China's independent refineries are ramping up imports of discounted fuel oil blended from Russian barrels to use as low-cost feedstock amid a shortage of government crude oil import quotas for some of them, according to trade sources and data.
Western sanctions over Russia, including the looming Feb. 5 embargo and price cap on refined products, have been pushing Russian fuel oil barrels eastward into Asia at attractive discounts since last year.
These have been flooding the ship-to-ship transfer hubs of Malaysia and United Arab Emirates' Fujairah since the second quarter of 2022. Traders blend these barrels with other oils to rebrand the fuel oil's country of origin, clearing the way for ship insurance and financing that would otherwise be banned under the sanctions, trade sources said.
Discounts offered on these fuel oil cargoes help to improve margins at Chinese independent refiners and replace crude that some companies are unable to import without quotas, the sources said. The trade also provides a way to get Russian oil to market and bring much-needed export earnings to Moscow.
"We've been looking at Russian fuel oil since December. It is cheap and does not require (crude) import quotas," said an executive with an independent refiner in eastern Shandong province.
The refiner has not received any government crude quotas for the past year or so and buys mostly straight-run fuel oil to produce diesel and gasoline, said the executive, who declined to be identified as he was not authorised to speak to the media.
These blended fuel oil barrels were last traded at about a $5 discount to benchmark crude ICE Brent on a delivered Shandong basis, said one source.
High-sulphur fuel oil values relative to crude have plunged into deeper discounts since the second quarter last year, with cracks hitting record lows at end-October.
China's total fuel oil imports surged to about 1.76 million tonnes in December, highest since September 2021, official customs data showed.
The uptick was driven by a surge in shipments from Malaysia to more than a one-year high at 620,000 tonnes, while monthly imports from UAE rose to 471,000 tonnes, highest in two years.
Meanwhile, direct imports of fuel oil from Russia slipped to 187,000 tonnes in December after peaking at 554,000 tonnes in October, even as total imports from Russia more than doubled year-on-year to 3.1 million tonnes in 2022.
"The deep discounts offered are driving the trend as independent refiners are price sensitive. China is still recovering, with domestic demand for refined fuels uncertain," said Emril Jamil, Refinitiv's senior analyst for crude and fuel oil.
"The trend will continue with the EU ban (on Feb. 5), with all natural outlets in Europe closed. Asia will continue to soak up cheaper Russian (fuel oil) barrels on top of crude," Jamil said.
Western trading houses have been the main suppliers of these fuel oil shipments to China, said four senior trading sources, who closely track the flows, adding that the elevated December levels will extend through February and beyond.
One of the top suppliers channelling these barrels to China is Swiss-based trader Vitol, they said.
Over the last four months, Brilliant Jewel, a floating storage facility chartered by Vitol, conducted ship-to-ship transfer operations with at least six vessels that previously loaded fuel at Russian ports, a Reuters analysis of shipping data on Refinitiv Eikon showed.
A second Chinese fuel oil trader said companies have become more relaxed in dealing with Russian barrels after initial confusion over the Group of Seven price cap and the potential risk of running afoul of sanctions.
"Initially the market took a wait-and-see stance before Dec. 5, but now many traders are moving fuel oil from these two hubs, with the top western traders being the more active," said the trader.
Leading Chinese bunker suppliers and traders like Sinopec and PetroChina's Chimbusco have also been sending more Russian high-sulphur fuel oil to bunkering hubs in eastern China's Zhoushan and Qingdao, sources said.
Shipping records show the companies have chartered several fuel oil shipments from Malaysia's Tanjung Pelepas port to Zhoushan and Hong Kong over the last four months.