Improving Transport Fuel Quality in China: Implications for the Refining Sector

The costs we calculate for reformulating Chinese gasoline and diesel to EURO standards ranges from 2.8 to 3.2 cents per gallon inclusive in 2005, 4.04 cents per gallon in 2008 and around 4.7 cents per gallon in 2010. By European and US standards, these costs are well within acceptable parameters, but we also must acknowledge that per-capita GDP is substantially lower in China than in the developed OECD countries. Again, these costs are based on equipment expansion costs and may be 25-50% higher if offsites, labor and other costs are included.

Given China's well-developed refinery base, the model shows that it would be least expensive for China to follow the "US Gulf Coast" model of investing in significant upgrading and hydrotreating capacity to allow the processing of the cheaper and lower quality crudes available in the market. Indeed, it is likely that the refinery configuration developed in the 2005 and 2010 scenarios would allow the processing of even heavier and lower quality—and cheaper—crude oils than the slate offered in the model. Compared to China's current situation, however, increasing product quality, and particularly reducing allowable sulfur content, will require significant investment in pretreatment units, either feed hydrofining units as was the focus of the 2005 results, or resid desulfurization units in the 2010 scenarios.

In general, mixed standards in which the major urban areas adopted stricter standards that the rest of the country were somewhat cheaper to achieve than a single standard nation-wide. This is particularly pronounced in the 2005 results, in which achieving Euro 3 or Euro 4 standards in the major urban areas representing 35% of total demand was some $50 million a year cheaper than going to Euro 3 standards nationwide. By 2010, however, the need for new capacity to achieve much higher product quality and to supply the additional demand reduces these differences. The costs of achieving Euro 3 standards nation-wide in 2010 barely differs from the costs of implementing Euro 4 (35%) or Euro 5 (15%) while the rest of the country met Euro 3 standards.

As mentioned earlier, the value of modeling exercises such as this one is in comparing scenario results to each other instead of in forecasting of exact investment directions or costs. Moreover, the model seeks the least-costly way to achieve the demand and quality requirements of each scenario, but alternatives do exist. Given numerous competing investment requirements that the Chinese oil companies face (particularly in expanding petrochemical production), it is possible to defer some of the near-term capital equipment investment in refining by judiciously selecting a slate of higher quality import crudes, taking advantage of the quality of the raw material instead of the capacity to upgrade lower-quality feed. Although this may reduce the equipment expenditures in the near term, it is likely that total system costs (borne by different entities, including consumers) would be higher than that described in the scenario results.

Aside from the volume and composition of the crude slate, the general product trade pattern does not shift substantially as a result of the various upgrading scenarios. Currently, China is highly import-dependent on LPG and fuel oil, and the high levels of LPG imports continues in all future scenarios. Similarly, until recently, China required supplemental imports of naphtha for its petrochemical industry; as demand for feedstock continues to grow strongly, imports of naphtha appear again in the 2010 scenarios. The only major shift in trading patterns is a moderate volume of diesel exports in the 2010 scenarios. Although China has been a large importer of diesel fuel in the past, the types of upgrading units necessary for improving product quality (such as hydrocracking) also increase product yields for diesel. Nonetheless, at around 125,000 b/d, these export volumes are not very large.