Chinese Economy - Progress on Strategic Petroleum Reserve for Chin

Chinese Economy - Progress on Strategic Petroleum Reserve for Chin
G7 Group, Aug 29, 2006

China is in the process of building extensive storage capacity for a strategic petroleum reserve (SPR). The capacity goal is 90 days of net import volume, which is about 400 million barrels, but this is a long run target. China has not yet begun to fill the reserve (although it plans to start before year end), and the rate at which it supplies the reserve is dependent on petroleum prices. Large purchases of oil from the international market for the SPR are unlikely anytime soon unless the oil price drops significantly (say to under $60 a barrel). What is behind this effort?

Soaring oil prices combined with China’s increasing dependence on imported oil products have spurred the government to expedite the pace of building its strategic petroleum reserve. The purpose is to secure oil reserves in case of a supply shock and to cushion against the impact of oil price on China’s economic growth. China is aware that in the absence of a petroleum reserve it is increasingly susceptible to economic sanctions triggered by international conflicts and general supply interruptions. Currently, China's commercial petroleum storage can only meet the nation's consumption needs for 21.6 days, compared with about 160 days for the US and Japan. At what stage is the overall SPR project?

- Four reserve bases are currently under construction: Two at Zhenhai and Daishan in Zhejiang province, one at Huangdao in Shandong province, and one at Dalian in Liaoning province.

- After these four bases are put into operation in 2008, China’s total petroleum storage (including existing commercial storage) will be able to satisfy the nation’s 30 days consumption. The NDRC recently disclosed that all 52 oil storage tanks (16 of them already completed in October 2005) at the Zhenhai oil reserve base, the largest among the four, will be completed for use by the end of October this year. The total capacity of storage is
5.2 million cubic meters. The other reserve bases are expected to be completed in 2007-2008.

- But China’s buildup will go further than this. When the whole project is completed, China expects to have petroleum storage capacity of 400 million barrels, or equivalent to about 90 days of net import volume. The government is already starting to select the new sites for the second phase of the SPR. And after that, additional sites are expected to be built in the hinterland of the country (Phase Three). Total planned storage of strategic petroleum is 10-12 million tons during Phase One; 28 million tons at the end of Phase Two; and another 28 million tons at the end of Phase Three.

China plans to start filling the SPR this year, but it is expected to take a long time to complete. Some of the newly-found oilfield output is likely to be incorporated into the SPR; however, China is unlikely to choose this time to import large additional amounts of petroleum to build the SPR, because it does not recognize the current oil price as a good deal.

Moreover, the country’s new oil windfall tax does not encourage additional imports. Domestic oil producers will be charged a tax of 20% or higher when the price of crude oil stays above US$40 a barrel. The tax rate is 40% when the price rises above US$60 per barrel, which is indicative of how the policymakers perceive oil prices. Hence we may expect that the filling of China’s SPR to be a gradual process.

Large purchases of oil from the international market are unlikely at this point and may remain so unless the price of price drops significant (say, to under $60 a barrel). Obviously, this price point estimate is based on a current assessment of the likelihood of supply interruptions. If the geo-political environment becomes more risky for oil supply, the pace of supplying the SPR can change.

Bottom Line: China is building capacity for an ambitious SPR. But it is not filling the capacity yet and when it starts -- probably later this year-- it will not do so aggressively, given the high price of imported oil. The capacity building will take at least several more years, and filling will obviously take longer, perhaps much longer.