Global Oil Demand Set to Tumble as China Cracks Down on Teapot Refiners

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Needless to say, for price purposes, a 400,000 bpd drop in global demand is the equivalent of a 400,000 bpd production surplus by OPEC or non-OPEC sources, certainly when it comes to price.

The importance of teapots to what remains a market mired in excess OPEC oversupply, was highlighted earlier this year when one of them purchased a spot cargo from Saudi Arabia, which broke from its usual policy of selling only under long-term contracts. Iran’s state-run oil company is said to be in talks to sell more crude to Trafigura in a strategy that may help it break into the market to supply the independent refiners.

If and when a substantial number of teapots are suddenly put offline by the government, both Saudi Arabia and Iran will scramble to find alternative buyers. To do that, they will have to offer generous price concession.

Among the notable losers from a teapot crackdown would be the independent commodity companies, such as Vitol, Glencore and Trafigura who have generated substantial profits shipping oil from the middle east to these sources of demand. As Chin Hwee Tan, the CEO for Asia-Pacific at Trafigura, said “the advent of the Chinese private refiners as major buyers of crude and exporters of product has been the biggest change in the market since the shale revolution. We’re doing significant business with them.”

Finally, it’s not just taxes: teapots face other headwinds including port and pipeline infrastructure not developing as fast as oil purchases. Chinese imports are also at risk of slowing because of ship traffic and lack of storage capacity. Concern about creditworthiness and lack of experience in international trade are also challenges. Slowing refining profits have forced cuts in processing rates, while the implementation of higher fuel-quality standards could force some of them to shut.

To be sre, some remain optimistic, such as BP, according to Andy Milnes, BP’s CEO of integrated supply and trading for the Eastern Hemisphere. Shandong Dongming last year got crude from the company as part of a long-term supply contract.

In spite of China’s clampdown, the government is still working toward “liberalizing oil markets, and would continue to encourage the operations of independent refiners,” according to Unipec’s Wang. “Many of them perhaps account for 70 to 80 percent of tax revenue in their cities, so the local government will want to keep them alive.” However, if there is one thing that is certain about Chinese “liberalization” reforms it is that things are certain to get much worse before, and if, they ever get better, once the government starts micromanaging every aspect of yet another formerly independent industry’s transition.

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That covers the demand side of the equation. As for the supply side, the store is well-known. As the following chart reveals, most OPEC members are producing more oil now than they were in January, or at any time during the past year.

To summarize: OPEC oil production near record and rising, shale slowly returning on line with every weekly increase in Baker Hughes oil rigs, while demand is about to see a sharp drop due to either China’s SPR nearing capacity, or the crackdown on teapots that is about to cut Chinese demand by as much as nearly half a million in barrels. How this will impact price, we leave to the central bankers to figure out, whose only recourse may be to start buying commodities in the open market, in addition to bonds and stocks, thus nationalizing yet another market.

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