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(Bloomberg) — China’s independent oil refineries face a reckoning this year as Beijing tackles overcapacity in the industry, and the crude they rely on becomes a lot scarcer.

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Over a fifth of the country’s oil refining is handled by smaller, privately owned outfits, many of them housed in the eastern province of Shandong. These independents, dubbed teapots, have a reputation as wily operators used to navigating razor thin margins. Some may now be at a tipping point where none of their old tricks to stay profitable will work. 

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China is the world’s biggest crude importer and the teapots are a cornerstone of a market that has driven gains in global oil demand for over a decade. But three firms in Shandong went bankrupt late last year and more company failures are predicted.

“This year, oversupply in China’s oil market will grow further,” said Mia Geng, an analyst at industry consultant FGE. “We could see more teapot shutdowns, both temporary and permanent.”

The teapots are at this pass because China’s economy is slowing and getting greener. Blame electric vehicles, but demand for the fuels they produce, such as gasoline and diesel, is shrinking. Fiscal constraints mean that local authorities are no longer willing to shield them from their tax responsibilities. And tighter restrictions on cheaper, sanctioned oil from places like Russia and Iran is choking off much of their supply.

China’s attempt to shift its economic growth away from smokestack industries has seen refiners saddled with a nationwide capacity cap of 1 billion tons a year for 2025. Room has been made for super-efficient, integrated mega-refineries like the Shandong Yulong Petrochemical Co. facility that began operating in September, which means that smaller, less profitable outfits are likely to be the casualties of meeting the target. Older teapots in Shandong are top of that list.

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Researchers at state-owned Sinopec, the country’s biggest refiner, said consolidation could force another 6 million to 10 million tons of capacity to close nationwide this year, according to a presentation in Beijing last month. London-based Energy Aspects Ltd. had earlier put the figure at 15 million tons, calling 2025 “the natural time to pile more pressure on teapots,” according to a note to clients in November.

Tax Take

Other government directives on energy efficiency include shutting smaller crude distillation units — the first step in refining oil — by this year. About 9 million tons of capacity in Shandong alone meets the threshold, according to Wang Yanting, an analyst with Chinese consultancy JLC. 

Beijing’s need to broaden its tax take also has implications for a sector notorious for skirting its obligations. About 40% of gasoline and diesel sold by teapots wasn’t properly taxed last year, according to research from China National Petroleum Corp., the nation’s biggest oil company. 

In September, the Shandong government gave an oral notice to teapots asking them to return some tax rebates on their fuel oil imports, said people familiar with the matter, who declined to be identified discussing a private matter. Fuel oil is an alternative for smaller plants that don’t have access to the government’s crude oil import quotas, and makes up about 10% of the feedstock used by teapots, according to Mysteel OilChem.

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Shandong’s government didn’t respond to calls seeking comment, so it’s unclear whether the request became an order or how many firms complied. But the attention on taxation is a worrying sign given that the province, which depends on refining for employment and economic output, has typically treated the teapots with forbearance. The fear in the industry is that more stringent tax accounting could impact many firms’ profitability, sending them into the red.

In fact, the three firms that went bust last year, which had a nameplate capacity of about 17 million tons, did so precisely because they were tax compliant, and because they shunned sanctioned oil, according to the people familiar. 

Teapots rely on cheaper Iranian crude and take around 90% of its exports, but prices have risen and the flow has dwindled since the US broadened sanctions in October on the dark fleet tankers that ply the trade between Iran and China. 

It’s a dynamic that will only worsen if the incoming Trump administration adopts an even more hawkish posture on trade with Iran. Beijing might be “willing to sacrifice the teapots to score some easy points against Trump by clamping down Iranian imports,” Energy Aspects said.

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Teapots are already running at 55% or less of capacity, according to Mysteel OilChem, and are likely to shrink runs even further, or shutter plants for maintenance for longer, in order to cope with the squeeze on margins. 

Industry executives and traders say some of these firms would have struggled to survive without favorable taxes and the availability of sanctioned crude at a discount.

On the Wire

The looming US-China trade war will test any hope for a boost in Asian equities this year, though stronger stimulus measures from Beijing will remain a key focus for investors in the region.

The yuan weakening past a level that China had been defending throughout December has returned the spotlight to its daily reference rate for the managed currency to gauge Beijing’s appetite to support it.

Vegetable market fire in China’s Hebei province kills eight.

This Week’s Diary

(All times Beijing unless noted.)

Monday, Jan. 6:

• Caixin China services & composite PMIs for December, 09:45

Tuesday, Jan. 7:

• China December foreign reserves, including gold

Wednesday, Jan. 8:

• CCTD’s weekly online briefing on Chinese coal, 15:00

Thursday, Jan. 9:

• China inflation data for December, 09:30
• China to release Dec. aggregate finance & money supply by Jan. 15

Friday, Jan. 10:

• Tianqi Lithium to offer lithium carbonate at first auction on SMM’s new trading platform, 09:30
• China’s weekly iron ore port stockpiles
• Shanghai exchange weekly commodities inventory, ~15:30
• China’s monthly CASDE crop supply-demand report

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