TOKYO -- A looming consolidation of China's independent oil refineries, known as "teapots," is raising fears of an export surge that could hit already sagging Asian prices.
Seven out of nearly 30 teapots concentrated mainly in the eastern province of Shandong are expected to be melded into one group, according to a local report published in early September. The long-term goal, the report said, is to develop a single competitive brand and increase the number of gas stations.
A similar move is apparently afoot in the central province of Zhejiang.
The consolidation drive comes as the government tightens controls on businesses that produce low-quality products or dodge taxes. A number of teapots have been implicated. Under the circumstances, some of the more powerful players appear to be seeking a realignment that would give them more clout with the authorities.
Teapots' production increases have already pushed down domestic prices and spurred export growth. In turn, this has applied downward pressure on the Asian market.
The same thing may happen if the industry consolidation makes the remaining companies more competitive. This could further dent the profits of Japanese and South Korean oil distributors handling Asia-bound exports.
The term "teapot" apparently stems from the fact that these players are dwarfed by China's big three state-owned majors, such as CNOOC.
The teapots emerged in the 1970s, following the discovery of domestic oil fields. Their business centered on using imported heavy oils and domestically extracted crude to make petroleum products. But in 2015, the government granted them crude import quotas -- previously the preserve of the three state companies. The idea was to introduce competition to the oil market.
Refineries that meet certain criteria are allowed to import crude on their own. Trade statistics show that China's crude imports reached 38 million tons in 2016, up from 30 million tons in 2014.
In recent years, the number of teapots has swelled to more than 100, accounting for about 30% of domestic crude oil processing volume last year. Although their capacity varies, major refineries can handle as many as 150,000 barrels a day -- on a par with refineries owned by large Japanese players like JXTG Nippon Oil & Energy and Idemitsu Kosan.
Teapots have been supplying large quantities of gasoline and other products in China, capitalizing on rising demand. The flexibility of private management -- including low labor costs -- seems to be helping them to undercut their state rivals.
The price war has been felt beyond China's borders.
The state companies have increased exports to maintain market conditions, driving down petroleum product prices in Asia. On the benchmark Singapore market, the margin after deducting crude prices from gasoline product prices was around $7 per barrel from July to August, down from around $20 in January 2016. This has eaten away at the profits of Japanese and South Korean distributors.
If the realignment goes ahead, the joint operation of oil tankers and integration of aging refineries are likely to lower refining costs. This will enhance the teapots' price competitiveness, possibly forcing state-owned companies to rely more on exports.
"Exports will temporarily increase until the less competitive state-owned oil companies reduce their capacity, which could become a destabilizing factor for the Asian market," said Takayuki Nogami, chief economist at Japan Oil, Gas and Metals National Corp.
Another possible trigger for increased exports from China: The expansion of infrastructure investment ahead of the twice-a-decade Communist Party congress, which starts next Wednesday, has been underpinning petroleum product consumption. If this momentum wanes, the ensuing glut could spur more exports.