Oil Market Report: 13 July 2007

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Highlights

  • Brent futures surged over $77/bbl by mid-July on tight fundamentals, increased geopolitical tension and indications of strong fund buying.  Falling refining margins suggest that market tightness is shifting from product to crude markets.
  • Global oil product demand is expected to rise by a robust 2.5% to 88.2 mb/d in 2008, largely due to a weather-related rebound in the OECD and strong demand in non-OECD countries.  This represents an increase of 2.2 mb/d, from the slightly revised (-0.1 mb/d) 2007 level of 86.0 mb/d.
  • Non-OPEC supply in 2008 is forecast to reach 51.0 mb/d (+1.0 mb/d), plus 5.5 mb/d of OPEC gas liquids (+0.7 mb/d).  Key growth drivers include the FSU, Latin America and global biofuels.  OECD Europe and North America continue to see production decline, despite strong growth from the US Gulf of Mexico and Canadian oil sands.
  • OPEC capacity rises by 1 mb/d in 2008 to average 35.4 mb/d, with the implication that spare capacity will post a modest rise.  In reality, the spare capacity comparison will depend to a large extent on OPEC production levels both in the second half of 2007 and next year.
  • Global refinery crude throughput increased by 0.2 mb/d in May to 72.7 mb/d and is 0.4 mb/d higher year-on-year.  Crude throughput is forecast to increase rapidly to an August peak of 75.2 mb/d, on the back of higher runs in the OECD and the Middle East.
  • Preliminary end-June OECD stock data show an increase of 7.8 mb, as increases in the US and Japan offset a sharp downturn in Europe.  Together with an average 21.2 mb rise in stocks in April and May, this implies a second-quarter stock build around 550 kb/d and forward demand cover at end-June unchanged at 53.6 days.

2008: starting to improve flexibility

The Medium-Term Oil Market Report (MTOMR), released earlier this week, looked at the evolving pressures on the oil market for the next five years.  Understandably, the focus was on the tail end of the forecast, but it is easy to forget that the market will not evolve in a uniform way.  This month's Oil Market Report (OMR), with the roll over of our short-term forecasts to 2008 provides an opportunity to examine some of the possible near-term shifts in fundamentals and what implications they may have for the market.

Projected world demand continues the 2007 rebound, rising 2.2 mb/d in 2008, but it will likely be outpaced by rising supplies of biofuels (+350 kb/d), other non-OPEC (650 kb/d), OPEC NGL (0.7 mb/d) and rising OPEC capacity (1 mb/d).  Demand growth of 2.5% is driven by non-OECD countries, but OECD growth of 1.6% is inflated by the assumption of a return to normal weather conditions.  The net result is that the 'call on OPEC crude and stock change' rises to a range of 31.7-32.3 mb/d.

There are, as always, uncertainties in terms of weather, project slippage and GDP growth - in particular, it is difficult to estimate the projected rise in OPEC spare capacity in 2008.  This report does not forecast OPEC production and the estimate is therefore based on the assumption that OPEC will follow the growth in the call in the second half of 2007 and beyond.  A greater issue is the assumption that the 550 kb/d of Nigerian capacity shut in over the past 18 months remains offline.  At present, this seems a reasonable assumption, but security issues in the Niger Delta could shift effective capacities in either direction.  Similarly, there is the question of the impact of the recent nationalisation of ConocoPhillips and Exxon Mobil's operating shares by Venezuela, but here it would seem that the risk to capacity is more on the downside.

As we stressed in the MTOMR, OPEC spare capacity is only one factor among many in determining the oil price.  In 2004, OPEC spare capacity was more than 2 mb/d below current levels, but oil prices were $30/barrel lower.  A large part of that $30, we have argued, has been caused by product supply tightness.  Over the next five years, investment in upgrading capacity should increase the flexibility of the refining industry to meet demand-side and crude-quality challenges - and may therefore reduce some of these upside price pressures.  This increased flexibility starts to kick in from 2008, with modest improvements in global light/middle distillate supply capabilities and the greater potential to upgrade more fuel oil.

In 2008, improved Atlantic Basin light distillate supply potential is more due to the structural decline in European gasoline demand than refinery-level changes, but the introduction of additional hydrocrackers in Asia should improve middle distillate supply potential and in turn could tighten local fuel oil balances.  For fuel oil, strong demand from bunkering and industrial/power generation needs in the Middle East, removes almost the entire traditional regional surplus in 2008.  However, it will not be until 2009 and beyond that installed Middle East upgrading capacity rises to the point where local refiners will have to choose between producing more gasoline or meeting rapidly growing regional demand for fuel oil.

Overall, both in terms of spare upstream capacity and refinery flexibility, 2008 looks at this stage to be slightly more comfortable than 2006 and 2007.  While product specification differences will continue to restrict product trade, there is the potential for light and middle distillate supply tightness to ease slightly and for the fuel oil market to partially rebalance.  However, these are just two components of the myriad influences (including weather, OPEC policy, geopolitics and GDP growth) that will determine the direction of oil prices in the coming months.



Demand

Summary

  • Global oil product demand has been slightly revised downwards to 86.0 mb/d in 2007 (+1.8% over 2006), given minor baseline revisions to OECD figures.  In 2008, world demand is expected to rise by a robust 2.5% to 88.2 mb/d, in part due to a weather-related rebound in OECD demand.  In absolute terms, this is equivalent to an increase of 2.2 mb/d.


  • OECD oil product demand has been marginally adjusted downwards, following the review of historical North American and European figures (2005 and 2006) and the reappraisal of 2007 data for several countries.  Regional demand is now seen increasing by 0.5% in 2007, to 49.5 mb/d.  In 2008, growth is expected to jump to +1.6%, on the premise of normal winter conditions during the first quarter and the continued strength in North American demand, which is poised to rise by 1.4%.  Overall, with 50.3 mb/d, the OECD should contribute to roughly a third (0.8 mb/d) of global demand growth in 2008.
  • The risks to the 2008 OECD demand forecast lie predominantly on the downside.  These include: 1) economic uncertainties (particularly in the US); 2) weather vagaries (another mild winter); 3) interfuel substitution (in favour of natural gas); and 4) price risks (if the recent spike persists).
  • Non-OECD oil product demand has remained largely unchanged at 36.6 mb/d for 2007 (+3.6% over 2006).  Buoyant growth is forecast to persist in 2008, bringing non-OECD demand to 37.9 mb/d (+3.8% over the previous year).  Growth is expected to be driven by robust demand in China (+6.1% year-on-year) and the Middle East (+4.5%).  As such, the growth in non-OECD consumption will account for almost two-thirds of global incremental demand.
  • The 2008 non-OECD prognosis faces mainly upside risks.  A key uncertainty is whether Chinese and Middle-Eastern economic growth will actually be stronger than expected.  Given that China and the Middle East together currently account for about 45% of worldwide incremental demand, this could have significant implications.  Another - offsetting - risk is whether current prices subsidies (most notably in the Middle East) will remain in place.

OECD

According to preliminary data, total OECD inland deliveries decreased by 0.9% in May, compared with the same month in 2006.  This fall was related to European weakness (-3.7% year-on-year), which exceeded the modest gains observed in both North America and the Pacific (+0.3% each).



Europe's subdued demand was partly seasonal - May traditionally signals the transition between winter heating and summer driving - but also very much weather-related.  Indeed, the warm temperatures that prevailed in May across much of Europe reduced OECD heating oil demand, with deliveries falling by 16.8% on an annual basis.  Similarly, OECD fuel oil demand contracted by 5.3% as a result of weak electricity demand and some degree of interfuel substitution (natural gas).  Only demand for motor fuels (gasoline and diesel) registered increases in the OECD as a whole.  Gasoline demand rose by 0.4% year-on-year in May, supported by North America and the Pacific, while diesel deliveries gained 3.3%, sustained essentially by North America.



Overall, we expect OECD demand to reach 49.5 mb/d in 2007 (+0.5%) and 50.3 mb/d in 2008 (+1.6%).  The relatively strong 2008 growth forecast is based on the premise that the 2007-08 winter will be normal.  Under this assumption, all OECD areas should post strong year-on-year gains (+1.4% in North America, +1.8% in Europe and +1.7% in the Pacific).  It is worth noting, though, that North America, which accounts for over half of OECD demand, will remain the primary engine of growth in the OECD.

Finally, it must be emphasised that this forecast could err on the downside, for several reasons: 1) economic uncertainties (should activity in the US be less robust than is currently expected given housing woes, coupled with other worldwide financial imbalances); 2) weather vagaries (if the forthcoming winter proves as mild as the previous one, demand for heating and fuel oil could plummet); 3) interfuel substitution in favour of natural gas if it stays competitive compared with fuel oil (notably in North America and Europe); and 4) price risks (we assume a nominal oil price equating to around $68.6/bbl basis Brent in 2008, based on a futures curve of late May 2007, but we may reassess this assumption if the current price shifts are sustained).





North America

According to adjusted preliminary data for May, inland deliveries in the continental United States - a proxy of demand - shrank by 0.4% versus the same month in the previous year. The main factor of weakness was heating oil; deliveries plummeted by 29.2% year-on-year.  This is partly related to seasonal factors (more benign temperatures) but also to reclassification issues (low-sulphur distillates are now classified as 'diesel').  As such, diesel reported a year-on-year gain of 7.6%.  Nonetheless, this category relates mostly to on-road diesel (including ULSD), which suggests that economic conditions are still resilient.  Gasoline demand, meanwhile, rose by only 0.7%, very much in line with seasonal patterns - and despite high retail prices.



Looking ahead, US50 demand is poised to increase by 1.5% to 21.3 mb/d in 2008.  This outlook is based on expectations of relatively strong economic growth (+2.8%, according to the IMF) and on the assumption that temperatures will be normal over the next winter, as opposed to the previous one.  The first factor should support buoyant demand for transportation fuels, with gasoline rising by 1.0% (in line with previous years) and diesel by 2.8%.  The second factor should sustain a rebound of heating oil (+7.2%).  But, as noted before, there are several downside risks to this prognosis.

Coupled with strong Mexican demand, overall consumption in OECD North America is seen growing by 1.4% to 26.1 mb/d in 2008.  Mexico's consumption is forecast to expand by 2.5% to 2.1 mb/d, mostly boosted by strong demand for transportation fuels (+4.8% for gasoline and +3.7% for diesel).  Canadian demand, meanwhile, is expected to remain essentially unchanged at 2.3 mb/d



Europe

Preliminary figures show that total oil product demand in Europe plummeted by 3.7% in May on a yearly basis.  As noted earlier, demand usually falls in April-May as the winter ends and then rebounds with the summer.  However, the warm temperatures that prevailed in May amplified the seasonal fall (heating-degree days or HDDs were some 9% lower than the 10-year average).  As a result, heating oil deliveries contracted by 16.5% on an annual basis, while fuel oil demand shrank by 9.3% since electricity consumption remained subdued.



Turning to the main markets, oil product demand shrank by 14.0% year-on-year in Germany, where heating oil deliveries plummeted by 44.4%, according to preliminary delivery data.  In fact, German household stocks remained filled at 53% of capacity in May - unchanged versus April, when stocks usually fall to their lowest level before starting to build up again.  Similarly, French demand was dragged down (-5.5%) by weak heating oil deliveries (-20.5%). In Italy, meanwhile, total demand fell by 5.0%, given weak fuel oil deliveries (-25.3%) - although, as we have hitherto noted, fuel oil demand could rebound if the summer drought is more severe than expected.

With regards to 2008, demand in OECD Europe is poised to surge by 1.8% to 15.7 mb/d.  As with North America, this forecast assumes relatively strong economic growth, notably in the main countries (France, Germany, Italy, Spain and the UK, which together account for almost two-thirds of European consumption) and normal winter weather.  More interestingly, growth in 2008 will be mostly driven by heating fuels, as opposed to transportation fuels.  Nevertheless, this prediction faces similar downside risks as in North America.



Pacific

According to preliminary data, oil product demand in the Pacific rose by a modest 0.3% in May, compared with the same month in the previous year.  Demand growth was essentially supported by LPG (+9.2%), naphtha (+4.4%), and jet/kerosene (+1.8%).  In terms of individual countries, Japanese oil product demand contracted by 0.2% on an annual basis, for the seventh month in a row.  This was due to relatively mild temperatures and to structural weakness in transportation fuels, notably gasoline (diesel deliveries rose by 3.6%).



In Korea, meanwhile, total oil product deliveries rose by 1.1% year-on-year, boosted by strong naphtha (+8.0%) and gasoline deliveries (+7.1%).  Moreover, the country implemented a long-awaited move to raise its domestic diesel fuel tax by 7.5% starting 1 July, in order to bring diesel prices in line with gasoline prices (the fuel tax accounts for about 60% of the end-user price).  The diesel fuel tax rose to about 57 cents per litre (from a previous level of 53 cents); the gasoline fuel tax, by contrast, remains unchanged at 80 cents per litre.  As such, retail prices in Korea currently stand at approximately $1.83 per litre of gasoline and some $1.39 per litre of diesel.  Nevertheless, there may be a modest price impact on domestic diesel demand.

Turning to 2008, demand in OECD Pacific is poised to race ahead by 1.7% to 8.5 mb/d.  As with the rest of the OECD, this prognosis assumes sustained economic growth (particularly in China, the recipient of most of the region's exports) and normal winter temperatures.  The former should support transportation fuel and naphtha growth, notably in Australia and Korea, where economic activity remains solid, while the latter should boost heating fuels (notably kerosene in Japan).



Non-OECD

Our forecast of non-OECD oil product demand has remained largely unchanged at 36.6 mb/d in 2007 (+3.6% over 2006).  Moreover, we expect that growth will remain buoyant in 2008, bringing non-OECD demand to 37.9 mb/d (+3.8% over 2007).  As now, non-OECD consumption growth - almost two-thirds of global incremental demand - will continue to be driven by buoyant demand in China (+6.1% year-on-year) and the Middle East (+4.5%).

By contrast to the OECD, this forecast could err on the upside.  Indeed, given data uncertainties, a big question is whether Chinese and Middle-Eastern economic growth will actually be much stronger than expected.  Since China and the Middle East account together for about 39% of non-OECD demand and for 16% of global demand (and for about 45% of worldwide incremental demand), this could have significant implications for the outlook.  A counterbalancing risk, though, is whether current price subsidies (most notably in the Middle East) will remain in place - if not, demand growth could be curtailed.

China

Apparent demand in China (defined as refinery output plus net oil product imports, adjusted for fuel oil and direct crude burning, smuggling and stock changes) increased by approximately 4.9% year-on-year in May.  Demand growth for naphtha, gasoil and residual fuel oil was particularly strong (+19.3%, +5.3% and 5.2%, respectively), supported by continued petrochemical demand, farming activities and construction.  In addition, gasoline and jet/kerosene demand rose by 1.9% and 9.5%, respectively, following the seven-day '1 May' holiday.  Coupled with minor revisions to 1Q07 and April estimates, we have adjusted fractionally downwards our short-term growth forecast.  Total Chinese oil product demand is expected to increase by 5.8% in 2007, to roughly 7.6 mb/d.



Looking to 2008, Chinese demand is seen rising by 6.1% year-on-year to 8.0 mb/d.  This outlook assumes very strong economic growth (+9.5%, according to the IMF), which should foster significant demand growth across virtually all product categories, particularly naphtha (+7.0%), gasoline (+6.8%) and gasoil (+5.7%).  However, as noted earlier, there is a significant upside risk to this prognosis, notably much stronger-than expected economic growth - the government has just revised up its GDP growth estimate for 2006 (+11.1% instead of +10.7%); as such, the 2007 and 2008 forecasts may in the end prove too modest.  Although trade - the main engine of growth, accounting for almost 40% of GDP - could face protectionist restrictions in several key markets - chiefly the US - there are no indications to date that this may happen in the short term.  As such, economic growth could well exceed current forecasts and thus push up oil demand.



There could be, nonetheless, a dampening factor: retail prices.  Indeed, the periodic rumours regarding the liberalisation of gasoline and diesel prices and the implementation of a national fuel tax have resurfaced - allegedly, both could happen next October.  Although it is premature to speculate on the effects of such hypothetical moves - which would entail social and political costs - such a significant increase in retail prices of transportation fuels would probably dampen demand.

Has Anything Changed in China's Wholesale Market?

On 1 January 2007 the government formally implemented the so-called 'rules of crude market management' that would, in principle, open China's crude and oil product wholesale market. The move was prompted by the country's obligations upon its ascension to full WTO membership (December 2006). Six months on, however, it remains unclear whether the market has experienced the structural changes that the new measures were supposed to bring about.

Indeed, although 11 companies have been issued with wholesale licences since January, seven are subsidiaries of three state-owned companies (CNOOC, Sinochem and China National Aviation Fuel), two are joint ventures with another state-owned company (Sinopec) and only two are private companies (one Chinese independent, Rong Li Oil Storage, and one international oil major, ExxonMobil). Moreover, given that 99% of the already existing distribution companies (of which there are 2,514) belong to state-owned entities, it becomes implausible to argue that the wholesale market has undergone a significant transformation towards true competition and away from state control.

This lack of competition can be traced back to Sinopec and CNPC's wholesale monopoly, which was mandated in 1999. As such, both companies became the only qualified wholesalers, which would in turn supply all other wholesalers and retailers. In theory, a new entrant - assuming it fulfils the high barriers to entry (a minimum amount of registered capital and storage capacity) - could overcome this obstacle by importing oil products by itself. However, all imported products would have to be sold at government-capped prices.

As such, the vast Chinese domestic market remains arguably unprofitable for most actors, with the exception of the largest firms. In fact, there have been reports that some 80 companies are looking for foreign buyers in an attempt to exit the market (some are apparently bundling their assets in order to become more attractive). In the end, the current framework could be seen as a first step towards greater liberalisation, but it may also have the effect of reducing the refining and product supply markets to a few players with strong operational and financial capabilities. That could provide better competition than the current duopoly; however, the real issue for the future is whether retail prices will be freed to fully reflect changes in the world market.

Other Non-OECD

In May, for the first time in nine months, oil product sales in India - a proxy of demand - fell by 0.2% year-on-year, dragged down by naphtha and 'other products'.  Although transportation fuels posted gains, according to preliminary data, these were limited compared with recent months.  Gasoline deliveries rose by 'only' 2.2% (compared with about 10% on average since the beginning of the year), while gasoil/diesel sales increased by 3.6% (compared with the previous four-month average of roughly 7%).  Meanwhile, 'other products' (which include bitumen, lubricants, etc.) fell by 13.8% - possibly reflecting strong stock-building in the previous year - in sharp contrast to average monthly growth of roughly 10% since January.  More interestingly, naphtha demand fell for the second consecutive month (-5.8%), possibly confirming the greater availability of natural gas and heralding a resumption of naphtha's gradual decline.



As a consequence of naphtha's structural decline, we expect that India's oil product demand growth will return to its underlying trend in 2008, rising by 2.3% year-on-year to 2.8 mb/d (compared with +4.1% in 2007).  Nevertheless, if natural gas shortages were to occur again, naphtha demand could sporadically increase, thus lifting next year's overall demand level.

FSU apparent demand - defined as domestic crude production minus net exports of crude and oil products - remains virtually unchanged from last month's report, since the revisions to supply and trade figures tended to offset each other.  In May, the region's net exports continued to peak at close to 9.0 mb/d.  Nonetheless, net exports are expected to decline in 3Q07 due to increased duties from 1 June.  Overall, FSU demand is expected to average 4.0 mb/d in 2007 (0.2% lower than in 2006) and about 4.1 mb/d in 2008 (+2.4%).  This forecast, however, is hampered by the great uncertainty surrounding regional trade data.

Demand in the Middle East continues to race ahead, driven by low retail prices, an ongoing economic boom in most countries in the region, and young and growing populations.  A vivid illustration is provided by Saudi Arabia, where year-on-year oil product demand growth averaged almost 5% in the first four months of this year, largely as a result of buoyant gasoline and gasoil sales (approximately 42% of total demand).  Total consumption in the Kingdom is thus expected to reach 2.2 mb/d in 2007 (+4.5% year-on-year) and 2.3 mb/d in 2008 (+5.1%).



A similar pattern is expected to prevail in the region as a whole.  In 2008, total Middle-Eastern demand is forecast to rise by 4.5% to 6.8 mb/d, slightly faster than this year (+4.3%).  However, along similar lines as in China, this forecast is contingent on several factors that present a varying degree of risk - much stronger than expected economic growth and the potential reduction of retail subsidies.  This latter issue is perhaps the most important one in the Middle East, as attested by recent riots in Iran as a result of the implementation of a rationing scheme for gasoline in June (which followed May's 25% price hike).

Supply

Summary

  • World oil supply in June fell by 550 kb/d to 84.3 mb/d, as maintenance curbed North Sea production and seasonal factors limited North American output.  OPEC also saw crude supply down by 45 kb/d on the month.  Non-OPEC supply should rebound in July before maintenance again dents August output.
  • Non-OPEC production estimates for 2007 are cut by 220 kb/d versus last month's report, with revisions focused on OECD Europe and North America.  The adjustments result entirely from a methodology change.  This removes a non-OPEC contingency factor of -0.4 mb/d from the 'adjusted call on OPEC crude and stock change', incorporating it instead in the baseline non-OPEC forecast.  Excluding the methodology change, non-OPEC estimates are actually revised up by some 50 kb/d.
  • The non-OPEC forecast roll-out for 2008 shows supply reaching 51.0 mb/d, plus 5.5 mb/d of OPEC gas liquids.  Annual growth for both components thus accelerates to +1.0 mb/d and +0.66 mb/d respectively.  Saudi Arabia, Qatar and Iran account for the sizeable rise in OPEC NGLs.  Key drivers of 2008 non-OPEC growth are the FSU (+430 kb/d), Latin America (+290 kb/d), non-US/Brazilian biofuels (+250 kb/d), Africa (+130 kb/d) and OECD Pacific (+110 kb/d).  OECD Europe and North America continue to see production decline, despite strong growth from the US GOM and Canadian oil sands.
  • June OPEC crude supply fell by 45 kb/d to 30.17 mb/d, as lower Saudi and Iraqi supply countered modest recovery from Nigeria.  Nigerian production shut-ins eased to 600 kb/d in early July but sizeable risks remain that may cap Nigerian capacity close to 2.4 mb/d through 2008.  Venezuela too faces growing political and regulatory challenges that could undermine capacity.  But total OPEC production capacity could rise by 0.6 mb/d to 34.7 mb/d at end-2007, and further to 35.9 mb/d by end-2008.  Saudi Arabia's late-2007 Khursaniyah project drives the anticipated capacity expansion.


  • The 'call on OPEC crude and stock change' for 2007 shows a similar profile to last month, rising by 2.8 mb/d between 2Q07 and 4Q07 and implying a diminishing margin of OPEC spare capacity.  The call also rises by some 0.6 mb/d on average in 2008, to a midpoint of 32.0 mb/d, although rising OPEC capacity levels could prevent further tightening in spare capacity.

All world oil supply figures for June discussed in this report are IEA estimates.  Estimates for OPEC countries, Alaska and Russia are supported by preliminary June supply data.

An abbreviated non-OPEC supply overview this month focuses on the roll out of our forecast to 2008, with discussion of key areas of expansion and decline.  However, to avoid duplication, several of the themes underpinning this analysis are elaborated upon in the MTOMR, released on 9 July.  Readers are advised to consult MTOMR for a more detailed discussion of factors affecting supply in 2008 and beyond.

The 2008 Outlook for Non-OPEC Supply

Non-OPEC supply is expected to continue to recover after the levelling off around 49-49.4 mb/d evident in 2005/2006.  It reaches 50.0 mb/d in 2007 and 51.0 mb/d in 2008.  Total non-OPEC growth is expected to average 600 kb/d this year and 980 kb/d next year.  An additional 190 kb/d of growth this year comes from OPEC gas liquids, with an even stronger 660 kb/d increase from that source of supply expected for 2008.  Non-OPEC projections have been adjusted downwards to account for a proliferation of unscheduled field outages and new field start-up delays.  Nonetheless, as outlined in the recently released edition of the IEA MTOMR, the backdrop to the forecast is an impressive list of new field start-ups for the 2007-2009 period which offsets prevailing net decline from baseload non-OPEC production calculated at 4.6% annually.



Growth in non-OPEC supply continues to migrate away from the mature OECD producing regions. However, the next few years should see a temporary respite from the sharp declines in OECD production seen during the mid-2004 to mid-2006 period.  OECD total production declined on average by 5% year-on-year from mid-2004 to mid-2006, exacerbated by extreme weather, unscheduled pipeline and production facility outages and a lengthening list of new project delays.  With cost inflation and shortages of labour, raw materials and equipment likely to persist, so too will delays and disruptions.

The forecast methodology has been adjusted accordingly, notably to incorporate a field 'reliability' factor (see below).  Nonetheless, a slowing in total OECD decline has been evident since the middle of last year.  Although unlikely to be reversed entirely, we do see more modest rates of total annual OECD production decline closer to 1.5% annually as representative of the likely trend for 2007/2008.  And while certain governments in OECD areas have tightened access and fiscal terms in light of higher prices, major development projects are proceeding.  Significant new supplies are expected in the next 18 months from the Canadian oil sands, offshore areas like the US Gulf of Mexico, New Zealand and Australia and, to a lesser extent, the North Sea (including the recent 200 kb/d Buzzard start-up in the UK).  This is not enough to offset prevailing 4-5% net decline from the mature segment of production, but is a moderating influence nonetheless.

Output from Mexico remains on a downward trend.  Although fiscal reform is being discussed that might eventually boost Pemex's ability to raise upstream investment, little respite from short-term production decline is expected, with total crude production slipping by 5-6% in both 2007 and 2008, reaching 2.9 mb/d next year.  The maturing Cantarell field sees output slide by some 15% annually, with offsets in 2008 largely restricted to the Ku-Maloob-Zaap complex, where output is expected to reach 515 kb/d from less than 250 kb/d in 2002.



However, just as OECD decline has moderated, so too has the stellar growth in FSU supply seen in the first half of the current decade.  Double-digit growth fuelled by Russia, and to a lesser degree by expanded supply from new fields in the Caspian republics of Azerbaijan and Kazakhstan, has given way to more modest growth as access and fiscal terms have tightened.  The role of centrally controlled state/quasi-state companies has increased and delays in expanding export capacity infrastructure have also taken effect.  Nor has the FSU been immune from the general tightness in upstream construction, drilling and service capacity evident elsewhere.  That said, continued modest growth from the FSU in 2007/2008 seems to us the most likely prognosis, with the region collectively expanding output by  500 kb/d on average (3.9% pa) both this year and next.  Our medium-term projections through to 2012 see Azerbaijan and Kazakhstan increasingly taking the growth baton from Russia, where supply growth potentially slows until the middle of the next decade.

Latin American supply growth, having slipped back in 2006 and 2007 (partly on new field delays) is seen regaining levels around 290 kb/d in 2008.  Regional supply reaches 4.8 mb/d next year from 4.5 mb/d in 2007.  Growth is concentrated in Brazil, with crude output reaching 2.15 mb/d compared with 1.9 mb/d in 2007.  Deepwater developments at the Roncador, Polvo, Golfinho, Piranema and Marlim Leste fields underpin potentially the strongest year yet for Brazilian supply growth.  Brazilian biofuels output, largely ethanol from sugar cane, adds a further 50 kb/d next year to reach 360 kb/d.  As noted in the MTOMR, Brazilian ethanol enjoys competitive advantages regarding production costs, agricultural land use and infrastructure compared with biofuels in other countries, which sustains its medium-term growth.

Methodology Change Accounts for Bulk of Non-OPEC Forecast Adjustment This Month

Extreme weather, Russian geopolitical developments and new project delays have all retarded non-OPEC supply, notable in 2005/2006. While the OMR in 2001-2003 tended to understate non-OPEC supply, 2004-2006 has seen the opposite trend. Original non-OPEC forecasts for 2005 and 2006 proved over-optimistic to the tune of 1.0 mb/d-plus, or around 2%. Moreover, OECD supply has consistently come in below initial forecasts for the past ten years. In part, this derives from a prevailing 'business as usual' methodology, with normal operating conditions and on-schedule project completions assumed until contrary evidence arises. And while the past twelve months have seen non-OPEC annual growth recover again to around +1.0 mb/d, large risks remain for the 2007-2012 outlook.



To reflect this, a 'reliability' adjustment is henceforward applied to the non-OPEC forecast on a country-specific basis. The OMR and the MTOMR previously presented a headline non-OPEC forecast unadjusted for supply contingencies, but appended with cautionary notes on a tendency for supply to 'under-shoot' initial projections by 300-400 kb/d. Then, from the OMR dated 13 March 2007, an 'adjusted call on OPEC crude and stock change' was introduced, in parallel with the base 'call', containing adjustments for non-OPEC supply risk (350 kb/d). Now, in an effort to be more explicit about the adjustment, a historically-derived factor is instead included in the headline non-OPEC supply forecast, with the adjustment to the 'call on OPEC crude and stock change' correspondingly reduced.

In the past three years, OECD supply has slipped 1.0 mb/d below initial forecasts, although heavier than usual storm losses and project slippage account for an estimated 35% of this shortfall in 2004 and 65% in 2005 and 2006. The reliability adjustment factor which we now include in the non-OPEC forecast represents the residual difference between initial forecast and outcome, after netting off slippage and extreme weather. The forecast already attempts to capture these latter two influences within the normal methodology. The extra adjustment for field reliability explicitly acknowledges that, given tight drilling and service markets and ageing infrastructure, unscheduled outages are now part of the industrial landscape. Conversely, more modest upward adjustments are applied for those countries which have tended to be 'under-forecast' in the past, providing upstream conditions in those countries going forward warrant this.

Henceforward an allowance of -410 kb/d for non-OPEC supply is included, allocated by main country and region (but not by field). The new adjustment is calculated from an observed five-year average divergence from initial forecast. The adjustments show up as aggregated miscellaneous-to-balance line items by country in the field-by-field database. Adjustments have been calculated as follows:



The reliability adjustments will evolve over time in both scale and location as forecasts are replaced by actual production data. There may be an inbuilt conservatism for the new forecast by use of a constant factor rather than a fixed proportion of the changing production base. But, as noted above, a degree of conservatism is probably warranted given the currently prevailing operating environment.



With the reliability adjustment of -410 kb/d applying from the middle of the second quarter of 2007 onwards, ceteris paribus, this month's non-OPEC estimate for 2007 should be some 275 kb/d below last month's. Ironically, total non-OPEC adjustments this month total only -220 kb/d, as net upward adjustments accruing from recent field data provide a partial upside offset of +55 kb/d. Overall, downward adjustments accrue this month to North America, Europe, non-OECD Asia and Africa. Upward adjustments come from the OECD Pacific, the FSU and China. Azerbaijan and China in particular see stronger expectations now after incorporating May production data.

Otherwise, Latin American supply looks sluggish for 2008, amid a general worsening of the investment climate for international operating companies.  Ecuador is expected to see continued decline, with production slipping to 470 kb/d in 2008 from 500 kb/d in 2007.  The potential reintegration of Ecuador within OPEC follows calls by President Correa to boost Ecuador's equity stake in existing fields at the expense of private companies. A recent loosening of upstream terms in Colombia has yet to bear fruit, albeit production does seem to have stabilised closed to 530 kb/d after aggressive decline earlier in the decade.

Other non-OPEC producing regions face a contrasting supply outlook for 2007/2008.  Chinese supply growth averages 150 kb/d in 2007, but this slows to 50 kb/d in 2008, taking total production to 3.88 mb/d next year.  A twin-pronged increase from offshore and onshore north-western production this year helps offset decline at more mature easterly onshore production from fields such as Daqing and Shengli.  While further upside may be possible for 2008 from north-western supply, we have restricted growth next year to offshore fields which have been clearly identified as new production prospects.  Elsewhere in Asia, growth accelerates to 70 kb/d after stagnating in 2007, with Malaysia, the Philippines and Vietnam expected to see strong growth, partly based on higher gas condensate supplies.



The other key source of expected non-OPEC growth in 2008 is Africa.  Despite Angola moving into the OPEC fold in January 2007, regional supply increases by 130 kb/d to 2.71 mb/d next year.  Longer-term expansion from new producers such as Equatorial Guinea and Mauritania now looks to be further off, after the impact of tightening upstream operating regime and reservoir problems respectively.  Sudan, and Congo however help to push regional supply higher, as output from other key producers levels off or enters decline.  Questions continue to surround the political backdrop in Sudan.  There have been calls for sanctions against the government for activities in the Darfur region, but the opening of a new export terminal on the Red Sea has led to a rise in Dar Blend crude output to some 150 kb/d and total national production to around 450 kb/d.  Production is expected to increase to 560 kb/d in 2008, as Dar Blend output rises further to 275 kb/d, and increased Nile Blend supply is forthcoming from the recently started Thar Jath project. Congolese production adds a more modest 30 kb/d in 2008 to reach 250 kb/d on higher supplies from the offshore Moho Bilondo field.

Other Sources of Supply Growth - Biofuels

Global biofuel production - largely ethanol and biodiesel - is forecast to increase by an impressive 32% in 2008 (+350 kb/d) to reach 1.45 mb/d.  This follows similar growth in 2007, albeit from a low absolute base.  Widespread biodiesel growth in OECD Europe accounts for 38% (135 kb/d) of next year's increase, while the US, Brazil and non-OECD Asia each adds at least 50 kb/d to prevailing supply (predominantly ethanol for the US and Brazil, which is included in those countries' total oil supply data).  Nonetheless, despite sharp increases in percentage terms, this outlook mirrors a generally cautious forecast for biofuels in 2006-2012 as contained in the MTOMR.  Although installed capacity (based on firm projects) potentially reaches nearly 3.0 mb/d in 2012 from 1.0 mb/d in 2006, either substantial amounts of capacity could remain underutilised, or some projects may slip.  Questions continue to surround biofuels' economic viability (given rising feedstock costs), competing claims on land use between energy and food supply and an apparent lack of specific policy mandates for biofuels uptake within the vehicle fuel pool.

Other Sources of Supply Growth - OPEC Gas Liquids (NGL and condensates)

OPEC NGL and condensate supply growth of 660 kb/d in 2008 outstrips any other single component of the 'non-OPEC' projection for next year.  Total supply reaches 5.5 mb/d, after having consistently grown by some 8% annually for 2001-2006. Gas liquids (ethane, propane, butane and pentanes from gas processing plants, plus field gas condensates) produced outside of OPEC's quota system for crude oil see their strongest year since an estimated increase of 0.5 mb/d in 2004.  In 2008, as in 2004, growth centres on new projects being developed in Saudi Arabia (domestic utilisation), Qatar and Iran (both export-driven, but also increasingly targeting domestic use).

Saudi Arabia could see growth of 345 kb/d with inauguration of the associated gas processing facilities at the Khursaniyah project.  Non-associated gas liquids from the Hawiyah processing facilities also contribute.  Increases from both Qatar and Iran of some 150 kb/d are orientated towards gas condensate.  The Dolphin and Ras Gas 3, 4 and 5 projects account for Qatar's increment, while in Iran, the increase will depend on successful completion of phases 6, 7 and 8 at South Pars.  Moreover, rising output of light/sweet OPEC condensate in 2008 will likely affect the quality of the marginal barrel of global supply.

Our forecast for 2008 and beyond, while implying an ambitious pace of new project start-ups, nonetheless implies a fairly static liquids-to-gas ratio for the main gas producing regions.  While in theory one might envisage liquids recovery to rise over time, caution over future NGL availability is in order, given that new gas processing capacity faces the same construction and labour bottlenecks as confront the oil sector.  Moreover, an increasing number of major oil producers face increased gas reinjection requirements, which could limit gas liquids extraction.  But, on balance, we believe a number of key factors we have itemised previously will encourage continued strong growth in NGL supply:

  • OPEC gas development is increasingly targeting local, as opposed to export, markets, to free up oil for export. This diminishes the potential NGL supply impact of weaker international gas demand;
  • The impetus to minimise gas flaring is growing;
  • Much Middle Eastern gas is stranded, with a clear incentive to strip out liquids to maximise early revenue flows.  Wet gas streams are preferentially developed ahead of dry gas for this reason;
  • Qatar and Iran are tending towards modular gas supply and export infrastructure, less prone to time and cost overruns than new, stand-alone projects (albeit Iran faces other impediments in terms of investment terms and local demand growth);
  • A significant and growing amount of NGL supply will derive from non-associated gas, less prone to delays if crude capacity plans are deferred.

OPEC Crude Oil Supply in June

Total OPEC crude supply was 45 kb/d lower in June than upwardly revised May levels of 30.2 mb/d.  Revised data for Saudi Arabia and Angola underpinned the higher May estimate.  In June, Saudi Arabia, Iraq, Indonesia and Libya are estimated to have seen production decline by a collective 205 kb/d, while Nigeria, Iran, the UAE, Qatar and Algeria added a combined 160 kb/d.  OPEC-10 production (excluding Angola and Iraq) in June averaged 26.6 mb/d, some 1.5 mb/d below corresponding output one year ago, and 1.9 mb/d below the September benchmark against which last autumn's managed cuts in production were measured.  This has allowed notional OPEC spare capacity to reach 3.9 mb/d, although effective spare capacity excluding Indonesia, Iraq, Nigeria and Venezuela stands closer to 2.8 mb/d.



This report's analysis suggests a sharp rise in the requirement for OPEC crude between a second quarter low point of some 30 mb/d and nearer 33 mb/d by the fourth quarter.  Moreover, as our OPEC capacity expectations (table above) illustrate, late 2007 installed capacity of 34.7 mb/d implies that spare capacity could tighten from current levels.  The market in the second half of 2007 could oscillate uncomfortably between sharply lower inventories if OPEC continues to curb output, or tightening spare capacity if it follows the 'call'.  Nor does the situation become materially more comfortable in 2008, despite stronger growth in both non-OPEC supply and OPEC capacity.  OPEC could add over 1.0 mb/d of net new capacity in the course of 2008, reaching 35.9 mb/d.  However, nominal spare capacity by 4Q08 seems unlikely to exceed 3 mb/d, despite net capacity gains from Saudi Arabia, Kuwait, Qatar, Iran, Libya and Algeria.



OPEC Ministers meet next on 11 September in Vienna, and seem to be distancing themselves from the likelihood of boosting production officially before then.  OPEC representatives in recent weeks have stressed speculation, refining bottlenecks and geopolitical tensions as underpinning high and volatile prices.  Two issues which may arise at the Vienna meeting are calls for the setting of a ceiling for Angolan production and the possibility of Ecuador being readmitted as a full member.  Ecuador, which now produces just over 500 kb/d, had its membership frozen in late 1992, in part after non-payment of membership dues.

Saudi Arabian crude supply is revised up to 8.7 mb/d for May, with a modest cut to below 8.6 mb/d estimated for June.  Latest available JODI (Joint Oil Data Initiative) data are backed up by upwardly revised tanker sailing data for May.  Weaker earlier May estimates had been based on lower domestic refinery runs due to refinery maintenance.  While higher June refinery runs are implied by lower anticipated refinery maintenance, early indications are of an offsetting cut in crude exports.  June estimates, as for all the OPEC countries, remain subject to verification as more complete tanker sailing data become available.  However, comments from Saudi Oil Minister Naimi in early July tended to reinforce perceptions of production around 8.6 mb/d. Nor has there been any sign of significant change in Saudi production policy for July and August, with term liftings reportedly remaining broadly stable at June levels.

Crude capacity for Saudi Arabia is seen by this report rising to 10.9 mb/d by end-2007 and 11.4 mb/d at end-2008.  The Khursaniyah project is likely to start up in December 2007, reaching 500 kb/d of Arab Light capacity by 2H08, alongside some 300 kb/d of gas liquids.  Initial volumes of new extra light crude are also expected from the Shaybah field expansion and the Nuayyim project by the end of 2008.  The two fields combined will eventually add a gross 300 kb/d to Saudi crude capacity.  Capacity additions in Saudi Arabia for now are focussed on lighter/sweeter crude grades, before the next major heavy/sour increment expected from the Manifa project from 2011.

Iraq's crude supply for June (net of reinjection and storage) is estimated at 1.94 mb/d, comprising 1.52 mb/d of exports and 0.42 mb/d of local consumption.  Crude exports were down by some 60 kb/d from an upwardly revised May level of 1.58 mb/d.  Exports remained limited to those from the southern terminals of Basrah and Khor al-Amaya, plus 10 kb/d of cross-border pipeline sales to Syria.  However, with Iraqi Kirkuk crude in storage at Ceyhan, Turkey reportedly increasing to nearly four million barrels in June, state marketer SOMO announced a tender for sales of three one million barrel cargoes to be lifted by 23 July.  Refiners OMV, Tupras and Saras subsequently were awarded 1 mb each, implying a potential extra 0.1 mb/d for July Iraqi exports.

Uncertainty continues to surround Iraq's fledgling hydrocarbon law, currently before the national assembly.  Having agreed to a 17% share of oil-related revenues, the Kurdistan Regional Government (KRG) is pursuing its own upstream licensing round, and is still questioning, among other factors, the relative roles of a future Iraq National Oil Company (INOC) and the regional authorities.  The KRG is also reportedly opposed to Baghdad's removal for later consideration of annexes covering field and acreage allocations.  The KRG's own draft oil law, which it insists will comply with the national version, is believed to facilitate production sharing contracts with foreign operators.

Nigerian crude supply in June is estimated at 2.08 mb/d, a rise of 70 kb/d from May levels.  On average, June saw 765 kb/d of crude production shut-in due to rebel attacks and pipeline outages, compared with 815 kb/d in May.  By 11 July, total shut-ins had fallen back to 600 kb/d after Shell completed repairs on the Nembe pipeline, where leaks, unrelated to rebel attacks, had caused the shut-in of 77 kb/d of Bonny Light.  Agip also reinstated 65 kb/d of offshore Okono production, and there were unconfirmed reports that 13 kb/d of long-idled Forcados production had been reactivated.  However, further attacks were sustained during June by facilities serving the Escravos and Brass River export streams.  A four-day workers' strike which had threatened to further curb oil production and exports was ended on 25 June after the government partly rescinded fuel price rises put in place by outgoing President Obasanjo.  The new government of President Umaru Yar'Adua also agreed to set up committees to examine the fuel price issue and proposed sales of oil refineries and power stations.

While the situation in Nigeria now appears marginally less grave than in May/June, rebel attacks and kidnappings of oil sector personnel continue in the Niger Delta.  A ceasefire by main rebel group MEND also expired in early July.  How successful the government will be with its target of six months in which to stabilise the Niger Delta security situation remains to be seen. Shell has announced that initial export liftings will begin again from the 380 kb/d Forcados terminal in July.  However, initial volumes will comprise oil placed in storage before major production shut-ins occurred last year, with little sign yet that substantial Forcados production recovery is imminent.  Reflecting continuing uncertainty over the prospects for some 545 kb/d of long-term shuttered Nigerian capacity in the Niger Delta, we have removed this tranche from our Nigerian capacity estimates for 2007/2008 and beyond.  This effectively anchors expected Nigerian capacity close to the current sustainable level of 2.4 mb/d for the rest of 2007 and 2008, albeit any significant turnaround in restarting output could cause us to revisit likely Nigerian capacity levels in months to come.

May Angolan crude supply came in nearly 50 kb/d higher than our preliminary estimate last month, at 1.6 mb/d (plus 90 kb/d of gas liquids not counted towards the crude total).  Despite the start-up on 18 June of the deepwater Block 17 Rosa field (operator Total), June supply is estimated relatively flat at 1.6 mb/d due to maintenance work elsewhere.  Nonetheless, steady Angolan production build-up is expected for 2007/2008 from Rosa, the Dalia field, BBLT, Greater Plutonio (now scheduled to start in 3Q07) and Kizomba C (starting 3Q08).  Capacity could hit 1.8 mb/d by the end of 2007 and 2.15 mb/d by late 2008.  For now, Angola, like Iraq, remains outside an idled OPEC quota system, although there have been calls from within the organisation for an Angolan quota to be decided later in 2007 or in 2008.

Venezuelan crude oil supply in June is estimated at 2.37 mb/d, unchanged from May.  Heavy Orinoco crude output destined for the four major upgrading projects is assumed at 475 kb/d for last month, versus capacity of 630 kb/d.  Government sources again stressed that production curbs were in support of OPEC production policy.  However, industry sources have been expressing concern for some time as to the sustainability of Orinoco upgrader production if their effective renationalisation leads to the flight of existing operating companies from the country.

This came into sharper focus in late June as ExxonMobil and Conoco announced they would sever ties with the Cerro Negro and Hamaca/Petrozuata upgrader projects respectively, having failed to agree diminished equity participation and compensation terms with state PDVSA.  In the process, PDVSA has increased its control over the Orinoco projects collectively from around 40% to nearly 80%.  Oil Minister Rafael Ramirez recently reported that Orinoco production had fallen further to 418 kb/d.  Additional potential problems for Venezuelan production are foreseen if recent strike action by sub-contracted drilling workers intensifies.  PDVSA recently terminated operating contracts with private drilling companies covering drilling rigs which it owns, based in Lake Maracaibo.  The displaced workers are demanding that PDVSA employ them directly.  PDVSA says recent protests have not affected production.

OECD stocks

Summary

  • Total OECD industry stocks built by 20.9 mb in May, as increased refinery throughputs and lower seasonal demand caused product inventories to rise.  Despite this improvement, gasoline (and fuel oil) stocks remained below average and total OECD forward demand cover is only just in line with the five-year average, at 53.6 days.
  • End-April inventory data were revised up by 18.9 mb as upward corrections in crude and 'other' oils of 11.2 mb and 9.4 mb respectively offset a minor downward revision of 1.6 mb in product stocks.  The biggest single revision was an 8.3 mb upward correction of crude oil inventories in the Pacific.
  • Preliminary end-June stock data showed a further increase of 7.8 mb in the OECD, as increases in the US and Japan offset a sharp downturn in Europe.  This implies flat forward demand cover for end-June at 53.6 days, and a second-quarter stock build of 550 kb/d, in line with the seasonal average.


OECD Industry Stock Changes in May 2007

OECD North America

North American total industry inventories rose by 18.3 mb in May, largely on a 19.5 mb increase in products.  This was driven by gasoline stocks in the US, which rose by 8.2 mb, as refineries returned from maintenance.  Total distillate stocks in the US also increased by 5.5 mb, while crude was up by 3.5 mb.

Preliminary end-June data showed total US industry stocks rising by 20.2 mb on the month, of which 11.5 mb was crude and 8.7 mb products.  Crude stocks at Cushing, Oklahoma, fell by 2.7 mb to 23.6 mb at the end of June as refineries in the area ramped up runs following planned and unplanned maintenance, lending WTI (and particularly WTI spreads) some support.  In contrast, PADD 3 crude stocks increased by 11.5 mb as several VLCCs, that had previously been used as floating storage, were chartered elsewhere and unloaded.  As noted in the Freight section, oil on water has fallen to unusually low levels for this time of year, reducing another part of the supply buffer ahead of the summer.



US gasoline stocks rose by 3.6 mb by the end of June, as refineries focused on producing the motor fuel for summer use.  Nevertheless, this leaves end-month cover (reflecting cover for peak seasonal driving needs) unchanged at 21 days, two days below its five-year average.  Refinery throughputs remained on average 0.5 mb/d lower than in June last year, but imports have more than compensated for the difference.  Meanwhile, total distillate stocks fell by 300 kb as a 2.9 mb draw in heating oil was only partly offset by a 2.6 mb increase in diesel stocks.  Total distillate stocks have now also fallen to the bottom of their five-year average range in terms of forward demand cover, at 30 days.  A key issue for the market is now whether the seasonally low gasoline stocks will constrain the normal seasonal build in distillates.



OECD Europe

European industry stocks fell by 9.3 mb in May.  This was largely because of a downturn in crude inventories of 7.3 mb, partly related to oil field maintenance in the North Sea.  Crude levels fell by 4-5 mb each in Germany, France and the UK, but rose by 4.1 mb in the Netherlands and by a further 5.1 mb in sum in other European countries surveyed.  Product stocks also fell by 1.2 mb, holding below the five-year range following stock draws in Germany and Italy.

Preliminary Euroilstock data for end-June show a further stock draw of 16.3 mb, largely in products (-10.4 mb), though crude dipped too by 5.9 mb.  The product fall was largely in middle distillates, which drew by 5.3 mb and gasoline, down by 2.7 mb, as a steady stream of exports continued to move to the US.

OECD Pacific

End-May Pacific industry inventories rose by 11.9 mb following increases in both crude and products of 6.6 mb each and an offsetting draw in natural gas liquids of 1.3 mb.  Unusually, most of the change stemmed from Korea, where crude and products each rose by around 5 mb.  The tendencies were clear, in that the product build was due to middle distillates increasing in both Korea and Japan, by 2.7 mb and 1.3 mb respectively.  As in the other OECD regions, gasoline stocks fell in both countries, however only by a marginal 0.1 mb each.

End-June preliminary data from the Petroleum Association of Japan (PAJ) showed a further increase in total stocks of 3.9 mb.  Interestingly, even as refineries ramped up throughputs after maintenance, the increase was wholly in crude.  In products, a gasoline draw of 1.0 mb, and a dip in residue (-0.7 mb) were balanced by naphtha and middle distillates.  As in the US and OECD Europe, Japanese gasoline inventories remain at or below their five-year average range.



OECD Inventory Position at End-May and Revisions to Preliminary Data

Total OECD industry stocks stood at 2,646 mb at the end of May, 20.9 mb higher than end-April, but 23.0 mb down on the year.  Crude inventories stood at 979 mb, only 1.0 mb higher from April and 17.0 mb lower than end-May 2006.  Total products totalled 1,377 mb, 24.9 mb higher month-on-month, but 3.4 mb lower year-on-year.  'Other oils' rose by 13.2 mb in May.  Forward demand cover again slipped slightly, but in round numbers remains at 54 days, again unchanged from end-April and from end-May 2006.  Forward cover is now in line with its five-year average, having declined steadily from the beginning of the year.



Recent Developments in ARA Independent Storage

Total product stocks held in independent storage in the Amsterdam-Rotterdam-Antwerp (ARA) area rose by 1.6 mb in June and remain at the top of their five-year average.  Over the month, the greatest change was in gasoil, which rose by 1.3 mb, which would fit with reports of surplus German and other heating oil being sent down the Rhine to NWE storage.  Fuel oil and naphtha rose by 0.6 mb and 0.4 mb respectively, while jet/kerosene and gasoline fell by 0.4 mb and 0.2 mb.  All products except gasoline are towards the top of their respective five-year average ranges.  The lower gasoline levels are likely due to transatlantic exports to fill the structural US supply deficit and offset unplanned outages.

Recent Developments in Singapore Stocks

Total product stocks held in Singapore rose by 0.5 mb.  Increases in light and middle distillates of 1.7 mb and 0.1 mb respectively offset a downturn in fuel oil stocks of 1.3 mb.  Light distillates have now swung well above their five-year average range, while in contrast middle distillates are only in line with their five-year average on strong demand in the region.



Prices

Summary

  • Brent futures surged over $77/bbl by mid-July on a tighter market, increased geopolitical tension and indications of strong fund buying.  Near-term tightness on lower North Sea crude supplies due to field maintenance and still-curbed OPEC output coincided with strong summer refiner demand, and was reflected in Brent's move into backwardation.
  • Markets appear crude-driven, as gains in benchmarks outpaced those in key products despite ongoing US refinery issues.  Crude's dominance was reflected by refining margins falling in all regions, but on the whole, product cracks and refining margins remain at historically high levels.
  • Product markets were relatively weak in comparison to crude as refineries increased throughputs, albeit slowly.  Although US, European and Japanese gasoline stocks remain tight, gasoil differentials to crude were broadly stronger as distillate stocks fell in the US and Europe.  Fuel oil prices rose to record highs in some regions on strong utility buying and approaching bunker specification changes in NWE Europe, but remain heavily discounted to crude.
  • VLCC rates from the Middle East Gulf drifted below seasonal averages in June, falling most notably on westbound trades.  Global volumes of oil at sea are now unseasonably low.  Ample tonnage eroded clean tanker rates in the Atlantic Basin in June, despite high US gasoline imports.


Overview

A further tightening of the market pushed Brent futures above $77/bbl, not far off their record $78.30 seen last August.  While downstream problems have not yet abated, supply was further constrained and demand remained strong even in the face of high prices.  While weekly and monthly data show refinery throughputs remain below average in the US, crude strength appears to reflect demand for July and August delivery.  In addition, further support was derived from geopolitical worries.

A rise in commodity prices in general is potentially indicative of strong underlying economic growth, while the weaker dollar often adds short-term support to dollar-denominated commodity prices.  More importantly, ICE Brent's return to backwardation portends near-term tightness in crude markets.  Although OECD refiners are still ramping up from maintenance and unplanned problems persist, the strong rise in crude prices would appear to indicate competition from downstream buyers, even though crude stocks remain high in the US.

The end of Nigerian rebel group MEND's ceasefire, and a subsequent wave of new kidnappings was widely reported as supporting prices, even though actual production levels have not been further curtailed.  A strike by Nigerian unions in mid-June had no effect on crude output, but subsequent threats of strikes by Brazilian and Venezuelan oil workers keep the potential threat to oil production to the forefront.  OPEC has however indicated it will act if it sees any sign of a crude shortage.  However, it will take time for data to be available to back up the current price signals and with Saudi Arabia reportedly keeping August term volumes unchanged, a shift in output targets ahead of the September meeting seems unlikely.  Other geopolitical tremors, such as the terrorist bombings in the UK, Hamas taking control of the Gaza strip or ongoing tension over Iran did not affect oil flows per se, but added to the heated temperature of the markets.



On the demand side, Chinese crude imports in June rose by 20% year-on-year to 3.44 mb/d on strong summer demand for travel and electricity.  A lack of hydroelectric and nuclear power is leading Japan to burn more fuel oil and crude for summer cooling.  And in the US, even recent record-high gasoline pump prices appear not to have caused a significant change in consumers' behaviour so far, with increased driving reported over the Independence Day holiday.

Funds activity has also increased in the crude markets.  Latest weekly CFTC data showed a surge to record highs of both open interest and non-commercials' net long position in WTI, hinting at a belief in sustained higher oil prices.  Some have noted that the steady rise in futures coincides with both the period in which commodity indexes roll over their positions, but also the beginning of the third quarter, in which funds typically make new investment decisions.  However, it also coincided with a marked tightening of forward crude spreads with both WTI and Brent futures toying with backwardation.

Spot Crude Oil Prices

The dynamics of the US crude market changed, as WTI prices regained strength and improved vis-à-vis Brent.  This was largely due to a fall in crude stocks at Cushing, Oklahoma, which have now returned to 22.8 mb in early July, compared with their early April high of 28.0 mb.  To some extent however, the crude overhang seen at Cushing, that has distorted US crude markets, has simply switched to the US Gulf. Refineries returned in the Midwest, and a number of VLCCs, temporarily storing crude offshore, were reported to be unloading on the USGC, boosting crude stocks in PADD III.  However, the flooding and shutdown of the Coffeyville, Kansas, refinery may yet change this again, as it is expected to boost Cushing stocks.

Physical Brent took strength from North Sea maintenance, with supply there cut by around 465 kb/d month-on-month in June, contributing to a draw in European crude stocks.  The impression that Atlantic Basin refiners are competing for tightened North Sea crudes is heightened by Brent's relative strength versus not only sour crudes such as Dubai and Oman, but also eastern light sweet benchmark Tapis.  A change in Dated Brent pricing methodology, whereby the major price assessors apply a price de-escalator to Forties crude as its sulphur content increases, has also contributed to the Brent price shift.



European sour crude Urals also strengthened versus similar Mars and Oman, though the announcement of a 3 mb Kirkuk tender from Ceyhan sharply reduced NWE Urals's premium versus its Mediterranean counterpart.  A strong Dated Brent premium over ICE BWAVE should further reduce the Russian crude's attractiveness versus Middle Eastern sour grades, which are priced off the latter, though hikes in Saudi and Iranian official selling prices (OSPs) in early July somewhat made up for this.



Refining Margins

Refining margins fell across the board in June, as crude prices increased strongly, outpacing product gains.  US margins tumbled most on sharp downturns in gasoline after a series of moderate stock builds.  On the US Gulf Coast, margins have now approximately halved since early-May highs, again underpinning our argument that crude has taken over as the market driver.  US West Coast losses were also marked, despite distillate crack spreads increasing.  In Europe, hydroskimming margins turned negative again after a spell in positive territory in May.  Singapore margins generally moved least, though Tapis hydroskimming improved slightly after Tapis remained essentially flat.



Spot Product Prices

Refined product markets were marked by gasoline's weak performance relative to distillates.  Despite all the focus on tight gasoline supplies - end-June stocks in the US, Europe and Japan remain well below average levels - this was not reflected in differentials, which fell, notably in the US.  In terms of crack spreads, these have deteriorated significantly, notably in Europe, where they had been unusually high on strong exports to the US, showing up in falling European gasoline stocks in June.

Distillate crack spreads were mixed, with diesel and heating oil flat on the whole and jet/kerosene falling quite sharply.  Gasoil prices took some strength from falling stocks in the US and Europe, despite higher runs, and in Asia from Latin American buying, after the winter there turned unusually cold.  Despite the onset of summer travel, jet spreads fell, in Asia possibly due to a hike in Korean exports of 25% in July.



Fuel oil prices made strong gains, mostly on strong demand for power generation.  In Asia, low-sulphur waxy residue (LSWR) saw its discount to Dubai narrow on strong buying (normally prompted by Japanese demand or Indonesian refinery problems), while high-sulphur fuel oil (HSFO) was supported by lower South Korean exports and lower arbitrage volumes from Europe.  In Europe, support for fuel oil will also come from new, lower sulphur requirements for bunker fuel to come into place in the English Channel and North Sea from 11 August.  This new Sulphur Emissions Control Area (SECA) will require a maximum of 1.5% in marine bunker fuel, as is already the case in the Baltic Sea.



End-User Product Prices in June

Most end-user prices rose in June, except gasoline prices in Canada and the US, which declined by 2.1% in US dollars, ex-tax.  In comparison, gasoline prices in other OECD countries rose by 3.0% on average, with increases of 5.0% and 5.5% in the UK and Italy respectively.  Other OECD ex-tax product prices in US dollars all gained on average, with 1.8% growth for diesel, 1.8% for heating oil and 2.7% for fuel oil.

Freight

VLCC rates from the Middle East Gulf drifted below seasonal averages in June, falling most notably on westbound trades.  Global volumes of oil at sea are now unseasonably low.  The upside potential for rates in the summer, prompted by a decline in Asian refinery maintenance, is diluted by ongoing limits on OPEC exports.  Interest in crudes from the Atlantic Basin and Mediterranean pushed rates from these regions slightly higher in June.  Ample tonnage eroded clean tanker rates in the Atlantic Basin in June, despite high US gasoline imports.

Tanker trackers report that volumes of oil in transit remain well below seasonal norms, apparently confirming low vessel employment for this time of year.  Growing VLCC availability was boosted further in the second half of June by the discharge from several of these two-million barrel vessels which had been storing crude temporarily in the US Gulf.  VLCC rates from the Middle East Gulf to US Gulf fell from $20/tonne at the start of June to around $15/tonne in early July.



OPEC cargo reductions continue to undermine any potential for a seasonal rebound in vessel demand as Asian refineries return from maintenance.  In line with recent months, Saudi Arabia announced that it will supply 9-10% less crude to refineries in the Far East than contracted volumes in August.  VLCC rates from the Middle East Gulf to Japan, now booking for loading in August, are currently around $9/tonne, down by over $3/tonne from early June.  However, eastbound rates have shown signs of rebounding in early July.

Suezmax rates from West Africa to the US Atlantic rose by over $1/tonne, to reach $11.50/tonne in the second half of June.  Corresponding VLCC rates rose by a similar amount in early July.  While these increases coincided with a temporary halt in hostilities from a major rebel group in Nigeria and delays at Nigerian ports, higher Mediterranean chartering was probably more supportive.  Black Sea to Med million-barrel rates jumped by $4/tonne in the middle week of June, peaking at almost $12/tonne.  There were also reports of improved economics for spot exports of African or FSU grades to the US.  Increased interest in Aframax vessels in the Caribbean lent support to late-June rates for the sector and reduced broader vessel availability.  Brisk chartering elsewhere contributed to firmness in Aframax rates in the North Sea in June, despite maintenance at production facilities.

Clean product tanker rates fell in June, especially in Western markets.  Clean rates for 30,000-tonne trades from Northern Europe to the US Atlantic Coast dropped below $20/tonne at the end of June having started the month near $26/tonne.  US gasoline imports remain but increased supply of product tankers in the Atlantic and Mediterranean have had an offsetting effect on spot charter rates.  By contrast, limited tanker availability may have bolstered Singapore to Japan clean rates in late June following a quiet month of chartering activity, when refineries increasingly returned to operations.

Refining

Summary

  • Global refinery crude throughput is estimated at 72.7 mb/d in May, 0.4 mb/d higher year-on-year and 0.2 mb/d above April Higher crude runs in the non-OECD regions and OECD North America offset the decline in the OECD Pacific.  Crude throughput is forecast to reach 75.2 mb/d in August, as refiners seek to meet strong demand in the Atlantic Basin before maintenance work in the autumn.
  • OECD refinery crude throughput was 38.1 mb/d in May, largely unchanged from April and last May's level.  Higher crude runs in North America and Europe offset the maintenance-related decline in the Pacific.  OECD crude throughput in June is estimated to be 0.3 mb/d higher at 38.4 mb/d.  The return of refineries from maintenance in the Pacific, North America and Europe are expected to push OECD crude throughput to 39.4 mb/d in July and 40.3 mb/d in August.


  • Naphtha yields in the Pacific bounced back in April to fresh ten-year highs, driven by gains in Korea and Japan.  European naphtha yields declined as refiners preferred to switch production into gasoline and jet/kerosene, which rose to the top of the five-year range.  North American refiners continued to focus on gasoil/diesel production, at the expense of the jet/kerosene yields.  Gasoline yields were also weak, linked to below-average FCC utilisation in the US.
  • In 2008, an easing of the current gasoline market tightness should be seen.  To a lesser extent gasoil and diesel markets should also ease, but jet markets could remain relatively tight.  Fuel oil markets are expected to enter a rebalancing phase as increased demand and new upgrading capacity reduce the need for the product to be discounted against crude prices.

Global Refinery Throughput

Global crude runs were an estimated 72.7 mb/d in May, up 0.2 mb/d from April's 72.5 mb/d and 0.4 mb/d higher year on year.  Crude runs are expected to increase, to a summer peak of 75.2 mb/d in August, before dropping 1.6 mb/d in September as autumn maintenance kicks in.  The peak summer crude throughput assumes that the refinery-reliability problems currently affecting the US ease, although we retain a 0.5 mb/d assumption of offline capacity in August for North America.  Chinese crude runs in July will be boosted by the start-up of Sinopec's 160 kb/d crude unit at its Yanshan refinery, but offset partly by lower runs at Petro China's Dalian refinery.  Ultimately, Sinopec will mothball two older 60 kb/d crude units at Yanshan, which will reduce runs further, although a definitive schedule for this was not available at the time of writing.



North American crude throughput remains constrained by the large number of refineries running at less than full capacity due to operational problems.  In addition to the high-profile incidents in the US Midwest at Coffeyville's Kansas and BP's Whiting refineries, we have noted a further 25 plants which are subject to disruptions, in addition to planned maintenance at a number of refineries.

April data have been received for some non-OECD countries, leading us to revise up our estimates for crude throughput to 34.4 mb/d for the non-OECD.  This offsets slightly lower OECD estimates for the month.  Conversely, preliminary data for May have led to number of revisions in the FSU, China and Latin America and lowers total non-OECD runs to 34.6 mb/d from last month's 35.0 mb/d estimate.

OECD Refinery Throughput

OECD Third-Quarter Forecast

Third-quarter crude throughput is expected to hit a seasonal peak in August of 40.3 mb/d, an increase of 2.2 mb/d from May's 38.1 mb/d.  Gains are forecast to be evenly distributed between the regions, averaging 0.7 mb/d.  In the Pacific, completion of Japanese (and latterly Korean) maintenance should see runs reach 7.3 mb/d.  Korean runs should receive a boost from the imminent restart of SK Incheon's mothballed 75 kb/d crude tower, which is currently scheduled for the middle of July.  North American and European runs should both increase by 0.7 mb/d, although this assumes a cessation of current US reliability problems.



Weekly data for June point to a sharp recovery in runs in Japan, following the conclusion of most maintenance work.  Work appears to have been heavier over the first half of the month, but runs recovered strongly by the end of the month.  Early July saw a number of refiners reporting operating problems, including Shell's Yokkaichi plant, where a residue cracking unit was taken offline.  At the time of writing the unit was expected to restart in mid-July, affecting gasoline production, just ahead of the peak demand season.



US weekly data indicate that June crude runs were 15.4 mb/d, in line with our conservative expectations for the month and 0.5 mb/d below both June 2006 levels and the five-year average.  Crude runs were lower than average on the Gulf and West Coasts, largely due to planned maintenance, and in the Midwest and East Coast due to unplanned outages.  Gulf and West Coast crude runs should increase with the return to service of a 240 kb/d crude unit at ExxonMobil's Beaumont refinery and a 200 kb/d crude unit at Chevron's El Segundo refinery, both scheduled for late July.  Further increases will occur when BP's Whiting facility, which at the time of writing has shut down its remaining crude processing for inspection, resumes full operations, although the timing of this remains uncertain.

Monthly US data for April indicate that refineries continued to struggle with upgrading unit reliability issues, leading to lower-than-average capacity utilisation for the month.  As noted in last month's report the strong level of gasoline and gasoline blending component imports during the month, and strong alkylate premiums indicated that FCC utilisation rates were likely to have been constrained, although we expect to see some improvement in subsequent months' data.

May OECD Data

OECD crude throughput in May averaged 38.1 mb/d, 0.1 mb/d ahead of our forecast, driven by higher-than-forecast runs in Europe.  Crude throughput was flat compared with April's downwardly revised (-0.1 mb/d) level, as increased throughput in North America and Europe was offset by the heavy decline in Japanese runs, reducing Pacific throughput.



North American crude runs were 0.4 mb/d higher than in April, largely driven by the continued recovery in US West Coast runs from March's historically low levels.  Canadian crude runs remained depressed, following the disruption to Imperial's Nanticoke and Sarnia refineries and the planned turnaround at its Dartmouth refinery.  Pacific crude throughput fell as expected by 0.5 mb/d, as Japanese refineries reached the annual peak in maintenance activity, while refiners in Korea and Australia increased runs slightly, ahead of the start of seasonal maintenance.



Gains in Europe were largely in France, where throughputs rose by 0.3 mb/d as refineries recovered from the disruption of the Fos port strike and completion of maintenance in April at Total's Donges and Shell's Berre l'Etang refineries.  Elsewhere runs were broadly lower, although little planned work was reported with the exception of a partial shutdown at PCK's Schwedt refinery.  Crude throughput was 0.1 mb/d higher year-on-year, as gains in France, Italy and the Netherlands were largely offset by declines in Germany, Belgium and Sweden.



OECD Refinery Yields

Naphtha yields in the Pacific bounced back in April to fresh 10-year highs, driven by gains in Korea and Japan.  Naphtha yields were 11.2%, 1.6 percentage points (17%) above the five-year average and April 2006 levels.  Continued strong demand from petrochemical producers and refiners looking to capture strong gasoline prices underpinned the naphtha crack, encouraging higher yields.  Fuel oil yields also increased during April from the 10-year low reached in March, but remain below average levels.  This increase, which is centred on Japan, is likely to have been the result of refiners increasing the use of marginal hydroskimming capacity to boost overall production levels to offset the impact of the start of seasonal maintenance.



European naphtha yields declined in April as refiners appeared to switch marginal light distillate production into gasoline, given the stronger crack spreads as a result of problems with US refineries.  Lower naphtha yields would also appear to have boosted jet/kerosene production, although to a lesser extent. Nevertheless, the jet/kerosene yield was at the top of its five year range and gasoil/diesel was similarly strong.  These latter two products may see continued strength in subsequent months' data as hydrocrackers at Total's Gonfreville and Neste's Porvoo refineries reach full production.



Outlook for 2008

Next year should see the start-up of 1.5 mb/d of new crude distillation capacity, almost half of which will be in China. The balance of the growth is well-dispersed, with most regions contributing to the growth (notable exceptions are Europe and the Pacific). North American crude capacity is expected to increase by 116 kb/d, driven by a number of small scale expansions at refineries operated by Valero, Holly, Frontier and others. Latin America should see the beginning of Brazilian expansion coming onstream plus the restart of the Cienfuegos refinery in Cuba.

The Middle East's 250 kb/d growth in crude distillation capacity relies on the start of Qatar's 146 kb/d condensate splitter and the expansion of Saudi Aramco's Rabigh and Iran's Bandar Abbas refineries. Growth in Other Asia is largely due to the 150 kb/d of Indian crude capacity expansions. These include the second phase of Essar's Vadinar refinery and the expansion of IOC's Koyali refinery in Gujarat, both tied into new upgrading units and desulphurisation. Reports of the phased start up of Reliance's 580 kb/d Jamnagar refinery over the course of 2008 suggest that its inclusion in our product supply model only for 1Q09 might be overly cautious. However, without confirmation of exactly which units will start and when, we retain the assumption that refinery throughput will only reach full capacity at the beginning of 2009.

Upgrading additions are expected to further add to the supply of light products in 2008 and start to tighten the fuel oil pool, as discussed in our recently published MTOMR. Coking capacity additions of over 400 kb/d are expected to occur largely in China, North and Latin America. An equally large tranche of hydrocracking capacity is expected to commence operations during 2008, adding to the supply of low sulphur middle distillates. Furthermore, we expect 1.5 mb/d of hydrotreating capacity additions next year, 60% of which are aimed at the diesel desulphurisation. Only 25 kb/d is targeted at hydrotreating residue, despite the tighter bunker fuel sulphur limits that will be introduced in Europe by the beginning of the year.

The net impact on our global product balance is mixed during 2008. Naphtha markets look to remain tight during the year, however gasoline supply potential looks set to outstrip demand by quite a wide margin. At the same time jet/kerosene markets are expected to remain tight. Similarly, only marginal easing of the gasoil/diesel market is expected next year. Fuel-oil cracks are expected to start to tighten as a result of the commissioning of the upgrading capacity noted above. Overall the key question is how the market will resolve these shifts in balance between demand and supply potential, particularly ahead of the even bigger changes we expect to occur in 2009.