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Why China's New Tax Policy Could Impact Global Oil Demand

By Ellen R. Wald, Ph.D.CommoditiesJul 18, 2018 05:01AM ET
www.investing.com/analysis/heres-how-new-tax-policy-could-impact-chinese-oil-demand-through-to-2019-200331487
Why China's New Tax Policy Could Impact Global Oil Demand
By Ellen R. Wald, Ph.D.   |  Jul 18, 2018 05:01AM ET
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Maybe Chinese oil demand projections are more complicated than most media are telling us.

China was a key source of demand throughout the oil price downturn. The country’s reported economic data helped convince market watchers that China would keep buying oil for consumption and for its strategic petroleum reserves. China’s small, independent refineries were permitted by the government to purchase certain quotas of crude oil on the open market. In addition to the massive amounts purchased for state-owned refineries, demand from these refineries was easy to forecast because of the biannual permit process.

Now, there are several important changes that could impact Chinese oil demand for the rest of 2018 and into 2019, and, by association, oil prices. These are issues that will not be reflected in the basic economic data China reports and may not turn up in major headlines.

The most obvious change has been an increase in crude oil prices. The price of the Brent benchmark has risen more than 5% since January 2018 and this has cut into the margins that independent Chinese refiners have been making on their products.

Next, the Chinese government recently instituted new tax rules that require independent refineries to pay a consumption tax of $38 per barrel of gasoline and $29 per barrel of diesel. This will have a serious impact on profits.

These factors have pushed many of the independent refineries in China to switch to fuel oil instead of crude oil. The refineries can make better margins processing fuel oil than crude oil because they are able to deduct the tax when they sell their refined products later.

However, there are still added costs of purchasing fuel oil instead of crude oil and this has resulted in a decrease in refinery runs in recent months. According to a survey from a Chinese consultancy, independent refiners in China operated at about 63% of their total capacity in May.

Chinese economic data may also be obscuring the challenges facing Chinese independent refineries. Official data showed that Chinese refinery runs rose 8% in June as compared to last year and increased by 1.5% from the previous month. However, the gains came from Chinese state-owned refineries and overshadowed the losses from independent refiners, according to an analysis from Reuters.

The Chinese government actually raised the crude oil import quotas for independent refineries last week, but it seems unlikely that refineries will use up their quotas in 2018. Unless China retracts its tax policy, global markets could lose an important source of crude oil demand. However, there are some creative solutions these refineries could pursue to increase their margins even with higher oil prices and higher taxes.

One avenue is to increase purchases of Iranian oil that Iran is offering at discounted prices. Chinese independent refiners were some of the first to begin purchasing cargoes of Iranian oil after the UN sanctions regime ended in 2016. Iran also targeted these refineries specifically as a way to regain customers.

Chinese state-owned refineries have long-term contracts with China’s largest oil suppliers—Saudi Arabia and Russia—but its independent refineries have helped make China the largest purchaser of Iranian oil. These refineries could try to get around U.S. sanctions by working through the single Chinese banking institution that has defied U.S. sanctions on Iran previously—the Bank of Kunlun—to purchase crude oil at significant discounts from market rates. If this avenue is successful, we could actually see an increase in the amount of Iranian oil China is purchasing as sanctions go into effect.

However, those Chinese purchases of Iranian oil may not have much impact on the global oil market for a few reasons:

  1. The refineries might not purchase from anyone else if not from Iran, so the purchases may not displace any other purchases,
  2. That oil might not go anywhere else if not to these Chinese refineries, so it is not really on the open market, and
  3. The oil would be sold at a significant discount below the global prices.

Chinese oil demand plays a significant part of global oil demand but market watchers should be aware that the basic data offered from China often does not tell the entire story.

Why China's New Tax Policy Could Impact Global Oil Demand
 

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Why China's New Tax Policy Could Impact Global Oil Demand

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Jay Unni
Jay Unni Sep 02, 2018 4:31PM ET
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It seems this is a negative for oil prices, as Iran will be taking a hit on lower oil prices, and fulfilling all excess Chinese demand.
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Aug 23, 2018 3:16AM ET
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Check it and
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abhishek das
abhishek das Jul 21, 2018 3:19PM ET
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Insightful and thought provoking analysis.
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inderjeet virk
inderjeet virk Jul 18, 2018 11:21AM ET
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despite the oil market in deficit mr trump will keep the oil market in check till November 4 by twitting
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