China may import more crude or refined products in the next few months, after official figures showed a sharp drop in oil and fuel inventories in August.

China's commercial crude inventories fell 2.5 percent by the end of August from a month earlier, and those of refined products by 10.9 percent, according to China Oil, Gas & Petrochemicals, a publication of the Xinhua agency.

The draw in crude and products isn't surprising, given the large decline in oil imports in August and the increase in refinery throughput.

Crude imports were 18.4 million tons in August, equivalent to 4.33 million barrels per day (bpd), and the weakest for 22 months.

The first five months of the year saw stronger-than-expected crude imports, averaging 5.68 million bpd.

The three months since then have seen the average slump to 4.91 million bpd, as China's demand growth eased and strategic and commercial stock-building tailed off.

It's likely that at least 600,000 bpd of imports in the first five months went into strategic and commercial inventories as China fretted over the potential threat to supplies from Iran as Western powers ramped up sanctions against Tehran's nuclear program.

With the easing of supply concerns, it was always likely that China would cut its imports to be more in line with demand.

However, the weak August outcome was probably too much of a cut, which is likely to be reversed in coming months, especially if refiners ramp up production.

The strong draw in commercial product stocks alone is enough to suggest that China will need to produce, or import, more fuels in coming months.
Diesel inventories fell 14.9 percent in August, while gasoline dropped 6.9 percent and kerosene by 2.8 percent.

If China needs to replenish stocks, and assuming a slightly stronger outlook for industrial production in the fourth quarter as some of the government's stimulus kicks in, the question then becomes whether refiners will choose to boost runs or import refined products.

So far this year growth in refinery throughput has been modest, notwithstanding the 2.6 percent jump in the daily run rate to 8.89 million bpd in August from the same month last year.

For the first eight months of the year, runs are up only 1.6 percent and China's refineries will have about 11.6 million bpd of capacity by the end of 2012, up from 10.8 million at the end of last year.

That means that refinery utilization is now around 77 to 80 percent, depending on just how much of the new capacity expected this year has been commissioned already.

This shows there is plenty of room to ramp up crude processing, and the reason it hasn't been done before now is that Chinese refiners have been loss-making because of regulated pricing, in contrast to the strong margins enjoyed by other Asian processors.

However, two fuel price hikes in the last two months, taking the total this year to four, will act to boost margins and may encourage refiners to increase runs.

Of course, much of what refiners do to increase runs will depend on the state of the domestic economy.

While there is no doubt growth has slowed, with industrial production increasing at 8.9 percent in August, the weakest in 39 months, the growth in refinery runs has failed to keep pace with even the lower growth profile.

Growth in refinery runs has hovered between 1 percent and 2 percent for most of 2012 and even recorded a decline in April, a stark contrast to the 6 percent to 10 percent expansion recorded in the first eight months of 2011.

The fourth quarter is also usually a period of building up commercial inventories ahead of winter demand.

While Chinese refiners could choose to import refined products rather than crude, high prices for fuels in Asia coupled with lower crude prices may encourage them to process more domestically.

The incentive to increase domestic runs may be increased if crude prices weaken further, or at least don't recoup last week's losses, with Brent down about 5 percent from its level on Sept. 14.

While a return to the record monthly crude imports seen in the first half of 2012 are unlikely, it's likely that August marks the low point and the rest of the year should see imports above 5 million bpd.