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Conclusion
Asian refining margin backed by diesel strength climbed to more than a 6-
month high, shrugging off weak seasonality. Our cross-sector collaboration
concludes diesel will continue to surprise the market on the upside in 2H.
Besides a seasonal demand pick-up, rising coal output on growing demand
for coal should boost demand for diesel, a key fuel for mining vehicles.
Impact
Diesel margin soars on stronger-than-expected demand. Asian refining
margin climbed to more than a 6-month high to around $9/bbl. Looking into
details, diesel strength is a real surprise. Despite weak seasonality, Asia
diesel margin rose to $14/bbl in Aug (vs our est. of $12/bbl), 37.5% higher
than 2016. In fact, China’s diesel demand for June grew 0.14mb/d (+3.9%
YoY), averaging 3.52mb/d in 1H17 amid strong industrial production growth.
Looking at 2H, rising coal output to further support demand for diesel,
fuel for mining equipment and vehicles. Looking at 2H17, we estimate
Asia’s diesel margin will continue to be supported by rising demand from coal
mining industry. China’s power demand is soaring due to the heatwave hitting
northern China. On top of that, severe flooding in early July led to hydro
power curtailments, resulting in more demand for coal power generation. (Fig.
3, 5) In addition to power demand growth: 1) China’s policy to stabilize
thermal coal price at 78$/t (vs. the current 94$/t) by increasing coal
production; and 2) seasonal demand pick-up in 2H (Fig. 33) will be other
drivers of diesel strength. We expect diesel demand in China to remain
supported in 2H, rising YoY by 0.14 mb/d (YoY+4%).
Supply-side positive from China remains intact - we see the street’s
concerns over China’s teapot refineries overblown. While Asia’s demand
for refined product rose by YoY+4.1% in June, refining production in Asia
slipped by -0.1% relative to 2016. In particular, despite a rise in utilization
ratio, Chinese teapot (=small/independent) refineries’ diesel output remains
largely flat YoY. (Fig. 9, 10) China has given teapots crude import quota at the
expense of the closure of inefficient capacity. This means, unlike the street’s
concerns, teapots’ diesel production will not continue to grow. Furthermore,
considering diesel exports constraints by current quota, we think teapots’
additional production and, in turn, more pressure for diesel exports towards
Chinese oil majors is less likely. (Page 4~5 for details)
Outlook
Our positive view on the Asian refining space remains firm. Asia refining
s/d now reached a balance from oversupply on unprecedented level of
underinvestment since year 2013. On top of that, as being evidenced by
recent diesel strength, any demand-side positives lead to stronger-thanexpected
margin. We see upside potential for our FY17/18 refining margin
forecast of 7.5$/bbl. We are positive on (KR) S-Oil/SK Innovation, (JP)
JXTG, and Indian refineries including IOCL and BPCL. These two Indian
refiners have 40~50% exposure to diesel related products. (Fig. 11). Among
Asian refiner names, we have an Underperform rating on (IN) RIL and (TW)
FPCC given their hefty valuation (Fig. 49).
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