Chinese state-owned company Sinopec is upgrading its refineries to produce higher quality transport fuels for the domestic market by next year.

Sinopec chairman Fu Chengyu was quoted by Xinhua news agency on Friday as saying the company would complete upgrades of desulfurization facilities at its refineries by the end of this year, and start producing gasoline and diesel that meet the National Phase IV -- equivalent to Euro 4 -- emissions standard from 2014. This would limit sulfur levels to 50 parts per million.

China has set a deadline for the Phase IV standard for gasoline to be adopted nationwide by January next year, and that for diesel by the end of 2014.

Sources say refiners have been given at least a year to transition to the new legislation. Implementation of new emissions standards has often been delayed over the last few years, largely due to the lack of low-sulfur fuel.

Fu's comments come after the capital Beijing has seen air pollution reach hazardous levels recently, prompting calls for the introduction of tighter fuel specifications to be accelerated.

According to the Xinhua report, Fu said the refining sector should bear some responsibility for the high levels of pollution but that it was not the fault of the companies. Rather, emissions standards in the country are insufficient, he said.

Beijing on February 1 became the first and only city in China to adopt the Phase V standard where sulfur levels have to be below 10 ppm. Other eastern areas such as Shanghai, Jiangsu and the Pearl River Delta use Phase IV fuels while the rest of the country still adheres to Phase III specifications.

"China's [emissions] standards are not high enough, only Beijing has mandated sulfur levels of 10 ppm and under, but the whole country in general has standards of 150 ppm. If the standards do not increase, upgrades and modifications to facilities will not happen," Fu said.

HIGHER COSTS MAY LEAD TO FUEL PRICE HIKES

According to Sinopec sources, the company's major refineries such as Zhenhai, Guangzhou, Maoming and Hainan are now able to produce Phase IV gasoline.

The additional cost is estimated at Yuan 150-250/mt ($24-40/mt) compared with Phase III gasoline, with the construction cost of a gasoline hydrogenation unit estimated at around Yuan 200-300 million, one source said.

On Monday, Sinopec said it had successfully produced its first batch of Euro V standard RON 92 gasoline at its Gaoqiao refinery in Shanghai.

The company also plans to start a new 2.4 million mt/year hydrocracker later this month at Maoming, and commission a 1.2 million mt/year gasoline hydrogenation unit in Hainan during the third quarter of this year.

In its white paper on the environment released in November 2012, Sinopec said it had spent Yuan 492 million over 2005-2010 to upgrade its refineries to produce Phase III standard fuels. Last year, it completed diesel upgrading projects across its refineries and started supplying Phase V diesel to Beijing.

Sinopec's rival PetroChina is also preparing for tightened regulations. Its Lanzhou refinery, which already produces Phase IV fuels, also put on stream a new 3.5 million mt/year diesel hydrogenation unit last year, according to a refinery source.

The Dalian refinery also expects to complete a 2.25 million mt/year gasoline hydrogenation unit by April this year, similarly allowing it to produce Phase IV fuels, said another source.

"With the added costs [to produce low sulfur fuel] involved, fuel prices will eventually have to rise," said Yan Shi, energy analyst at UOB-Kay Hian Investment Consulting in Shanghai.

China regulates retail prices of diesel and gasoline although it has tried to make adjustments closer in line with fluctuations in international crude oil prices. Under the current pricing mechanism, the National Development and Reform Commission can review and adjust regulated prices of gasoline, gasoil and kerosene if the 22-day rolling average of a basket of Cinta, Dubai and Brent benchmark crude prices rise or fall by more than 4% from the previous price adjustment.

The last price change was in mid-November last year, when the NDRC cut gasoline and diesel prices by about 3.5%, in line with falling crude prices.

Analysts had previously anticipated more pricing reforms to be announced this year, although they are only expected to be unveiled after the National People's Congress leadership meetings in March.

But traders said Monday the new fuel specifications could prompt pricing reforms to be introduced more quickly.

"If the new pricing mechanism is introduced, and the review period could be shortened [from 22 days], that means prices will likely be conforming to market dynamics," said a trader in Guangzhou.