The Chinese government's new measures to clamp down on counterfeit tax invoices for fuel oil purchases could greatly impact the earnings of the country's independent teapot refiners, sources said this week.
The new rules, published by the State Administration of Taxation or SAT on January 6, subjects oil companies to new tax reporting procedures from February 1 that are specifically aimed at combating counterfeit tax invoices.
Every transaction in China is typically accompanied by an invoice, which the government uses to track the tax paid on that transaction.
SAT says its new technology will individually encrypt value-added tax invoices for fuel oil and naphtha with digital and Quick Response Codes -- optically machine-readable labels -- which will contain detailed information about the cargoes, including the identities of both buyer and seller and the volume traded, and whether it is subject to consumption tax.
This means it will become difficult for buyers and sellers to mask the origin of volumes and thus evade taxes, an ongoing issue that has long frustrated government efforts to collect tax revenue despite repeated clampdowns, industry sources said. New SAT guidelines issued at the end of 2012 to clarify existing taxes have had no impact and traders largely continue to evade taxes as before.
All oil and oil products in China are subject to VAT, typically levied at 17%, but not all oil products are subject to consumption tax, for which the rate varies. Crude oil in China is not subject to consumption tax, but a Yuan 0.8/liter or Yuan 812/mt ($133.10/mt) consumption tax is levied on fuel oil. Oil products sold to end users are not subject to consumption tax if they have been refined from fuel oil, while oil products refined from crude oil are.
TEAPOT REFINERS' APPETITE FOR IMPORTED CRUDE TO WANE
Teapot refineries in eastern China's Shandong province have in the last year increased consumption of crude for burning as feedstock, particularly imported barrels, according to data from Beijing-based energy information provider JYD Commodities Hub. Total crude consumption by the teapot refiners was 3.45 million mt in December, accounting for 82% of their total feedstock needs in the month, up 576,300 mt or 20% year on year, the JYD data showed.
However, as crude import quotas are strictly controlled by the government and awarded to only a handful of state-owned companies, the majority of teapot refiners technically do not have the right to buy imported crude.
Despite this, a significant volume of heavy high-sulfur Merey crude from Venezuela has been consistently sold to teapot refineries. According to JYD, these refiners consumed around 5.14 million mt of Merey crude in 2013, much higher than the 3.16 million mt of M100 -- Russia-origin straight-run fuel oil consumed as feedstock in the same period.
Market sources say refiners get around the crude import restriction by declaring their crude purchases as consumption tax-paid fuel oil in the VAT invoice. They then escape paying consumption tax on their finished oil products as the feedstock was declared as fuel oil.
Under the new tax invoicing system however, every transaction detail will be captured in the sales invoice, enabling the tax office to trace its source and end user, regardless of how many middlemen are involved.
SAT said the move will improve the efficiency of tax collection.
"Superficially, the move is to improve work efficiency for tax collection, but the new digital and QR codes will enable tax authorities to trace all information, which means it will not be possible to manipulate invoices," a source with state-owned trader Chinaoil said.
"Once the new VAT anti-counterfeit system is introduced, the supplier and other detailed information of a fuel oil cargo reflected in an invoice can be traced easily, which will increase the difficulty or even eliminate the possibility of manipulating VAT invoices and tax evasion for those products," another source added.
REBOUND IN FUEL OIL DEMAND
Market sources say the new invoicing system could severely impact teapot refiners' appetite for imported crude oil. "It will be a big blow to demand for Merey crude if the new regulation is implemented," one source said.
A source at one teapot refiner said the facility currently runs on 70% crude, most of it Merey grade, and its profits will be cut by the new rules.
Some teapot refiners have also been importing consumption tax-free asphalt to use as feedstock and similarly declaring the cargoes as consumption tax-paid fuel oil to escape the consumption tax on finished oil products.
Teapot refiners said the new taxation system will impact their ability to use imported asphalt and crude oil. Refiners will likely return to importing straight-run fuel oil, their standard feedstock in the past.
"Teapot refineries' dampened demand for imported crude oil is expected to be filled by imported straight-run fuel oil," a fuel oil trader said, adding that may push up the premium for the grade.
The price of M100 -- straight-run 180 CST fuel oil with 1.5% sulfur -- was most recently pegged at a premium of $109/mt to Mean of Platts Singapore 180 CST assessments for delivery 15-35 days forward into Qingdao and Shanghai ports, a Platts weekly China fuel oil review showed last Thursday.
This was the highest level seen since 2004, when Platts started assessing Russian M100, according to Platts data.
NAPHTHA, BUNKER IMPACT
The new tax rules will have a similar impact on the naphtha trade. Naphtha sold by major state-owned refineries to private wholesalers, which is liable for the Yuan 1/liter or Yuan 1,385/mt consumption tax, has routinely been declared by buyers as tax exempt due to sales to end users in the chemicals sector for the production of ethylene and aromatics, which qualify for tax exemption, sources said.
The tax office said it would tighten this loophole by introducing separate VAT invoices for naphtha sold to ethylene and aromatics producers, which will be different to those for sales to other end users, where naphtha consumption is taxed.
The new rules will also extend to domestic fuel oil blenders, which typically buy raw materials such as asphalt, shale oil, coal tar and residual oil for blending to produce 180 CST fuel oil. Except from residual oil, which is classified as fuel oil and subject to consumption tax, the other raw materials are free of consumption tax.
Like teapot refiners, blenders typically declare raw materials as consumption tax-paid fuel oil to escape consumption tax on their end products. Traders say with the new rules, blenders will likely have to pass on the cost of the consumption tax on the finished 180 CST fuel oil to their buyers, which are typically private wholesalers who sell it to the bunker sector.
The Yuan 812/mt consumption tax added to the value of the fuel would lead to a Yuan 138/mt rise in the 17% VAT payable on it. That implies a total of Yuan 950/mt in additional costs on blending materials, or Yuan 285-380/mt of incremental cost in the production of blended fuel oil, according to Platts calculations.
"If the consumption tax cannot be escaped, fuel oil blenders will inevitably pass the cost on to end users, mainly domestic shipping companies," a trader said.
The shipping sector currently consumes about 80-90% of domestically blended 180 CST fuel oil in China, with other end users such as factories and power plants having largely switched to other fuels such as natural gas and coal in recent years.
While the shipping sector is expected to absorb the higher bunker costs given the lack of viable alternatives, more price-sensitive end users who can substitute, such as industries using it as boiler feedstock, might stop buying the domestically blended product altogether, market sources said.
