Oil Market Report: 11 October 2007

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Highlights

  • WTI crude futures rose above $80/bbl in September on falling US, European and Japanese crude and product stocks and expectations that tighter conditions will be seen in the fourth quarter.  Storm-related shut-ins in the Gulf of Mexico provided additional support early in the month, but from now hurricane risks will gradually ebb.
  • OECD industry stocks changes largely reflect tighter crude markets as refiners raised throughputs to meet summer driving demand.  The July stock build was revised down by 14.8 mb and preliminary data show respective draws of 21.0 mb and 27.4 mb in August and September - implying a counter-seasonal 3Q stock draw of 360 kb/d.  End-August forward cover fell below the five-year average to 53.5 days.
  • Global oil demand remains unchanged at 85.9 mb/d in 2007 (+1.5% over 2006) and 88.0 mb/d in 2008 (+2.4%).  Downward OECD revisions in North America and the Pacific offset upward adjustments in the FSU.  Economic growth assumptions are trimmed slightly ahead of IMF and OECD assessments of recent financial market volatility.
  • World oil supply increased by 415 kb/d in September to 85.1 mb/d, as rising output from North America, China and OPEC offset Caspian maintenance.  Production through to the year end should be bolstered by higher OPEC supply, the end of seasonal maintenance and ebbing hurricane risks.  However, project delays remain a key forecasting risk.
  • Higher Iraqi output helped lift OPEC crude supply by 245 kb/d in September to 30.7 mb/d, leaving OPEC spare capacity little changed at 2.7 mb/d.  OPEC-10 plan to raise supply by 500 kb/d from 1 November.  The midpoint of the 'call on OPEC crude and stock change' is lowered by 0.4 mb/d in 3Q07 to 31.2 mb/d, but is seen rising to 32.5 mb/d in 4Q.
  • Global crude refinery throughput is seen falling to a seasonal low of 73.0 mb/d in October, 1.9 mb/d below the August peak as maintenance takes place in the OECD, China, the Middle East and the FSU.  However, global crude runs are projected to rebound to 75.5 mb/d by the end of the quarter.

High prices, high uncertainty, low stocks

History often repeats itself.  Comparing the path of crude prices this year with those of 2006 shows a broad upward trend from the start of the year through to the start of the gasoline season, before prices fell back at the beginning of August.  Fundamentally, there were similarities underpinning this trend.  OECD crude and product stocks followed similar paths and there was the seasonal recurrence of tight pre-summer gasoline supplies.  But since August, price trends have diverged sharply.  In 2006, prices continued to fall sharply, weakening throughout the rest of the year, while in 2007 they moved to record levels.

Some of the recent rally was due to Hurricane Dean's timely reminder that, after last year's hiatus, storm risks in the Gulf of Mexico remain a threat.  Winter is approaching and sharply falling OECD stock levels have also played a part.  The threat that housing-market weakness may depress oil demand next year appears to have been pushed to one side.

The apparent sidelining of future demand issues does not mean that the market focuses exclusively on the immediate balance.  Expectations can mould physical supply and demand patterns in a way that can influence the oil price.  In particular, stockholders will adjust their price at which they will release stocks to the market depending on expectations of future supply, demand or price (see prices section).  To this extent, it is not surprising that the market currently has an upward bias.  The latest OECD data show stock cover falling below the five-year average and, despite the wide range of demand forecasts, there is a broad consensus that supplies will get tighter this winter.  In other words, high prices are a rational result of current market conditions and expected future fundamentals.  What is harder to tell is to what extent expected future demand or stock draw is factored into current price levels.

Looking at this from another angle, it is clear that demand does matter - after all, supply and demand always have to balance.  The question is, at what price?  Perhaps a demand response is already being seen.  There has certainly been considerable substitution, where possible, away from oil and towards natural gas (that is a price effect, albeit a relative one).  In the light of $80/barrel oil, it is also perhaps not surprising that we have seen very large downward revisions to US demand data for July, the second consecutive such move.  More recent weekly US demand data are also relatively weak.  Even the previously robust transportation sector seems to be affected, with recent gasoline demand growth slowing somewhat.  Based on this information, it looks as if 3Q year-on year US oil demand growth may fall slightly this year.

From an analytical perspective, it may be premature to argue that prices are causing US demand (in particular the formerly robust gasoline market) to contract.  Income, and therefore GDP growth, will remain the primary determinant of demand, and these are in turn linked to the health of the housing market.  Weather effects have played a part elsewhere in the OECD this year, but again price and substitution are also key.  Outside the OECD, demand seems robust, but that is partly artificial.  With prices subsidised in many key growth regions, a shift in policy (again more likely at $80 oil) could rein in demand as it did in late 2005.  But in China and the Middle East, the two key demand growth regions, there seems little chance of a removal of subsidies in the near future.

The crystal ball will clearly remain fogged for some time.  Winter has to take its natural course and it will take time to understand the impact of recent economic events.  As such final winter demand will, as always remain uncertain.  That is why we have stocks - to deal with the unexpected or unforeseen.  Those stocks are clearly tighter than they have been for some time, but what is driving market expectations and therefore prices is the lack of confidence that they will be replenished.

Demand

Summary

  • Global oil product demand remains virtually unchanged at 85.9 mb/d in 2007 (+1.5% over 2006) and 88.0 mb/d in 2008 (+2.4%).  Downward OECD revisions (in North America and the Pacific) were offset by upward adjustments in non-OECD countries, most notably in the FSU.
  • OECD oil product demand has been lowered in both 2007 (-72 kb/d) and 2008 (-113 kb/d), given downward revisions to preliminary data for both North America (gasoline and residual fuel oil) and the Pacific (gasoil and 'other products').  In addition, following the publication of revised 2006 annual data, the baseline of US demand was only marginally increased, as this report had already anticipated some 85% of that adjustment.


  • OECD demand is now expected to increase by 0.2% in 2007 to 49.3 mb/d, and by 1.5% in 2008 to 50.1 mb/d.  This outlook continues to be based on prevailing economic forecasts from the IMF and the OECD, slightly adjusted for some countries based on the median from Consensus Economics' surveys, and on normal weather conditions during the coming winter.  The forthcoming assessments of these international institutions will shed more light on the consequences of the US subprime crisis.
  • Non-OECD oil product demand has been adjusted upwards in both 2007 and 2008 (+55 kb/d and +87 kb/d, respectively), largely due to changes in the FSU baseline.  The changes were mostly related to a historical reappraisal of NGL supply in the FSU, which, along with net exports data, constitute the basis of the region's apparent demand calculation.  Overall, non-OECD demand is seen reaching 36.6 mb/d in 2007 (+3.2% on an annual basis) and 37.9 mb/d in 2008 (+3.7%).  This forecast continues to assume that subprime woes are unlikely to spillover into China and the Middle East, which together account for over half of worldwide oil demand growth.

OECD

According to preliminary data, total OECD inland deliveries (a measure of oil products supplied by refineries, pipelines and terminals) fell by 0.5% in August, compared with the same month in 2006.  Continued demand weakness in both the Pacific (-2.2% year-on-year) and Europe (-0.9%) more than offset North America's modest gains (+0.2%).

As in previous months, the continued weakness in OECD Europe demand is largely related to much lower-than-average deliveries of heating oil in Germany and France.  In both countries, end-users seem intent on delaying the refilling of their tanks, probably expecting that prices may fall in the next few weeks or that the winter may prove to be mild again.  Thus, Europe's heating oil deliveries tumbled by 10.1% on an annual basis in August.  By contrast, Europe's fuel oil market came back to life, with demand increasing by 4.6%, mostly in Italy.  In OECD Pacific, demand was dragged down by weak jet fuel/kerosene (-7.5%), gas/diesel (-7.1%) and 'other' product deliveries (-15.7%), particularly in Japan.  Erratic summer weather conditions in July depressed holiday travel and induced stock builds, which were subsequently drawn down in August, thus impacting overall deliveries.  In OECD North America, meanwhile, demand rose by a modest 0.2%, underpinned by strong growth in transportation fuels, particularly in Mexico.  Regional deliveries of gasoline and gas/diesel increased by 1.0% and 6.8%, respectively.




Overall, OECD demand is forecast to reach 49.3 mb/d in 2007 (+0.2%) and 50.1 mb/d in 2008 (+1.5%), on the premise that temperatures during the forthcoming winter will be in line with the average of the previous ten years and that, pending a thorough assessment, the fallout from the US subprime crisis remains relatively limited in terms of its impact on economic growth.  North American demand, which accounts for over half of OECD demand, is poised to increase by +1.1% in 2008, while Europe and the Pacific are both expected to rebound (+1.7% and +2.4%).  As noted in previous reports, however, these forecasts are liable to be revised once the potential effects of the ongoing subprime woes are fully appraised by the main international economic institutions (IMF and OECD) and if winter temperatures were to be milder than currently expected.







North America

Inland deliveries in the continental United States - a proxy of oil product demand - were flat in August versus the same month in 2006, according to adjusted preliminary data.  The relative weakness of LPG, naphtha, jet fuel/kerosene and 'other products' was offset by gains in gasoline (+0.7%), gas/diesel (8.3%) and residual fuel oil (+21.9%).  It must be noted that these figures take into account revisions to the 2006 baseline, as discussed more extensively in the text box below.

Coupled with revisions to preliminary monthly data, US50 total oil product demand is expected to reach 20.9 mb/d in 2007 (+0.9% over 2006), virtually unchanged from last month's report, and 21.1 mb/d in 2008 (+1.2% versus 2007, slightly lower than the previous forecast).  This outlook has not yet made any major adjustment to its US GDP assumptions, as we are waiting for a more precise assessment of the consequences of the subprime crisis, notably from the IMF and the OECD.  However, the recent interest rate cut by the Federal Reserve (50 basis points) indicates that US policy makers consider that subprime-induced downside threats to economic growth outweigh inflationary risks.

In addition, this forecast assumes that normal temperatures during the forthcoming winter will induce greater demand for heating oil and some interfuel substitution back from natural gas.  However, it should be noted that several meteorologists are predicting yet another warmer-than-average winter in most of the US with the exception of the Pacific Northwest - the culprit this time would be the La Niña phenomenon (unusually cold ocean temperatures in the eastern equatorial Pacific Ocean).  Nevertheless, these predictions have proven quite unreliable in the past.  For example, in the US Northeast - the world's de facto largest heating oil market - La Niña has typically brought warmer temperatures in October, but this year the month is expected to be cooler than normal.



At first glance, this summer's driving season appears to have been relatively subdued, despite a fair summer overall - the number of cooling-degree days (CDDs) in June was within the ten-year average, while July had 21 fewer days than the average, and August posted 51 more.  Gasoline demand increased by roughly 0.6% per year in each of this year's summer months - a slower pace than observed in the recent past (about +1.0% on average in the past few years).

The relatively modest growth in gasoline demand is probably due to a combination of relatively high retail prices and efficiency improvements, although there are also some data uncertainties.  Although prices tend to rise every summer, US motorists may be marginally changing their behaviour on the perception that retail prices have reached record highs (even though this is not the case in real terms).  There is not much tangible evidence to support this hypothesis, but the sales of larger vehicles (such as SUVs and pick-ups) have apparently stalled - thus suggesting that motorists may be gradually switching to smaller, more efficient cars rather than driving less.  Nevertheless, SUVs themselves are also becoming more lighter and efficient.  As such, it is too early to fully discern the changes that are taken place in the composition of the US vehicle fleet.

On the data front, it is unclear whether weekly gasoline deliveries data - which serve as the basis of preliminary monthly estimates - systematically track ethanol, which is increasingly becoming a significant component of the overall gasoline pool.  Ethanol data are more difficult to capture, as the fuel is usually blended in distribution terminals (as opposed to refineries).

Regarding gasoil, year-on-year comparisons of specific distillates have also become problematic given the switch to low-sulphur specifications (500 ppm).  Although this process began more than a year ago (in June 2006, six months earlier than mandated), a significant chunk of what used to be labelled as 'heating oil' (given its high sulphur content) is now classified as 'diesel'.  As a result, the 'diesel' category may have become a less reliable indicator of trucking traffic - and hence of overall economic activity, since trucks carry some two-thirds of the country's goods - as it now includes a portion of demand that is prone to weather and interfuel substitution effects.

Fine-Tuning US Demand

In late September, the US Energy Information Administration released the latest edition of its Petroleum Supply Annual (PSA), which includes revisions to preliminary 2006 monthly demand figures. PSA data has historically tended to adjust upwards monthly figures published in the Petroleum Supply Monthly (PSM). This year was no exception; total deliveries in 2006 were 101 kb/d higher, thus moderating the year-on-year decline highlighted by monthly data.

As such, US demand contracted by 0.6% in 2006, instead of the previous PSM-based estimate of -1.0%. Although the revisions concern all product categories, they tend to be mainly concentrated in 'other' products and gasoline, followed more distantly by residual fuel oil, jet fuel and LPG. For 2006, the adjustment for jet fuel is minor when compared to 2005, but that of 'other' products was much larger.



Revisions to demand figures are normal and represent a welcome fine-tuning of preliminary estimates. US data reporting, however, makes it difficult to gauge actual demand growth. The EIA segregates their data sets, since quality improves with time: annual data are generally more accurate than monthly numbers, which in turn are more precise than weekly figures. As such, US annual data tend to come in above monthly levels, but weekly figures (which are themselves rarely revised) from the Weekly Petroleum Status Report tend to be adjusted down by PSM data.

Moreover, current-year data (based on PSM estimates) are not adjusted by the same proportion when PSA revisions for the previous year figures are published. Admittedly, the overall adjustment is relatively small (total demand in 2006 came in 0.5% higher than previously estimated). Nevertheless, year-on-year growth rates by product become somewhat distorted, thus blurring the overall US demand picture and leading to heated debates over some trends implied by weekly and monthly figures (for example, whether gasoline demand is indeed softening and if so to what extent).

Attempting to overcome these problems, since 2005 we have aimed at anticipating both monthly and annual revisions on a product-by-product basis based on past changes. Even though such an extrapolation is necessarily arbitrary and imperfect, it has helped cushion the changes to preliminary US data. Last year, our revision to 2005 demand figures was +36 kb/d (about 25% of PSA's adjustment); this year, our adjustment of 2006 data came in at +16 kb/d (almost 16% of the actual revision). Regarding 2007 figures, we have slightly increased our pre-emptive annual adjustment - applied since the beginning of the year - from +84 kb/d to +94 kb/d. The monthly adjustment, by contrast, is more random, as it is based on the three-month average revisions to weekly data from monthly figures.

Finally, the strength of fuel oil deliveries in August is explained by warm temperatures, which boosted power demand as air-conditioning use rose.  This may suggest that the adoption of natural gas - which has favourably competed in price with fuel oil for most of 2007 - has reached a limit, despite continuing low prices.  As such, future surges in fuel oil demand will likely be related to peak power loads

Preliminary data suggest that the buoyant growth in Mexican oil demand observed during the past five months has come to a sudden halt: deliveries were flat year-on-year in August.  However, this lack of growth was largely due to the weakness in fuel oil (-18.0%), which represents about 13% of total demand, and in 'other products' (-15.0%).  Transportation fuels, by contrast, continue to post vigorous expansion, with gasoline demand growing by 5.1% on a yearly basis, jet/kerosene by 14.1% and diesel by 3.3%.



Declining Fuel Oil Demand in Mexico?

In Mexico, as noted, falling residual fuel oil demand offset growth in other products in August. The question is whether fuel oil has resumed the slow decline/stagnation pattern observed over the past two years, as natural gas makes further inroads in both industry and households. From that perspective, the surge of the past few months would be an anomaly, explained by unexpected peaks in electricity demand and/or interruptions in natural gas flows. However, there are reasons to remain cautious before heralding the inevitable demise of fuel oil in Mexico.

On the one hand, it remains to be seen whether gas-fired power generation will keep pace with demand; indeed, continued economic expansion no only requires more power per se, but also alters consumption patterns as per capita income rises (for example, more people are able to purchase air-conditioning units). Admittedly, the prospects for gas-fired power are encouraging. Gas supplies are multiplying - the government has just awarded Repsol the tender to build the country's third LNG plant, in the Pacific state of Michoacán (after Sempra's Baja California terminal and Shell's Altamira in the Gulf of Mexico) - and construction lead-times of gas power plants are relatively short. Still, fuel oil will probably remain the feedstock of choice to meet a significant share of baseload electricity demand (thermal sources represent about 46% of the country's total generation capacity).

On the other hand, on a more anecdotal basis, part of the recent surge in fuel oil demand may have been related to a new factor: the sabotage of pipelines. Over the past few months, a disgruntled Marxist rebel group, the People's Revolutionary Army (EPR), has twice hit Pemex's facilities, severely disrupting gas flows and forcing large end-users to find alternatives to natural gas, such as fuel oil.

Following July's attack in west-central Mexico, the EPR blew up six major pipelines in early September in the southeastern state of Veracruz. Given that Veracruz is a key route for the transportation of natural gas and LPG from Campeche's offshore fields to the country's industrial north and to the capital in central Mexico, the damage was significant. Indeed, natural gas deliveries to as many as 2,500 companies and thousands of residents in eleven states were cut off, leading to considerable disruptions and even complete shutdowns in key industries (at the time of writing, Pemex had restored much of the lost supply).

It is premature to assess whether such attacks will become a persistent feature - although the EPR has vowed to continue its actions - or whether Pemex and the government will be able to improve the security of oil infrastructure (a difficult task, since pipelines run for thousands of kilometres). In the meantime, fuel oil demand growth will probably register a blip in September's figures.

This would indicate that economic growth remains resilient, even though the Mexican economy is closely linked to that of the US, which is now the subject of much debate regarding its short-term outlook.  Therefore, Mexico's oil product consumption forecast could be adjusted if the subprime meltdown were to curb US demand for manufacturing imports from its southern neighbour, leading to an economic slowdown in key oil consuming regions in Mexico.



Nevertheless, the government seems willing to support energy demand.  Indeed, in late September President Felipe Calderón ordered an immediate freeze on gasoline, LPG and power prices, in order to curb inflationary pressures.  The move over-rides the fiscal reform approved by Congress early in the month, which among other measures mandates a gradual 5.5% hike in gasoline and diesel prices, to be achieved over the next 18 months.  (The fiscal package also included a small tax break for Pemex, aimed at improving its finances, but the state-owned company will have to bear the brunt of the price freeze.)

Europe

Our outlook for European demand remains largely unchanged for 2007 and 2008, at 15.4 mb/d and 15.6 mb/d respectively, despite continued high oil prices, cooler-than-normal weather and small adjustments to our GDP assumptions for several countries.  Although preliminary data for August indicate once again lower-than-expected deliveries, official data for July came in higher than anticipated, leading to a net upward revision of 50 kb/d to 3Q07 demand.  Annual demand growth has been adjusted to -1.1% for 2007 (from -1.2% previously) but remains unchanged at +1.7% for 2008.

GDP growth assumptions have been slightly lowered for the largest European economies in 2H07 and 2008, based on the median institutional forecasts surveyed by Consensus Economics.  As such, Germany's 2008 GDP growth is now seen at 2.2%, compared to 2.4% assumed in last month's report.  France's GDP has similarly been adjusted lower to 2.1% from 2.3%, while Italy has been lowered from 1.7% to 1.6% and the UK from 2.7% to 2.0%.  However, the income effects have largely been cancelled out by higher 3Q07 demand, partly carried forward into 2008.  The extent to which high end-user prices are affecting demand is still uncertain.  Indeed, a weak dollar means that European end-user prices were actually lower year-on-year in August in national currency terms.

Official data for July were much stronger than preliminary demand indications for several countries.  In particular, high temperatures contributed to the 100 kb/d upward revision to Turkey's oil demand following a surge in gasoil demand for electricity generation.  However, although the number of cooling degree days was equally high in August, the strength of July demand relative to the cooling trend militates against carrying this revision forward.  Spanish demand has also been revised higher by 49 kb/d for July, growing by a robust 3.6% year-on-year, mostly due to high jet/kerosene and diesel/heating oil demand.  Although too late for inclusion in our forecast this month, preliminary data for August (JODI) show demand growing by 2.2%, slightly lower than our 2.9% current forecast.  Smaller upwards revisions have also been made to the UK (+25 kb/d), the Netherlands (+20 kb/d) and Germany (+18.5 kb/d).

Across Europe, preliminary August data indicate a lower demand picture than previously anticipated.  Again, the bulk of the shortfall stems from Germany, where both heating oil and naphtha continue to lag behind expectations.  German households added only 130 kb/d to their domestic heating tanks in August, compared to a five-year average end-user stock build for that month of almost 250 kb/d.  To an extent, the lower fill rate is likely to be related to high prices, but we are wary that filling can increase rapidly if colder temperatures materialize.  With the year-on-year surplus from last winter now completely eroded (at the end of August, household tank fill stood at 58% of capacity compared to 60% last year), there is the potential for a sharp rebound in German heating demand.



French deliveries continued to be supported by strong demand for diesel and jet kerosene in August. After posting 7.2% annual growth in July, diesel deliveries in August rose by 4.7% above a year-ago, more than offsetting the structural decline in gasoline demand.  Similarly, continued growth in French vacation travel bolstered jet/kerosene growth in July by 3.3% and by 2.4% in August.  As in Germany, other gasoil demand continues to lag year-ago levels as the effect of last year's mild winter, and subsequent high consumer inventories, linger.



Italian demand was supported by strong residual fuel oil demand in August as higher temperatures boosted electricity demand, related to the increased use of air conditioning.  At the same time, hydro-generation was 6.2% lower than last year.  Fuel oil is being gradually replaced by natural gas, but there are concerns about potentially tight gas supply in the forthcoming winter; this could foster a spike in fuel oil demand should temperatures prove too cold.  Meanwhile, demand for transportation fuels and other products fell in line with seasonal patterns.  Both diesel and jet/kerosene posted year-on-year growth, leaving total Italian demand 4.3% higher than last August.



Pacific

In August, according to preliminary data, oil product demand in the Pacific contracted by 2.2% on a year-on-year basis.  Deliveries declined for all product categories bar naphtha (+3.7% year-on-year) and residual fuel oil (+7.2%).  Thus, LPG deliveries fell by 3.2%, gasoline by 1.1%, jet fuel/kerosene by 7.5%, gas/diesel by 7.1% and 'other products' by 15.7%.  The largest product demand contractions occurred in Japan, and were probably related to secondary stock drawing following July's poor summer weather conditions (which restrained air travel, leisure driving and electricity demand).  Nevertheless, Korean and Australian demand continues to be relatively resilient, supported by naphtha in the former and by transportation fuels in the latter.

Given these revisions, we have slightly adjusted downwards our 2007 and 2008 prognosis.  OECD Pacific demand is now expected to average 8.3 mb/d in 2007 (-0.8% on a yearly basis), and rebound to 8.5 mb/d (+2.4%) in 2008.  However, as with the rest of the OECD, this forecast relies on the premise of normal winter temperatures and on prevailing economic assessments.  Moreover, following the release of disappointing 2Q07 GDP figures (-0.3% year-on-year), there are concerns that Japan's recovery, largely driven by exports, may be endangered by a slowing US economy (some observers, though, attribute the slowing to tight domestic fiscal and monetary policies).

In Japan, oil product demand contracted by 3.7% year-on-year in August, according to preliminary data.  As last month, all products bar fuel oil for power generation (+21.3%) and naphtha (+2.7%) fell.  As this report has often argued, Japan's energy demand decline is largely structural, given demographic factors and efficiency improvements.  However, oil demand is also highly sensitive to weather conditions, prices and nuclear outages.



Indeed, poor weather in the middle of the summer hit leisure travel, but August's heat wave and the resulting cooling needs boosted power demand.  The latter had to be met by thermal plants (fuelled by direct crude and fuel oil) given that a significant share of the country's nuclear generation capacity is offline following a series of operational problems (another plant, belonging to Hokkaido Electric Power, was shut down in late September).  Meanwhile, high retail gasoline prices, which remain at record levels, also tended to discourage holiday travel over the summer.  Given this subdued demand picture, product stocks were relatively plentiful by end-July, thus helping to explain why deliveries were so low in August.

In Korea, preliminary data indicate that total oil product demand fell slightly in August (-0.5% year-on-year), mostly on weaker-than expected distillates and fuel oil deliveries (-7.0% and -9.5%, respectively).  The weakness of gasoil (diesel and other distillates) is probably related to secondary stock draws, following the previous month's build prompted by the 7.5% diesel fuel tax hike.  Naphtha deliveries, meanwhile, continue to post strong growth (+4.7%).  At this pace, naphtha could well account for half of total Korean oil demand (it currently represents 41%) in only a few years.



Finally, in Australia, total oil product demand rose by an estimated 1.2% in August, to some 960 kb/d.  Demand continues to be driven by transportation fuels, on the back of strong economic growth.  For the past eight months, both gasoline and jet fuel/kerosene have been growing at roughly 2.0% year-on-year on average, while diesel has shot up by about 6.7% on average.



Non-OECD

China

According to preliminary data, 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 4.3% year-on-year in August.  The main driver was the sharp rise in gasoline (+11% year-on-year), prompted by the summer holiday season.  Several other product categories also registered gains: gas/diesel (+7.5%), naphtha (+10.9%) and 'other products' (+12.1%).

By contrast, residual fuel oil consumption tumbled in August (-22.8% on a yearly basis), resuming a pattern of continued weakness since late 2006, only occasionally interrupted by blips in domestic demand.  As noted in previous reports, 'teapot' refineries - which generally use residual fuel oil as a feedstock - are the de facto swing producers in China, meeting the gap between demand and state-owned companies' supply by providing off-spec diesel (notably for agricultural machinery and equipment) and heavy products such as asphalt.  Teapot output falls when demand recedes, for example during the rainy season (roughly from July to October), when agricultural and construction activities slow down.  But it is also sensitive to feedstock prices, particularly of imported fuel oil, which continue to remain high, despite the halving of the fuel oil import tax in early June.  As such, net fuel oil imports in August plummeted by almost 50% to some 320 kb/d.



How Resilient is the Chinese Economy?

It is often claimed that the Chinese economy is bound to slow down significantly as it export sector faces weaker demand in both the US subprime-stricken economy and the European Union (which would be also affected by virtue of spillover effects). However, even though exports contribute to about 40% of China's GDP (and 2.5% of global GDP), this pessimistic scenario is far from certain.

On the one hand, the effects of the subprime turmoil are yet to be fully appraised, whether in terms of magnitude and geography. Some sectors of the US credit market are showing signs of revival (notably in commercial paper). Moreover, Europe appears so far largely untouched, despite problems at some banks. Therefore, it may be premature to augur a sharp economic slowdown in OECD countries.

On the other hand, the Chinese government has two major economic tools at its disposal: huge foreign currency reserves - currently standing at some $1.3 trillion - and a very favourable exchange rate policy. The former could help deliver a fiscal stimulus if need be, while the latter will arguably contribute to maintain the export momentum. Current spending ahead of next year's Olympic Games suggests that fiscal policy can be implemented despite China's decentralized political structure. The yuan's depreciation vis-a-vis the euro over the past few months (the mirror image of the euro appreciation with respect to the US dollar) has resulted in Europe becoming China's largest export market.

Other observers argue that inflation is actually a bigger threat. Current inflationary pressures, however, are probably temporary. They are mostly related to food prices and arguably due to supply constraints that may ease in the months ahead. Admittedly, wages are also rising, but this is the natural result of productivity gains. Moreover, the government can resort to short-term measures to curb inflation, such as freezing end-user prices in a variety of sectors - ranging from food to energy, as it happened in late September.

In sum, political considerations suggest that the Chinese government will most likely do the utmost to keep the economy growing, through heterodox means if necessary. Guaranteeing social and economic stability ahead of the forthcoming five-yearly Communist Party congress, which will renew the country's leadership until 2012, and of next year's Olympics, which are intended at raising China's global standing, is paramount. Meanwhile, short-term inflationary pressures will arguably militate against lifting caps on key consumer prices. As such, the recurrent rumours of either a price rise or the imminent implementation of a fuel tax (due next March, according to the Chinese Association of Automobile Manufacturers), which would curb the country's galloping demand and tackle the growing environmental problems, should probably not be taken at face value.

Our forecast of total Chinese oil product demand remains virtually unchanged, despite a minor downward revision to 3Q07 estimates.  Demand is seen reaching 7.6 mb/d in 2007 (+5.7% year-on-year) and 8.0 mb/d in 2008 (+5.6%).  We are cautiously optimistic that strong economic growth will continue and that fuel price controls and subsidies will remain in place for the foreseeable future.



Other Non-OECD

In August, according to preliminary data, oil product sales in India - a proxy of demand - increased by 3.8% on a yearly basis.  Growth remains strong across all product categories bar 'other products' (but, as we have noted in previous reports, preliminary figures for this category have tended to be revised significantly upwards over the past few months).  Most notably, gasoline demand continues to roar ahead (+9.2% year-on-year in August).  For most of this year, gasoline sales have risen at double-digit rates as a result of buoyant economic growth, which in turn has stimulated the rapid expansion of the country's vehicle fleet.  India's oil demand is thus expected to rise by 4.6% in 2007, but should slow down in 2008 (+2.3%) as naphtha continues to decline in favour of natural gas.



We argued last month that the outlook of India's natural gas market depends upon addressing several key pricing issues.  One of them seems to have been solved: the government finally approved with only minor changes the price formula at which Reliance Industries (RIL) will sell gas from its D6 field in the Krishna Godavari basin.  The price has been set at $4.20/mmbtu (instead of RIL's proposed $4.33/mmbtu) over five years from the start of commercial production.  The slight price difference was intended to appease the government's Communist allies, which were backed by several power and fertiliser companies that sought a much lower price.

This "price discovery" suggests that D6's development will go ahead.  More importantly, it will also set the basis of a competitive domestic gas market as prices will be applied uniformly irrespective of the end-user.  The previous policy, by contrast, applied differentiated tariffs according to a taxonomy of users that created significant imbalances (it distinguished between power generators, industrial users, fertiliser and petrochemical companies, and households).

FSU apparent demand - defined as domestic crude production minus net exports of crude and oil products - has been significantly revised upwards since 2000 and through to 2008.  As detailed in the Supply section of this report, the changes to the baseline stem from the reappraisal of NGL production in Russia.  In addition, there were significant upward adjustments to trade data, notably in 3Q07.  Overall, FSU total oil product demand was increased by 75 kb/d in 2007, to 4 mb/d, and by 130 kb/d in 2008, to 4.1 mb/d.



In terms of growth rates, though, oil demand is expected to contract by 3.1% this year, which seems counterintuitive given the region's buoyant economic growth.  This inconsistency is arguably related to the quality of regional trade data, which is notoriously volatile, as we have pointed out in previous reports.  Indeed, trade data may be overestimated, thus depressing apparent demand.  Striving to solve the conundrum of FSU demand, we are currently examining other sources of data, as well as alternative methodologies.  As such, further revisions may take place in the forthcoming months.

Supply

Summary

  • World oil supply increased by 415 kb/d in September, to average 85.1 mb/d.  Rising output from North America, China and OPEC, helped to offset a Caspian maintenance-derived decline of 235 kb/d from the FSU.  With potentially higher OPEC production in October/November, and the combined impact of lower North Sea maintenance and the end of the Atlantic hurricane season, global supply should continue to rise through end-year, albeit potentially lagging demand growth.
  • Non-OPEC production is revised higher by 155 kb/d for 2007, to 50.2 mb/d and by a similar amount for 2008, to 51.2 mb/d.  Upward revisions centre on Russian NGL production and stronger supply from North America.  These offset weaker numbers for the North Sea, Brazil and China.  Non-OPEC yearly growth accelerates from 0.4 mb/d in 2H07 to some 1.0 mb/d for 2008.  The FSU, Brazil and global biofuels generate most of 2008's growth. Separately, OPEC NGL growth for 2008 is trimmed to a still-sizeable 595 kb/d, on the basis of weaker Iranian prospects.
  • Project delays and cost over-runs remain a key downside risk for the forecast, affecting around 735 kb/d worth of projects in this issue of the OMR alone.  Tightness in raw materials and equipment are the main cause, although recently announced changes in the fiscal and regulatory environment for Russia, Kazakhstan, Venezuela, Ecuador and, to a lesser extent, Alaska and Alberta, could impact upon longer-term supply levels beyond 2008.
  • September OPEC crude supply gained 245 kb/d to reach 30.7 mb/d, largely due to higher Iraqi output.  The OPEC-10 are scheduled to add 500 kb/d of supply compared to August, effective 1 November.  Individual output allocations for the new 27.3 mb/d target suggest proportionately lower market shares for Indonesia, Iran, Nigeria and Venezuela. Anticipation of potential Iraqi and Angolan supply increases may underpin the reallocation. OPEC effective spare capacity remained close to 2.7 mb/d in September.
  • The 'call on OPEC crude and stock change' is revised down by some 0.4 mb/d in 3Q07 and by 0.3 mb/d for second-half 2008, based on weaker 3Q demand and higher non-OPEC supply.  Nonetheless, the 4Q07 call still averages close to 32.5 mb/d, 1.2 mb/d higher than in 3Q.  On an annual basis, the call on OPEC rises by at least 0.4 mb/d in 2008.


All world oil supply figures for September discussed in this report are IEA estimates.  Estimates for OPEC countries, Alaska, and Russia are supported by preliminary September 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 adjustments focused in the OECD.

OPEC

September OPEC supply is estimated up by 245 kb/d from August, at 30.66 mb/d.  Iraq underpinned the increase, as higher domestic crude use and renewed exports from Ceyhan in Turkey boosted supply by 190 kb/d.  Widespread, if modest, increases from other producers were largely offset by a combined 100 kb/d reduction in supply from Nigeria, UAE and Indonesia.  All told, September supply came in slightly below preliminary expectations, with continued pipeline outages in northern Iraq, and delays to new field start-up in Angola curbing production growth.  All other things being equal, higher volumes are expected from both these producers in October.

Effective OPEC spare capacity (net of Indonesia, Iraq, Nigeria and Venezuela) is largely unchanged at 2.7 mb/d, with 81% of the total held by Saudi Arabia.  Installed capacity is expected to rise by 270 kb/d by the end of this year to 34.5 mb/d and by a further 1.3 mb/d in 2008.  Recent reports from Nigeria that 550 kb/d of currently-shuttered Forcados, Bonny and EA capacity might be re-instated by around the middle of 2008, if realised, could push installed OPEC capacity higher still, perhaps to around 36.3 mb/d by the end of 2008.  For now our estimates exclude this slice of idled Nigerian capacity.  Shell was reported to have lifted force majeure on Forcados export shipments, having accumulated significant volumes in storage, even though production remains at only a fraction of pre-disruption levels.

At the time of writing Ecuador's Oil Minister had announced plans to officially rejoin OPEC, potentially at the organisation's 5 December meeting in Abu Dhabi.  Ecuador produces 0.5 mb/d of crude and was previously a member of the group until January 1993.

Higher Iraqi oil supply in September was the main reason for higher OPEC output overall, contributing 190 kb/d, or 78%, of the monthly increase.  Total crude supply (exports plus domestic use) averaged 2.18 mb/d.  Domestic crude use in refineries and power plants rose to nearly 500 kb/d from 385 kb/d in August, despite renewed attacks on the pipeline feeding crude from Kirkuk to the Baiji refinery.

Total Iraqi exports reached 1.68 mb/d, an increase of 75 kb/d compared to August.  Southern exports via Basrah and Khor-al-Amaya actually fell by nearly 100 kb/d to 1.5 mb/d, but this was countered by the loading of 4.7 mb onto tankers at Ceyhan in Turkey.  A further 2.5 mb was awarded in a second tender but is not thought to have been lifted from Ceyhan until early-October.  A third tender of 5 mb was awarded on 8 October with liftings scheduled to be completed by the end of the third week of October.  At the time of writing in early October, pipeline flows to Ceyhan were reported to be running at 300 kb/d, after sporadic shipments which averaged 95 kb/d in September.  A fourth sales tender was reported to be in preparation.

OPEC Gets Specific Again, Briefly

OPEC-10 production has yet to show significant signs of increasing ahead of the 500 kb/d rise in target output scheduled for 1 November. Although OPEC tanker sailings may be rising in October according to preliminary schedules, once again Iraq and Angola (which are not bound by OPEC-10 production guidelines) are responsible for much of the increase.

In mid-September the OPEC Secretariat published individual allocations corresponding to the 27.253 mb/d output target announced at the 11 September Ministerial meeting. Although now removed from the OPEC website, suggesting some internal debate as to their legitimacy, these were nonetheless the first explicit details on country-specific targets since those agreed in June 2005 alongside the 28.0 mb/d ceiling of the time. Although OPEC members subsequently agreed to cut supply by 1.2 mb/d from November 2006, and by 500 kb/d from February 2007, neither pact specified individual production levels.



Reportedly, August 2007 was used as the baseline for the latest aggregate production level, whereas September 2006, just after the peak of recent OPEC-10 output, was used as a starting point for the new individual targets. Subject to their validity, the allocations award greater market share to Algeria, Kuwait, Libya, Qatar, Saudi Arabia and the UAE at the expense of Indonesia, Iran, Nigeria and Venezuela. This is not surprising given the relative changes in production that have occurred in the past couple of years. Iran and Venezuela appear to have been affected to the greatest extent by the new targets. Iran's 3.82 mb/d is 100 kb/d below recent near-capacity production levels, while Venezuela experiences the sharpest drop in allowable production, from 3.2 mb/d to 2.5 mb/d. The organisation has long deferred the politically difficult task of reallocating production limits, but may have seen 2008's impending inclusion of Angola in the management mechanism requiring the issue to be addressed sooner rather than later.

Angolan crude output in September was largely unchanged from August at 1.65 mb/d, as further delays hit the Greater Plutonia project.  This was reported to have finally begun producing on 1 October, at initial rates close to 80 kb/d, and is expected to build eventually to rates in excess of 200 kb/d.  Plutonia supplies are reflected in Angola's October and November export programme, which are seen hitting 1.73 mb/d and 1.8 mb/d respectively.  A Sonangol executive was reported in early October citing 2.5 mb/d as an acceptable production target for the country, with output due to reach 2 mb/d and remain close to that level through to 2008.

Abu Dhabi state producer ADNOC announced in late September that average monthly UAE crude supply had been cut by 40 kb/d due to a leak at a gas compression unit.  Maintenance work at the offshore Upper and Lower Zakum and Umm Shaif oilfields is likely to curb UAE production by a more sizeable 600 kb/d for the bulk of November.  This represents around half of the fields' capacity and term customers have correspondingly been informed of a cut in November supplies.  The emirate has reportedly been selling extra volumes ahead of November and may also have extra crude available during maintenance at the Ruwais refinery scheduled for the December to February period.



Iranian state producer NIOC signalled in early October that the country's crude capacity goal is now 4.9 mb/d by 2014, after earlier pronouncements had suggested 5.2 mb/d by 2011.  Our assumption in July's MTOMR was that after levelling off around 4.0 mb/d, Iranian capacity could potentially slip to 3.8 mb/d by 2012 in the absence of foreign investment which is currently limited by geopolitical factors and by an economically unattractive investment model.  Current Iranian supply is estimated at 3.9 mb/d although briefly published OPEC output allocations for November showed a lower Iranian level of 3.8 mb/d (see above). In this month's report, start-up for NGL and condensate output from phases 6-8 of the South Pars gas project has been pushed back from late 2007 to mid-2008.  This affects an ultimate 140 kb/d of liquids output, but curbs Iranian and OPEC NGL supply by a more modest 10 kb/d in 2007 and 75 kb/d in 2008.

Non-OPEC Overview

Non-OPEC annual supply estimates for 2000-2008 are revised up by as much as 150 kb/d with the inclusion of an extra tranche of NGL supply from Russia.  Also, lower-than-expected hurricane outages for the Mexican and US areas of the Gulf of Mexico (GOM) contribute to a 230 kb/d upgrade to 3Q07 estimates of North American supply, also modestly boosting 2008 projections.  In all, non-OPEC supply now stands at 50.2 mb/d for 2007 (a net increase of 0.6 mb/d from 2006), rising by 1.0 mb/d to 51.2 mb/d next year.  Growth averages 0.4 mb/d year-on-year in the second half of 2007, but accelerates to nearly 1.0 mb/d for the bulk of 2008.  The FSU, deepwater Brazil, biofuels, offshore Australasia, US GOM, Canadian oil sands,  Sudan and China drive next year's growth, offsetting sharp decline from much of the remainder of the OECD production base.

While our projections since July for both the OMR and MTOMR have included a downward adjustment to account for a proliferation of unscheduled field outages, new project over-runs continue to act as a drag on the forecast.  In updating the analysis for this month's report, delays to new field start-ups of between one month and three years have been factored in for certain projects in Brazil, the UK, Norway, and the US GOM (as well as for Algeria, Angola, Iran and the UAE within the OPEC fold). In total, some 735 kb/d of global production slips to a greater or lesser extent.  We continue to resist the temptation to 'slip' every new project.  Instead, we try to take a realistic, project-specific view based on company guidance, augmented by evidence of progress on the ground, delays in the provision of equipment and associated infrastructure or fiscal/regulatory changes which may impact upon project economics.  Moreover, the past few months have shown that project slippage can be over-ridden by upward adjustments if production remains unaffected by unscheduled stoppages, which were the main rationale for the adjustment factors introduced in July.  Forecasts remain dynamic, and are naturally prone to adjustment as progressively more information on individual fields becomes available.

This month also sees a number of developments on the fiscal/regulatory front which may influence supply levels, if not in 2007/2008, then for the time horizon of the MTOMR.  Russia, Venezuela, Ecuador and Kazakhstan all announced moves which further boost state control over the upstream sector.  In the case of Alaska and Alberta, proposals seek to raise the state's share of revenue from hydrocarbon production in light of higher oil prices.  Mexico meanwhile, has eased the crippling tax burden on state-producer Pemex. 

OECD

North America

US - September Alaska actual, others estimated:  Changes to total US oil supply for 2007 and 2008 are minimal, with downward revisions for the US GOM from revised 2006 monthly data (-75 kb/d) being largely offset by upward adjustments to 3Q07 after much lower than assumed September hurricane outages.  US crude supply slips to 5.09 mb/d in 2007 and to 5.04 mb/d in 2008, while NGL output is held broadly steady at 1.75 mb/d.  Gulf of Mexico crude bucks the declining trend, rising by 60 kb/d in 2007 and by 125 kb/d in 2008, reaching 1.48 mb/d.  Growth in refinery additives and oxygenates (including ethanol) amounts to 80 kb/d in 2007 and 35 kb/d in 2008, taking total output next year to 615 kb/d.



September proved another sluggish month for Alaskan output, with crude stalled at less than 650 kb/d on processing unit outages.  North Slope production has struggled to recover after last year's pipeline outages.  State authorities announced details of new oil and gas tax legislation which would boost the tax on net company profits to 25% from a current 22.5%, while granting 20% credits for capital expenditure and further credits for exploration.

Production shut-ins in September in the GOM proved much less than the assumed rolling five-year average.  Tropical depression 10 caused an estimated loss to September output of 2.8 mb with peak precautionary closures of 815 kb/d on 21 September.  The closures averaged 95 kb/d for the month, markedly below the assumed 380 kb/d.  Assumed losses for the remainder of the hurricane season in

October and November amount to 345 kb/d and 185 kb/d respectively although, to date, October has seen little sign of major disruptions.  The relatively benign September weather temporarily offsets an otherwise-downward adjustment to US GOM oil supply.  Final US monthly data for the GOM in 2006 came in 75 kb/d lower than preliminary estimates and the lower baseline overall carries through to 2008, reducing next year's GOM total by 25 kb/d.  Notwithstanding, GOM supply shows continued year-on-year growth, with imminent field start-ups including Genghis Khan, Atlantis and Neptune.

Canada - July actual:  Growth in Canadian oil supply in 2007 amounts to 180 kb/d, with 150 kb/d coming from conventional supply (Albertan bitumen and offshore Newfoundland output), and some 55kb/d from upgraded heavy oil.  Total oil supply reaches 3.37 mb/d in 2007 (of which 1.96 mb/d is conventional crude), with a levelling off in 2008 (despite continued oil sands growth) to 3.36 mb/d.   Supply estimates are actually revised up by 45 kb/d for 2007 and 25 kb/d for 2008, as earlier double-counting within the field reliability factor is removed and also based on higher baseline Albertan conventional crude output.



Further proposed changes to the Canadian upstream fiscal environment emerged in September.  The Newfoundland government, having earlier set a 4.9% stake and royalties as preconditions for approving the offshore Hebron-Ben Nevis development, now envisages taking up to a 10% stake in future offshore projects.  The province also seeks to take over the Federal government's 8.5% stake in the existing 180 kb/d Hibernia field.  Meanwhile, Albertan authorities propose raising the fiscal take on oil sands projects from 47% to 64%, on conventional oil projects from 44% to 49% and on natural gas projects from 58% to 63%.

Mexico - August actual:  August crude production losses due to Hurricane Dean proved to be less than originally estimated, although NGL supply for the month came in 30 kb/d lower than expected.  Crude losses for the month are revised down from 425 kb/d to closer to 300 kb/d.  There were also reports that production from the offshore Ku-Maloob-Zaap complex reached over 600 kb/d at one point in September.  This report retains an earlier forecast of KMZ averaging 515 kb/d in the fourth quarter of 2007 and some 550 kb/d in 2008, but if preliminary September production highs are sustained, there is scope for upward revision to our forecast.

Mexican crude output is projected to fall by 4-5% in both 2007 and 2008, averaging 3.1 mb/d and 3.0 mb/d respectively.  However, state producer Pemex may obtain some relief from the decision by both houses of congress to approve a tax reform bill which will cut its tax obligations from 79% to 74% in 2008 and 71.5% by 2012.  This is seen giving the company an extra $2.7 billion for investment in 2008, although as noted in the demand section, this may be partly offset by an effective freeze on domestic product prices.

North Sea

UK - July actual:  Aggregate UK production data for July (field-by-field data runs through June) came in higher than expected, effectively cancelling out that month's downward field reliability adjustment of 160 kb/d.  However, increments from a series of small new gas/condensate fields appear to be lower in net terms than earlier assessments suggested, and Forties system production has been scaled back by some 50 kb/d from 4Q07 onwards as a result.  While build-up from the Buzzard field helps to stem prevailing UK offshore production decline this year (output stabilises at 1.6 mb/d), renewed decline sets in from 2008, when offshore production falls to 1.43 mb/d. Additionally, NGL and onshore crude supply amount to 235 kb/d and 20 kb/d respectively for the UK in 2008.



Norway - July actual, August provisional:  Total Norwegian supply estimates for 2007 and 2008 are unchanged at 2.5 mb/d and 2.4 mb/d respectively, being slightly below latest government projections, which envisage 2.5 mb/d in both 2008 and 2009. Start-up of the Volve, Alvheim and Vilje projects is pushed back in our forecast from 3Q to 4Q07.  However, a partial offset comes from earlier start-up at the Ormen Lange project, which began operations in September compared to our earlier assumption of December.  Ormen Lange is seen producing around 20 kb/d of gas liquids in 2008.

Former Soviet Union (FSU)

Russia - August actual, September provisional:  Russian output projections are revised up by 170 kb/d for 2007 and by 200 kb/d for 2008, largely due to improved capture of NGL output (see below).  Russian crude production is forecast to increase by some 0.2 mb/d in both 2007 and 2008, averaging 9.6 mb/d and 9.8 mb/d respectively. In addition, NGL supply averages 470 kb/d in both years.  Higher Rosneft crude supply also contributes to the upward revision, amid signs that the company is scaling up target production levels after the recent take-over of former Yukos production assets.  Year-round production from Sakhalin 2 production facilities was officially deferred from 2007 to 2008, although the OMR forecast had already assumed a 2008 start-up for winter production.



Extending Russian Gas Liquids Coverage

Data transparency can be clouded by the differing ways in which national administrations report data. Some estimates of crude oil production include only crude oil, some group together crude and condensate and some also incorporate field output of LPG and other gas liquids. Inevitably, our own and other analysts' databases include inconsistencies in the way that gas liquids are captured, reflecting the various ways that NGL are reported in national data. As a general rule however, we try to include both condensate and NGL in the 'NGL' category, leaving crude as a discrete entry on its own.



For some time we have been aware of potentially understating Russian natural gas liquids (NGL) supply, although a lack of clarity about what was or was not included in official production statistics made any adjustment difficult. We have now added an estimate of annual Russian gas processing plant supply to an existing assessment of condensate production. Monthly Gazprom liquids output data are assumed to consist predominantly of gas condensate. In arriving at Russian total monthly oil supply therefore, Gazprom's portion of production is allocated condensate quality and converted from tonnes into barrels at 8.5 barrels/tonne. All other monthly production data was, and still is, allocated as crude oil.

Recently, the IEA's annual non-OECD Green Book statistics for Russia began incorporating an NGL component. Using this, and market intelligence on gas processing operations from a number of sources, we have boosted Russian NGL supply reported in the OMR to include both field condensates and NGL (ethane through pentanes-plus) from gas processing units for the period 2000-2008. Both components are listed under the 'NGL' category in OMR databases. On a net basis, the adjustments add over 60 kb/d to Russian oil supply in 2002, nearly 150 kb/d for 2005/2006, 160 kb/d for 2007 and 175 kb/d for 2008. This also feeds through into implied demand.

Kazakhstan - August actual:  Total Kazakh oil production averages 1.36 mb/d in 2007 and 1.46 mb/d in 2008 (including around 0.3 mb/d of gas liquids from the northern onshore Karachaganak project).  The bulk of 2008 growth comes from the Chevron-operated Tengiz field, where production is seen reaching 400 kb/d in late-2008 from current output of 280 kb/d.  Company statements recently have suggested output attaining 500 kb/d in 2008.  The OMR retains a more conservative view until uncertainties over transport infrastructure (see below) and a lawsuit relating to sulphur storage at the oilfield are resolved.

The Kazkah parliament in September approved legislation allowing the government to annul oil and gas development projects on economic or national security grounds.  This was initially seen by some as a prelude to renegotiation of terms for the long-delayed Kashagan project (see page 26 of report dated 12 September 2007).  However, in recent days the Kazakh President has said that progress on Kashagan can recommence without root and branch contract renegotiation.   Nonetheless, observers see the Kazakhs likely to apply financial penalties to operator Eni arising from repeated delays at Kashagan.  One piece of potentially positive news for the troubled Kashagan project emerged when shareholders of the associated CPC pipeline agreed to Transneft calls for higher pipeline tariffs and debt restructuring, which could open the way for Russian approval for plans to double CPC capacity to 1.4 mb/d.

Preliminary data show total FSU net oil exports of 8.77 mb/d in August, 180 kb/d lower than July, which themselves were revised up by 60 kb/d, to 8.95 mb/d.  Month-on-month decreases in August were centred on products, which fell by 200 kb/d compared to July.  An increase in Russian export duties from 1 August prompted decreases of 80 kb/d and 50 kb/d in crude exports from Black Sea and Baltic ports respectively, the former also possibly exacerbated by delays in transit through the Turkish Straits.  However, an offsetting 80 kb/d surge in crude exports through the BTC pipeline left total seaborne crude exports down by only 60 kb/d.  Higher product export taxes curbed product cargoes by 50 kb/d and 60 kb/d for fuel oil and gasoil respectively.



Lower Caspian production in September, due to field maintenance, is likely to reduce BTC and CPC cargoes by over 300 kb/d, although most of this should be back in October.   Loading schedules suggest that an offsetting rise in Transneft exports in September could leave total FSU net exports down 250 kb/d from August levels, albeit potentially rebounding in October.

Revisions to Other Non-OPEC Estimates

Production estimates for Azerbaijan are trimmed by 10 kb/d for 2007, centred on weaker-than-expected August and October supplies from the ACG fields.  Recovery after July storm outages affecting offshore Chinese production was slower than expected, with August output coming in 165 kb/d below initial estimates, although September is expected to have seen a supply rebound.  Brazilian output is revised down for the 3Q07-1Q08 period, with operational problems continuing to affect Campos Basin supply.  Brazilian crude output is nonetheless expected to rise sharply by 0.3 mb/d in 2008, after a rise of 90 kb/d in 2007.  Sudanese production is trimmed by 50 kb/d for the August-October 2007 period to reflect the impact of summer flooding on production.  However, Sudanese production from existing fields is seen rising by 120 kb/d in both 2007 and 2008, reaching 575 kb/d next year, on the basis of recently-completed pipeline capacity.



OECD stocks

Summary

  • Total OECD industry stocks fell 21.0 mb in August, as increases in products and 'other oils' failed to offset a 29.2 mb crude draw, compounding a downward revision to end-July data of 14.8 mb, again mostly in crude.  As a result, forward stock cover fell below the five-year average to 53.5 days at the end of August, despite downward adjustments to third and fourth-quarter demand.


  • Crude inventories fell in all three regions and are now below the bottom of the five-year range in the OECD Pacific.  Product stocks remain tighter, especially gasoline, which stays at the bottom of its five-year range in all three regions.  European middle distillate stock cover has also fallen beneath the five-year low, a sharp reversal from the first quarter when stocks were bloated by mild winter conditions.
  • Preliminary September data for the US, Japan and the EU-16 show a further 27.4 mb draw, driven by falling crude stocks.  This indicates a third-quarter stock draw of 33.3 mb or 360 kb/d, which contrasts with the average 280 kb/d 3Q stock build of the past five years.

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

Total OECD industry stocks fell 21.0 mb in August, to 2,663 mb, and are 70.4 mb lower than at the end of August last year.  Crude inventories fell by 29.2 mb, which was partially offset by increases in total products and 'other oils' of 6.7 mb and 1.5 mb respectively.  Total product stocks are now 56.5 mb lower year-on-year, with OECD gasoline's gap to year-ago levels widening to 18.0 mb - the bottom of the five-year range in all three regions.





July stock data were revised down by 14.8 mb, due to a downward shift of 10.9 mb for crude.  Europe made up most of the change, as stocks there were revised down by 14.7 mb.  In North America and the Pacific, crude downward revisions were mostly offset by slight increases in product stocks.



OECD Industry Stock Changes in August 2007

OECD North America

Total North American stocks fell by 13.2 mb in August, with a crude draw of 15.6 mb only slightly offset by increases of 1.4 mb in products and 1.0 mb in 'other oils'.  Most of the crude draw took place in the US, where stocks fell by 12.9 mb, while in Mexico, they drew by 2.7 mb.  August was the peak of the driving season and hence also saw high refinery throughputs to meet demand.  But in the case of Mexico, crude stocks likely also suffered from production shut-ins when Hurricane Dean hit offshore crude installations in the Gulf.



Preliminary weekly data for the US in September showed a further crude draw of 7.9 mb on lower imports, and stocks at WTI delivery point, Cushing, Oklahoma, decreasing by a further 2.1 mb.  Although total US crude stocks remain close to the top of the five-year range, inventories at Cushing have now fallen by one-third since a recent peak in mid-May.  Rising autumn refinery maintenance may see crude stocks rise again, though partial shut-ins at Canada's two oil sands upgraders - some output of which flows south to Cushing - may offset this.

North American product inventories rose by 1.4 mb in August, all of which took place in Mexico.  However, the relatively flat total number does not reflect the fact that while the region's gasoline stocks fell by 12.1 mb (and residual fuel by 1.3 mb), 'other products' and middle distillates built by 9.2 mb and 5.5 mb respectively.  As in the other two OECD regions, North American gasoline inventories remain at the bottom of their five-year range.

Weekly US data for September showed total product stocks rising again by 6.8 mb as demand entered the autumn shoulder season.  Distillate stocks rose by 3.7 mb, fuel oil by 1.0 mb and gasoline by 0.2 mb.  While forward demand cover of gasoline stocks has improved by one day to 21 days on lower seasonal demand (and marginally higher stocks), it is more difficult to judge whether US heating oil stocks are sufficient to meet winter demand.  Due to off-road diesel's recent switch into the 'diesel' sub-category of distillates, it is difficult to make year-on-year comparisons.  But heating oil stocks in the crucial PADD 1a, New England, have increased in line with their five-year average, regardless of the diesel reclassification.  On the other hand, as the EIA pointed out, stocks of propane, also used for winter heating, are at their lowest pre-winter level since 1996.

OECD Europe

Total European industry stocks fell by 6.1 mb in August, as a 4.3 mb crude draw added to declines in total products and 'other oils' of 1.0 mb and 0.9 mb respectively.  Crude draws took place in Norway (-4.7 mb), France (-2.3 mb), Italy (-1.5 mb) and other Europe (-1.8 mb), while inventories increased in the UK (+2.6 mb), the Netherlands (+2.2 mb) and Germany (+1.5 mb).  Preliminary September Euroilstock data for the EU-16 show a further 5.5 mb crude draw.



Product inventories in Europe fell by 1.0 mb in August, as draws in gasoline and distillates of 2.8 mb and 0.2 mb were only partly offset by increases in fuel oil and 'other products' of 1.3 mb and 0.8 mb respectively.  Total product stocks in Europe have now fallen below their five-year range, having declined by around 50 mb in total since January.  An unseasonable draw in middle distillate stocks, albeit from an unusually bloated level following last year's mild winter, is driving this decline.  In terms of forward demand cover, the drawdown is even more pronounced, falling by 5.6 days from May to 32.9 days at end-August, below the lower end of the five-year range.

This development reflects higher exports, as refinery yields and production remained stable, and demand was well below average in the first half of the year (though we expect a rebound year-on-year in the second half).  OECD data show that Greece exported more gasoil into the Mediterranean, and outflows from the Netherlands increased to Nigeria, Argentina, Brazil and Syria.  While fuel oil stocks have also fallen 12.1 mb from a January high to around 70 mb, gasoline and 'other products' stocks are little changed, and all remain at the bottom of the range.  Preliminary September data from Euroilstock show that total product stocks in the EU-16 fell another 6.8 mb, of which 5.3 mb was middle distillates.

OECD Pacific

Total Pacific industry inventories fell by the least of all three regions in August - by only 1.7 mb in total, but may have seen a larger fall in September.  A strong crude draw of 9.4 mb was partly offset by increases in product stocks and 'other oils' of 6.3 mb and 1.4 mb respectively.  The crude draws were almost evenly split between Japan and Korea.  Total Pacific crude stocks have now fallen to 166.4 mb, which is 8.3 mb lower than last year and just below their five-year range.  Moreover, preliminary data for September from the Petroleum Association of Japan (PAJ) show a further crude draw of 8.9 mb despite a downtick in refinery throughputs.



Product stocks in the OECD Pacific rose by 6.3 mb in August, buoyed by a seasonally normal 6.6 mb increase in distillates.  A lesser 1.0 mb gasoline build was offset by a 1.3 mb draw in 'other products', while fuel oil stocks were flat.  Unlike crude developments, product stocks diverged strongly, with a 10.3 mb build in Japan partly offset by a 4.0 mb draw in Korea.  Japanese middle distillates increased by 8.4 mb, reflecting in large part the seasonal rebuild of heating fuel kerosene stocks ahead of winter.  Gasoline and 'other products' also rose, by 1.4 mb and 0.6 mb respectively, while fuel oil was basically flat.  In Korea, the product draw stemmed from 'other products' and middle distillates each falling nearly 2 mb.

Preliminary PAJ data for September showed Japanese product inventories falling 5.1 mb to the bottom of their four-year range, as refinery throughputs fell.  Fuel oil drew by 2.7 mb, in part on stronger demand from electricity utilities to compensate for less nuclear power.  Gasoil stocks were also down by 2.1 mb, while gasoline and jet fuel fell by 0.6 and 0.3 mb respectively.  Naphtha and kerosene built by 1.3 mb and 0.5 mb.

Recent Developments in Singapore Stocks

Product stocks in Singapore, as surveyed by International Enterprise, remained relatively unchanged in September, falling by only 200 kb.  Stock levels in all three categories were almost exactly in line with five-year averages.  Fuel oil stocks notably fell by 710 kb, reflecting a slightly tighter market, which supported regional prices.  Lower Iranian exports due to demand for electricity generation are reportedly causing Singapore-bound cargoes to be diverted, as more fuel oil is drawn into the Middle East, both on stronger utility demand in Gulf states and a thirsty bunker market in Fujairah.  Meanwhile, light and middle distillates increased by 350 kb and 160 kb respectively.















Prices

Summary

  • WTI crude futures rose to record highs above $80/bbl in September on Gulf of Mexico storm-related shut-ins and expectations that supplies will tighten further in the fourth quarter.  Impending winter demand, amid crude and product stock draws in the US, Europe and Japan contributed to upward pressure.  This was amplified by a lack of confidence that the falling inventories will be replaced.  Crude benchmarks WTI and Dubai received further support from regional factors, while Brent suffered from weak refining margins.
  • September refining margins fell in most regions and remain weak, as increasing product prices failed to keep up with crude gains.  US margins suffered due to narrowing gasoline and gasoil crack spreads on the Gulf and West Coasts respectively, leaving cracking margins substantially lower than just a few months ago.  In Europe, Brent's relative strength versus Urals caused north and south margins to diverge.  Singapore margins remain depressed.
  • Product prices rose but lagged behind crude.  Distillate crack spreads now hold their usual seasonal premium to gasoline and naphtha as the market focuses on winter heating fuels.  However, forecasters currently see the la Niña weather phenomenon increasing the possibility of warmer-than-average winter temperatures in the US and Japan.  The Asian high-sulphur fuel oil market tightened on lower Iranian exports, which diverted other eastbound cargoes.  Gasoline cracks were flat.


  • VLCC freight rates to Japan rose above $9/tonne in late September due to a temporary tightening of Middle East Gulf fundamentals.  Freight rates may see additional support in the coming weeks from increased OPEC production, an end to refinery maintenance and higher fourth-quarter demand.  Clean tanker rates were soft in September as vessel availability ran ahead of demand during the autumn shoulder season.

Overview

Front-month WTI crude futures first rose above $80/bbl in mid-September, breaking records in nominal terms on storm worries, an expected tight crude balance going forward, more refinery problems and increased geopolitical tension.  WTI and Brent futures both remain backwardated and front-month WTI retains a $2.50/bbl premium over its North Sea counterpart.

Various hurricanes and tropical storms threatened Gulf of Mexico oil installations, especially in late August/early September and a major preventative mid-September shut-in of US GoM crude and gas production caused WTI to peak at $83.90/bbl (Brent followed some days later, peaking at $81.05/bbl).  While this and other shut-ins have only been brief, and virtually no damage has been reported, the storms have been a reminder that last year's hurricane-free season was unusual and that weather can be a major determinant of oil prices.  However, while the hurricane season is only formally over at the end of November, recent forecasts do not expect much more threatening storm activity.  The first cold snap of the year in the US Northeast caused attention to shift to winter heating needs.  While we hold little faith in long-term temperature projections, a consensus is emerging that the US (and Japan) could see warmer-than-average winters, in the former case due to a prevailing la Niña condition.



Looking ahead, the prospect of a tight crude balance until at least the end of the year is another factor supportive of current high oil prices.  OPEC's announcement at its 11 September meeting that it would hike output by 500 kb/d from 1 November did little to stem the upward rise in oil prices.  While the increase showed OPEC was attentive to market concerns, even demand forecasts at the low end of the spectrum project a higher call on OPEC this winter.  The implied 4Q stock draw would come in addition to a provisional estimate of a 360 kb/d draw in the third quarter.  Crude tightness is underpinned by worries that stocks will not be replenished, and re-emerged geopolitical tensions.  Mexican pipeline blasts hardly affected exports, but there was some apprehension that they could eventually be added to ongoing issues in Nigeria, Iran and Iraq.

Recent unrest in Burma and latterly also in Pakistan also raise concerns.  The Burma unrest has a particular significance for oil demand as it appeared to be prompted by a raising of domestic fuel and other consumer goods prices.  This follows disturbances in Indonesia in 2005 when subsidies were reduced, and protests in Iran when rationing was introduced.  As such, there could be considerable reluctance to pass on higher prices to consumers in countries with large subsidies. 

In contrast, product markets were relatively calm and on the whole, product prices failed to keep up with crude, despite relatively low OECD product stock levels.  Demand dips seasonally in the autumn and there are some (as yet not clear cut) indications that consumption is beginning to react to high prices.  Going forward, these factors remain key downside risks to demand, as does the possibility of another unseasonably warm winter.

Falling Crude Stocks - It's All Down to Perceptions

The shift of the crude oil forward curve from contango to backwardation has led some market participants to project that supplies will be easier to come by over the coming months. Stockholders, faced with lower future prices, would appear to be better off selling their stocks on a spot basis and buying them back more cheaply further forward. But taken at face value, that argument would suggest that the emergence of backwardation would prompt a fire sale from storage, either leading to the depletion of all but working stocks, or by depressing the spot market so much a contango would be reinstated. That does not happen, so academics try to explain this difference as a 'convenience' yield. Perhaps a more intuitive way of viewing the concept of convenience yields is from a trader's perspective.

The forward discount in the market offers the trader a return from selling spot and buying forward. A stockholder therefore has to look at the risk/reward ratio for various trading options. The options are broadly:

  • Receive a guaranteed return by selling the stock now;
  • Sell spot and buy forward;
  • Hold on to physical stocks.
  • In the first case, the trader exits all oil market pricing risk, but has no physical supply in the present or future - possible for a speculative trader, but not perhaps for a refiner. In the second case, the trader swaps timing, supply security and quality risks for the return provided by the backwardation. In the final choice, the trader estimates that the risks outlined in the second case outweigh the return from the lower forward price or projects that the backwardation will widen.

    It is clear therefore that the case for automatic stock liquidation when a market enters backwardation is not clear-cut. It is even less so when a tighter market is expected (as is arguably the case through the end of this year). This exercise also highlights why the size of the backwardation acts as a barometer for perceived future market tightness and risk. Ultimately though, if supplies are inflexible and cannot rise to meet demand, stocks have to be drawn or prices have to rise to the point where demand abates.

    In the current market, we have seen OECD crude stocks fall by an estimated 58 mb since the end of June since futures moved into backwardation. Despite remaining near the upper edge of their five-year range, this is still a clear downward trend. While crude stocks remain highest in the US, relatively speaking, it is the low (and) falling crude stocks at WTI delivery point Cushing that are dictating prices and forward price structures. Stocks in Japan and Europe are also much lower - particularly when the preliminary September draw is included, underscoring the backwardated market structure.

    Ultimately, there are clear financial incentives to liquidate stocks when a backwardated market structure evolves. Nevertheless, expectations of a tight future supply/demand balance may limit the extent to which backwardation encourages actual stock draw. Absent incremental supply via stocks, market rebalancing may therefore only come from a price-induced curb on demand.

Spot Crude Oil Prices

Spot crude prices rose in line with futures but benchmarks remain somewhat out of kilter.  Due to falling Cushing crude stocks, WTI has once again returned to more normal market relationships with other light sweet crudes.  However, there remains concern that pricing relationships could still become distorted if regional bottlenecks once more emerge (see 'WTI: Contango to Backwardation' in report dated 10 August 2007).  Some traders are blaming the prevailing backwardation in WTI futures as causing a backlog of unsold cargoes on the US Gulf Coast market, though it seems more logical to infer that this stems from current autumn maintenance, and cargoes delayed by storms.  However, it may perhaps be fair to argue that the widening premium of WTI over GoM crudes such as Mars and Maya reflects a temporary surfeit of supply to the region.

In the North Sea, Dated Brent weakened versus other light sweets, reflecting lower refining margins in Europe and US Gulf Coast.  Azeri Light strengthened on a combination of maintenance and a brief outage on the BTC pipeline, which reduced its flow into the Mediterranean.  However, Brent widened its premium against Urals on higher Russian exports in September ahead of a hike in export duty and an increased flow of Iraqi Kirkuk barrels into the Mediterranean.  Of two 5 mb tenders announced for September, only 4.6 mb were actually lifted in September, with further cargoes delayed until early October.  A third tender, for October delivery, has just been announced.



The Asian market for Middle Eastern crude was influenced by Shell's purchase of an unprecedented 400+ 25 kb cargoes ('partials') on the Dubai/Oman market, thus inflating the lesser-quality Dubai to a small premium over Oman and potentially raising the price of Middle Eastern Gulf crude to Asia.  Asian refiners will generally be expecting higher allocations of Saudi and other Gulf term volumes for November, when OPEC has said it will raise output, but the availability of November volumes of Abu Dhabi crude are of greater concern, as the emirate is planning maintenance on its Umm Shaif, Lower and Upper Zakum fields in November.  Asian refiners bought around 1.1 mb/d of West African crude for October loading, down slightly from September's 1.3 mb/d.  Regional light sweet Tapis remained at a relatively steady premium to similar Atlantic Basin grades.



Refining Margins

Refining margins mostly fell in September and remain quite low.  US cracking margins in particular are now substantially lower than just a few months ago.  The most recent weekly data even showed Brent cracking on the US Gulf and ANS cracking on the West Coast respectively dipping below zero.  In the US as elsewhere, it appears to be crude strength rather than relative weakness in products driving the change.  In contrast to the other regions surveyed, gasoil cracks dipped on the US West Coast, while gasoline spreads to crude weakened substantially on the US Gulf Coast.



In Europe, refining margins were mixed, with Brent and Urals margins diverging in Northwest Europe and Mediterranean spreads rising overall.  Depressed Urals, due to an influx of medium sour barrels, obviously helped, as did the stronger gasoil market in the south.  Singapore margins remain depressed, with fuel oil cracks dipping on average in September, despite an uptick late in the month (and in early October).  As a result, Korean SK reported in mid-September that it was planning to trim refinery throughputs in November/December.



Spot Product Prices

Product prices increased, but with falling refining margins, markets overall remain crude-driven.  Winter's approach has meant an increasing focus on heating fuel and distillates in general, though current weather forecasts for the US and Japan indicate warmer-than-average temperatures ahead.  US heating oil stocks in the crucial Northeast are in line with their five-year average, though year-on-year comparisons are difficult to make since the phase-out of high-sulphur off-road diesel this summer.   European middle distillate inventories at the end of August were unusually low in terms of forward cover at only 33 days.  Strong demand for transportation fuels was noted during the month, which, coupled with lower Russian exports into NWE (after the now complete halt to exports through Tallinn), triggered a backwardation in ICE Gasoil.



European demand is expected to remain strong, with German consumer heating oil stocks below average (58% of capacity) and further distortions possible ahead of the 1 January 2008 switch to 0.1% gasoil (for heating and off-road diesel) in Europe and a switch to 10 ppm diesel in the UK from December.  In Asia, additional Indonesian buying ahead of Ramadan supported prices.



High-sulphur fuel oil discounts to crude have narrowed, especially in Asia, where substantially lower September/October exports from Iran have led to eastbound cargoes being redirected to regional ports.  Power shortages in several Middle Eastern countries in the summer have highlighted growing electricity demand, and UAE port Fujairah has pulled in bunker cargoes.  Unusually, even India was heard sending a cargo to the Middle East.  Fuel oil exports totalling 2.5 million tonnes were originally reportedly fixed to arrive in Asia in October and while some of this may have subsequently been diverted to other regions, this is still likely to represent the highest shipment volumes in several months.  Japan meanwhile also saw fuel oil stocks decline, as it sought barrels for direct burning, after September saw a further nuclear power station shut down.



Gasoline cracks were flat or slightly lower in September and early October, despite low stocks, with the weakness reflecting seasonally lower demand.  There was however a brief respite in the trend following an unexpected shut-in at Indonesia's Dumai refinery, leading to an increase in its gasoline (and diesel) purchases for October delivery.  Asia may also look to send more barrels to the US West Coast as price spreads have widened.  Meanwhile, naphtha cracks have also recovered somewhat again, especially in Singapore on growing petrochemical demand.



End-User Product Prices in September

OECD end-user prices overall rose 12.2% above last year's September level in US dollars and remain 2.6% above August.  As a result of the US dollar depreciation, Europeans saw retail prices rise only 5.7% as opposed to a 14.7% increase when valued in US dollar terms.  Gasoline and diesel prices are on average 7.9% higher year-on-year in the US, while in the rest of the OECD, these prices averaged an increase of 3.9% (year-on-year) in national currency terms as opposed to the 11.7% rise in US dollar terms.  With winter approaching, OECD heating oil prices are only 2.0% higher on average in national currency terms than a year ago, while the average price for LSFO rose 9.6% on the year.  Overall, year-to-date, OECD retail prices in national currency terms have been on average 3.4% lower than last year.

Freight

Freight rates remained low in September compared to previous years, although a moderate mid-month firming indicated a temporary tightening of regional vessel fundamentals.  A November rise in OPEC output alongside an end to autumn refinery maintenance and higher fourth-quarter oil demand could lead to a more sustained rise in crude tanker demand in the coming weeks.  Clean tanker rates were soft in September as vessel availability ran ahead of demand during the autumn shoulder season.

VLCC rates from the Middle East Gulf to Japan remained near 2007 lows of $7/tonne in early September.  Tanker demand has been limited by constraints on OPEC exports this year, while deliveries of new vessels have increased tanker supply.  Another bearish note for ship owners this month has been the rise in bunker prices, representing a squeeze on earnings.  In the second half of September, the booking horizon for long-haul arrivals entered the post-refinery maintenance season and VLCC rates to Japan rose to around $9/tonne.  Double-hulled vessels, especially favoured by Japanese charterers, became increasingly scarce.  Although rates faded in early October, OPEC's pledge to raise production by 500 kb/d from 1 November should support long-haul crude trade and, ultimately, freight rates.  VLCC rates from Middle East Gulf to US rose from a mid-September trough of under $13/tonne to end the month around $15/tonne.



Demand for Atlantic Basin crude transportation rose in September, as Asian buying of West African cargoes rebounded after a quiet August, and North Sea production maintenance wound down.  Suezmaxes trading from West Africa to the US Atlantic Coast, at a multi-year low of under $7/tonne in mid-September, finished the month at $8.50/tonne.  Aframax trading from North Sea to Europe rose from under $4/tonne in mid-September to over $6/tonne the following week before easing slightly.  Higher flows of Russian crude through Black Sea and Baltic ports partially offset lower Mediterranean tanker demand resulting from maintenance-driven reductions to Caspian exports via Ceyhan.

Clean tanker rates remained rather soft in September.  Maintenance in Eastern and Western refining centres limited product flows relative to vessel availability.  Middle East Gulf to Japan rates for 75,000-tonne cargoes fell from $21/tonne at the end of August to under $18/tonne at end-September.  A reported rise in transatlantic gasoline flows to the US could explain a $2/tonne firming in late September, pushing 33,000-tonne rates on this route over $15/tonne.

Refining

Summary

  • Global refinery crude throughput is forecast to average 73.0 mb/d in October, its seasonal low point.  The decline of 1.9 mb/d from the August peak of 74.9 mb/d is due to refinery maintenance lowering throughputs in the OECD, China, the Middle East and the FSU.  Global crude runs are however projected to rebound to 75.5 mb/d by the end of the quarter.


  • September OECD throughput is estimated to have averaged 38.7 mb/d, sharply lower than the August summer peak throughput of 39.7 mb/d.  Heavy maintenance in Europe and the US, operational problems in some US regions and the protracted recovery by refineries affected by Hurricane Humberto have all contributed to this drop in runs.  Crude throughput is forecast to fall to 38.5 mb/d in October, but should increase in November and December, as seasonal maintenance winds down, although operational issues remain a potential drag on the outlook.
  • European light product yields increased as a result of recent upgrading capacity additions.  However, operational problems at Neste's newly installed hydrocracker may subsequently increase fuel oil yields in Europe.  Pacific fuel oil yields fell in July to 15.6%, below the five-year range and could fall by a further two percentage points if the recently-completed heavy oil upgrading unit in Korea works as anticipated.
  • OECD Pacific product markets should see lower net fuel oil exports as a result of upgrading investment by Japanese and Korean refiners over the course of 2008.  Correspondingly higher distillate production will boost net exports of diesel from the region as refiners continue to invest in raising production of ultra-low sulphur and sulphur-free light products at the expense of fuel oil.

Global Refinery Throughput

Global refinery throughput is projected to reach its seasonal low point in October, as maintenance work and ongoing disruption to US refineries curtail crude throughput.  Crude runs are expected to average 73.0 mb/d during the month, slightly below September's 73.2 mb/d.  The month-on-month decline in OECD throughput is offset by gains in China and Latin America with the completion of planned maintenance work.  Crude throughputs are forecast to rise during November and December, driven by increases in the OECD, the FSU and China.  The latter increase is also expected to be underpinned by the start-up of new crude distillation capacity at PetroChina's Dushanzi refinery towards the end of the year.

The seasonal rise in heating-related demand for gasoil and kerosene is expected to drive much of the increase, with European refiners also having to adjust to the introduction of tighter sulphur specifications (0.1% sulphur instead of 0.2%) for gasoil as of January 1, 2008.  The specification changes effectively require lower-sulphur gasoil to be supplied by refineries during the fourth quarter.  This may in turn limit imports of Russian gasoil (typically 0.2% sulphur) to Europe, unless sufficient quantities of ultra-low-sulphur gasoil material are available for blending.  Furthermore the planned change in UK diesel sulphur limits in early December to 10 parts-per-million sulphur (ppm), from 50 ppm, may also tighten distillate markets towards the end of the year.  In the Pacific, higher fourth-quarter crude throughput (+0.2 mb/d) compared to a year ago reflects the absence of run cuts, due to lower product stock levels and an assumed stronger margin environment, although renewed signs of weak demand for kerosene may yet again see crude throughput reduced to stabilise stocks levels.



August global crude throughput is revised up 0.1 mb/d to 74.9 mb/d, on the back of higher than expected Latin American and Chinese crude throughput, the latter being a result of lower than forecast run cuts.  This was offset by lower OECD crude throughput in August (see below).  Global crude throughput in September has been revised down to 73.2 mb/d (-0.3 mb/d) due to higher than anticipated maintenance work and unplanned refinery outages in North America, the FSU and China.

OECD Refinery Throughput

OECD - August Actual and Fourth-Quarter Forecast

Lower-than-expected throughput in August and September (for the US and Japan) has reduced our estimate of third-quarter OECD crude throughput to an average of 39.3 mb/d, a downward revision of 0.2 mb/d from last month's report.  September throughput is estimated at 38.7 mb/d, a decline of 1.0 mb/d from August with the impact of continued refinery problems in the US Midwest and Gulf Coast remaining an important drag on overall OECD refinery activity levels.



US Gulf Coast throughput was also curtailed by extended shutdowns following Hurricane Humberto at three refineries totalling 0.8 mb/d.  Elsewhere in North America the disruption to crude supplies in Mexico following a pipeline explosion is estimated to have cut crude runs at the Tula and Salamanca refineries by an average of 95 kb/d in September.  Weekly data for the US point to crude runs averaging 15.3 mb/d in September, reaching their lowest level since March and well below the summer peak seen in late July.  In addition to the problems already highlighted on the Gulf Coast there was heavy maintenance in the Midwest, and the continued partial outage at BP's Whiting refinery.

The seasonal increase in refinery maintenance in October will continue to constrain throughput in North America and Europe.  Runs are expected to increase on the US Gulf Coast and decline on the US West Coast, where heavier maintenance downtime is forecast.  Elsewhere, the acceleration of work originally planned for 2008 at Harvest Energy's north Atlantic refinery in Canada has lowered our estimates for October and November crude runs.  In Europe, several refiners are expected to undertake shutdowns with work scheduled in the Netherlands, Norway, Portugal, Spain and Sweden.  OECD Pacific crude throughput should recover slightly in October, as lower maintenance in Japan and Korea raises activity levels ahead of peak winter demand.  Furthermore, fourth quarter utilisation rates have been reduced to reflect the slight downward adjustment to the OECD demand forecast, published this month.  Consequently, fourth-quarter crude runs are now estimated to average 39.3 mb/d, an increase of 0.4 mb/d year-on-year.

OECD Data for August

OECD August crude throughput averaged 39.7 mb/d, 0.3 mb/d lower than forecast last month.  Crude runs were approximately 0.1 mb/d lower than expected in all regions.  Crude throughput was up 0.2 mb/d from July, with Japan accounting for most of the increase with North American and European crude runs flat.  Compared to August 2006, OECD crude runs declined by 0.7 mb/d, largely as a result of the 0.5 mb/d year-on-year drop in European crude runs, stemming from, inter alia, run cuts at ConocoPhillip's Wilhelmshaven refinery in Germany.







OECD Refinery Yields

OECD refineries continue to reduce fuel oil yields, driven by investment in upgrading capacity.  European refiners reduced fuel oil yields to below 13.7% of production in July from 15.3% in previous months, with the start-up of new hydrocracking capacity at Porvoo in Finland and Gonfreville in France.  Corresponding increases in diesel/gasoil yields were also seen.  However, ongoing operational problems at Neste's Porvoo refinery suggest that fuel oil yields may increase again in the subsequent months, before the unit is in a stable mode of operation (currently assumed to be late in the fourth quarter, following remedial work).



Pacific fuel oil yields are expected to decline from their existing low levels with the start of new upgrading equipment in South Korea, which could reduce yields by a further two percentage points from the current level of 15% effectively cutting regional fuel oil production by up to 15% of current levels.  There would be a corresponding increase in the yield of distillate and other products



North American distillate yields increased to the top of the five-year range in July and are expected to continue to remain strong over the balance of the year.  North American gasoline yields dipped in July as throughput gains in FCC and coking capacity lagged the increase in crude runs.  Furthermore alkylate premiums on the Gulf Coast rose to their highest level since August 2006, suggesting that problems with catalytic cracking units (and possibly reformers) were once again undermining gasoline output levels.

OECD Pacific Product Balances - 2008 Outlook

In the first of a series of more in depth looks at regional forecasts from our recently completed medium-term global product supply model, this month we consider prospects for the Pacific in 2008.

The OECD Pacific should see higher distillate and lower fuel oil net exports in 2008. Refinery investment is dominated by new upgrading and hydrotreating capacity and this is expected to boost the production of ultra low sulphur distillate and gasoline at the expense of fuel oil. The growth in product supply of these grades next year is therefore expected to outpace the region's modest demand growth.

In recent years OECD Pacific countries have all introduced more stringent transport fuel standards and refinery investments reflect the growing need for ultra low sulphur fuels. In Australia and Korea even more stringent sulphur limits are expected to be introduced by the beginning of 2009 with premium gasoline and diesel moving to effectively sulphur free levels

Korean upgrading investment through the end of 2008 is geared toward increasing low-sulphur diesel production and fuel oil conversion. The Ulsan refinery has recently added an 80 kb/d diesel hydrotreater, while the Yosu refinery has just started the 155 kb/d vacuum distillation unit with a 55 kb/d residue hydrocracker, both of which are expected to raise distillate production.

Japanese refinery investments in 2007 and 2008 are designed to increase ultra low-sulphur gasoline production. Until the end of 2008, the main refinery additions in Japan include a 14 kb/d gasoline hydrotreating unit in 2007 and an 18 kb/d fluid catalytic cracker which should start in 2Q08. The start up of a 60 kb/d condensate splitter in late 2007 or early 2008 at Kashima will raise condensate processing capacity, with the heavy naphtha fed into a 20 kb/d reformer to boost supplies of high octane blending material.

Overall, the OECD Pacific should see higher distillate exports from Japan and Korea in 2008, largely offset by rising imports into Australia and New Zealand. The region has long been a net exporter of diesel and kerosene, and refinery investments will continue this trend. Similarly, the need to import marginal barrels of gasoline and naphtha to meet demand is also set to continue. Gasoline consumption has stabilised since reaching a high of 1.6 mb/d 2004, while naphtha demand has continued to grow, due to increased petrochemical use. Mainly as a result of the lack of gasoline demand growth and investments in upgrading units and condensate splitting capacity, the OECD Pacific is expected to reduce imports of gasoline and naphtha by 44 kb/d and 32 kb/d in 2008 compared to 2007. As a result of upgrading additions, the region is expected to decrease fuel oil exports by 50 kb/d in 2008.