China's Private Oil Companies Struggle Against SOEs With New Tax Policy from Beijing
Independent oil refineries import and process almost a fifth of the 9.57 million barrels of crude oil that China brings in daily. But that profitable corner of the world's largest oil importer is now squirming under new tax policies that Beijing hopes will slim down the competition to state-owned refineries.
The number of private refineries in China has shrunk massively over the past two decades, as state-owned Sinopec and China National Petroleum Corporation (CNPC) have grown. From more than 200 private refineries in 1995 to less than 20 today, the market has seen increased mergers and closures of China's "teapots"--as independent refineries are often called, for their ramshackle appearance compared to the state's fully integrated facilities.
A new consumption tax of $38 per barrel on gasoline and $29 on diesel was announced earlier this year, beginning March 1. And by last month, teapot refineries were already showing signs of stress. Some began imports of "straight-run fuel oil," the residue left over from crude oil distillation, which can be used to cushion the refineries' margins.
Haike Petrochemical's general manager, Xu Yuan, told Reuters that the new tax rates and stricter enforcement will see plants fold outright, without the chance to merge.
Meanwhile, other refineries in Asia will feel relief from fewer exports from Chinese refineries. And China's state-owned oil companies Sinopec and CNPC, which own internationally traded subsidiaries Sinopec Corp. and PetroChina, will enjoy a greater share of the market.
The tax hikes came with a series of administrative reforms that will close loopholes that had long buoyed the teapot refineries, who struggled to compete with the better equipped national oil companies before 2015. The independent companies were not licensed to import crude oil directly, and bought it from state-owned companies, whom they often sold the refined product back to.
The teapots weren't particularly profitable, and exploited tax loopholes to stay afloat. Different oil products incur different import duties and consumption tax rates. By mislabeling or mixing imports, companies could avoid taxes. A new invoicing system, however, tracks the history of an import using product codes.
The independent refineries' profits have soared since 2015, however, when the central government began licensing companies to import crude directly. Within the year, state-owned companies began to complain that the competition was uneven. Tax-evasive practices meant that, according to one PetroChina general manager, independent refineries paid almost half the tax rate as state-owned groups.
Previous efforts to crack down on tax evasion have failed. The consumption tax was administered by the provincial governments, but the funds went to the central government. Teapots enjoyed protection from local governments, who valued employment and tax profits over the consumption tax.
This March, however, the tax policy rewrite removed provincial governments from the equation. The independent refineries, like Haike Petrochemical, Hengli Petrochemical and China Oil HBP Group, which previously relied on finding protection and loopholes, must now specialize in hedging their margins to remain profitable.
Sinopec, on the other hand, announced in March of last year that it would increase spending on exploration for new oil deposits by $2.67 billion compared to 2016.
Requests for comment from Hengli Petrochemical and China Oil HBP Group were not returned at the time of publication, and as of yet have not made any public statements about the new tax policy.
"Beijing created a new country's worth of oil imports when it granted [teapots] the right to directly access imported crude," Dr. Erica Downs, a Fellow at the Center on Global Energy Policy, wrote in 2017.
The independent refineries themselves would have accounted for the seventh-largest importer in the world. China's independent refineries raise crude oil imports and refined exports and depress profit margins around Asia . In 2016 and 2017, the main destinations for China's refined oil product exports were Singapore, Hong Kong, the Philippines, Bangladesh, Australia and South Korea. Fewer imports from independent refineries means fewer exports of surplus product, particularly diesel fuel, around the Asian market.
The Chinese government had long sought to eradicate teapot refineries, for the better part of the past 20 years. But the new 2015 licensing for crude oil imports showed a new turn. Analysts, like Dr. Downs, saw the Xi Jinping administration try to push competition in the market, forcing state-owned companies to tighten up and run more efficiently.
And earlier this year, Hengli won approval to import 400,000 barrels of crude oil per day, the largest quota ever granted. But the new tax laws have ended the golden era for independent refineries, ensuring that their profits remain inside import tax law. And so long as the independent refineries are able to stay afloat, the new crackdown increases profits for the national oil companies Sinopec and CNPC, who can enjoy supportive policies and non-threatening competition.