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Independent oil refiners in China, in mounting competition with state-owned firms, are plotting their reinvention in the face of disruption.

China’s crude oil refining sector has undergone major changes in the past year, particularly impacting the country’s smaller-scale independent players, known as “teapots”. As of 2016, teapot oil refineries are prohibited from exporting their oil products, putting them at what could be an insurmountable disadvantage. State-owned rivals now control diesel and gasoline exports, tying independent refineries’ fortunes to the domestic market. Further complicating matters, and squeezing margins, the government has been changing policies and imposing new taxes on teapots.

Domestic expansion is less and less of an option in the current climate, as China’s annual fuel demand growth dropped to a three-year low in 2016. “The good days won't last much longer, as China’s oil demand has been shrinking”, said Zhang Liucheng, Vice President of China’s largest independent refiner, Shandong Dongming Petrochemical Group.

The most viable solution is to broadly diversify, and independents are doing just that. “They had already been diversified and nimble at working around the various government they are definitely looking for ways to step up their game and have better people, global access and financing to do so”, said Michal Meidan, an analyst at Energy Aspects, a consultancy.

Oil executives at some of China’s top independent refiners outlined their strategies to Reuters: Dongming plans to extend its business from transportation fuels to plastics and synthetic rubber, as well as fine chemicals and possibly small-scale onshore fields, said Zhang. Another factor in the survival equation for independent refiners is to expand trading operations. To this end, Zhang wants to combine physical oil and gas trading with financial services, perhaps extending lower-interest credit to fellow teapots. Shandong Haike Group, in keeping with Beijing’s heightening clean energy priorities, said it will open a factory that makes electrolytes used in lithium batteries for electric vehicles. Shandong Chambroad Group is looking at lumber processing, Chairman Ma Yunsheng said.

For some independent refiners, diversification is seen as an opportunity to grow from a local company into a global one. The first teapot to own a refinery abroad, Shandong Hengyuan Petrochemical “wants to become a regional player, combining assets at its home base in Shandong with the refinery in Port Dickson, Malaysia, that it recently acquired from Shell”, Reuters reports. The expansion will entail establishing a trading desk in Kuala Lumpur to secure crude for the two plants. “Without differentiating yourself, the competition will be tough”, Hengyuan Chairman Wang Youde concludes.

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