Oil Market Report: 10 August 2007

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Highlights

  • Benchmark WTI reached a record high of over $78/barrel and moved into backwardation in July before falling back sharply on a combination of concerns over growth, unwinding of speculative positions and poor refining margins.  High crude prices and increased refinery throughput further pressured already negative returns from marginal refineries in July, but these have subsequently recovered somewhat.
  • World oil supply is seen lagging demand in July, despite a 1.1 mb/d monthly increase to 85.3 mb/d.  However, monthly gains from non-OPEC producers could prove short-lived as maintenance and seasonal factors will likely reverse the July increase in August and September.  Non-OPEC production estimates for 2007 and 2008 remain largely unchanged from last month's, at 50.0 mb/d and 51.0 mb/d, respectively.
  • July OPEC crude supply increased by 385 kb/d to 30.5 mb/d reflecting the restart of previously shuttered Iraqi and Nigerian supply rather than a policy shift to meet 3Q07and 4Q07 demand.  OPEC has indicated that no change in production policy is likely ahead of the 11 September meeting, suggesting little change in delivered supply until 4Q07 at best.  Effective spare capacity remains at just under 3.0 mb/d.
  • Forecast global oil product demand remains unchanged at 86.0 mb/d in 2007 (+1.8% over 2006) and 88.2 mb/d in 2008 (+2.5%).  A surge of demand for fuel oil, direct-burn crude and gasoil in Japan (linked to TEPCO's problems) and several Gulf countries has been largely offset by downward revisions in non-OECD Asia and the FSU.
  • A build of 13.3 mb in OECD industry stocks in June lifted the 2Q07 increase to 67 mb or 0.73 mb/d - below the five-year average for this period.  A counter-seasonal stock draw looks likely during 3Q07.  Total OECD industry stock cover stood at 54.0 days at the end of June, 0.1 day lower than at end-May and 0.4 days below June 2006.
  • Global refinery crude throughput is estimated at 73.3 mb/d in June, and is seen rising by 1.3 mb/d in July as scheduled and unscheduled maintenance comes to an end.  August throughput has been revised lower to 75.1 mb/d, to reflect economic run cuts and higher non-OECD maintenance activity, primarily in China and the FSU.

The price of poor data

The financial market concerns that prompted the recent dip in oil prices has added to the big analytical divisions already apparent in the market.  Prices remain high and crude futures markets have been toying with backwardation - both of which seems at odds to the high level of OECD crude stocks at the end of June.  From a fundamental perspective, the rise in oil prices in June and July is explainable: refiners booked crude to meet peak throughputs in July and August, and concern that OPEC will undersupply the market increased the price at which refiners are willing to draw down their stocks, so inflating prices.

But, with the limited hard data to hand, there is still a wide margin for interpretation of current and future fundamentals.  We have weekly data for the US and Japan, but to get a preliminary picture of the OECD takes six weeks.  The Joint Oil Data Initiative (JODI) has made huge inroads into the collection of more timely and accurate data, but there is still very little information on stock levels outside the OECD.

Some countries are still struggling to set up data collection systems, but for most monitoring stock levels at ports, loading terminals and refineries is as easy as collating supply or product-by-product demand data.  Many (if not most) companies probably have the ability to report these data on a real-time basis.  So why the lack of data?

There are two common arguments.  Firstly, some non-OECD officials have indicated that several years of high prices have led industry to run on minimal stocks and they worry that if they release this information, they might push oil prices higher than they already are.  That is the easiest issue to address: do not worry - the market already implicitly assumes they are zero.  Secondly, that stock data are commercially sensitive.  That may be the case, but keeping it secret has scarcely led to consumers paying less and the US and Japan show it can be done.  US regulations are generally very responsive to industry's needs, yet the comprehensive weekly data published by the EIA demonstrate that commercial sensitivities can be overcome.

This is not just about data coverage, it is also about the timeliness of data.  In the OECD, weekly European data are conspicuous by their absence (even China and Russia industry publications provide some weekly data!).  While there are some genuine concerns in Europe about cost and the quality of the trade data available, some of the often-heard arguments against the publication of more frequent data fail to see the bigger picture.

Statisticians argue that data quality becomes poorer if you produce them more frequently.  This may be true, but every analyst understands there is a trade off between timeliness and accuracy.  Weekly data are less accurate than monthly data; monthly data are less accurate than annual.  But the JODI experience shows that data quality improves if it is collected regularly under a continual assessment process.

It is also wrong to interpret the focus on the US weekly data as a sign that more timely data increase market volatility.  Experiences in other commodity markets show that it can have the opposite effect.  Copper traders have long had the benefit of regular reports of stocks from the London Metal Exchange (LME).  These exchange-deliverable stocks were originally held in warehouses in North West Europe and provided limited information to those outside of the trading fraternity.  Yet, like the weekly US oil data, they provided a market focus:  analysts would forecast changes and prices would swing around their release.  But as the geographical coverage of the LME widened and the frequency of the stock data releases increased, the volatility surrounding the numbers dwindled.

To those involved in market analysis, it is clear that more comprehensive and more frequently released data improve market understanding.  Moreover, if doing so knocks several hundredths of a cent off the average oil import bill it would be cost effective.  In the current environment, the uncertainties associated with a lack of data could bear a much higher cost.



Focusing on the high level of US stocks as evidence that the market is well supplied ignores the low level of Japanese crude stocks and European inventories at average levels.  In days of forward demand cover, these stocks are below normal and logic suggests they may be even lower from a global perspective.  Our projections suggest stocks will be drawn down further in August and September, yet when OPEC members come to assess the market at their 11 September meeting, they will have to hand only OECD-wide data from June.  If ever there was a compelling argument for the benefits of wider and more frequent stock data coverage, it is now.

While refinery tightness partly explained rising prices in the second quarter, that reasoning evaporated in July as global throughputs soared and refinery margins plunged.  Historical data alone will not provide answers.  Prices provide a strong signal too.  With volatility in financial markets elevating concerns about future demand, the last thing the global economy needs is higher oil prices.  Undersupplying the market in this context could bear considerable risks.

Demand

Summary

  • Global oil product demand remains unchanged at 86.0 mb/d in 2007 (+1.8% over 2006) and 88.2 mb/d in 2008 (+2.5%).  A surge of fuel oil and direct crude burning in Japan and of gasoil and fuel oil in several Gulf countries has been largely offset by downward revisions in non-OECD Asia and the FSU.  Even though there are concerns regarding the spill-over effects of the US subprime market woes onto the world economy, the International Monetary Fund has recently strengthened its outlook for 2008.


  • OECD oil product demand has been revised upwards in both 2007 and 2008.  This results from minor 2Q07 revisions to several countries and, more significantly, to the outage of Japan's largest nuclear plant after a major earthquake in July.  Japan is now seen burning about 140 kb/d of additional low-sulphur fuel oil and crude for power generation at least for a year.  OECD demand is thus expected to increase by 0.6% in 2007 to 49.5 mb/d, and by 1.7% in 2008 to 50.3 mb/d.  This forecast also assumes normal winter conditions during 4Q07 and 1Q08 and the continued growth of North American demand (+1.4%).
  • Non-OECD oil product demand has been slightly adjusted downwards in both 2007 and 2008.  Revisions include minor downward changes to China and other Asian countries, and a slight increase in summer demand for gasoil and fuel oil in Gulf countries, given reported gas shortages in their power generation sector.  Overall, non-OECD demand is expected to reach 36.5 mb/d in 2007 (+3.5% on an annual basis) and 37.8 mb/d in 2008 (+3.8%).
  • This demand forecast has not yet accounted for the effects of the gasoline rationing scheme in Iran.  Although official sources claim that demand has fallen sharply, anecdotal evidence suggests that traffic is back to pre-rationing levels.  The lack of detailed data makes it premature to revise downwards the country's gasoline demand outlook, but this report will continue to monitor developments closely.

OECD

Preliminary data indicate that total OECD inland deliveries decreased by 1.2% in June, compared with the same month in 2006.  This fall was related to demand weakness in Europe (-3.7% year-on-year) and the Pacific (-1.6%), which exceeded North America's modest gain (+0.5%).

The weakness in OECD Europe demand is largely related to lower-than-average deliveries of heating oil in several countries, notably Germany and France; overall, the region's heating oil demand plummeted by 16.7% on an annual basis.  In addition, fuel oil demand contracted by 3.5% given relatively subdued electricity demand, although fuel oil consumption could rebound if drought conditions in southern Europe worsen.  In OECD Pacific, demand was dragged down by weak transportation fuel deliveries (gasoline fell by 0.7% and diesel by 2.6%), particularly in Japan.  In OECD North America, by contrast, demand was supported by transportation fuels, notably in the US (where the driving season is in full swing) and Mexico.  Regional deliveries of gasoline and diesel increased by 0.6% and 3.5%, respectively.







Overall, OECD demand is forecast to reach 49.5 mb/d in 2007 (+0.6%) and 50.3 mb/d in 2008 (+1.7%), on the premise that temperatures during the forthcoming winter will be in line with the previous 10-year average.  Under this assumption, year-on-year growth in all OECD areas should be strong.  North America, which accounts for over half of OECD demand, will remain the OECD's main engine of demand growth, increasing by +1.4% in 2008.  Meanwhile, Europe and the Pacific are both seen rebounding by +2.0%.  It should be noted that forecast demand in the Pacific has been revised upwards following the outage of Japan's largest nuclear plant, which was closed down for safety reasons after a particularly strong earthquake in July.  This unexpected event is likely to result in Japanese utilities burning additional fuel oil and crude to meet power demand at least until 3Q08.





North America

According to June's adjusted preliminary data, inland deliveries in the continental United States - a proxy of oil product demand - shrank by 0.2% versus the same month in 2006.  The main factor of weakness was once again heating oil, which plummeted by 25.3% year-on-year.  This is related to both seasonal factors (warmer temperatures, with some 14 more cooling-degree days or CDDs than the ten-year average) but also to reclassification issues (low-sulphur distillates are now counted as 'diesel').  Jet/kerosene also fell (-4.0%), but in line with the five-year average.

By contrast, diesel deliveries (mostly road-diesel, including ULSD) reported a year-on-year gain of 3.7%.  Compared with the strong growth rates of the previous two months (almost 10% on average), this may suggest that economic activity, albeit resilient, is slowing down somewhat.  Similarly, gasoline demand rose by only 0.1%, despite this being the driving season.  This may indicate that high retail prices are also starting to eat into demand, but drawing such conclusions from primary demand (i.e. derived from refinery deliveries) may be premature.

Indeed, the IMF still predicts relatively strong US economic growth in 2008 (+2.8%), despite having revised down by a notch its 2007 forecast (from +2.2% to +2.0%).  There is a risk that the housing market woes and ensuing financial markets turmoil could herald a slowdown of consumer spending.  Nevertheless, real GDP in 2Q07 grew by a surprisingly strong 3.4% (annualised).  This suggests that, despite an often talked-about slowdown, the economy continues to hold its ground, albeit at below-trend growth for the second year in a row.  On this basis, and assuming normal temperatures during the forthcoming winter, we still expect US50 demand to increase by 1.5% to 21.3 mb/d in 2008.



Mexican demand rebounded strongly in June (+5.9%), pulled up by vibrant growth in gasoline (+6.8%), jet fuel/kerosene (+10.5%) and residual fuel oil (+14.9%) deliveries.  Gasoline is poised for its fifth year of buoyant growth in a row, as a result of a rapidly expanding vehicle fleet, which in turn has been fuelled by the spread of consumer credit and economic growth.  More interestingly, the rise in jet fuel/kerosene is related to the emergence of several low-cost airlines over the past few years; competition has become fierce, and ticket prices have fallen significantly, thus further stimulating air travel demand.  Meanwhile, the spike in fuel oil deliveries, after almost two years of falling or stagnating consumption, suggests that electricity demand is booming as a result of strong economic activity (and also in part due to seasonal, warmer weather).  In the medium term this rebound is unlikely to last, as new gas-fuelled generation capacity comes on stream.



In early July, a rebel group, the People's Revolutionary Army (EPR by its Spanish acronym), claimed responsibility for an attack against several of Pemex's pipelines in west-central Mexico.  The group justified its act against the state-owned company on the grounds that it no longer serves the interests of the 'people' but those of the 'oligarchy'.  The attack severely disrupted natural gas supplies to households and industries in the area, as well as crude deliveries to Pemex's Salamanca refinery.  Only a few of the 1,200 companies that were affected (notably car makers) reportedly managed to switch to other fuels in order to keep their operations running during the week-long gas outage.  As such, a blip in LPG and fuel oil consumption is likely to have occurred in July, in addition to a drop in natural gas consumption.



Europe

According to preliminary data, total oil product demand in Europe shrank by 3.7% in June, compared with the same month in the previous year.  The fall was related to start of summer (there were about 121 more CDDs than the 10-year average).  High prices may also have prompted end-users to draw stocks or postpone the seasonal refilling.  As a result, heating oil deliveries contracted by 16.7% on an annual basis, while fuel oil demand shrank by 3.5% since electricity consumption remained somewhat anaemic.

Regarding the main European countries, demand in Germany and France was dragged down by weak heating oil deliveries in June.  According to preliminary data, total oil product deliveries were 7.7% lower in Germany on an annual basis, with heating oil plummeting by 36.3%; in France, the figures were -3.4% and -23.1%, respectively.  Nevertheless, the German heating oil market - the largest in the continent - is showing some signs of revival: household stocks rose from 53% to 55% of capacity, albeit one month later than usual (stocks usually begin to rise in May).  Nevertheless, it remains to be seen whether German households sustain their filling pace; as in 2006, it will likely be related to price fluctuations.



Further south, the picture was similar, with demand in both Italy and Spain constrained by weak heating oil and residual fuel oil deliveries in June.  Total demand fell by 5.1% in Italy and by 0.3% in Spain on a yearly basis; heating oil contracted by 14.5% and 5.0%, respectively, while fuel oil shrank by 15.8% and 1.5%.  Nevertheless, fuel oil demand in the region could rebound if the summer drought proves to be more severe than expected and curbs hydropower capacity utilisation.  It should be remembered that Italy and Spain account together for about 25% of Europe's fuel oil market.



Finally, given the healthy outlook of the main European economies (both in terms of domestic demand and exports), coupled with expectations of normal temperatures during the forthcoming winter, we foresee that OECD Europe demand will rise by 2.0% to 15.7 mb/d in 2008.



Pacific

According to preliminary data, oil product demand in the Pacific declined by 1.6% in June, compared with the same month in the previous year.  Overall demand was curbed by weak transportation fuel deliveries (gasoline fell by 0.7% and diesel by 2.6%), particularly in Japan.  Demand for heating fuels (kerosene in Japan and Korea, and other gasoil elsewhere) remained weak (-2.7%).  Residual fuel oil deliveries, meanwhile, rose by only 1.4%.  By contrast, demand for 'other products' (which include direct crude burning for power generation) jumped by 15.5%, mostly as a result of rising electricity demand in Japan.

In Japan, oil product demand in June contracted for the fifth month in a row, falling by 2.9% on an annual basis.  All products bar residual fuel oil (+4.0%) and crude for power generation (+30.9%, included in the 'other products' category) fell.  Aside from the country's structural weakness in transportation fuels, the decline was largely seasonal; total demand was in line the five-year average.

The spike in both fuel oil and direct crude burning was due to strong industrial demand in June, coupled with lower nuclear and hydropower generation rates.  Moreover, the strength of both products is likely to prevail in the months ahead, following the shutdown of the Kashiwazaki-Kariwa nuclear plant after the major earthquake that hit northwest Japan in mid-July.






Coping with Japan's Nuclear Outages

On July 16, a 6.8-magnitude earthquake (Japanese scale) hit the city of Kashiwazaki, located on the island of Honshu (in Niigata prefecture, about 250 km northwest of Tokyo). The earthquake led to the shutdown of the Kashiwazaki-Kariwa nuclear plant, the largest in the world. The facility, owned and operated by Tokyo Electric Power Company (TEPCO), has a total nameplate capacity of 8.2 GW - enough to provide electricity to some 16 million households (about 34% of Japan's total).

Although the plant itself suffered relatively minor damage, there were radiation leaks, prompting the government to order its shutdown on safety concerns - namely whether it can withstand another earthquake of such a magnitude (the plant was designed for a 6.5 scale), and more crucially, whether it was built over an active fault-line. This has further tarnished the reputation of Japan's nuclear industry, which has been recently sanctioned for having covered up serious incidents in several plants over the past two decades and falsified maintenance data.

This incident comes ahead of peak electricity demand (usually from late July through to September), and will oblige TEPCO to meet the shortfall with thermal generation using a panoply of fuels (low-sulphur fuel oil, low-sulphur crude, LNG and coal) and buy surplus power from other utilities and from industries equipped with co-generation facilities. As such, we have raised our forecast of fuel oil demand by an additional 55 kb/d and that of direct crude consumption by 85 kb/d through to July 2008. This prognosis assumes that the plant will be idle for one year, as has been reported; however, the shutdown could become permanent (local residents have attempted in the past to rescind the plant's license). Should this happen, we will revise our outlook for 2H08 and beyond accordingly.

In Korea, meanwhile, total oil product deliveries fell by 0.7% year-on-year in June, mostly because of falling gas/diesel and residual fuel oil demand (-8.6% and -2.7%, respectively).  The weakness of these products offset the continued strength of naphtha (+8.1%), gasoline (+4.9%) and jet fuel/kerosene (+10.3%) deliveries.  Although diesel deliveries remains above the five-year average, demand may fall further in July as the effects of the 7.5% diesel fuel tax hike, which began on 1 July, are fully felt by end-consumers.



Given Japan's nuclear predicament, we have revised up our outlook for 2008 demand in OECD Pacific, which is now seen growing by 2.0% on a yearly basis, to 8.6 mb/d.  As with other OECD areas, it should again be emphasised that this forecast relies on sustained economic activity and normal winter temperatures.



Non-OECD

China

China's apparent demand (defined as refinery output plus net oil product imports, adjusted for fuel oil and direct crude burning, smuggling and stock changes) rose by an estimated 3.0% year-on-year in June.  Continued petrochemical demand, farming activities and construction work supported strong demand for naphtha, gasoil and 'other products' (+9.9%, +9.5% and +12.1%, respectively).  However, gasoil demand is likely to be somewhat less buoyant over the next few months as the yearly fishing ban is implemented and the country enters the rainy season, which tends to slow down construction activity.



By contrast, residual fuel oil consumption shrank in June by 6.5% on a yearly basis.  This suggests that both fuel oil-fired power plants and 'teapot' refineries in southern China significantly cut their use as a result of soaring import prices (which have reached record highs in Singapore over the past three months).  Power plants have reportedly switched to coal and, to a lesser extent, LNG.  Meanwhile 'teapot' refineries have seemingly cut their runs to around 30-40% of capacity as capped domestic retail prices make refining operations unprofitable in the face of higher feedstock prices.  Despite the halving of the fuel oil import tax since 1 June (to 3%), only those users requiring higher-specification fuel oil have continued to purchase it abroad; the rest have turned to the lower-priced domestic fuel oil blend.

The renewed mismatch between international and domestic prices has led to a repeat of oil product shortages, notably gasoline.  This has almost become a familiar sequence in China: 1) international prices rise, but domestic prices remain static; 2) margins fall, prompting refiners and retailers (particularly the large state-owned Sinopec and CNPC) to increase exports, which are much more lucrative; 3) the government then urges oil companies to fulfil their obligations to supply the domestic market; 4) oil companies more or less comply but loudly protest because of mounting downstream losses and demand once again a hike in domestic retail prices; and 5) the government placates state companies by offering a compensating end-year subsidy and adjusts - marginally - retail prices.  So far this year, the cycle has reached the fourth step; the fifth one will likely take place over the next few months - however, inflationary pressures, the forthcoming People's Congress in October and next year's Olympics probably militate against a significant retail price increase.



Given minor revisions to 2Q07 estimates, we now expect total Chinese oil product demand to increase by 5.7% in 2007, to 7.6 mb/d, and by 5.8% in 2008, to 8.0 mb/d, on the premise of continued strong economic growth.  Indeed, the IMF has raised its own outlook for this year and the next (+11.2% and +10.5%, respectively).  However, this reassessment does not necessarily mean that the Chinese economy is overheating, but rather that official data are becoming more accurate and credible (the IMF changes were arguably prompted by the government's own revisions to historical GDP growth data).

Other Non-OECD

According to preliminary data, oil product sales in India - a proxy of demand - increased by 6.2% in June on a yearly basis, pulled up by very strong increases in gasoline (+19.7%), gasoil (+19.8%) and residual fuel (+15.4%).  By contrast, 'other products' (which include bitumen, lubricants, etc.) fell by 17% - possibly because of strong stockbuilding in the previous year, but most likely reflecting statistical glitches.

Indeed, May's figures were revised up to account for a 2.2% rise in total demand, instead of the small 0.2% drop previously reported, with the largest adjustment in the 'other products' category.  Naphtha demand, meanwhile, fell for the third consecutive month (-22.5%), suggesting that natural gas supplies are growing, thus leading to the resumption of naphtha's gradual decline.

As such, India's oil product demand forecast remains largely unchanged when compared with last month's report.  Demand is expected to rise by 4.3% in 2007 to slightly above 2.7 mb/d, but growth should slow down to 2.3% in 2008 (2.8 mb/d) as a result of naphtha's structural decline.





FSU apparent demand - defined as domestic crude production minus net exports of crude and oil products - has been slightly adjusted downwards in both 2007 and 2008, compared with last month's report.  Downward revisions to supply figures, particularly in 2Q07, were larger than expected.  Coupled with increased export duties from 1 June (crude duties rose by 28% to $200/tonne) and maintenance at Novorossiysk, the region's net exports, albeit still relatively buoyant, averaged 8.8 mb/d in June, down from May's 9.1 mb/d.  As such, 3Q07 net exports are expected to fall to 8.6 mb/d.  Overall, FSU demand is expected to average 3.9 mb/d in 2007 (1.4% lower than in 2006) and about 4.0 mb/d in 2008 (+2.0%).  However, as noted in previous reports, this forecast is subject to great uncertainty given the volatility regional trade data.

Argentina's Energy Shortages

As noted in a previous report (Oil Market Report dated 13 December 2006), Argentina has been confronted to mounting energy shortages, notably since mid 2006, as supply has failed to match the fast pace of demand growth, which has soared as the economy has recovered from the country's economic meltdown of 2002. This year, the situation has become even more pressing, largely as a result of an extremely severe winter. Whereas gasoil shortages were the key issue a year ago, this time the problem concerns both gasoil and, more significantly, natural gas.

At issue is the government's continued reluctance to allow domestic retail prices to rise. This has not only discouraged private investment in domestic gas production (most of which comes from mature, declining fields) but has also prompted downstream players to reduce gasoil production in order to boost fuel oil output (exported at international prices or sold to domestic utilities) and to export as much gasoil as possible (or at least minimise imports). However, fearful of stoking inflation (which is already running at more than 10%) and of upsetting voters ahead of October's presidential election (the current president's wife is the leading candidate), the government has targeted and fined oil and pipeline companies, imposed an export tax and an export pre-approval rule on gasoil, cut gas exports to neighbouring Chile and increased prices (of gas) for industrial users. Residential users, by contrast, have not even been encouraged to save energy.

However, these measures, albeit politically expedient, have been predictably insufficient to solve the problem. For example, gasoil shortages reportedly caused delays in harvesting and planting new crops in various temperate regions in June, while several industrial users have been forced to significantly reduce their operations over the past two months because of the lack of gas and/or power. As such, the government has been obliged to import more gas from Bolivia and electricity from Brazil and Uruguay. More significantly, in mid July it launched a 90-day programme to subsidise gasoil and fuel oil consumption, hoping to temper the effects of the gas shortage. It remains to be seen, however, whether the programme will prove to be temporary, since the structural causes behind the surge in demand - extremely low retail prices - have not been tackled. In the end, Argentina could find itself in a situation reminiscent of that prevailing in Iran, namely galloping energy consumption, very onerous subsidies and a high import bill.

In the Middle East, oil product demand remains buoyant, given the encouraging combination of low retail prices, strong economic growth and favourable demographics.  However, the region's rapid economic expansion, coupled with the start of summer, is causing power generation bottlenecks as gas supplies become insufficient to meet soaring electricity demand.  Power shortages are reportedly acute in Kuwait, where the authorities have launched a rationing programme during peak hours, and the UAE (industrial users, such as cement producers, in Ras al-Khaimah and Fujairah were reportedly switching to coal, while rolling blackouts have occurred in Abu Dhabi and Sharjah).  In other areas demand for gasoil and especially fuel oil, aimed at feeding power generators, has also reportedly spiked.

More generally, for some countries such as Kuwait, Saudi Arabia or Iran, turning to fuel oil for power generation makes economic sense, especially where power plants are close to refineries.  Rather than upgrading refineries or processing lighter crude oil to reduce fuel oil output - whose value has sharply diminished as export markets have shrunk, notably in Europe - local refiners can process their readily available reserves of heavy crude to produce large volumes of fuel oil, which in turn can replace direct crude burning for power generation.  This excess - and more valuable crude - can then be exported.  Nevertheless, as highlighted in our July 2007 Medium-Term Oil Market Report, if fuel oil demand sharply increases, the region will arguably be obliged to become a net importer - just when the worldwide supply of fuel oil is expected to diminish as a large amount of upgrading capacity comes on stream by the end of the decade.

Although the start-up of Qatar's Dolphin gas project should help relieve the ongoing gas shortages in the short term, we have slightly increased our assessment of gasoil and fuel oil consumption in the region over the summer months.  Middle East demand is now seen reaching 6.6 mb/d in 2007 (+4.5% year-on-year) and 6.9 mb/d in 2008 (+4.3%).

It is important to note that this forecast has not yet incorporated the effects of the gasoline rationing scheme in Iran, which was launched in June (following May's 25% hike in retail prices).  Given the lack of detailed data, we believe it is premature to make an adjustment to the country's gasoline demand outlook for 2007 and the years ahead.  Nevertheless, we will adjust our figures as new information becomes available.

Following Up on Iran's Gasoline Rationing

Iran's gasoline rationing scheme, which was introduced in late June with the aim of drastically cutting demand and hence imports, poses several analytical and policy challenges that make it difficult today to assess the outlook of the country's gasoline demand in the short- and medium-term. In a nutshell, the scheme establishes a defined monthly volume for each type of vehicle; motorists can buy up to six months' worth of gasoline in advance (instead of four months as initially announced), and unused rations can be carried over into the next rationing period. The rations are monitored by a system of electronic 'smart' cards.

The first challenge is to assess the effectiveness of the scheme in its first month after implementation. According to official sources, over the course of July demand fell by as much as 150 kb/d (roughly 30% of total gasoline consumption). In addition, the government claims it won't buy spot gasoline cargoes for the rest of the year. However, anecdotal evidence suggests that traffic in Tehran is now back to pre rationing levels.



Most likely, gasoline demand has fallen only slightly. Indeed, it could be argued that motorists have barely changed their behaviour, for two reasons. Firstly, despite May's 25% hike, retail prices are still very low (about 12 cents per litre), and the more so when compared with international prices; secondly, by allowing motorists to purchase up to the equivalent of a six-month quota in advance the government is only postponing the day of reckoning. Similarly, it is unclear whether imports have actually fallen and that stocks are being drawn down - after all, spot buying can be replaced by term contracts. In fact, imports will probably persist even if the rationing proves successful. According to the consultancy group FACTS GLOBAL ENERGY, domestic production will continue to be insufficient to meet demand at least until the end of the decade, when several refining projects will come on stream.

What will happen after the six-month period - or more likely, when motorists use up their allocation? By September, the government is expected to set a price for gasoline purchases in excess of the defined quotas. What remains unclear is at what level will the price be set: similar to international prices (some 60 cents per litre), closer to regional levels (around 30 cents on average), or somewhere in between. This issue has reportedly become very contentious. The government is torn between political imperatives - fearing that higher prices would stoke inflation (already running at some 16%) and prompt a repeat of the riots that erupted when the scheme was introduced - and economic realities - the need to curb the onerous subsidies and rising import bill that prompted the scheme in the first place. Another consideration is geopolitical: reducing the country's import vulnerability in case its nuclear program leads to import restrictions.

The answer is perhaps to be found in the black market, where gasoline is reportedly sold at or close to international prices. If rationing is maintained but quotas prove insufficient, the black market will effectively set the price for heavy users. As a result, smuggling out of Iran will probably cease, since Iranian prices would be higher than in neighbouring countries. Some users, such as taxis, may even find that reselling their entire quota is more profitable than actually working. In the end, overall consumption would probably fall.

However, the black market may also effectively ignite inflation and deepen social inequality. Higher gasoline prices may not show up at the pump, but may be reflected in the price of other goods, since the country is highly dependent on road transportation. In sum, the choices ahead are difficult, and at this point it is difficult to determine either current demand or to foresee an eventual outcome. Therefore, for now, we have left our forecast unchanged but will continue to monitor the situation closely.

Supply

Summary

  • World oil supply in July gained 1.1 mb/d compared with June, averaging 85.3 mb/d.  However, the 2Q total of 84.9 mb/d stood only 0.1 mb/d above levels of a year ago.  Total OPEC supply in July increased by 0.4 mb/d from June, while post-maintenance recovery from North America, the North Sea and FSU saw non-OPEC supply up by 0.7 mb/d.  However, monthly gains from non-OPEC could prove short-lived as maintenance and seasonal factors will likely reverse the July increase in August and September.
  • Non-OPEC production estimates for 2007 and 2008 remain largely unchanged from last month's, at 50.0 mb/d and 51.0 mb/d respectively.  Despite marginal changes overall, North American, Asian and Middle Eastern supply profiles now look stronger, offset by weaker expectations for the North Sea, Australia, FSU, Vietnam, Brazil, and Africa. OPEC gas liquids contribute 4.9 mb/d to supply in 2007, rising to 5.5 mb/d next year.  The FSU, China and global biofuels are key contributors to non-OPEC growth in 2007, augmented by Brazil, Australia, Canada's oil sands and Sudan for 2008.
  • A focus on OECD supply issues suggests upside potential versus forecast US GOM supply, subject to the severity of the current Atlantic hurricane season.  Our own 2007 storm outage assumption of some 33 mb, based on a five-year average, is higher than recent US EIA allowances.  Moreover, the recent incorporation of a field reliability adjustment is aimed at minimising downside forecast risk for mature producing areas such as the North Sea.
  • OPEC crude supply in July increased by 385 kb/d to 30.5 mb/d.  Gains centred on previously shuttered Iraqi and Nigerian supply, rather than a concerted move to boost output in line with rising demand.  However, there is no guarantee that July's increases from either country can be sustained.  Delaying further increases in OPEC supply to beyond 11 September implies cargoes would only reach consuming markets very late in 2007.  Spare capacity is also likely to remain tight, at or below current near-3 mb/d levels, for the balance of the year.
  • The 'call on OPEC crude and stock change' rises this quarter to a midpoint centred on 31.9 mb/d and to 32.9 mb/d in 4Q, nearly 2.5 mb/d above current OPEC output.  Moreover, against a backdrop of robust demand growth, the call potentially increases by at least 0.6 mb/d for 2008 as a whole.  With risks over non-OPEC supply and global demand arguably lying in the same direction (downward), there appears to be little chance of overshoot were OPEC to raise supply to the market.


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

Note:  Random events present downside risk to the non-OPEC production forecast contained in this Report.  These events can include accidents, unplanned or unannounced maintenance, technical problems, labour strikes, political unrest, guerrilla activity, wars and weather-related supply losses.  Specific allowance has been made in the forecast for scheduled maintenance in all regions and for typical seasonal supply outages (including hurricane-related stoppages) in North America.  In addition, from July 2007, a nationally-allocated (but not field-specific) reliability adjustment has also been applied for the non-OPEC forecast to reflect a historical tendency for unexpected events to reduce actual supply compared with the initial forecast.  This totals -410 kb/d for non-OPEC as a whole, with downward adjustment focused in the OECD.

OPEC

OPEC crude supply in July rose by 385 kb/d from a downward-revised June level, to average 30.5 mb/d.  While this represents the sharpest gain in OPEC supply since June 2006, increases were largely confined to hitherto-disrupted output from Iraq and Nigeria (whose combined production was 440 kb/d higher than in June).  A more accurate measure of where OPEC is in relative terms therefore comes from the observation that, despite July's increase, OPEC-10 production (excluding Iraq and Angola) stood 1.6 mb/d below levels of a year ago.  Effective OPEC spare capacity remained anchored below 3.0 mb/d.



In July and early August, OPEC representatives continued to play down the possibility of officially increasing supply ahead of the Organisation's 11 September meeting in Vienna.  Refining constraints, geopolitics and speculative activity were again cited as the main drivers of high prices.  Much has been made of high absolute US crude inventories, without reference to the tighter measures of forward demand cover, lower stocks elsewhere, and limited OPEC spare capacity.  The scale (540 kb/d) and 'just-in-time' nature of OPEC capacity increases between now and end-2007 means that spare capacity is unlikely to change significantly, leaving the market facing equally unattractive alternatives.  With capacity additions lagging demand growth, a belated rise in OPEC supply to put a floor under 4Q stocks would occur at the cost of narrowing spare capacity.  Alternatively, static OPEC supply would see modest widening in the spare capacity margin, but sharply lower inventory.

Timing is also an issue, since any concerted increase in OPEC supply, even if agreed on 11 September, would likely affect October (or even November) liftings, therefore only reaching main consuming markets in November, or even December.  Saudi Arabia tends to announce allocations for the following month in the second decade of the preceding month, and could therefore presumably boost October supplies at relatively short notice.  But other Middle East Gulf producers tend to announce allocations some five to six weeks before lifting, suggesting either that decisions to boost October liftings need to be made ahead of the September meeting, or that higher supply will not reach refineries until later in the year.  Contract flexibility allows some leeway to change volumes at short notice, but either way, OPEC is leaving things



late if it is to sustain market balance and avoid a sharp tightening of inventories.

July's largest change came in the form of a 275 kb/d increase in Iraqi supply, which averaged 2.2 mb/d (its highest since October 2004). Local crude use is thought to have remained largely unchanged at June's level of 410 kb/d.  Exports from southern ports increased from 1.5 mb/d in June to 1.69 mb/d, while around 95 kb/d (2.97 mb) of northern Kirkuk crude was lifted in three cargoes from Ceyhan in Turkey.  Total exports were made up to 1.79 mb/d by some 10 kb/d of cross-border sales into Syria.  There have been no reports of a new tender for Ceyhan exports, suggesting northern pipeline flows from Kirkuk to Ceyhan remain sporadic and inventory remains low.  Despite encouraging signs last month therefore, total Iraqi August exports may struggle to match July levels.

Moreover, uncertainty continues to surround the regulatory framework for the country's oil sector.  Kurdish regional authorities complain that the version of the federal oil law now before Parliament is different from the version they previously approved and are in the process of finalising separate legislation to apply to the Kurdish region.  Nationally, parliamentarians have now departed on summer recess, stalling further progress on the legislation.  And recent diplomatic activity suggests that the issue of Kurdish rebel incursions into Turkey from northern Iraq has yet to be solved.

Nigerian supply is estimated up by 165 kb/d in July to 2.21 mb/d.  Repairs on the Nembe pipeline (Bonny Light crude) and indications of further recovery in production from the Forcados and Escravos streams underpin the rise in production.  In line with rising July wellhead production levels, scheduled August export liftings also look likely to increase.  However, offline production remained in excess of 620 kb/d for July as a whole, with producers stressing that full reactivation of production will take a long time.

Despite progress in reactivating shuttered production, the political situation remains volatile.  That said, the new government of President Umaru Yar'Adua and Niger Delta rebel groups are preparing the ground for formal talks which could aid restoration.  Also, the controversial sale of stakes in the Port Harcourt and Kaduna refineries to a local consortium, which underpinned strike action in June, was reportedly cancelled in July by the government, removing for now a further possible source of disruption.

Angola saw production rise by an estimated 40 kb/d in July, reaching 1.64 mb/d of crude (plus 90 kb/d of gas liquids), despite a brief outage at the Dalia field.  The end of scheduled maintenance work and rising supply from the recently started Rosa field drove Angolan supply higher.  However this was countered by slippage from Iran, where supply is estimated to have fallen by 50 kb/d compared with June, based on preliminary tanker sailing data, at 3.85 mb/d.  State National Iranian Oil Company (NIOC) reported production start-up at the Paranj oilfield in July which may attain 70 kb/d when fully developed.  Also, initial production from the Azadegan field began, with a target of 20 kb/d by end-2007.  Later-phase development to 300 kb/d will probably require Iran to find foreign partners to replace Japan's Inpex, which relinquished operatorship in 2006.

Venezuelan supply is estimated marginally lower in July at 2.34 mb/d.  Official pronouncements in July variously put output from the four Orinoco projects at between 420 kb/d and 520 kb/d, compared with heavy crude upgrading capacity of 630 kb/d.  On top of uncertainties surrounding Orinoco output following the departure last month of ExxonMobil and ConocoPhillips, there are reports that PDVSA is struggling to obtain sufficient rigs to sustain both Orinoco and conventional crude operations.  Oil Minister Ramirez was quoted as having reduced the active rig target for 2007 from 191 to 120.  Reluctance by rig contractors to contribute 10% of contract value to social programmes within Venezuela may be one cause of this.

Non-OPEC Overview

Downward adjustments affect non-OECD supply for 2003-2005 after accounting for annual data received from non-member countries (the IEA's 'Green Book').  However, overall non-OPEC revisions are modest at -10 kb/d, -35 kb/d and -40 kb/d for the three years respectively.  Syria, Oman, Ivory Coast, South Africa, Cuba, Guatemala and India all see downward revisions for 2004/2005, although these taper off for 2006, leaving the non-OPEC total for last year largely unchanged at 49.4 mb/d (net of Angola).

A stronger 2007 outlook now for China, Malaysia and North America adds 15 kb/d to this year's forecast (50.0 mb/d).  However, these elements are outstripped in 2008 by a now-weaker outlook for the North Sea, Australia, the FSU, Latin America and Africa, which cut around 30 kb/d from 1Q08 supply (12 kb/d for 2008 as a whole).  Non-OPEC supply for 2008 is now estimated at 51.0 mb/d.  Annual non-OPEC growth accelerates from 465 kb/d in 2006 (net of Angola), to 620 kb/d in 2007 and 950 kb/d in 2008.

This year's growth derives largely from the FSU, China, biofuels, Canada and Brazil.  In 2008, the FSU, Brazil and biofuels again drive the forecast, supported by Australia and Africa.  The North Sea, Mexico and non-OPEC Middle East see continued decline for 2007 and 2008.  Yearly non-OPEC growth slips from the near-1.0 mb/d levels evident between July 2006 and March 2007, averaging 0.7 mb/d during 2Q07, and 0.4 mb/d in the second half of 2007, before regaining 1.0 mb/d throughout 2008.

Unscheduled field outages and operational problems continued to impact on non-OPEC supply in June and July, including those at the Mutineer/Exeter field (Australia), liquids associated with the CATS gas pipeline outage (UK), Heidrun (Norway), Albacore Leste (Brazil), various Petrotrin fields (Trinidad), N'kossa (Congo) and Chinguetti (Mauritania).  The list is not exhaustive, but tends to support the change in methodology we applied to the non-OPEC forecast from last month.  'Reliability' adjustments are now applied on a national basis, reducing the base case production forecast for those countries which historically have been most prone to unscheduled disruptions or delays.



OECD

North America

US - July Alaska actual, others estimated:  Total US monthly oil output may already have peaked for 2007 during May at 7.6 mb/d.  Preliminary weekly data suggest a dip to 7.5 mb/d in June/July, while a combination of summer pipeline work in Alaska and the use of fairly aggressive hurricane outage assumptions for the GOM (see below) could see US output constrained within a 7.0-7.3 mb/d range for the rest of the year.  Rising ethanol supply only just offsets declining crude supply for 2007 as a whole, keeping total oil supply flat at 2006's level of 7.37 mb/d.  An increase to 7.42 mb/d in 2008 depends on rising GOM crude supply, in turn partly driven by the start-up of Atlantis (late 2007) and Thunder Horse (late 2008).



Is US Forecast Risk Moving to the Upside?

This month sees estimates for US total oil output revised up by 50 kb/d for 2Q07 and 100 kb/d for 3Q07, with longer range supply revised higher by 20 kb/d. Higher-than-expected May US crude production data, and a stronger trend based on weekly numbers for June/July partly nullify for those months the 125 kb/d downward adjustment applied to the US forecast by last month's methodology change, although this field 'reliability' factor is retained for August onwards. May ethanol production of some 405 kb/d was also stronger than expected and we have added 10 kb/d to the ethanol forecast, which now averages 405 kb/d for 2007 and 455 kb/d for 2008.

July production estimates for the Federal Gulf of Mexico (GOM) are revised up by 55 kb/d, reflecting the absence of hurricane-related disruptions. Specific allowance for typical hurricane outages has always been included in the OMR's GOM forecast for the July-December period (over and above the more recent 125 kb/d field reliability adjustment mentioned above). Based on the 2002-2006 five-year average, storm adjustments for GOM output for 2007 (and 2008) are as follows:



This August-December profile suggests a total oil production loss in 2007 of 33 million barrels (versus a lower US EIA estimate of between 13-23 million barrels for crude oil alone). Obviously, our five year average is heavily influenced by developments in 2004 and 2005, when Hurricanes Ivan, Katrina and Rita saw September outages peak at 0.5 mb/d and 1.1 mb/d in 2004 and 2005 respectively. In contrast, 2006 saw no output lost due to hurricane-related shut-ins. Indeed, netting out 2004 and 2005, average peak monthly hurricane outages for the preceding decade are closer to 75 kb/d. Moreover, latest predictions for the June-November Atlantic hurricane season have modestly scaled back the number of storms expected for 2007, albeit most still see hurricane activity at above-average levels. For now, with much of the season still to come, we are sticking with the five-year average hurricane adjustment. Clearly however, a repeat of the uneventful weather seen in 2006 could result in further upward revision to GOM production.

Canada - Newfoundland June actual, others May actual:  Canadian conventional crude production fell below 1.9 mb/d in May due to lower Albertan bitumen output.  Combined with lower NGL and synthetic crude supply, this pushed total oil output down to 3.25 mb/d from 3.32 mb/d in April.  However, syncrude unit outages had less of an impact than previously thought.  Indications for June suggest a 350 kb/d fall in total oil supply derived from maintenance at syncrude units and at the offshore east coast Terra Nova field.  July to September should see increases however as Alberta upgrader maintenance eases and new wells are brought onstream at the offshore Newfoundland White Rose field.  Growth of some 110 kb/d in Canadian oil supply this year centres on offshore increases (after a heavily disrupted 2006), from Albertan un-upgraded bitumen and from syncrude.  More modest growth in 2008 is heavily skewed to bitumen increases, with less of an increase from East Coast supply and Albertan syncrude.

Alberta oil sands remain the focus of longer-term Canadian supply growth.  Both Shell and Suncor, currently operating a combined 0.5 mb/d of upgrading capacity, have announced plans for major expansions.  Shell wants to add 400 kb/d of new upgrader capacity in four stages, with the first entering service in 2012.  A similar time frame is seen for Suncor's Voyageur South project, which would add 120 kb/d to current oil sands mining capacity.  However, oil sands expansion faces several barriers.  In the short term, construction workers are threatening strike action which could halt work on new projects.  Moreover, Alberta authorities in July ordered the shut-in of 121 gas wells to avoid pressure reduction in neighbouring oil sands deposits.  And the country's National Energy Board has predicted tighter pipeline capacity availability to the USA.  The Canadian Association of Petroleum Producers (CAPP) earlier suggested producers could face pipeline apportionment until 2008 when new capacity comes online.



Mexico - June actual:  Forecast Mexican oil supply is revised up by 30 kb/d for 2007 and by 45 kb/d for 2008, following markedly stronger-than-expected performance in June.  Recent months have seen a decline profile for the baseload Cantarell field which has been less extreme than preliminary indications from late 2006/early 2007 suggested.  Moreover, progress continues on expanding output from the nearby Ku-Maloob-Zaap complex.  Despite this, the overall trend in Mexican oil supply for 2007/2008 remains similar to last month's projection, falling by 140-150 kb/d in both years.  Crude output falls to 3.12 mb/d in 2007 and to 2.96 mb/d in 2008, with NGL output broadly stable overall around 430 kb/d.

President Calderon, presenting the country's National Infrastructure Plan, indicated that exploration and production expenditure for 2007-2012 would amount to $80 billion.  Under the plan, crude output is seen at between 2.5 mb/d and 3.2 mb/d by 2012, compared with our own MTOMR forecast last month of 2.7 mb/d.  The likelihood of Mexico stemming decline by way of joint ventures with foreign companies was dealt a blow in early August with the announcement that a Brazil-Mexico energy agreement would not prompt any change in Mexico's constitution, which forbids upstream oil foreign investment.

North Sea Prospects Remain Weak, Despite Healthy 2006/2007 Spending

Spending surveys show companies increasing upstream expenditure at double-digit rates, but in mature areas like the North Sea, it is becoming increasingly difficult to translate incremental dollars into incremental barrels supplied. Sector-wide cost inflation partly explains the trend but, for the North Sea, a combination of ageing resource base and infrastructure also make sustaining production particularly difficult. Nor is relative under-performance versus initial expectation in the North Sea anything new. An examination of OMR forecast OECD Europe oil production for the 11 years 1996-2006 shows an average and fairly consistent 'error' of some 450 kb/d per year (original forecast versus eventual outcome).

The previous assumption of normal field operations (typical average maintenance schedules, undisrupted access to pipeline infrastructure, no unplanned outages due to mechanical problems or strikes etc) partly explains the exaggerated downside risk for North Sea forecasts, although new field delays, exceptional weather outages and accelerating decline rates also played a role. This in large part prompted the methodology change introduced in the July issues of the OMR and MTOMR, whereby an oilfield reliability adjustment is now included in forecasts at a national level. Adjustments for the UK and Norway are 125 kb/d and 160 kb/d respectively (based on the recent three year trend, net of new field delays). In individual months when all goes well, UK and Norway supply estimates may be prone to upward revision. But for any given year, the now lower projections should help to capture in a proactive fashion the proliferating problems that mature producing area face, rather than merely reacting 'after the event'.



The challenges in sustaining North Sea supply are clearly evident. Summer field maintenance looks heavier than usual in 2007, notably in June and August. Longer scheduled stoppages can occur as facilities age. Unscheduled outages from ageing production and transport infrastructure can also proliferate, exacerbated by delays in sourcing service and maintenance crews in an overheated market. Replacing old equipment, performing well work-overs and refurbishing equipment can all be impeded by extended lead times. Recent damage to the Central Area Transmission System (the CATS pipeline) will keep up to 100 kb/d of UK liquids supply offline until late September, and Norway's Heidrun field also suffered an unplanned stoppage in July. Net output decline from the UK and Norway averages 10-15% for 2006-2008, despite offsets from new developments like Buzzard in the UK and Volve, Alvheim and Klegg in Norway. The two countries stand to lose 1.4 mb/d of combined output over 2006-2012.

Moreover, spending itself in these areas may now have peaked. UK producers suggest that while upstream spend grew by 20% to $22.7 billion in 2006, a 10% decline in 2007 could be followed by steeper falls in 2008. Statistics Norway has suggested that oil and gas spending in 2007 of $18.5 billion could fall to $13.7 billion in 2008 (although early expectations for the following year are always prone to subsequent upward revision). This scaling back in spending may in part be a reflection of a welcome topping-off in cost inflation. But UK producers attribute some of the cut to a now more stringent fiscal regime. Moreover, the North Sea and parts of North America face an ongoing trend whereby major operators are leaving mature provinces to concentrate on a smaller number of newer, potentially higher growth, areas.

Former Soviet Union (FSU)

Russia - June actual, July provisional:  Production data for June and July continued to show Russian output running around 2% ahead of 2006, averaging 9.9 mb/d.  For July, Rosneft production, and that from the seasonal Sakhalin 2 project, came in ahead of this report's earlier expectations.  However, this was offset by weaker than anticipated output from Lukoil, TNK-BP and Tatneft, leading to a 20 kb/d downward reduction in the Russian production forecast for 3Q07 onwards.  Moreover, stronger Rosneft performance results in part from its now almost-complete takeover of former Yukos production assets.  Either Rosneft or Gazprom are seen by most commentators as eventual owners of producer Russneft's assets (300 kb/d) after owner Mikhail Gutseriyev's end-July decision to sell up.

Russian growth in 2007 now comes in at 2.3% (+225 kb/d), followed by 1.8% (+175 kb/d) in 2008.  Recent reports suggest that year-round Sakhalin 2 crude production could be attained earlier than this report's assumption of end-2008.  Also, Gazpromneft (formerly Sibneft) announced it will boost spending by 66% in 2007 in order to raise output.  In both instances, this report retains a more cautious outlook until signs emerge that the higher targets are close to being reached.  The economy ministry's latest long-term production forecast sees output stable at 10.6 mb/d in 2015-2020.  Our own MTOMR last month projected Russian output of 10.6 mb/d for 2010/2011 and 10.5 mb/d in 2012, potentially rising further by mid-decade.



Kazakhstan - June actual:  June production (crude and condensate) came in 110 kb/d below earlier estimates, largely due to maintenance at the Tengiz field.  This report had earlier assumed 3Q maintenance, so a 30 kb/d downward revision for 2Q07 is offset by a similar upward revision for 3Q, leaving the 2007 forecast largely unchanged at 1.36 mb/d.  Production rises further in 2008 to 1.45 mb/d.

Further gains from Kazakhstan longer-term centre on the triumvirate of fields consisting of the existing Tengiz and Karachaganak and the currently underdevelopment Kashagan.  Early August is due to see the government opening talks with Kashagan partners to renegotiate the field's production sharing agreement, after delays have successively pushed back start-up from an original 2005 to a latest estimate of late 2010 (see MTOMR, July 2007, p38).  Meanwhile, in early July, Karachaganak Petroleum Operating (KPO) BV awarded a front-end engineering and design (FEED) contract for phase three of the Karachaganak processing complex.  This will substantially add to liquids production of 290 kb/d by 2012.



FSU net oil exports in June averaged 8.8 mb/d, some 270 kb/d lower than May levels.  Crude exports fell by 450 kb/d following a 28% increase in Russian crude export duties, from 1 June, to $200/tonne.  This was partially offset by a 190 kb/d increase in product exports, including an extra 160 kb/d of gasoil.

June crude exports of 5.98 mb/d were at a six-month low.  On top of higher Russian export duties, maintenance at Novorossiysk contributed to a 220 kb/d drop in Black Sea volumes.  Moreover, 110 kb/d less crude was exported via the Baltic in June.  A 100 kb/d month-on-month decrease in Druzhba volumes, and lower CPC transits after Tengiz field maintenance, saw total crude volumes via the Transneft pipeline system falling by 350 kb/d.  BTC pipeline exports from Azerbaijan in June were unchanged from May.

FSU exports in July could be up to 100 kb/d higher than in June, with loading schedules showing 50 kb/d more oil coming through the Transneft system and an extra 20 kb/d via BTC.  However, a further hike of 12% in Russian export duties was due on 1 August.  While this is set to reduce volumes exported through Transneft by up to 100 kb/d, a partial offset will come from higher Caspian volumes via BTC.

Other Non-OPEC

Brazil - May actual, June partly estimated:  The Brazilian crude production forecast for 2007 is trimmed by 5 kb/d and that for 2008 by 25 kb/d.  Nonetheless, Brazil remains one of the key contributors to non-OPEC supply growth in 2007 and 2008, adding 130 kb/d this year and 275 kb/d next, when crude output reaches 2.13 mb/d for the year.  In addition, NGL contributes 90 kb/d to 2008 supply and ethanol 360 kb/d.

A fire at the P-50 facility at the Albacore Leste field in the Campos Basin briefly shuttered 160 kb/d of capacity in early July but operations resumed in full within days. Oil workers also removed an earlier threat of strike action on 5 July.  Meanwhile, Devon Energy began production on 30 July at the Polvo field, ahead of this report's previous start-up estimate (November), albeit build-up to 50 kb/d plateau is now likely delayed until end-2008, and not the April 2008 earlier assumed here.  State company Petrobras's previous near-monopoly on production is diminishing, and foreign producers Shell and Devon will be joined in future by Chevron (the Frade field) and Anadarko/Norsk Hydro (Peregrino, formerly Chinook).

Revisions to Other Non-OPEC Estimates

As noted above, non-OPEC 2007 supply is revised up by 15 kb/d, while the 2008 forecast is cut by 10 kb/d.  Behind these apparently negligible overall adjustments, North American, Chinese, Malaysian, Syrian and Yemeni estimates are revised up by a combined 150 kb/d for both 2007 and 2008.  In contrast, the North Sea, Australia, FSU, Vietnam, Brazil, and Africa are trimmed by 145 kb/d in 2007 and by 180 kb/d in 2008.

An upward adjustment of 45 kb/d is applied for China from 3Q07 onwards.  June data, while matching our forecast of 3.83 mb/d in aggregate, nonetheless redistributes between fields where supply is growing and those in decline, boosting the forecast accordingly.  This continues a consistent, if unspectacular, trend of Chinese production growth seen so far this decade.  For Malaysia, May and June data came in 50 kb/d higher-than-expected, with a similar adjustment applied to the forecast through 2008.  Syrian and Yemeni historical data have been reassessed, leading to upward revisions of 5-10 kb/d each for 2007 and 2008.



Australian production is revised down by 30 kb/d for 2007 and 20 kb/d for 2008.  Mechanical problems have hit the Exeter/Mutineer field off NW Australia and maintenance is scheduled for August.  Start-up at the Puffin field, previously assumed for July, is now deferred to September.  Aside from Russia and Kazakhstan, FSU supply is affected by a 45 kb/d downward adjustment applied to Azerbaijan from 2Q 2007 onwards.  A database error resulted in our overforecasting supply for state producer SOCAR.  Reconciliation of latest JODI and Oil Ministry data for Vietnam for January-June 2007 leads to a 20 kb/d cut in 2007 output and 10 kb/d for 2008.  Chad, Congo and Mauritania now see lower supply for 2007/2008, with African supply overall curbed by 15 kb/d for 2007 and by 30 kb/d for 2008.  In Chad, new field increments may sustain supply at around 150 kb/d, rather than to increase it towards 200 kb/d as was assumed earlier.  Production restart at Congo's N'Kossa field, closed by fire in May, has been pushed back to August, and operator Total now sees a slower build back towards a 60 kb/d plateau.  Ongoing technical difficulties at Mauritania's Chinguetti field have reduced January-April output to 20 kb/d, and 10 kb/d is shaved off our production forecast to reflect the field's uncertain output profile.

OECD stocks

Summary

  • OECD industry stocks built by 13.3 mb in June as higher North American and Pacific inventories offset declines in Europe.  US crude and 'other products' saw the largest monthly change, increasing by 11.3 mb and 12.8 mb respectively, but US gasoline and Pacific distillates also saw substantial gains.   European crude and product stocks fell following lower regional crude supplies due to maintenance and unscheduled production outages and substantially reduced refinery throughputs respectively.


  • Preliminary data for July show OECD crude stocks falling by 11.7 mb as refinery throughputs increased seasonally.  Higher product stocks offset the drop, however, leaving total industry stocks 11.2 mb higher than at the end of June.


  •  Crude oil inventories at Cushing, Oklahoma, the delivery point for the NYMEX WTI contract, have fallen for the last eleven weeks and stocks, at 19.3 mb in early August, were at their lowest level since December 2005. As a result, the NYMEX WTI front month spread has moved back into backwardation after having spent almost three years in contango.  Lower forward prices support further crude draws as it is becoming very costly to store crudes priced off WTI.
  • The total second-quarter OECD industry stock build amounted to 0.73 mb/d, or a total of 67 mb. This is below a 2Q five-year average stock build of 0.85 mb/d (10-yr average: 0.82 mb/d).  A counter-seasonal stock draw during 3Q looks likely ahead of the northern hemisphere winter as global throughputs peak in July and August.  With continued field maintenance in the Atlantic Basin and likely suppressed OPEC supplies, the crude supply gap will have to be filled from inventories.
  • Forward demand cover for total OECD industry stocks stood at 54.0 days at the end of June, 0.1 day lower that at end-May and 0.4 days below June of last year. On a regional basis, forward cover came to 50.2 days for North America, 61.0 days for Europe and 52.5 for the Pacific.

OECD Industry Stock Changes in June 2007

OECD North America

Total North American industry inventories built by 22.2 mb in June as both crude and product stocks increased.  Total US crude oil stocks added 11.3 mb in June to close the month at 371.5 mb (including an allowance for territories), the highest monthly level on record.  Refinery demand continued to lag expectations, averaging almost 0.5 mb/d less than in June last year.  The year-on-year stock overhang was centred on the Gulf Coast as the narrowing of the front-month spread of WTI made the economics of floating storage less attractive, forcing an estimated 19 mb of light sweet crude stored in ships in the Gulf of Mexico to be offloaded.



In July, preliminary data showed crude stocks fell by 12 mb, the fall concentrated in the latter part of the month as refinery demand, particularly on the Gulf Coast, picked up sharply.  Crude stocks at Cushing continued to fall, finally reaching 19.3 mb in early August and the lowest level since December 2005.  This caused the front month spread of the NYMEX WTI contract to move into backwardation.  The forward price structure makes it costly to hold crude in storage, supporting further stock draws.  WTI also moved to a premium over Brent, possibly attracting light sweet grades to the US.  In July, the US recommenced crude deliveries to the SPR at a daily rate of 51.6 kb/d.

North American product inventories built by a total of 13.8 mb in June following higher gasoline and 'other products' inventories in the US.  As mentioned above, refinery output trended well below last year and average historical rates, but product imports more than made up for the shortfall.  Total US petroleum product imports averaged 3.7 mb/d in June, 200 kb/d higher than in the same period last year.

In July, US gasoline stocks continued to build, albeit at a slower rate, as record-high gasoline output and high imports offset strong demand. In the week ending 20 July, total gasoline imports, including blending components, hit a record weekly average of 1.65 mb/d.  In the following week, gasoline output hit a record 9.43 mb/d.  In terms of forward cover, gasoline stocks remain tight as demand remains robust.

Distillate stocks were rising faster than the seasonal norm in July due to high throughputs and increasing yields.  The diesel crack overtook gasoline in mid-July on the Gulf Coast.  Distillate demand remains very strong, however, growing by 4.1% for the last four weeks compared with the same period last year.

Total distillate inventories increased by 5.4 mb in July, to close the month at 127 mb, close to their five-year average.  The bulk of the increase came in heating oil stocks, narrowing their year-on-year gap to 21 mb.  The low heating oil stocks are mostly offset by higher diesel, in particular by ultra low sulphur diesel (ULSD) stocks.  The shifts in the composition of distillate stocks recently is in part due to a specification change for off-road diesel, this no longer substitutable by heating oil.  Differences in the date of implementation at the refinery, terminal and retail level may have caused part of the distortion.  In terms of forward demand cover, total distillate stocks are still trending at the bottom of their five-year range.

OECD Europe

European crude stocks fell by 2.6 mb in June as an increase in France (+2.8 mb) and other Europe (+2.1 mb) was offset by declines elsewhere.  European refinery throughputs, in France in particular, were sharply lower in June.  Refinery margins for simple hydroskimming refineries in Northwest Europe and the Mediterranean turned negative in June, but runs were not cut until July when the economics deteriorated further.  Offline capacity from several complex refineries which were in turnarounds was partly offset by lower regional crude supplies as unscheduled outages compounded seasonal maintenance in the North Sea.  At 334 mb, total European crude stocks are 4.8 mb lower than last year and on par with their five-year average.  In terms of forward crude cover, however, stocks are 24.4 days, on a par with last year.



Product inventories in Europe continued their downward trend seen since the beginning of this year as all product categories fell in June.  The largest draw was seen in France, where reduced output largely offset lower year-on-year demand. Deliveries in Germany and Italy were also weak.  German heating oil stocks rose to 55% of capacity in June, from 53% at the end of May, as end-users started to replenish their stockpiles ahead of the coming winter.  Consumers are taking advantage of oversupply in the inland markets and European heating oil barge prices being at their lowest since April.  This is the first monthly increase in German consumer stocks since last November, but not out of line with historical patterns.

Although total European product stocks, at 543.9 mb, remain 9.4 mb above those of last June, the majority of this year-on-year gain stems from Poland and Turkey, where product stocks have been increasing quite sharply since the beginning of the year.  In Poland, stocks are rising as the government strives to meet EU obligations by the end of 2008.  Turkey's stockpile has almost doubled over the last two years, the increase has most notably been seen in motor gasoline and middle distillate inventories.  If these two countries are excluded from the European aggregate for May (the last month where data for Turkey and Poland are available), total product stocks were less than 1 mb above last year compared with 12.3 mb for Europe as a whole.

Preliminary Euroilstock data for July show total industry stocks down by 2.3 mb as both crude and product stocks fell from end-June levels.

OECD Pacific

Crude stocks in the OECD Pacific moved sideways in June, as an increase in Japan was offset by a draw in Korean inventories.  Japanese stocks built by 4.7 mb despite higher crude runs.  Preliminary data show that June crude imports were 10% higher than May and 12% higher than last year  In July, PAJ weekly data show that Japanese throughputs increased by another 570 kb/d to trend above their recent five-year range.  Onshore crude stocks continued to build (+1.9 mb), however, as imports offset higher demand.

Weak product demand in the OECD Pacific in the first half of this year has reduced the impact of low product output on inventories.  In the January to June period, Pacific crude runs have been lagging levels of a year ago by an average of 70 kb/d.  Only in June did total Pacific crude runs surpass levels of a year ago, as higher Korean runs offset a continued lag in Japan.  The trend in oil demand for the Pacific is expected to be reversed in the latter part of this year, largely due to increased utility demand.  The shutdown of Japan's largest nuclear plant, TEPCO's Kashiwazaki-Kariwa, following the 16 July earthquake, has created additional demand for fuel oil and crude oil for power generation, adding 55 kb/d and 85 kb/d respectively for the next 12 months, or until the nuclear plant reopens.  In all, product stocks were on par with the five-year average and last year, but as demand is seen higher, forward stock cover has been reduced to 53 days, 3 days lower that last year.

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

Total OECD industry stocks ended June at 2,672.6 mb, 13.3 mb higher than May and 15.8 mb higher than a year ago.  The year-on-year increase is concentrated in US crude stocks and European product inventories.  In Europe, distillates in particular are trending above historical levels, with Germany, Poland and Turkey responsible for the bulk of the difference.  In terms of forward demand, however, both North America and Europe are relatively unchanged from last year, while the Pacific at 52.5 days is 3 days below last year.  For the OECD as a whole, forward demand cover stood at 54 days, cover was 0.4 days lower than last year.



Finalised data for May show a net upward revision of 12.9 mb for total industry stocks, mostly accounted for by adjustments to crude and NGLs.  US and European crude oil inventories were adjusted upwards by 7.5 mb and 5.3 mb respectively, partly offset by a downward adjustment of 5 mb in Japanese crude stocks.  Total product inventories were relatively unchanged as a smaller downward revision to North America was offset by upward changes elsewhere.



Recent Developments in ARA Independent Storage

Stocks held in independent storage in the Amsterdam-Rotterdam-Antwerp area built by 440 kb in July to close the month at 27.75 mb.  Gasoline stocks increased slightly despite continued high exports to the US, Middle East and Nigeria and as European refiners maximised distillate output and as local demand remained sluggish.



Gasoil stocks added 0.63 mb in July, and remain at the upper end of their five-year range.  Strong diesel cracks have encouraged refiners to maximize diesel output, while gasoil demand has been relatively weak.   Additional supplies came from inland German markets as barge flows up the Rhine were reversed, bringing supplies to ARA.  FSU imports slipped amid strong exports from the Latvian port of Ventspils to the US.  In addition, a strong contango on ICE gasoil futures further encouraged storage.

Fuel oil stocks moved lower for most of July as bunker demand remained strong and at least two VLCCs were loaded and shipped to Asia. In the latter part of the month, supplies moved higher on increased Russian arrivals.

Recent Developments in Singapore Stocks

Inventories held in Singapore, as surveyed by International Enterprise, fell for all product categories in July due to lower refinery output as ExxonMobil shut a 300 kb/d crude unit for maintenance.  Light distillates, including gasoline and naphtha, fell by close to a million barrels, or 10%, from the end of June.  Tighter supplies from the region's two main exporters, China and Taiwan, and robust demand from Indonesia supported the draw.  Weaker forward prices further supported moving product out of storage.

The draw in middle distillates was even steeper with stocks declining by 1.3 mb, or 16%.  Increased demand came from Vietnam and Indonesia, who both moved to tighter sulphur specifications for transportation fuels this summer.  Regional supplies of gasoil were also limited as shipments to Europe and Chile continued apace.  Chile has had to import gasoil for power generation after Argentina reduced natural gas shipments due to extreme winter temperatures and increased domestic demand.  Fuel oil stocks drew by 0.5 mb on lower European and Middle Eastern arrivals and high bunkering demand.  Japan's nuclear problems will likely tighten the Asia-Pacific fuel oil market in the coming months.



Prices

Summary

  • Benchmark WTI prices fell sharply in early August, correcting from the record high of $78.77/bbl made in late July.  Price volatility has increased as a combination of high crude prices and higher refinery runs put downward pressure on refinery margins.  This is a familiar cycle in the oil market, whereby crude tightness is initially transferred to product stocks.  Forward spreads have also been volatile.  NYMEX WTI has moved into backwardation following 11 consecutive weeks of stockdraws at its Cushing, Oklahoma delivery point, while spot Brent has flip-flopped between a premium and a discount to future months on shifting supplies of the North Sea benchmark.
  • In July crude took its strength from existing and anticipated near-term supply tightness, on a combination of lower non-OPEC crude output and OPEC's apparent determination to constrain its production.  In contrast, geopolitical issues were less prominent.
  • Refining margins fell in all regions in July, as crude's strength outweighed gains in fuel oil and, to a lesser extent, middle distillates.  Gasoline prices fell, dragging down US refining margins in particular.  Unconfirmed talk of economic run cuts at marginal refineries in Europe and China emerged.
  • July average product prices rose but failed to keep up with crude's gains as throughputs increased sharply, particularly in the US where downstream constraints eased.  US refinery utilisation moved back in line with its five-year average, allowing a slight rise in product stocks even as demand neared its seasonal peak.  Fuel oil was boosted by tight fundamentals in Asia and anticipation that Japanese utility TEPCO would hike purchases after it was forced to shut down its largest nuclear power plant.


  • Crude tanker rates continued to fall in July, with VLCC rates from the Middle East Gulf declining to two-year lows.  Volumes of long-haul oil-in-transit continue to be reported at unseasonably low levels, especially on westbound routes.  Clean tanker rates to Asia firmed in July but weakened west of Suez.

Overview

WTI oil futures rose to new heights in early August as strong crude fundamentals and stock draws at the NYMEX delivery point of Cushing, Oklahoma (see WTI:  Contango to Backwardation) caused a dramatic revaluation of the US benchmark.  ICE Brent however traded sideways for the second half of July having reached a peak mid-month, with a relaxation of product tightness offsetting upward pressures from WTI and refiner buying.  The front-month NYMEX WTI contract reached $78.77/bbl in trading on 1 August, surpassing last summer's mid-July record of $78.40/bbl.  Both WTI and ICE Brent swung back into backwardation on the front month during July, which for the US contract was the first time since October 2005, reflecting an increased perception of near-term crude tightness.  WTI also rose to a premium over Brent futures for the first time since early March.

WTI: Contango to Backwardation

After spending 20 months in contango and, more unusually, nearly five months at a discount to ICE Brent, NYMEX futures first swung back into backwardation in late July and subsequently returned to a premium to Brent. The change in market structure came as global crude fundamentals tightened. However, WTI's actual price level itself, including a new record high of $78.77/bbl, was arguably due more to the sharp decline in crude stocks at its delivery point in Cushing, Oklahoma. These rapid changes in price dynamics again raise the question of WTI's viability as a key crude oil benchmark (see 'Distorting a Benchmark' in report dated 12 April 2007).

As we noted in April, WTI's decline earlier this year was mostly due to a steady build-up in Cushing crude stocks as a result of Midwestern refinery outages. However, following 11 consecutive weeks of draws in Cushing, stock levels have fallen by 30% to a relatively low 19.3 mb. Moreover, some argue that perhaps only three-quarters of this volume is actually light sweet crude, deliverable against the WTI contract, while the rest is lower-quality Canadian oil. The partial shutdown of BP's 410 kb/d Whiting, Indiana, refinery has not forced it to raise its usual 200 kb/d light sweet intake, but the fact that it is running 200 kb/d less sour means that the relative sweet/sour share in Cushing-area storage may have changed.

Arguably, this makes WTI's behaviour appear more reflective of local rather than global tightness. Then again, were it really only local concerns that affected WTI, this begs the question as to why Brent also rose sharply and switched to backwardation (though the latter has since seen the first three months return to contango). Admittedly, crude supplies have been constrained in Europe too, by virtue of tighter North Sea output on maintenance and outages. And for that matter, the debate over Dated Brent's lower quality due to a temporarily higher proportion of Buzzard in Forties crude may also play a role. Furthermore, it seems clear that a sharp increase in speculative buying has also contributed to WTI and Brent's recent resurgence.

In addition to the return of more refineries in the Cushing area from maintenance and outages, another reason crude stocks have fallen is lower Canadian oil sands upgrader production during May/June. Most of their crude is sent to the US Midwest. July volumes of upgraded Canadian crude should already have been around 200 kb/d higher than June, and August should see a full return. In addition, as highlighted in Distorting a Benchmark, the influx of Canadian oil will, in any case, increase pressure on the market, at least until new pipeline routes are built to take the crude on to the US Gulf Coast. Developments over the next few months should shed more light on the debate over whether WTI is a global or purely regional benchmark.



However, in early August, prices dipped sharply as US and other stock markets fell on credit woes and reports showing US economic weakness in the housing and job markets.  Traders also noted considerable fund selling on the decline and may have redressed some of the large non-commercial net-long positions that had built up over the previous weeks.

While there are genuine concerns over the economic impact of the spill-over effects of weakness in the subprime mortgage market, there are other fundamental reasons to have supported a decline.  Demand and supply appeared relatively balanced in July following a temporary lull in OECD oilfield maintenance and higher-than-expected OPEC output.  Also, while global product demand is expected to remain high in August and September, crude demand may dip as Atlantic Basin refiners undertake maintenance in September.  In the same way that upward crude buying pressures emerged ahead of peak throughput at the end of July, the impact of lower crude demand would likely be felt in late August.  Refinery margins also weakened considerably, prompting talk of run cuts in Europe and China.



Unlike last summer, however, when prices fell sharply from early August after a relaxation in product markets, GSCI's withdrawal from the NYMEX Unleaded contract, and the end to hostilities in Lebanon, this year the anticipated crude tightness is pervasive and more based on fundamentals.  While North Sea outages and maintenance dipped in July, non-OPEC supply is still expected to fall by around 700 kb/d by September on further maintenance work.  FSU exports are also expected to dip in August on strong domestic demand and a further 12% hike in crude export duties from 1 August, while OPEC's output remains restrained.  Comments from OPEC officials have (so far) indicated little willingness to change its policy ahead of its 11 September meeting in Vienna.

Compared with previous months, in July and early August, geopolitical issues appeared relatively low-key - and in Nigeria, where unrest has been constraining supply for a year and a half, output restoration exceeded new shut-ins.  Furthermore, weather effects have been insignificant so far this summer.  However, until it becomes clearer what the outcome of the developments in financial markets will be, any signs of increased tension or hurricane activity, coupled with renewed speculative activity, are likely to keep markets volatile.

Spot Crude Oil Prices

Spot crude prices in July rose over June, primarily on the above-mentioned refinery buying.  The recent dip in refining margins may yet inspire some economic run cuts and take some pressure off the forward futures curve, but there are other factors at play.  In particular, the perception remains that the market will be undersupplied in the fourth quarter, raising the price at which refiners will be prepared to draw on stocks and putting upward pressure on spot prices.  These opposing forces are contributing to the flip-flopping of the forward curve between contango and backwardation.



Despite North Sea supply issues (maintenance, outages such as the one related to the shutting of the CATS pipeline, and the ongoing debate over Forties' quality), Dated Brent lost some of its strength vis-à-vis other light sweets such as WTI, Tapis or Azeri Light.  Moreover, Dated Brent has also declined versus sour benchmark Dubai, reducing the incentive seen in much of July for Asian refiners to buy more Middle Eastern and Asian crudes.  West African grades have been predominantly US-bound, driven partly by seasonal gasoline demand (US gasoline cracks are still higher than in other regions), but also due to factors relating to Asian demand.  Reports indicate that only 860 kb/d of West African crude are to head to Asia in August, the lowest flow in four years.  China, for example, imported more Iranian crude in the first six months of the year, around 440 kb/d, and refiners are bringing forward maintenance possibly in part due to low state-administered domestic retail prices.



However, these crude spreads do not paint the whole picture, as refining margins fell sharply in July, especially on the US Gulf Coast, where they were dragged down by falling gasoline cracks.  Were margins to remain low, we might see less crude moving to the US, in theory encouraging a drawdown in stocks rather than an increase in imports.  In Europe meanwhile, anecdotal news reports hinted at possible economic run cuts in both Northwest Europe and the Mediterranean.  In the US, WTI's return to strength sharply narrowed its discount to similar LLS, though not to ANS, which has by now risen to a strong premium on above-average refinery throughputs on the US West Coast.  In Asia meanwhile, anticipated Japanese interest in heavy sweet crude for direct burning has caused Indonesian Minas to rise to a premium to Dated Brent.

Refining Margins

Refining margins were down in all regions in July, as crude's strength outweighed modest gains in all products except gasoline.  This is reflective of tight crude fundamentals rather than product demand weakness, and the steady downturn in margins since mid-May highs is by now quite pronounced.  This was particularly true in the US, where gasoline's weakness had a greater impact on margins.  On the US West Coast, ANS's unusual strength meant its cracking margin even turned negative in late July.  Margins in Europe and Singapore in any case remained weaker than in the US but were also affected by the latter's gasoline malaise and subsequently less favourable arbitrage economics.  Even gasoil and fuel oil, which were far stronger, failed to lift margins in July, given crude price increases.

However, weak refining margins have already tempted talk of economic run cuts, which could lower demand for crude while tightening product fundamentals, thus raising margins again.  Indeed, calculations for early August show an uptick in European and US Gulf Coast margins following the recent price correction.



Spot Product Prices

In absolute terms, product prices gained overall in July, with the exception of gasoline, which fell as the end of the summer driving season approached.  The change in sentiment emanating from higher US gasoline production spilled over to Europe, where slightly less interest in transatlantic shipments was reported.  In addition, some news reports suggest Iran has tempered its spot gasoline buying, adding to the bearish sentiment.  Gasoline demand in Asia has also been weak on less interest from large spot buyers Indonesia and Vietnam so far for the third quarter, though this could pick up.

Middle distillates in contrast were quite strong.  A combination of light distillate yield maximisation, strong diesel and jet buying, and cold Latin American temperatures strengthened prices.  Chile has reportedly been sourcing cargoes in Asia due to a lack of exports from Argentina, and Singapore gasoil stocks have fallen to the bottom of their five-year average range.  In Europe, gasoil took some strength from Russian exporters sending more to the US, and Asian exporters redirecting some cargoes to the Middle East.







Fuel oil prices gained most in July.  Changes in fundamentals were subtle, with slightly lower Korean and Russian exports and higher buying interest from Japanese power utility TEPCO (if not actually significantly more purchases so far) the most noteworthy.  Korean refineries were undergoing maintenance in July, some of which slipped into August.  Russia reportedly briefly halved its product exports through Estonia (mainly fuel oil), following a dispute, amid government claims it would generally curb energy outflows through neighbouring countries.  However, at the time of writing, flows through Estonia had apparently been restored.  Lastly, August fuel oil arrivals in Singapore from the West were expected to be at an eight-month low of 2.2-2.3 million tonnes, lending additional support.



In Japan, much has been made of TEPCO's need for alternative feedstocks after it was forced to shut down a large nuclear power plant in mid-July.  Much of the incremental demand looks to be met by coal and gas, but the prospect of more fuel oil buying appears to have supported the market.  Both low-sulphur and high-sulphur fuel oil reached highs on the Singapore market as a consequence, in turn giving fuel-oil rich Middle Eastern crudes a boost.

End-User Product Prices in July

OECD countries mostly experienced rising end-user product prices in July.  Ex-tax, US-dollar gasoline prices in the US, Germany and Canada fell by 2.7%, 2.5% and 0.3% respectively, while in other OECD countries they rose by 2.6% on average.  OECD automotive diesel and heating oil ex-tax prices in US dollars increased by 2.6% and 3.7%.  Reflecting tightness in the global fuel oil market, the ex-tax price of LSFO increased by 6.6% on average in US dollars.

Freight

Crude tanker rates continued to fall in July, sinking to multi-year lows on several routes.  Weak vessel demand caused VLCC rates from the Middle East Gulf to sink to two-year lows.  Tanker movement reports suggest oil in transit is well below seasonal norms, especially on westbound routes, and will remain so for several weeks.  In the Atlantic Basin, production outages and economic run cuts in Europe offer further downside to prospective crude vessel interest.  Clean tanker rates trading to Asia firmed in July but weakened west of Suez.

From around $8.50/tonne in early July, VLCC rates from the Middle East Gulf to Japan had fallen to two-year lows of just over $7/tonne by early August.  Although Japanese throughputs increased in July, rates from the Middle East Gulf were eroded by weak regional tanker fundamentals.  In the third week of July, VLCC rates from the Middle East Gulf to the US Gulf fell to $13.43/tonne, their lowest level for nearly two years.  Recent low interest in chartering long-haul westbound vessels was reflected in oil tanker movement reports, which have been repeatedly stressing the significant dearth in oil currently in transit, especially to western destinations.  Saudi Arabia reportedly plans to keep US-bound term volumes steady until October and spot buying opportunities also remain limited by restraints on OPEC output.

West African VLCC rates to the US Gulf gained over $3/tonne in the last week of July, to breach $12/tonne.  Nigerian production recovery aided export flows, despite some minor loading delays at the Bonny terminal, while a strong WTI price may have also encouraged crude exports to the US.  However, West African crude tanker rates corrected downwards in early August.  Asian demand for West African cargoes reportedly fell to its lowest level in four years for August loading.  A seasonal dip in trade coincided with an extremely high Brent premium over Dubai, potentially undermining the economic incentive for July eastbound spot trading.



North Sea Aframax rates firmed in the first half of July by over $1/tonne to surpass $7/tonne, as North Sea production maintenance eased.  However, a combination of higher planned outages in August and unplanned problems, such as with the CATS pipeline, quickly reversed the early-month increases.  Rates were down to $4.45/tonne in early August.  Purported economic refinery run cuts in Europe may also further dent trade (and vessel demand) if refining margins remain weak.

Charter rates for clean tankers trading to Asia rose in July.  Lower naphtha prices spurred clean vessel interest from Eastern petrochemical manufacturers.  There were also reports of firm transpacific diesel trading to the US West Coast as well as South America, which is enduring an extremely cold winter, especially in Argentina and Chile.  Elsewhere, transatlantic 33,000-tonne clean rates to the US fell by over $5/tonne, to $14/tonne, in July.  Higher domestic gasoline and ethanol production in the US potentially reduced the need to import gasoline and gasoline blending components, although volumes remain firm at present.  Lower reported Iranian gasoline imports may also have contributed to weaker clean vessel demand in July.

Refining

Summary

  • Global refinery crude throughput is estimated at 73.3 mb/d in June, 0.5 mb/d higher than May, but 0.6 mb/d lower year-on-year, underscoring refinery problems, particularly in the US.  Record crude throughput in China of 6.8 mb/d and higher crude runs in Canada and the OECD Pacific underpin the monthly increase.  July crude runs are estimated to have average 74.6 mb/d, up 1.3 mb/d from June.


  • Third and fourth-quarter global crude throughput is forecast to average 74.5 mb/d and 75.0 mb/d respectively.  Peak summer crude runs in August, are seen 0.1 mb/d lower at 75.1 mb/d on the back of higher non-OECD maintenance activity, primarily in the FSU and China, and voluntary run cuts in Europe.  Crude throughput is forecast to dip in September before recovering strongly in the fourth quarter.
  • OECD refinery crude throughput is estimated at 38.3 mb/d in June, 0.2 mb/d higher than in May.  Higher crude runs in the Pacific and North America offset the maintenance-related decline in Europe.  OECD crude throughput in July is estimated to be 1.6 mb/d higher at 39.9 mb/d, with increases in all regions.  August crude throughput is forecast to increase by a further 0.5 mb/d to a summer peak of 40.4 mb/d.
  • Refineries in Europe and the Pacific boosted gasoline yields in May to capture the strong margins available following production problems in the US and Canada.  Despite these problems, North American gasoline yields increased in line with their five-year average.  Consequently, naphtha yields declined, reaching their lowest level in Europe since at least 1995. Gasoil/diesel yields remained strong, compared with the five-year range, while jet fuel was similarly strong in Europe and the Pacific, but weak in North America.

Global Refinery Throughput

Global crude throughput is estimated to have increased in June by 0.5 mb/d to 73.3 mb/d.  Higher runs in the OECD, largely driven by North America, and record throughputs in China of 6.8 mb/d, underpinned the increase.  Preliminary data show July crude throughput increased further, to an estimated 74.6 mb/d.  This increase comes despite reports that weak margins forced some refiners to cut runs in Europe and possibly the Pacific.  The full impact of any cuts, however, is not expected to be seen until August.  Furthermore, we have increased our estimate of maintenance for August in China, where heavy losses due to artificially low domestic prices have encouraged refiners to bring forward maintenance to curtail crude throughput where possible and Korea, where some work has slipped back from July.  Partly countering these negative impacts, we have increased our forecast for Japanese crude runs, following the outage at TEPCO's nuclear power plant, which will result in higher fuel oil use by utilities.  On balance, our forecast for the summer peak of crude throughput in August has been reduced to 75.1 mb/d from 75.2 mb/d due to the aforementioned factors.



Increasing refinery maintenance in September is forecast to reduce crude runs by 1.4 mb/d globally and is likely to tighten product markets ahead of higher demand in the fourth quarter.  Global crude runs in the fourth quarter are forecast to average 75.0 mb/d, an increase of 0.5 mb/d over the third quarter and 1.4 mb/d higher year-on-year.  Higher crude throughput in the OECD, China and other Asia (mainly India) account for the majority of this increase, driven by strong demand growth and additions to crude distillation capacity.

Global crude runs in May have been revised to 72.8 mb/d, 0.1 mb/d higher than last month's estimate.  Data published by non-OECD countries lead us to increase Middle Eastern (+0.2 mb/d), African and Latin American crude runs (both +0.1 mb/d) for the month.  Offsetting these gains, our estimates for non-OECD Europe have been adjusted lower for May and the balance of the year.

OECD Refinery Throughput

OECD Third and Fourth-Quarter Forecasts

Third-quarter crude throughput is expected to average 39.8 mb/d, in line with last year and an increase of 1.6 mb/d from the second quarter, as refiners increase runs to meet the seasonal peak in demand.  Crude runs are rising through July and into August in all three OECD regions.

September is forecast to see a material slowdown in OECD crude throughput, with runs falling by 1.1 mb/d month-on-month to 39.2 mb/d, 0.5 mb/d below last year's level.  A heavy programme of maintenance work is the cause of the lower throughput.  Maintenance work is expected to similarly limit October throughputs to 39.1 mb/d, but thereafter runs are expected to increase rapidly to 40.8 mb/d in December.

Incremental European crude throughput in August is likely to be limited by the implementation of economic runs cuts, due to the weak margin environment for hydroskimming refineries in the region.  We have assumed that run cuts were implemented gradually through July and that the majority of the impact will be seen in August.  In total, we have factored in a reduction in throughput of around 100 kb/d, at plants in Germany, Sweden and Greece, but some unconfirmed reports indicate the offline capacity may be as high as 300 kb/d.

Weekly data from Japan show crude runs reaching 4.2 mb/d in early August, which is just above the five-year weekly range for this time of year.  Japanese runs are likely to be raised further by the increased demand for fuel oil from TEPCO following the closure of its Kashiwazaki-Kariwa nuclear plant after the recent earthquake.

Similarly, weekly data for the US point to crude runs reaching 16.2 mb/d in late July, their highest level since late August 2005, just ahead of the disruption caused by Hurricane Katrina.  The return of refineries from maintenance on the Gulf and West Coasts, as well as fewer refinery reliability problems in July, have allowed crude runs to recover strongly from previous weak levels.  US weekly data indicate that July crude runs were, on average, 15.8 mb/d, in line with our forecast for the month and the July 2006 level.  Gulf Coast crude runs reached 8.0 mb/d, the highest level since July 2005, despite some 150-175 kb/d of capacity still shut-in at BP's Texas City refinery.  However, a spate of unplanned outages on the East and Gulf Coasts in early August reduced runs by 0.4 mb/d, with current reports suggesting that crude runs may not recover immediately.



There appears to be little prospect of a full resumption of the shut-in capacity at BP Texas City until the fourth quarter, at which time the refinery expects to resume processing of sour crude grades.  The restart of processing units after such a lengthy period is seldom trouble-free and further delays remain possible.  Midwestern crude runs remain lower than average, largely due to problems at BP's Whiting, Indiana, refinery, where the crude slate is restricted to sweet crudes, following the reduction in hydrotreating capacity.  BP now expects full output to be restored only in 2008, having taken the opportunity to improve process safety by upgrading the pressure-relief system through the installation of a new flare stack at the end of this year.

OECD Data for June

OECD crude throughput in June averaged 38.3 mb/d, 0.1 mb/d below our forecast.  Higher-than-expected runs in the Pacific and North America were more than offset by lower-than-forecast runs in Europe.  Crude throughput was 0.2 mb/d higher than May although 0.8 mb/d lower than June 2006 with the year-on-year shortfall largely in Europe and the US.



North American crude runs were 0.3 mb/d higher in June than in May.  Higher throughput in Canada accounts for the majority of the increase, as runs recovered, following outages, at Imperial's Nanticoke and Sarnia refineries and the completion of the turnaround at its Dartmouth refinery.  Pacific crude throughput recovered more strongly than anticipated in June with higher than forecast runs in Korea explaining the difference.  Japanese crude runs increased as refiners wound down maintenance activity, offset partly by some unplanned shutdowns, which carried on into early July.



European crude runs were universally lower than June 2006 with the exception of Denmark.  France's month-on-month decline in throughput of 0.3 mb/d was partly due to the turnaround at Total's 140 kb/d Mardyck refinery, but the reason for the balance of the decline is as yet unclear, although it is likely that other, unreported, maintenance work occurred elsewhere.

Elsewhere, runs increased month-on-month in Germany, following the completion of maintenance at PCK's Schwedt refinery, but decreased by 70 kb/d in Italy as the turnaround at Sarras's Sarroch refinery continued.

OECD Refinery Yields

OECD refinery yields in May reflect the regional variations in refinery performance and the extent to which refiners were undertaking maintenance.  Gasoline yields in North America increased from the April level, but only as far as the five-year average, despite the problems affecting Canadian and US refineries.  The increased need for US imports during this period and strong gasoline cracks, appear to have enticed higher gasoline production from refineries in the Pacific and Europe, with strengthening gasoline yields and declining naphtha yields. Furthermore, the extent to which the strong margin environment resulted in higher runs by marginal refining capacity may have resulted in additional supplies of middle distillates and fuel oil.



Monthly US data for May indicate that catalytic cracking (FCC) throughput remained weaker than average, slipping below levels of the previous year for the first time since February.  This data tie in with the peak of reported outages and the peak in margins, both also seen in May.  Conversely, coking throughput increased above the five-year average and hydrocracking feed rates in May continued to rebound strongly from their 1Q low, moving above the five-year range.  The feed rates for hydrocracking and coking capacity will be boosted over time by the continued investment by refineries to add new capacity.



Jet/kerosene yields remain strong in Europe, with data for France indicating that the recently commissioned hydrocracker at Total's Normandy refinery may be contributing to higher yields of diesel and jet fuel.  Conversely, North American jet/ kerosene yields remain under pressure, at the very bottom of the five-year range, despite a small increase from April's 10-year low.

By comparison, gasoil/diesel yields in North America continue to be at the top of the range.  Pacific gasoil/diesel yields are similarly strong as refiners in Korea approach the seasonal, tax-related, peak in distillate production in June and the corresponding trough in jet/kerosene yields.  However, with the completion of third-quarter maintenance we expect to see the seasonal increase in kerosene yields begin as refiners build stocks of heating-related kerosene inventories ahead of the winter.