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Highlights

  • Product market strength and rising tension throughout the Middle East supported global crude oil prices in May and through early June. At the time of writing, ICE Brent was trading at around $65.95/bbl, while US WTI was at $61.50/bbl.
  • Global oil supplies fell by 155 kb/d in May to 96 mb/d on lower non-OPEC output, but remained at a steep 3.0 mb/d above last year. Annual growth slowed marginally from March and April and remained roughly split between non-OPEC and OPEC countries. The forecast of non-OPEC supply growth for 2015 have been raised to 1 mb/d.
  • OPEC supply in May edged up 50 kb/d to 31.33 mb/d, the highest since August 2012. Saudi Arabia, Iraq and the UAE pumped at record monthly rates to keep output over 1 mb/d above OPEC's official supply target for a third month running. Oil ministers agreed to maintain that target at their 5 June meeting.
  • The estimate of global demand growth has been revised up to 1.7 mb/d for 1Q15 and 1.4 mb/d for 2015 as a whole. Momentum is expected to ease somewhat in 2H15, assuming a return to normal weather conditions and given a recent partial recovery in oil prices.
  • Global refinery crude runs reached an estimated 77.9 mb/d in April, 0.3 mb/d lower than March, and 1.7 mb/d above a year earlier. Delayed new capacity of 1.5 mb/d in non-OECD regions has lifted product cracks and OECD refining utilisation rates, and caused backwardation to re-appear in oil products markets.
  • OECD industry oil stocks built by a steep 38.0 mb in April, to stand 147 mb above average levels, as refined-product stocks moved to their widest surplus in over four years. Preliminary data indicate that OECD inventories added a further 12.6 mb in May although US crude stocks posted their first draw in nine months.

Imbalancing act

Short-term imbalances in the global refining industry appear to be supporting oil prices - whether directly for products or more indirectly for crude - in the face of a lingering supply overhang, the latest available data suggest. These imbalances could go some way towards resolving an apparent disconnect between crude prices and fundamentals: on the one hand, prices appear to have stabilised after staging a partial recovery earlier this year, and the contango in crude futures has narrowed; on the other hand, inventory builds continue amid signs of persistent oversupply.

Market participants typically take their cue from crude supply and product demand data, often leaving the midstream and downstream sectors of the industry off the radar. Developments in those sectors can at times play an important role in setting oil prices, however. This was notoriously the case in 2008, when global tightness in distillate production capacity not only underpinned a diesel rally but also sent crude markets to record highs, followed by a collapse. Refining tightness is not expected to resurface as an issue today amid generally rising global over-capacity, but a temporary imbalance has emerged as project delays and setbacks have prevented emerging non-OECD refiners from keeping up with local demand growth, even as consolidation has significantly reduced capacity in the OECD region. Glitches at US refineries have also prompted gasoline supply shortfalls in some parts of the US amid rising domestic demand.  The result of those twin developments has been an unexpected surge in refining activity, including where it was least expected: in the ageing and relatively uncompetitive European refining sector.

Two sets of data points capture this imbalance: non-OECD demand has grown by 1 mb/d year-on-year in 1H15, but non-OECD refinery runs have only gained an estimated 0.3 mb/d over the same period, as outages and delays at a series of mega-refineries - Saudi Arabia's Yanbu, the UAE's Ruwais, India's Paradip and Brazil's Abreu e Lima plants, as well as Colombia's Cartagena expansion - have caused as much as 1.5 mb/d in aggregated capacity shortfall. In contrast, OECD demand has grown more slowly - by about 0.6 mb/d - but runs have surged by an estimated 1.1 mb/d as refiners have sought to not only meet local demand but also ship products to far-flung market outlets. 

Recent oil market strength of course partly stems from unexpectedly strong global oil demand growth, which in 1Q15 surged to 1.7 mb/d, from an average 0.7 mb/d in 2014. Demand growth alone, however remarkable, could not have been the only source of oil price support, dwarfed as it was by a surge in global liquid supply to a towering 3.1 mb/d over the same period. Despite signs of a slowdown in non-OPEC supply, notably in the US, global production growth remains exceptionally high. As a result, oil inventories have soared, but their breakdown by product and region doesn't quite match that of demand. More than the rise in demand itself, it is that mismatch between product supply and product demand that seems to have supported prices. In particular, gasoline prices have found support from robust US demand, leading to a surge in crack spreads. Clean tanker owners have been enjoying a moment in the sun amid surging product-shipping demand. Pockets of product tightness in effect seem to have helped support the oil complex, pulling crude prices along.

Changing market expectations - as opposed to current conditions - may also explain the seeming divergence between prices and fundamentals. Supply responses are inevitably delayed, and the looming impact of oil companies' recent spending cuts, while not fully apparent, may already be baked into prices. Statistics also have a poor track record of capturing rapid market changes, as the statistical process often entails adjustments and extrapolations from recent trends, which naturally tend to assume business as usual. Current markets could thus be tighter than reflected in recent data. It remains that product imbalances have likely been a key factor behind recent oil price strength, and that particular source of support might soon wane as long-delayed refineries eventually reach full production.

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