China diesel in rare rally as tax fears, smog war stir supply worries

BEIJING, Nov 23 (Reuters) - A rally in China's diesel prices has pushed the fuel to a rare premium over gasoline as dealers scramble to scoop up supplies amid fears of shortages due to Beijing's war on smog and possible tax changes.

Led by a spike in benchmark crude prices, wholesale diesel prices have jumped 11% since October to 6,700 yuan ($1,011)/t on Tuesday in eastern Shandong province, a 320 yuan premium to gasoline, according to consultancy Longzhong Information Group.

Diesel, which normally trades at a discount to gasoline, touched a 500 yuan premium earlier this month, the widest premium in at least two years, even though the market remains well supplied.

"Diesel prices have been rising madly ... almost every day ... buyers were worried that if they don't buy today prices will go up more tomorrow," said Li Yan of Longzhong Information.

Analysts said there had been a steady drawdown in diesel inventories over the last couple of years as refiners favored gasoline production at the expense of diesel, and as growth in diesel demand eased alongside a moderating economy.

But refiners are still exporting the fuel and the market remains in surplus, illustrating the strength of market jitters about the potential impact of Beijing's battle to clear the nation's skies of pollution and potential changes in tax policy.

This year, curbing diesel truck use has been a key part of Beijing's war on smog.

Catching the market by surprise, China last month also banned high-sulfur diesel fuel burned by tractors and trawlers from Nov. 1, two months earlier than expected, with some smaller refineries not yet ready to produce the low-sulfur fuel.

"Only seven to eight independent plants out of dozens are capable of producing the National Five general-purpose diesel ... that tightened the diesel pool," said a Jiangsu-based dealer with a state-run firm, referring to the 10-ppm sulfur non-automotive diesel. The official declined to be named as he's not authorized to speak to press.

Adding to jitters, sources said market talk started in July that the government may introduce a levy on "raw white oil", a refinery product often used in lubricants or cosmetics that can also be used as a cheaper diesel substitute.

Talk of the levy led to sharp production cuts. One plant, Taizhou Petrochemical run by China National Offshore Oil Co in Jiangsu province, had halved its production of the blending fuel in recent months, said a dealer and an analyst, before it announced earlier this month that it would close for maintenance until late December.

Buyers were also spooked by extra export quotas awarded to state oil refiners in late October for the final months of the year, fearing that increased overseas shipments would thin domestic supply.

However, traders said the recent price rally would actually spur sales into China's home market, with domestic prices at a premium of 600 yuan/t to 800 yuan/t over Singapore spot market.

"We'll likely export less or even don't export for December," said a trader with a state oil refiner, who arranged two cargoes of diesel for export in November.

Dai Jiaquan, head of oil research at CNPC's Economic and Research Institute expected the diesel rally to taper off in a month or two as larger refiners are maximising runs to cash in on the bumper margins.

"The diesel rally should be short-lived, as China's overall refinery output growth will outpace demand," said Dai. ($1 = 6.5951 Chinese yuan renminbi)

(Additional reporting by Jessica Jaganathan in Singapore; Editing by Richard Pullin)

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