China Oil & Gas:Sharp recovery in diesel demand growth; refining margin improvement under way

China apparent oil demand growth recovered in June up c3% y/y, althoughdiesel demand growth at c5% y/y surprised us and may relate to strongerthan expected GDP performance in June (see here). Chinese oil demanddeclined at 0.6% y/y YTD, still well adrift of our 3-4% y/y forecast thisyear. Refining margins in June were US$2.5/bbl vs. nearly breakeven forthe 5M14; margins continue to trend toward US$2.0/bbl in July/August,supportive of 2H14 refining performance.

    Diesel demand growth – fastest since July 2011: Apparent oil demandwas up c3% y/y at 10.3 mn BOPD, led by gasoline demand growth of16% y/y and diesel demand growth of 5% y/y, breaking three months ofanemic diesel demand growth. Diesel inventories continued to decreasein June to c18 days of coverage (vs. avg 21 days in 5M14), the lowestlevel since December 2013.

    Improving macro expectations on PSL; positive for diesel demand:With reports of the government injecting Rmb1.0trn into the economyvia a loan to the China Development Bank (see here), we could expect tosee better than trend IP growth rates which in turn could be supportive ofdiesel demand in 2H14.

    July/Aug refining margins improving into 3Q14: Our theoreticalChinese refining margins in June were US$2.5/bbl, we forecast marginsin July/Aug at US$2.0/bbl. Refining utilizations in June improved to84% (vs. 79% in May) and operational reporting from Sinopec (largestrefiner) showed a 2% q/q uptick the refining throughput in 2Q14 (here).

    Chinese imports from Iran up 48% y/y, diversifying crude sources:Iran has become the 3rd largest crude supplier to China – behind SaudiArabia and Angola (see Figure 3 - Figure 4). China imported 629 kbd ofIranian crude in 1H14, with an average monthly acquisition cost of$107.7/bbl (Figure 5). While this is higher than the price paid for Saudicrude ($106.8/bbl), it was less costly than Angolan crude ($109.7/bbl).Diversifying its crude slate remains central to China’s energy security,and could also help China manage its average crude acquisition cost asits import requirements rise.

    Natural gas demand growth at 11% YTD; price hike a key focus:1H14 saw natural gas demand grow at c11% y/y, in line with ourforecasts. A key focus for the market going into August is if thegovernment will have a natural gas price hike similar to last year(Rmb0.4/cm); PetroChina suggests that a hike would representRmb11.8bn at the operating line (here).