China's two largest oil companies, both state owned, are buying more gasoline and diesel from small private refineries to help bridge a supply shortfall as the summer full consumption peak season draws near.

This increased purchasing from private refineries, an important source of fuel for independently-owned filling stations, will further squeeze their already declining market share of the gasoline and diesel market--the state oil companies usually suspend fuel supply to their rivals, especially when supply is very tight. But it is good news for the independents, who by some estimates own as much as 25% of China 's refining capacity.

China Petrochemical Corp., or Sinopec Group, the nation's largest refiner and China National Petroleum Corp., the largest oil and gas producer, may buy more fuel from private refiners and traders than last year's 60 million metric tons, or about 30% of combined annual fuel output of the two oil giants, Zhong Jian, chief analyst with C1 Energy, told Dow Jones Newswires Friday.

"The two groups must outsource, as their sales far exceed their (own) output capacity," he said. "They must rely on private refineries."

The state refiners have long had a complex relationship with independents or "teapot" refiners, often starving them of crude oil supplies, but then in times of shortages of products turning to them to help fill gaps in the market.

Often the teapots run at well below capacity, often processing fuel oil to make off-specification diesel, due to their inability to find enough crude in China 's regulated crude oil market.

This new buying is providing private refineries with excellent opportunities to expanding their share of China 's gasoline and diesel markets, Zhong said.

Shandong Shenchi Chemical Co., a private refiner with annual crude processing capacity of about 2 million tons, or 40,000 barrels a day, wants to sell more products to Sinopec and CNPC, and is willing to cooperate with them, an official with the company told Dow Jones Newswires.

"Sinopec and CNPC have expanded purchases from our company as our quality improved and is up to their standards," he said on condition of anonymity.

But Shenchi and the two state firms don't have cooperation in other areas, he said, noting that his company bought all its imported crude from traders.

Industry analysts say the government plans to eliminate 80% of the nation's teapot refineries in the next two years.

China will by 2013 limit the construction of new vacuum distillation units with a capacity of less than 200,800 barrels a day and eliminate VDUs with capacity of less than 40,000 barrels a day by 2013, the National Development and Reform Commission said end of last month.

Separately, the Ministry of Commerce Thursday issued instructions to ban illegal gas-filling stations, and to investigate unauthorized fuel price increases, the state-controlled Xinhua News Agency reported.

The NDRC sets domestic fuel prices, adjusting these to reflect changes in global oil prices, but because of inflation worries it has not allowed the full amount of the recent price run up to be passed on. This has acted as a fuel production disincentive to the state refiners, who have to rely heavily on imported crude.

C1 Energy's Zhong said electricity rationing expected this summer may lead to more diesel use for power generation, a repeat of what happened last year when there were widespread shortages of diesel.

China will likely face an electricity shortfall of about 30 gigawatts this summer--and the supply gap could expand further if temperatures soar and thermal coal supplies become tighter, the China Electricity Council said late last month.

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