ANALYSIS: New China Tax on MTBE, Aromatics to Raise Blended Gasoline Costs

The Chinese government's latest move to combat tax evasion by imposing a consumption tax on MTBE and aromatics is likely to raise gasoline blending costs and make imports of finished gasoline relatively more cost-effective, industry sources said this week.

China's State Administration of Taxation in mid-November announced a series of measures to take effect January 1, 2013, which include levying consumption tax on certain petroleum products that were previously exempted as well as requiring inspection certificates for those claiming exemption.

Specifically, the tax authority's notice of November 15 for the first time puts MTBE and aromatics in the list of products liable for consumption tax. The tax will be the same as the current rate on naphtha, which is Yuan 1,385/mt ($220/mt), or Yuan 1/liter.

MTBE and aromatics, commonly blended into gasoline to raise its octane level, are currently not subject to consumption tax. China exempts naphtha derivatives from consumption tax as a measure designed to encourage the petrochemicals industry and allow producers to recoup the consumption tax levied on naphtha.

Under the new rules, the exemption is being withdrawn for MTBE and aromatics sold for gasoline blending. Products obtained from naphtha that go into petrochemicals manufacturing will continue to enjoy exemption from consumption tax.

China's consumption tax is imposed on entities and individuals engaged in the production, processing or importing of taxable consumer goods.

BLENDED GASOLINE LESS ECONOMIC

Gasoline blenders in China usually buy MTBE and aromatics to blend with off-spec gasoline and naphtha, in order to raise its octane number.

"With MTBE and aromatics being taxed according to the new rules, the cost of blending gasoline will increase by about Yuan 648/mt," said a trader. That calculation is based on a typical ratio of 0.4 mt of MTBE and aromatics used to produce 1 mt of gasoline.

The Yuan 1,385/mt consumption tax, once added to the value of the blended gasoline, would also lead to a corresponding Yuan 235/mt rise in the value-added tax or VAT payable on it, which is levied at a rate of 17% of the product value. That implies a total Yuan 648/mt in incremental cost in the production of blended gasoline.

The bulk of gasoline supplied in China's domestic market--85-90%--is the finished product from state-owned refiners. About 10-15% of the supply comes from blenders and "teapot" refiners, sources said.

The teapot refineries, which are small-scale plants with little or no secondary processing capacity, typically process imported crudes and fuel oil to produce mostly gasoil and gasoline for sale in the domestic market. But due to their limited processing ability and poor quality feedstock, the gasoline produced needs to be blended with MTBE or aromatics in order to meet the national fuel standards.

The additional Yuan 648/mt tax incurred in the production of blended gasoline would put it on a par with or even higher than the cost of standard gasoline produced by the state refiners, the consumption tax on which remains unchanged at Yuan 1,388/mt, sources said.

On November 30, the price of National III standard 93 RON gasoline was around Yuan 9,000-9,100/mt, while the blended gasoline of the same standard fetched Yuan 8,400-8,500/mt, translating to a spread of Yuan 600/mt.

"If blended gasoline no longer has a price advantage compared with the barrels produced by the state-owned refineries, private gas stations may prefer to buy the better quality product from the state-owned refineries," said a trader of blended gasoline in Guangdong. "Eventually, demand for blended gasoline will be squeezed," he added.

Private-owned gas stations, which account for 25-30% of China's state sector-dominated retail network, are major buyers of blended gasoline. Sinopec and PetroChina's gas stations sell gasoline allocated from the group refineries.

The higher cost of blended gasoline will narrow the margins of the private gas stations and also raise gasoline retail prices, sources said.

OIL MAJORS MAY RAMP UP PRODUCTION OR CUT EXPORTS

If blended gasoline volumes in the domestic market shrink, the state-owned majors will have to plug the supply gap by stepping up production or cutting back exports.

"The production of blended gasoline is expected to grow by 5% roughly from 2011 to above 10 million mt this year, which accounts for about 10-15% of the total gasoline supply," said an analyst from Beijing-based energy information provider JYD Commodities Hub.

There could be a big gap in the country's gasoline supply if blended gasoline availability declines while demand continues to rise, sources said.

Chinese consumption of gasoline over the January-October period this year rose 11.3% from the first 10 months of 2011 to 70.9 million mt, according to Platts calculations based on official data released by the government.

Investment bank JP Morgan in August estimated Chinese gasoline demand could rise by about 12% in 2013.

Among the measures to increase supply, "the state-owned refineries could raise the yield ratio of gasoline... There are also new refineries coming on stream," the analyst added.

China could see more than 1 million b/d of new refining capacity coming online this year and in 2013, which could also help boost gasoline production.

"Besides increasing output, China could also export less gasoline in order to meet the domestic demand," said the analyst.

Statistics from China's customs department show the country exported 2.34 million mt of gasoline in the first ten months of this year. China is a net exporter of gasoline.

IMPORTS MAY LOOK GOOD

Meanwhile, costlier domestically blended gasoline would also likely narrow the price spread with Singapore-origin gasoline, opening up more import arbitrage opportunities, sources said.

The cost of Singapore-origin 92 RON gasoline imported into southern China's Huangpu port was estimated at around Yuan 9,100/mt inclusive of all taxes, based on Platts assessments November 30, while the spot price of domestically produced National III standard 93 RON gasoline with similar specifications was around Yuan 9,000-9,100/mt in Huangpu.

"There is no price gap between Singapore [prices] and domestic barrels currently. So we believe there will be more interest in importing gasoline when the blending costs rise next year," said a Guangdong-based gasoline blender.

Only state-owned companies such as Sinopec, PetroChina, CNOOC and SinoChem have the right to import gasoline into China.

"Private companies could turn to those state-owned companies and ask them to import gasoline on their behalf," the blender added.

Chinese imports of gasoline registered a big jump this year. The country imported 4,509 mt of gasoline during the January-October period, compared with just 141 mt over the same period a year ago, the latest statistics from China customs showed.