China Car Fever Lifting Gasoline Use Seen as Root of Diesel Glut

China’s love of cars and the gasoline that runs them is exacerbating an oversupply in another fuel decried by refiners across Asia, according to Bank of China International.

While refineries in the world’s biggest auto market process more oil to feed demand for motor fuel, they also end up producing diesel, which is being used less because of shrinking Chinese industrial activity, Xiao Fu, head of commodity markets strategy at the bank, said in an interview. Amid this “product mismatch,” excess gasoil is being shipped overseas, flooding regional markets and affecting profit margins, according to Fu.

Unlike China’s bloated coal and steel industries, refineries have so far been spared from President Xi Jinping’s drive to cut industrial overcapacity, with oil processing rising to a record last year and capacity seen expanding in coming years. That’s being driven by demand for gasoline on surging vehicle sales, which the state-backed China Association of Automobile Manufacturers predicts will gain about 6 percent this year, faster than the 4.7 percent pace in 2015.

“Gasoline demand in China is getting very strong and it’s a function of people driving different cars, like you and I having more money and buying nicer cars,” Fu said on Thursday in Singapore. “As China has its infrastructure set up to produce a lot more distillates such as diesel, when it makes more gasoline, it ends up having to export more distillates that would affect regional markets further.”

Gasoline Demand

China’s demand for gasoline will probably jump 6.8 percent a year in the 2015-2021 period, with the nation’s vehicle fleet expanding almost 10 percent annually, the International Energy Agency said in a report last month. Meanwhile, the slowest economic growth in more than two decades is slowing factory activity and reducing domestic diesel consumption. Industrial production rose 5.4 percent in the first two months of 2016 from a year before, the weakest reading since 2009.

The Economics & Technology Research Institute of China National Petroleum Corp., the nation’s biggest energy company, predicts that the country’s annual refining capacity may expand by 16.4 percent in the five years to 2020, with diesel making up 90 percent of the fuel surplus by then.

After China exported a record amount of diesel last year, profits from making gasoil in Asia slumped to $7.53 a barrel at the end of January, the lowest level since at least 2010.

Teapot Purchases

China’s demand for crude will grow as the nation’s independent refiners, known as teapots, purchase more supplies from overseas after the government eased import rules for the processors, according to Fu. Shipments will also be boosted by the country’s drive to fill strategic petroleum reserves in the world’s second-biggest oil consumer.

A total of 23 teapots have applied for crude-import quotas so far, of which 12 were granted annual licenses with a combined capacity of 51.39 million metric tons. Operating rates at the refineries clustered in the eastern Shandong province climbed earlier this year to the highest level since at least 2011, data from industry website Oilchem.net show.

“Higher refinery capacity could provide incentives for China to import more crude,” said Fu. Importing crude will help teapots improve the Yield of products from processing, compared with when they operated at lower rates by using fuel oil as feedstock, she said, adding that the building of strategic reserves will provide the “additional kicker” for imports.

China may start four new strategic petroleum reserve sites this year, augmenting its existing eight, as part of its ultimate goal of stockpiling enough oil to cover 100 days worth of imports by 2020. The country held about 29 days of supply as of the middle of 2015, according to Bloomberg calculations based on National Bureau of Statistics data. China in February bought about 8.04 million barrels a day of crude, the highest daily average on record.

To contact the reporters on this story: Serene Cheong in Singapore at scheong20@bloomberg.net, Sharon Cho in Singapore at ccho28@bloomberg.net. To contact the editors responsible for this story: Pratish Narayanan at pnarayanan9@bloomberg.net, Ovais Subhani

By: Serene Cheong and Sharon Cho

©2016 Bloomberg News