official during the annual Chinese congress meeting this month.

Uncertainty over whether that will change has caused some importers to temporarily halt LCO orders, according to FGE, a London-based energy consultancy. Overall imports will probably slip from as much as 450,000 barrels per day -- or about two million tons a month -- at the end of last year to as little as 300,000 in March and April, before recovering in the middle of 2021 due to seasonal factors, FGE said in a March 16 report.

But other importers may decide to accelerate LCO orders to build up inventories before any tax comes into effect, said Michal Meidan​, director of the China Energy Programme at the Oxford Institute for Energy Studies. Imports have historically been dominated by independent refiners known as “teapots” as well as small fuel distributors in eastern and southern China, though some state-owned refiners have also been known to buy.

Applying China’s existing fuel consumption tax to LCO imports would raise the cost by more than $200 per ton, making them less attractive relative to alternative diesel feedstocks.

LCO’s impact on pollution levels was one factor behind the tax proposal, in addition to lobbying from state-owned refiners, said the people familiar, who asked not to be identified discussing private information. The draft proposal has received support from refiners, but some government officials have raised concerns over the complexities involved in changing customs codes and taxation categories, the people said.

The proposal is also likely to face resistances from end-users of LCO-blended fuel, who would face higher costs for powering everything from fishing ships and barges to construction and agricultural machinery.

While some observers are skeptical of China’s emissions pledges, the country’s top leaders have vowed to make the fight against climate change a priority despite the potential short-term economic drag. Speaking at China’s most important political event of the year last week, Premier Li Keqiang said the world’s biggest energy user and polluter plans to reduce carbon emissions per unit of gross domestic product by 18% through 2025 and cut energy use per unit of GDP by 13.5%.

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