Oil Market Report: 13 November 2007

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Highlights

  • WTI hit a new record above $98/bbl in early November, driven by lower crude stocks, constrained supplies and new geopolitical tensions.  There are, however, strong indications that high prices are depressing demand, which, together with signs of higher output from Saudi Arabia, Iraq and Nigeria, have capped further price gains.
  • OECD industry stocks fell by 29.5 mb in September, with Japanese crude stocks falling to their lowest level in at least 20 years.  Total OECD forward inventory cover fell to 52.8 days, remaining close to the five-year average.  Preliminary data for October suggest a further 21 mb draw in crude and product stocks in the US, Japan and EU-16.
  • Global demand for 4Q07 is revised down by 0.5 mb/d given high prices, weaker-than-expected data from the US and FSU, and delays to European heating oil restocking.  Coupled with lower GDP growth, these revisions extend to the 2008 forecast, which has been adjusted down by 0.3 mb/d.  World demand now averages 85.7 mb/d in 2007 (+1.2% over 2006) and 87.7 mb/d in 2008 (+2.3%).
  • World oil supply saw a monthly gain of 1.4 mb/d in October, as non-OPEC outages receded and OPEC volumes increased. Recovery in China and Azerbaijan plus rising Russian output boosted non-OPEC supplies.  Continued outages in the OECD see non-OPEC supply levelling off in November before resuming growth in December.
  • October OPEC crude supply increased by 410 kb/d to 31.2 mb/d.  Half the rise came from Angola and Iraq, where supplies could increase further in November.  Signs of higher November supply from Saudi Arabia, Nigeria and others may be offset by UAE field maintenance.  OPEC October spare capacity slipped to 2.46 mb/d.
  • Global refinery crude runs are seen at 73.5 mb/d in 4Q, revised lower by 0.7 mb/d, on the back of weaker demand, increased offline capacity and higher planned maintenance in some regions.  Refinery outages and product specification changes have severely tightened European distillate markets.

$100 oil - a turning point?

Does $100/bbl crude oil mark a significant turning point in the oil market?  Psychologically, it is certainly significant.  At this level, oil prices would be close to their 1980 'oil-crisis' highs in inflation-adjusted terms.  Media attention is raising awareness of high prices, while consumers, feeling their pockets squeezed, have even resorted to protests in some OECD countries.  Government officials have signalled their concern and are highlighting the need to conserve oil.  China has raised domestic wholesale prices, while India, Malaysia and Chinese Taipei are looking at the need to reduce price subsidies.  But will $100/barrel oil have a significant influence on the path of oil demand growth?



From a practical standpoint, hitting a round number may not confer any specific damage, but the cumulative $70 rise in price since 2002 is, we believe, having a cumulative effect.  While short-term price effects are generally measured relative to sustained annual price increases, the recent dramatic price rise is having a 'short-term' shock effect, at the same time as consumers appear to be adapting behaviour to deal with steady annual price increases.  In Forecasting OECD Demand, we look at the components of OECD demand growth next year.  Superficially, our 2008 OECD demand growth of 610 kb/d looks strong relative to the flat demand structure of the past three years.  However, breaking OECD product demand down by driver highlights that the majority of our forecast growth is due to the assumption of a return to 'normal' weather - i.e. a rebound in heating fuel demand.  Indeed, transportation demand growth in the OECD is minimal, reflecting the effect of high prices, and stands in stark contrast to the steady growth seen in the past two years.

As with all forecasts, there are risks.  Weather-related demand could clearly move either side of 'normal'.  Balancing that, our transport demand projections may be too low.  While there are clear signs that the rise in prices since the second quarter this year has pressured gasoline and diesel demand growth in the OECD, it is too soon to believe that significant structural changes have taken place (such as a more fuel-efficient car fleet) to make this lower level of demand permanent.  Therefore, higher prices have affected OECD end-user behaviour, but this change in behaviour may not be permanent.

But the mature economies are only supporting actors in our global demand growth projections.  The bulk of 2008 demand growth remains within non-OECD countries, where regional growth patterns are expected to be similar to the past two years.  The only outlier is the FSU, where preliminary 2007 data show a demand contraction - an outcome that goes against the trend of strong economic growth, but could also reflect efficiency improvements or data quality issues.  Overall, the assumption of strong economic growth in key non-OECD countries continues to drive accelerating oil demand growth.

High prices may affect non-OECD forecasts - particularly if the $100 benchmark results in a reduction of subsidies in the coming months - but the effects on market balances may not be that large.  Evidence of falling product stocks in China suggests that apparent demand calculations in recent months have been artificially depressed, meaning that the recent rise in domestic prices could allow demand to rebound.  The underlying path of economic growth is also far stronger than the price effect, so it is unlikely that these higher prices will materially alter the demand path in China.  In the other key growth area, the Middle East, rising oil revenues mean that subsidies can be more easily financed and are unlikely to be removed.  Together, these two regions in 2007 account for some two-thirds of global oil demand growth.  Elsewhere, price impacts following the removal of subsidies could be more significant - but as always, oil demand will remain subservient to the main driving force:  economic growth.  Risks to oil demand growth are therefore concentrated more in the potential for spillover economic weakness from the housing sector and the fall-out from the subprime crisis than in high oil prices.

Whether high oil prices will put pressure upon economic growth is a much harder question to answer.  Oil prices are but one of many factors determining the path of economic growth.  However, its importance is increasing.  In the US for example, the share of household expenditures on transportation fuels has seemingly risen to their highest level since the mid 1980s.  And it is a reasonable assumption that if high oil prices are affecting behaviour, then high prices are having an economic impact - hitting consumer spending and eating into corporate profitability at the margin.  The effect may not be large, but it could be more significant if other areas of economic weakness emerge.

As to whether $100/barrel is sustainable; it is something that is hard to answer in the short term.  There are certainly a number of factors that could push prices lower:  mild weather, higher OPEC supply, improved refinery operability and weaker economic growth.  However, these would have to push against a tightening global market balance.

The findings of the July Medium-Term Oil Market Report and the latest World Energy Outlook suggest that the strong latent demand growth from developing countries is likely to meet supply-side constraints over the medium term.  In other words, there would have to be a particularly strong downturn in the economic cycle to overwhelm the ongoing upswing in the commodity cycle.  Ultimately, whether $100 oil proves a turning point in consumer and government thinking towards energy efficiency is more significant than its direct impact on oil demand growth.

Demand

Summary

  • Global oil product demand has been revised down by roughly 160 kb/d in 2007 and 300 kb/d in 2008.  The changes were related to OECD revisions (in North America and Europe), notably in 4Q07, given high-price effects on gasoline demand and 'other products' in the US, and delayed heating oil tank-filling in Europe.  These changes were further compounded by adjustments in the FSU.  World demand is now expected to average 85.7 mb/d in 2007 (+1.2% over 2006) and 87.7 mb/d in 2008 (+2.3%).


  • OECD oil product demand has been lowered in both 2007 and 2008 (-110 kb/d and -250 kb/d, respectively).  Stronger-than-expected September demand in the Pacific, driven by Japan's power generation needs as a result of a heat wave, failed to offset a weaker outlook for both North America and Europe.  Data revisions and the reassessment of economic conditions, prices and interfuel substitution in favour of natural gas weighed down on the oil demand forecasts for both areas.  The IMF's economic outlook for the US and several key European countries turned out to be weaker than anticipated, particularly in 2008.  Despite strong 3Q07 GDP growth, the downside risks for the US economy are significant, as evidenced by recent economic data and by the Federal Reserve's second interest rate cut since September.  Moreover, the effects of this year's price rise are seemingly already contributing to slowing down transportation fuels demand, notably in the US.  Finally, the prospects for natural gas substitution, particularly in Europe and the US, have been slightly reassessed.  Overall, OECD demand is now expected to decline to 49.2 mb/d in 2007 (-0.2% year-on-year), but it is nonetheless seen increasing to 49.8 mb/d in 2008 (+1.2%).
  • Non-OECD oil product demand has been adjusted downwards in both 2007 and 2008 by roughly 50 kb/d on average, largely due to changes in FSU estimates.  Both supply and net exports, which serve as the basis for the region's apparent demand calculation, were revised.  Overall, non-OECD demand is seen averaging 36.5 mb/d in 2007 (+3.1% on an annual basis) and 37.9 mb/d in 2008 (+3.6%).  This forecast assumes that China and the Middle East, which together account for over half of worldwide oil demand growth, will remain both largely untouched by the US subprime woes and to a large extent insulated from international oil prices, given the prevalence of subsidies on end-user prices.
  • The high cost of oil product subsidies across much of the developing world, particularly in Asia, is becoming a very sensitive issue as international oil prices continue to rise to near-record levels.  But despite the growing financial burden that subsidies imply, it seems unlikely at this point that the largest Asian countries will reduce or even abolish subsidies, given concerns that such a move could prompt a consumer backlash.  China's 9% adjustment to wholesale transportation fuel prices (which translates into an 8% increase in retail prices) attempts to address the financial pressures on both state-owned oil companies and 'teapot' refineries and to tackle oil product shortages.  Chinese demand, meanwhile, is expected to remain strong, driven by continued economic growth.


OECD

According to preliminary data, total OECD inland deliveries (a measure of oil products supplied by refineries, pipelines and terminals) grew by 0.1% in September on a yearly basis.  The strong rebound in oil product demand observed in the Pacific (+7.3% year-on-year) offset demand weakness in both Europe (-1.9%) and North America (-0.8%).



As detailed below, the strong rebound in OECD Pacific demand was mostly driven by Japan, which struggled to meet soaring electricity demand amid ongoing nuclear outages.  Thus, the deliveries of oil products that can be used in power generation soared in the region:  residual fuel oil surged by 4.8% on an annual basis and 'other products' (which include direct crude) by 7.0%.

Meanwhile, the weakness in OECD Europe demand continued to be related to stubbornly lower-than-average deliveries of heating oil in Germany and France.  In both countries, end-users once again delayed the refilling of their tanks.  Consequently, Europe's September heating oil deliveries tumbled by 18.3% year-on-year.  In OECD North America, meanwhile, demand contracted by 0.8% as a result of weak deliveries across all products bar LPG, gasoline and diesel, notably in the United States.



OECD demand in both 2007 and 2008 has been adjusted down, as a result of data revisions and a reassessment of economic conditions, prices and interfuel substitution in favour of natural gas.  Although this report had attempted to pre-empt the revisions to the IMF economic outlook (based on median forecasts from Consensus Economics), the Fund's assessment of several key OECD countries turned out to be weaker, thus weighing on demand.  The effects of this year's price rise, which may prevail during the winter months and which is already contributing to slow down transportation fuels demand, notably in the US, have also been reappraised.  Finally, the prospects for natural gas substitution, particularly in Europe and the US, have been slightly reassessed.  As such, OECD demand is forecast to reach 49.2 mb/d in 2007 (-0.2%) and 49.8 mb/d in 2008 (+1.2%).  Moreover, seeking to improve transparency and market understanding, we are presenting in detail the assumptions behind our OECD demand forecast (see Forecasting OECD Demand below).





Forecasting OECD Demand

There is a lively debate regarding short-term forecasting of OECD demand. Indeed, oil product consumption in the region is driven by several key factors that interact in complex ways. As a result, the OECD 2008 demand outlook varies significantly across forecasters, and this has a significant impact with respect to the prognosis of next year's global demand (by contrast, the assessment of non-OECD demand is broadly shared by most observers).

This report's OECD forecast has tended to be on the high side of the scale, prompting some analysts to suggest that it is unsubstantiated. Seeking to clarify the basis of our outlook, we have broken down the main drivers that influence demand growth. This segmentation provides some insights on how oil demand in the OECD has evolved and sets the basis for our prognosis. It is useful to consider the regions, before looking at aggregate figures. All charts below refer to year-on-year demand growth, in mb/d.

In North America, despite strong transportation demand, total oil demand fell in 2006 because of 1) strong interfuel substitution (IFS) away from oil in power generation (arguably because of both competitive natural gas prices and recovery from the devastating hurricanes of late 2005) and 2) mild weather, which reduced heating needs. In 2007, actual data suggest that some of the IFS will be reversed, but continued mild weather early in the year will further weigh down on heating needs; as such, growth will exclusively be driven by transportation. For 2008, this report makes two key assumptions: first, that the combination of a moderate economic slowdown and high retail prices will significantly curb transportation growth; second, that the forthcoming winter will be normal, thus bringing back some of the lost demand for heating fuels. Overall, demand is expected to increase by about 220 kb/d in 2008 (+0.9% on a yearly basis).



In Europe, IFS away from oil in power generation and limited heating needs because of mild weather kept demand flat in 2006. In 2007, preliminary data indicate that IFS will continue, reflecting the structural penetration of natural gas. The mild weather effect will also prevail (evidenced by German consumers' reluctance to fill their heating oil tanks, although this is also arguably related to price expectations). In 2008, this report assumes normal weather and hence a rebound in heating needs. Crucially, transportation demand is kept essentially unchanged to account for price effects and some economic slowdown in the largest European countries. This forecast may be overstating the weather rebound, but it should be noted that it may also be understating transportation requirements. Overall, demand is seen increasing by roughly 210 kb/d in 2008 (+1.4%).



Finally, in the Pacific, two-thirds of the sharp fall in 2006 demand were entirely due to mild weather conditions, which depressed heating fuels use, while the rest was due to IFS away from oil in power generation. Both factors will continue to weigh down on 2007 demand, according to preliminary submissions, although the nuclear outages that have crippled Japan's utilities over the year (particularly in the third quarter) have led to partial reversal of IFS in favour of oil products (mostly residual and direct crude) for power generation on the back of very strong electricity demand. In 2008, IFS back into oil is expected to accelerate significantly, since most of the nuclear plants that have been idled will remain offline at least until the third quarter. In addition, as with the rest of the OECD, this report assumes that winter temperatures will be normal, bringing back heating demand. As for transportation growth, it is seen to remain marginal, as Japan's structural decline will largely offset growth elsewhere. Overall, demand should rise by some 180 kb/d in 2008 (+2.2%).



In sum, the fall in OECD demand in both 2006 and 2007 is primarily due to mild weather conditions, and IFS, despite strong demand for transportation fuels. The first factor curbed demand for heating fuels, while the second reduced the use of oil products in power generation. In 2008, roughly two-thirds (67%) of the OECD's 610-kb/d expected demand increase will be related to normal weather conditions, while 20% will be due to transportation needs (a very conservative assumption) and 13% will be traced to IFS in favour of oil.



North America

Inland deliveries in the continental United States - a proxy of oil product demand - fell by 1.0% year-on-year in September, according to adjusted preliminary data.  More significantly, this trend appeared to be more pronounced in October (-2.7%), according to weekly data (prone to revisions, though, as monthly figures are released).  In both months, deliveries of naphtha, gasoline, distillates (diesel and other gasoil), residual fuel oil and 'other products' were weaker than previously expected.  Overall, this has led to a 300 kb/d downward revision in the 4Q07 forecast.



This weakness is arguably related to both economic conditions and the effects of high oil prices.  Tellingly, gasoline growth slowed down sharply in September (to +0.1% year-on-year), despite relatively warm weather (the number of cooling-degree days in that month was 25 higher than the 10-year average), before contracting in October (-0.5%) for the first time since late 2005.  If confirmed by monthly data, this may suggest that US motorists are finally starting to adjust their behaviour to perceived worsening conditions - given the continued uncertainties regarding the economic outlook and the sharp rise in oil prices.

The questions regarding the health of the US economy have indeed become pressing, not the least because of contradictory data.  On the one hand, over the past few weeks several major banks have announced massive losses as a result of subprime turmoil, leading to renewed stock exchange volatility, a further slide of the dollar vis-à-vis other currencies and concerns about the soundness of the country's financial system.  On the other hand, preliminary data indicate that nominal GDP rose by almost 4% on a yearly basis in 3Q07.  Nevertheless, US policy makers continue to believe that the risks to economic growth far outweigh inflationary risks (some observers attribute the strong GDP growth in the second and third quarters to a temporary rise in military spending).  Thus, the Federal Reserve slashed its federal funds rate by 25 basis points in late October - following September's 50-basis-points cut.

Most recent economic data - stalling permits and housing starts, falling home prices, the levelling out of new durable goods orders, the pick-up in business inventories, lower consumer confidence and poor third-quarter corporate earnings, to name only a few - seem to confirm that economic activity is indeed slowing down.  In other words, both consumer spending and private investment could be already contracting.  More worryingly, however, inflationary pressures may be building up, fuelled by rising oil prices and the falling dollar (although the latter is supporting the rise in US exports).  Eventually, the retail prices of transportation fuels - which currently lag behind crude prices - will also rise.

Will the US economic woes herald a sharp contraction in oil demand?  Much will depend on whether the country escapes recession and whether oil prices remain at their current levels in the medium term.  The housing slowdown will probably induce a marked demand decline in related energy-intensive industries (lumber, construction and shipping).  Meanwhile, the resilience of household demand - epitomised by gasoline - will arguably be related to the weight of fuel expenses relative to average household spending, which is probably approaching levels last seen in the early 1980s (according to the latest Consumer Expenditure Survey from the US Bureau of Labor Statistics (BLS), this share averaged about 4.5% in 2005).  However, the country's suburban sprawl and the relatively limited availability of public transportation outside big cities will probably limit the reduction of non-discretionary driving.  On the basis of these considerations, US50 total oil product demand is expected to reach 20.8 mb/d in 2007 (+0.4% over 2006), and 20.9 mb/d in 2008 (+0.8% versus 2007).





Preliminary data for September suggest that the stalling trend in Mexican oil demand observed in August continued:  deliveries fell by 1.8% year-on-year.  This weakness was partly due to lower fuel oil demand (-11.4%), as well to a marked slowdown in the pace of gasoline and diesel growth.  Indeed, gasoline deliveries expanded by only 1.7% on a yearly basis (compared with an average of about 6% over the past two years), while diesel deliveries grew by a paltry 0.3%.  This may indicate that Mexico's manufacturing industry, which is highly dependent on the health of the US economy, could be slowing down.  Nevertheless, such conclusion may be premature, since other sectors, such the airline industry, are showing greater resilience:  jet fuel/kerosene demand rose by 10.6% in September.

Europe

Continued weakness in heating oil deliveries in main consuming countries, slightly lower GDP assumptions and persistent high fuel prices led again to a downward adjustment to our assessment of oil consumption in OECD Europe.  Demand in 3Q07 is now seen at 15.5 mb/d for the region as a whole, a contraction of 0.8% from the same quarter last year and 76 kb/d lower than in last month's report.  As a result, total demand is expected to average 15.4 mb/d in 2007 (-1.6% versus 2006), but it should rebound to 15.6 mb/d in 2008 (+1.4%).

In September, total oil product demand in OECD Europe reached 15.7 mb/d, an increase of 2.3% (+423 kb/d) from August, but 1.9%, or 300 kb/d, lower than in the same month last year.  Preliminary data for main consuming countries came in weaker than expected again, leading to a downward adjustment from our previous forecast of close to 300 kb/d for the month.  Deliveries in France, Germany and Switzerland were surprisingly low.  The main weakness continued to be concentrated in heating oil, which for Europe as a whole has been cut by 288 kb/d for the month.





Our demand assessment for August remains largely unchanged following the submission of official monthly data.  Lower estimates for Italy and the UK were offset by upward revisions in France, Germany and Spain.  Revisions to Turkey in 2006 raised the baseline by 52 kb/d, limiting to an extent the downwards revisions to demand overall.  The inclusion of the latest IMF world economic outlook did not significantly change our demand forecast for OECD Europe, as most of the changes had already been pre-empted with the inclusion of the median forecasts from Consensus Economics last month.  There were only minor downward revisions to the prognosis in a few countries.

Demand for transportation fuels, including gasoline, diesel and jet kerosene, has been surprisingly robust given high prices, although consumers are becoming increasingly concerned as prices continue to rise.  Although the weak dollar has partly shielded European consumers from the effects of the sharp rise in international oil prices, end-user prices for transport diesel reached record highs in October (in Euro terms) in both France and Germany.  As a result, there have been some end-user protests.  In France, fishermen went on strike in early November to protest against the rising cost of diesel and called for government subsidies.  Similarly, taxi drivers, farmers, road transport firms and private ambulance companies have also requested lower fuel taxes or direct government handouts.  Nevertheless, transportation fuels demand continues to show some annual growth.  In 2007, transportation fuels demand is expected to be 1.8% higher than in 2006, with growth in all main consuming countries bar the UK (France:  +0.5%; Germany:  +1.5%; Spain:  +3.5%; Italy:  +0.3%; Turkey:  +6.8%; Ireland:  +6.7%; and the UK:  -0.4%).

As has been previously noted, the weakness of European demand in 2007 is concentrated in heating oil (-12.3% year-on-year), and to a lesser extent in residual fuel oil (-4.6%), which is structurally declining across most of the continent.  Heating oil demand continues to lag levels of a year ago and is poised to be some 12% lower in 2007, compared with last year (Germany:  -31.2%; France:  -9.3%:  Italy:  -13.4%; and Switzerland:  -26.6%).  As discussed extensively in previous reports, this is mostly due to a tax increase from January 2007 in Germany, which induced higher-than-normal stock building in 2006, and to an exceptionally warm 2006/2007 winter, which depressed demand and has resulted in lower stock filling during all of this year.



Although German consumer stocks had already fallen below levels of a year ago by the end of August, September's filling rate was also lower than normal, most likely as a result of high prices.  End-users added only 2% of capacity to tanks in September (a monthly increase of 134 kb/d), thus reaching 60% of capacity (compared with 65% last year).  This is 140 kb/d lower than the five-year average filling rate and the lowest addition to storage for September since 1995.  As a result, stocks are now at 121 mb, or 10 mb less than in the same month last year.  Looking ahead to October and November (the start of the heating season), demand for heating oil will have to pick up as consumers have less opportunity to draw down inventories (assuming, of course, normal weather conditions).  Consumers normally draw stocks from November until March, before starting to fill their tanks again in April.  This pattern, however, is becoming increasingly sensitive to actual prices - and price expectations - and is thus becoming less predictable than in previous years.  In France, the government recently doubled the prime de la cuve (financial aid for heating oil purchases for low-income families).  The measure is expected to cost Euro 70 million (Euro 150 per household) and limit some of the demand impact of high prices.

Residual fuel oil demand, meanwhile, has also been revised down in 3Q07, notably in Italy, which until this year was Europe's largest fuel oil consumer (surpassed by the Netherlands in 2007 due to bunker demand).  Final Italian data for August point to a lower power demand than previously expected, leading to an adjustment of -109 kb/d for that month (fuel oil demand declined by 11.9% on a yearly basis).  Regarding September, inland delivery data for fuel oil were very weak, but given that these data are prone to revisions we have followed the submitted JODI demand data which showed a small increase year-on-year.  Nevertheless, the 2008 residual fuel oil forecast has been lowered by an average 30 kb/d to reflect ongoing fuel oil substitution in power generation.  Italian fuel oil demand is now seen contracting by 8.9% in 2008, compared with an 11.7% decline in 2007.



Pacific

Preliminary data show that oil product demand in the Pacific jumped by 7.3% on a year-on-year basis in September.  Deliveries for all product categories bar LPG were higher than in the previous year.  Interestingly, the rebound was particularly strong in Japan, which accounts for almost two-thirds of the region's total oil product demand.  Japan's underlying consumption was strong, boosted by power demand amid nuclear shortages and very high temperatures - there 60 cooling-degree days less in September compared with the 10-year average, similar to August (+59) but much more than July (-109) and to a lesser extent June (+22).  In addition, there was probably a consumer-level inventory rebuild following the summer's relatively poor weather conditions, which had depressed demand.

Given these new data, the 2007 and 2008 forecasts for the region have been slightly revised.  OECD Pacific demand is seen somewhat stronger, averaging 8.4 mb/d in 2007 (-0.6% on a yearly basis).  It is expected to rebound in 2008 (but slightly less than previously anticipated) to 8.5 mb/d (+2.2%), on the assumption that normal winter temperatures will bring back some of the demand for heating fuels (kerosene, heating gasoil, fuel oil and direct crude) that was lost in the previous winter.



According to preliminary data, oil product demand in Japan rose by an unprecedented 13.3% year-on-year in September.  The jump was very much related to the high temperatures that prevailed in late August and during much of September, which sharply boosted electricity demand.  Since several large nuclear plants have been idled for most of this year - including the world's largest, Tepco's Kashiwazaki-Kariwa plant, damaged by an earthquake in July - many utilities were forced to turn to thermal power.  It should be noted that prior to the series of operational problems (expected to last at least until mid-2008), nuclear power represented almost 30% of the country's electricity generation.  As such, demand for naphtha, fuel oil and direct crude rose sharply in September (+5.9%, +25.4% and +68.0%, respectively).  In addition, transportation fuels also surged, as motorists took the roads to take advantage of warm weather; gasoline, in particular, rose by 7.7% on an annual basis, while diesel increased by a respectable 3.9%.

Although we had anticipated greater demand for power-generation fuels since the outage of Kashiwazaki-Kariwa, the heat wave of August and September exceeded all expectations.  Indeed, the surge in electricity demand for air conditioning was so dramatic that the largest utility (Tepco, which accounts for roughly 25% of Japan's generating capacity) had to reduce supplies to its largest industrial customers in order to avert a massive blackout in the Tokyo metropolitan area.  In order to meet electricity needs, in September the company was obliged to boost its consumption of fuel oil by 140%, of direct crude (included in 'other products') by 212% and of naphtha (rarely used, but currently much cheaper than LPG) by 2,787%.  In addition, Tepco's demand for LNG and coal also increased significantly (14% and 20%, respectively).



In Korea, preliminary data indicate that total oil product demand contracted by 3.9% year-on-year in September.  The fall was related to feeble diesel and fuel oil deliveries (-5.9% and -19.3%, respectively).  Diesel's weakness (the second month in a row) continued to be arguably related to stock draws - deliveries had jumped by 33% in July, in anticipation of the 7.5% diesel tax hike.  Nevertheless, demand for other transportation fuels remained strong, with gasoline jumping by 7.6% and jet fuel/kerosene by 17.3%.



Meanwhile, the relatively subdued demand for fuel oil is partly due to LNG substitution for power generation, as gas is currently cheaper than residual in Asian markets.  (The resumption of deliveries to North Korea following the nuclear weapons agreement has contributed to tighten the fuel oil market).  However, there are reports that a major utility - Korea Electric East-West Power Corporation (KEWPCO) - is buying fuel oil cargos in anticipation of winter demand.  Finally, growth in naphtha deliveries - the largest component of total Korean demand - slowed down slightly to +3.2%.

As in other oil importing countries, the rise in international prices has become a contentious political issue (South Korea is the world's fifth largest crude oil importer).  Opposition lawmakers have reportedly lobbied the government to lower domestic sales taxes on oil products, while President Roh Moo-hyun has ordered to review the living standards of low-income earners and eventually to draw up measures to help them.  The Finance Ministry, however, opposes any changes to the tax regime.  Korea's tax system is structured in such a way that the effect of international oil price rises on local retail prices is delayed, thus providing a temporary buffer - but if the import price continues to rise, local retail prices may eventually spike and hence moderate oil demand growth.

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 2.7% year-on-year in September.  Although all product categories bar residual fuel oil registered gains, the relatively modest increase in total demand was mostly related to the drawdown of domestic product stocks and the relative 'weakness' of gasoline demand (which grew by 'only' +4.9% year-on-year) and to the continued fall in fuel oil demand for the second month in a row (-27.7% on a yearly basis).



The softening of gasoline demand is seasonal, as it follows the end of the summer holiday season.  By contrast, the tumbling residual fuel oil consumption, as noted in previous reports, is very much due to high oil prices.  Indeed, the price of fuel oil, both domestic and imported, has risen so much that the output of 'teapot' refineries - which generally use fuel oil as a feedstock - has seemingly virtually dried up.  In September, net fuel oil imports plummeted by almost 30% to some 230 kb/d (compared with August, when imports had in turn dropped by some 50% vis-à-vis July).

Unsurprisingly, this situation is very much related to capped domestic retail prices.  According to some estimates, when international crude oil prices rise above some $65/bbl, Chinese refiners find it financially unattractive to manufacture oil products for the domestic market.  During previous oil price surges (as in 2006), output from teapots - which are the de facto swing producers in China - tends to contract significantly, only recovering either when international oil prices recede or in case of strong, seasonal domestic demand for specific products such as off-spec. diesel or asphalt.  Meanwhile, state-owned companies resist supplying the domestic market until product shortages prompt the government to force them to boost output regardless of financial considerations.  The NOCs have been previously compensated for their losses with generous government handouts (partly funded by the windfall tax on crude introduced in March 2006).

But this time, as oil prices surpassed $90/bbl, the supply crunch spread beyond the south-eastern coast (past shortages had been largely limited to Guangdong province).  During October, inland service stations across the country - and crucially, even in the capital, Beijing - were forced to ration diesel (and in some, 90 and 93 RON gasoline as well).  Although state-owned Sinopec and PetroChina vowed to increase supplies (either through higher imports or increased output), local traders suggested that the NOCs were quietly resisting the government's pressure to meet domestic demand.  Seeking to find a compromise, on 31 October the government announced a 9% surprise increase in gasoline, diesel oil and jet fuel/kerosene 'guidance' (wholesale) prices from 1 November.

Our forecast of total Chinese oil product demand has been adjusted down slightly as a result of the fuel oil-driven revisions to 3Q07 estimates.  Demand is seen reaching 7.5 mb/d in 2007 (+5.4% year-on-year) and 8.0 mb/d in 2008 (+5.6%).  This forecast assumes that the recent rise in transportation fuel prices will have a negligible effect on consumption.



A Careful Balancing Act

The Chinese government, torn between the imperative of curbing inflationary pressures and the need to assuage both the refiners' financial predicament and consumers' squeeze, tried to square the circle by unexpectedly increasing transportation fuel prices in late October.

However, at Rmb 500/tonne (about $9.40/bbl), the wholesale increase of roughly 9% - the first since May 2006 - is probably too limited to significantly improve refining margins under current crude market conditions (oil prices have surged by almost 35% over the past year). Nevertheless, the rise will provide the government with more political leverage vis-à-vis the state-owned companies, which will find it difficult to continue resisting calls to supply the domestic market (imports will probably rise first, as refinery runs cannot be immediately increased). In addition, the government is probably hoping that the rise will also tempt some teapot refineries to resume production and hence contribute to stabilise the market.

On the demand side, the rise in retail prices (capped at 8% above wholesale prices) is likely to be easily absorbed by consumers, mostly because China's underlying economic growth remains strong. Manufacturing companies - which account for the bulk of diesel demand - are prospering on the back of booming exports will arguably maintain their consumption levels. As for private Chinese drivers (who sustain gasoline demand), most belong to the flourishing middle-classes, which have seen their purchasing power steadily expand.

Moreover, at about $0.70/litre, gasoline and diesel prices remain well below international levels. In addition, the government will reportedly provide direct subsidies to the worst-hit end-users, ranging from fishermen and farmers to urban taxi drivers. Nevertheless, the price hike may have some inflationary impact, but at this point this is difficult to evaluate - however, the NDRC has reportedly ordered local governments to prevent price increases in most goods and services. But it can be argued that the move could create expectations that future price adjustments are likely, especially if international oil prices continue to rise - if so, oil product hoarding and hence shortages could well continue over the next few months.

Other Non-OECD

In September, preliminary data indicate that oil product sales in India - a proxy of demand - increased by 2.2% on a yearly basis.  Growth remained strong across all product categories, with the exception of fuel oil (-3.0% year-on-year) and 'other products' (-11.3%, although preliminary figures for this category have tended to be revised upwards over the past few months).  It is worth noting that demand for transportation fuels continues unabated, with gasoline, gasoil and jet fuel/kerosene sales rising by 8.0%, 2.8% and 2.7%, respectively.  Our forecast of India's oil demand thus remains largely unchanged.  Total consumption is expected to rise by 4.5% in 2007 to almost 2.8 mb/d, and slow down slightly to +2.3% in 2008 as natural gas continues to displace naphtha.



In early October, the government announced the beginning of country-wide mandated sales of 5% ethanol-blended gasoline (E5).  The ethanol content is set to be raised to 10% by October 2008 (refiners, though, can already sell E10 if they wish to).  Although E5 was introduced in India in 2004, it was only sold in the nine sugar-producing states and three union territories; elsewhere, the adoption of E5 was delayed by infrastructure bottlenecks and, more importantly, by pricing issues, as refiners and sugar producers failed to agree on the blendstock's price.  To overcome the latter obstacle, the government established a uniform ex-refinery ethanol price of Rupee 21.50/litre (about 54 cents), which will be valid over the next three years.  As for infrastructure, some observers argue that it will be quickly built, since the industry was waiting for the government to mandate blending before proceeding.  On the basis of 5% blending, India's ethanol demand is estimated at some 550 million litres/year.



According to preliminary data, oil product demand in Thailand grew by 2.3% year-on-year in August.  Although total consumption has seemingly trended well below last year's levels, the cause is to be found in much lower residual fuel oil demand.  Indeed, all other product categories have registered relatively strong growth, particularly LPG (+9.6% year-on-year per month on average since the beginning of the year, on the back of high subsidies) and jet fuel/kerosene (+10.2% on average, as Bangkok's airport consolidates its position as a major Asian hub).  Even gasoline and gasoil, which had tumbled following the abrupt retail price increases of two years ago (when subsidies for both products were removed), have posted average monthly growth rates of +2.8% and +1.7% since early 2007, despite continuously rising prices.

Meanwhile, the fall in residual fuel oil demand is related to the rapid penetration of natural gas in power generation.  The Electricity Generating Authority has been behind this interfuel substitution, given that gas is both cheaper and cleaner.  Thailand has thus joined a number of Asian countries, such as Japan, China or India, that have actively encouraged the use of natural gas for environmental and financial reasons.



FSU apparent demand - defined as domestic crude production minus net exports of crude and oil products - has been revised downwards by about 50 kb/d in both 2007 and 2008.  The changes were related to adjustments of both supply and trade estimates for 3Q07 and 4Q07.  Overall, FSU total oil product demand is expected to average 3.9 mb/d in 2007 (-4.3% year-on-year) and 4.1 mb/d in 2008 (+3.6%).

As noted in previous reports, the contraction of apparent oil demand in 2007 is largely due to the volatility of regional trade data - although it could also be related to efficiency gains in industry and the power sector.  We are still prospecting for alternative data sources that would allow a better estimate of apparent demand.  Intuitively, the region's demand should be more in line with strong economic growth, particularly in Russia, where fuel oil demand is reportedly growing rapidly as the country attempts to free more natural gas for exporting.

Coping With Rising International Oil Prices

As in China, rising international oil prices are creating a dilemma for the Indian government, namely whether to maintain administered end-user prices or cave in to the increasingly loud complains of loss-making refiners, both public and private. According to recent estimates, state-owned marketing companies - Indian Oil, Hindustan Petroleum, Bharat Petroleum and IBP - could lose around Rupee 550 billion ($13.8 billion) in the current fiscal year (ending March 2008) as a result of the gap between international and domestic oil prices (India imports some three-quarters of its crude requirements).

India's state-owned companies, though, are partially compensated through the issuance of government oil bonds worth some $6 billion, which cover about two-fifths of the losses. This is not the case for the private sector. As a result, the three largest operators - Shell India, Reliance Industries and Essar Oil - have become increasingly disgruntled. The companies argue that, by discriminating in favour of the NOCs, the policy of capping the retail price of gasoline, diesel, kerosene and cooking gas contradicts the stated goals of fostering competition and economic efficiency. The current policy, instituted in 2005 with the aim of curbing inflation, reversed the market liberalisation that had gradually been implemented over the previous decade.

More worryingly, the three majors have warned that the private retail network is close to collapsing. On the one hand, they themselves have either closed retail outlets or frozen their expansion plans. On the other, they note that some 2,000 dealers, which collectively invested some Rupee 50 billion ($1.3 billion) when the market was liberalised, risk losing their investment since they are unable to profitably compete against the NOCs. The market share of private retailers has fallen from 15% in early 2006 to about 4% today. It remains to be seen, however, whether the Indian government will adjust retail prices. Furthermore, the political window of opportunity is limited, with looming elections in key states in December and nation-wide parliamentary elections in 2009.

But neither China nor India are the only countries facing the subsidy versus market conundrum. Across the developing world, the prevalence of capped retail prices well below international levels is leading to similar problems, as illustrated by the following examples: fuel shortages (Argentina, Bolivia), fiscal imbalances (Malaysia, Chinese Taipei, Indonesia), falling downstream profitability (Vietnam, Maldives) or a combination thereof. By contrast, countries that decided to totally or partially remove fuel subsidies over the past few years saw oil demand fall sharply (such as Thailand in 2005/2006). Yet the sudden adjustment or even total removal of subsidies may lead to a consumer backlash (as in Iran and Burma), in addition to unwelcome inflationary pressures.

Nevertheless, as international oil prices continue to rise, the governments of several other Asian countries - Indonesia, Malaysia and Chinese Taipei - are also quietly debating whether to adjust their administered regimes to let retail prices rise and reduce their fiscal burden (for example, by limiting sales of subsidised fuel to private cars, as it has been recently suggested in Indonesia).

In the end, should current high oil prices last, most developing countries would likely be affected and economic growth would probably recede. Arguably, only the biggest oil producing countries are in a position to absorb the huge cost of maintaining subsidies thanks to mounting oil export revenues. According to the IMF, oil and gas producers in the Middle East and Central Asia, where oil products are heavily subsidised, are expected to earn a combined $750 billion in 2007, roughly four times as much as early in the decade.

Supply

Summary

  • World oil supply gained 1.4 mb/d in October versus September, as non-OPEC outages receded and OPEC began to raise output. OPEC crude supply increased by 410 kb/d, half of which derived from Angola and Iraq.  Non-OPEC gains centred on an assumed rebound from China and Azerbaijan after September outages, and an observed rise of 65 kb/d from Russia.  Continued outages in the OECD see non-OPEC supply levelling off in November before renewed growth in December.
  • The non-OPEC production forecast is trimmed by 35 kb/d for 2007 to 50.1 mb/d, but is largely unchanged at 51.2 mb/d for 2008. Growth should recover after a mid-year lull, with 2Q and 3Q07 totals revised down by 55 kb/d and 85 kb/d respectively, following the receipt of more comprehensive data from North America (2Q) and the FSU, China and Latin America (3Q).  The FSU, China, North America and biofuels drive non-OPEC growth in 2007, with the FSU, Brazil, Australasia and biofuels key for 2008.
  • High oil prices remain a mixed blessing as regards the short-term upstream operating environment.  Partly, they reflect real barriers to investment, with project delays due to infrastructure bottlenecks and a tendency for host governments to revise upstream operating terms.  For the longer term, exploration activity shows signs of recovery, and significant new discoveries are beginning to materialise, although it is too early to say to what extent these will offset declines in baseload supply.
  • October OPEC crude supply increased by 410 kb/d to 31.2 mb/d, with half of the rise from Angola and Iraq.  Both these producers should also see higher supplies in November.  OPEC-10 production averaged 27.15 mb/d, a gain of 195 kb/d for the month.  Signs of higher November supply from Saudi Arabia, Nigeria and others may be counteracted by UAE offshore field maintenance. OPEC effective spare capacity slipped to 2.46 mb/d.
  • The midpoint 'call on OPEC crude and stock change' is revised down by 0.2 mb/d for 2007 and by 0.4 mb/d for 2008.  The call averages close to 32.0 mb/d for 4Q07, while the trend for 2008 shows an annual gain of up to 0.5 mb/d, and an average call for the year centred on 31.2 mb/d.  Weaker prognoses for late year OECD and FSU demand underpin this month's revisions to the call.


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

OPEC crude supply increased by 410 kb/d in October and averaged 31.2 mb/d for the month.  Half of the rise came from Angola and Iraq, amid new field start-ups and resurgent northern pipeline exports respectively.  Both of these producers should also see higher supplies in November, potentially rising by a combined 150 kb/d.  Saudi Arabian supply estimates are revised up for September, and the Kingdom is thought to have boosted supply by another 100 kb/d in October, to nearly 8.9 mb/d. Venezuela, Kuwait, Qatar, Nigeria, Algeria and Libya each nudged supply higher in October, giving a collective increment of 95 kb/d.  4Q OPEC NGL supply should also increase based on new supplies from Qatar and Saudi Arabia.

OPEC-10 production averaged 27.15 mb/d, a gain of 195 kb/d versus September, ahead of the agreed 1 November increase of 500 kb/d.  Signs of higher November supply from Saudi Arabia, Nigeria and others may be counteracted by UAE offshore field maintenance, with preliminary tanker tracking data suggesting only modest aggregate increases in supply in the early part of November.  Unexceptional VLCC rates and other early sailings indicators argue against supplies rising by the full 500 kb/d pledged for November.  OPEC effective spare capacity slipped to 2.46 mb/d in October.



Ecuador has now formally applied to rejoin OPEC and the country's re-entry will be decided upon during the OPEC Heads of State Summit in Riyadh on 17-18 November.  Ecuador's Oil Minister has said it will press for a quota of 530 kb/d, above current production levels, which are closer to 500 kb/d.  If readmitted, Ecuador will come in below Indonesia and Qatar the organisation's smallest producer.  Ecuador's previous membership of OPEC was suspended in late 1992.

Representatives of China, the US, EU and IEA all recently expressed concerns over the economic dangers of rising crude prices and a need for more crude to replenish winter stockpiles.  Nonetheless, OPEC's public line remains that recent price increases have been driven by geopolitical concerns and speculative activity.  OPEC's Secretary General in early November called for tighter regulation in oil markets to reduce speculative investment.  Although Oil Ministers will participate in the Riyadh Summit in November, public pronouncements suggest a formal review of production may have to wait until the next Ministerial meeting in Abu Dhabi on 5 December.  Ecuador's oil minister suggested OPEC should target prices that will safeguard oil's market position, blunting expectations of Ecuador taking a more hawkish line on re-entry.

Back in the Black

October was the first month since August 2006 when collective OPEC-12 production exceeded levels of a year ago. While superficially suggesting a policy shift of sorts, in reality core OPEC producers remain reluctant to produce at volumes that would arrest the recent slide in OECD inventory cover towards five-year averages. The dual risks of rising supplies from elsewhere and another milder-than-normal northern hemisphere winter may still be deterring sustained increases from producers. Physical capacity limits may also increasingly be a constraint. October's supply rebound was largely driven by rising output from Angola and Iraq - exempt from voluntary production restraint measures ? rather than by concerted increases across the OPEC-10. These two, plus a potentially temporary recovery in Nigerian volumes also look likely to be key drivers of OPEC increases in November.



Whether more comfortable industry stock cover re-emerges by winter's end depends on two key factors. Seasonal demand will of course be crucial. From a supply perspective, output from Indonesia and Venezuela on the one hand, and Nigeria on the other, is still struggling in the face of an unattractive investment environment and rebel attacks respectively. Angolan supply may level off after breaching 2 mb/d and a continuation of Iraq's nascent recovery cannot be taken for granted. The other piece of the winter supply puzzle becomes the realisation of core Middle East Gulf countries' short-term capacity expansion plans, and their management of that capacity in determining appropriate supply levels.

Angolan October crude output is estimated up by some 100 kb/d, at 1.73 mb/d, with a further 100 kb/d of gas liquids giving total supply of 1.84 mb/d.  The newly started Greater Plutonia field was reportedly producing 100 kb/d at the end of October and should attain 200 kb/d in the first half of 2008.  ExxonMobil also announced start-up at the Marimba field in offshore Block 15.  However, we see this project largely sustaining capacity at the existing 250 kb/d Kizomba A project, rather than adding significant extra barrels.  December is likely to see initial production from the Mondo field, part of the Kizomba C project, which should ultimately produce 200 kb/d in late 2008.  Angolan capacity could hit 2.15 mb/d by that time.  Last month state producer Sonangol was reported as claiming that Angola would seek an OPEC production target of 2.5 mb/d when it joins the quota system, likely to occur some time in 2008.

UAE crude supply is thought to have stabilised at 2.55 mb/d, initially recovering from an earlier leak at a gas compression unit, but late October then saw offshore production rates slow as maintenance began.  Maintenance work at the Upper and Lower Zakum and Umm Shaif oilfields will curb UAE November production by 600 kb/d, raising questions over OPEC-10 plans to enact in full their 500 kb/d increase scheduled from 1 November, at least on a wellhead production basis.  However, rising UAE output ahead of November may mean the impact on November sales can cushioned by volumes out of storage.

Nigerian September supply levels are revised up to 2.18 mb/d on the basis of higher tanker sailings data.  October supply is held largely unchanged, despite reports of higher Forcados output (with Shell lifting force majeure on Forcados exports in early October).  Attacks on the Mystras FPSO shuttered 50 kb/d of production at the offshore Okono-Okpoho field and workers were also kidnapped from the shuttered EA field, likely delaying until later in 2008 the 115 kb/d facility's reactivation.  Over 0.5 mb/d of Nigerian production remains shut-in due to attacks on production facilities and pipelines, with signs that MEND rebels may again be stepping up attacks on oil installations, ending the new government's grace period.

Our estimate of Saudi Arabian supply in September is revised up by 100 kb/d to 8.75 mb/d, on higher exports. The upward trend continued in October, with supply rising to 8.85 mb/d.  While exports likely rose by more than 100 kb/d (early indications suggest spot tanker sailings were up by 250 kb/d), a partial offset came from the start of maintenance at the Rabigh refinery, which continues into November.  Saudi Arabia's November target was reported around 8.94 mb/d, but supplies may rise above that level if an attempt is made to offset reduced supplies from UAE and elsewhere.  Aramco announced that Asian term customers will receive full volumes for November and December lifting, compared with 10% cuts in place in October.  Broader regional tanker movements also suggest higher November supplies.  Moreover, prices to US and Asian destinations have been cut for December, again indicative of rising availability.

Will Iraqi Northern Exports Stabilise at Higher Levels?

Iraqi October oil supply reached 2.3 mb/d, its highest level since April 2004. We have long identified securing offtake as a key short-term driver of Iraqi production levels. Sharply higher production from northern fields was facilitated in part by sustained refinery crude use (total Iraqi domestic crude use is estimated close to September's 0.5 mb/d, despite renewed attacks on the crude line feeding the Baiji refinery). More importantly, crude exports from storage at Ceyhan in Turkey averaged 258 kb/d, to which can be added some 12 kb/d of cross-border flows to Syria. Pipeline flows north from fields around Kirkuk to Ceyhan (which this report excludes from monthly supply until lifted by tanker or piped to Turkish refiner Tupras) were even higher, at an estimated 395 kb/d, a post-war record. This was despite the threat of attacks on the pipeline from PKK insurgents. Southern exports from Basrah and Khor al-Amaya remained close to 1.5 mb/d.



There is official confidence that security on the northern export pipeline has improved to the extent that SOMO hopes to award 300 kb/d worth of term export deals for a three-month period around mid-November. Since September, state marketer SOMO has been able to award tenders worth 26 mb of crude, with an estimated 4.7 mb lifted in September and 8.0 mb in October. ExxonMobil and Cepsa have been regular lifters over the past two months, and further unreported volumes may also have accrued to Turkish refiner Tupras. The impending award of a further 6 mb tender would take potential Ceyhan exports for November to a recently unprecedented 19 mb, or 630 kb/d. In reality, substantial volumes will likely slip into December, for logistical and tanker availability reasons.



Non-OPEC Overview

This month sees a modest downward adjustment to non-OPEC output for 2007, but a largely unchanged forecast for 2008.  Adjustments this year focus on August and September production, with lower output from the USA (August), Canada and Brazil (September onwards), China (September), and Russia (September).  However, preliminary October indicators show a rebound in supply from all these producers and, combined with upgrades to forecast supply from Australasia, Russia and Mexico, the 2008 total comes in at 51.2 mb/d, 1.1 mb/d above the expected 2007 total.  Oil growth next year will be heavily centred on the FSU, Australasia and Brazil.  Within a declining North American total, deepwater Gulf of Mexico and Albertan oil sands provide bright spots among otherwise declining baseload supplies.  And global biofuels (including Brazil and the US) generate 33% of next year's non-OPEC supply growth, adding 355 kb/d to reach 1.5 mb/d of output.  Mexico and the North Sea continue to show sharp declines overall, despite some new field offsets.  OPEC NGL growth looks like enjoying a 2008/2009 spike.



Forecast uncertainties remain manifold.  The sheer proliferation of projects approaching completion suggests sharp increases in non-OPEC supply, but brings forth its own problems.  With capacity expansions being weighted towards offshore projects, tightness in the availability of service crews and equipment for subsea installation may be taking over from drilling capacity shortages as a key source of project delays.  Recent outages for existing production infrastructure in Canada, Alaska, Mexico, the North Sea and Brazil highlight the value of our field reliability adjustments in minimising subsequent forecast adjustments. For the longer term, fiscal changes being discussed now by host governments will help dictate the pace of new project developments for the next decade.  And we should not overlook an apparent and overdue uptick in international exploration activity which can, on occasion, yield dramatic results.

OECD

North America

US - October Alaska actual, others estimated:  Overall, US oil production for 2007 and 2008 remains close to last month's forecast at 7.44 mb/d and 7.41 mb/d respectively (with crude at 5.1 mb/d this year and 5.0 mb/d next).  Latest available aggregate data reduce August and September supplies by 130 kb/d and 25 kb/d respectively, but the absence of hurricane-related outages in the GOM in October boosts last month's total by 340 kb/d.  The US production forecast includes a five-year rolling average hurricane adjustment for 3Q and 4Q (focused on September/October) based on actual production outages.  The inclusion in our current adjustment of the atypically disrupted years 2004 and 2005 leaves November/December supply projections prone to upward adjustment of 150 kb/d on average if weather conditions prove benign this month (the Atlantic hurricane season traditionally closes at the end of November).

October saw some new GOM production facilities enter service ahead of our earlier expectations, namely Atlantis (capacity 200 kb/d likely in 2008) and Genghis Khan (20 kb/d). However, there were counteracting reports of delayed start-up for the Neptune and Tahiti fields, with our original estimate of a 2008 start at Neptune, rather than 2007, being borne out.



October Alaskan production again suffered unplanned outages, with Prudhoe Bay crude averaging below 300 kb/d after operations were disrupted by a fire.  However, supply had recovered by early November.  Recent performance from the West Sak and Alpine fields lies below our earlier assumptions, leading to a 15 kb/d downward adjustment to the Alaskan crude forecast, to 730 kb/d for 2007 and 715 kb/d for 2008.  Alaskan lawmakers are reviewing alternative proposals to either raise the state's net profits tax from 22.5% to 25%, or to leave the base rate unchanged but impose a windfall tax at high oil price levels.

Canada - Newfoundland September actual, others August actual:  After a gain of some 165 kb/d expected for 2007, Canadian oil production is expected to level off around 3.35 mb/d in 2008 (with conventional crude oil supply contributing 1.95 mb/d in 2007 and 1.92 mb/d in 2008).  Government data showed lower Albertan conventional production in June-August, and result in downward adjustments of 25-30 kb/d to the Canadian forecast overall.  Conventional output is also expected to be hardest hit when Alberta's new fiscal regime enters service in 2009.  Meanwhile, amendments to the oil sands fiscal regime have been reported as less onerous than originally proposed.  Price-dependent royalties prior to cost recovery will range from the current 1% to 9%, with post-payout rates ranging from the present 25% to a new higher rate of 40%.

Offshore Newfoundland, the Terra Nova field suffered more problems in October, this time with a generator outage.  The field has seen disrupted supply during 12 of the last 22 months, illustrating the rationale for our inclusion of a field reliability adjustment for forecast production from several OECD countries.



Mexico - September actual:  September crude production rebounded after the impact of Hurricane Dean in August to average 3.16 mb/d, some 70 kb/d higher than our forecast, although this was partly offset by lower-than-expected NGL output.  However, the upstream sector was hit by weather disruptions again in October.  Firstly, storms in the fourth week of October led to the death of 21 workers when adjacent drilling installations collided in heavy seas.  Then late in the month, high winds prevented export liftings and forced the shut-in of an estimated 2-3 mb of production, although production was being restored in early November.  We have trimmed our October crude production estimate by over 80 kb/d, subject to revision when official production data are available.

North Sea

Norway - August actual:  While August Norwegian crude production came in 35 kb/d lower than earlier estimates, preliminary September data suggest crude output of 2.0 mb/d, around 270 kb/d higher than this report's forecast.  We have trimmed our maintenance and unscheduled field outage adjustments for September 2007 accordingly, but will retain higher curbs for 2008 until field-specific data for September become available next month.  North Sea storms in the first week of November briefly caused the precautionary shut-in of between 300 kb/d and 500 kb/d of production at the Ekofisk, Valhall, Grane, Oseberg and Visund fields.  We have assumed a cut to November supply from these fields amounting to 100 kb/d, although this amount is netted off our previous field reliability adjustment, and therefore represents a transfer within the Norwegian total rather than a cut in the forecast per se.  In all, expected Norwegian crude supply is largely unchanged, at 2.0 mb/d for 2007 and 1.8 mb/d for 2008.



Pacific

Australia - August actual:  Australian production is expected to see resumed growth for the first time since 2000 in 2007/2008.  Crude output gains 45 kb/d this year to reach 480 kb/d, and rises by another 100 kb/d on average in 2008.  Early October saw the start-up of 43.6°API crude production at the Puffin field in the northern offshore Bonaparte Basin.  We had earlier assumed a gradual build to peak, but it now appears capacity 30 kb/d production will be attained quickly.  BHP Billiton also announced that the 80 kb/d Stybarrow field will enter service before the end of 2007, in advance of our forecast February 2008 start-up.  Some 25 kb/d has been added to this report's Australian forecast as a result.

Former Soviet Union (FSU)

Russia - September actual, October provisional:  Total Russian oil output remains on track to grow by 2.5% in 2007, with a further 2.2% increase assumed for 2008.  Production averages 10.1 mb/d this year and 10.3 mb/d next, with corresponding volumes for crude of 9.6 mb/d and 9.8 mb/d respectively.  Russian output had dipped in September, partly due to maintenance work at the Chayvo field in the Sakhalin 1 complex, which saw production dip to 175 kb/d.  However, a 60 kb/d rebound here in October was also reflected in total Russian supply.  Production from Russia's largest operator, Rosneft, continues to run ahead of our own, and indeed the company's expectations.  Output is now close to 2.3 mb/d and the company has upgraded production guidance for 2007 from an original 1.8 mb/d to 2.0 mb/d.  While acquisitions have driven much of Rosneft's recent growth, there are reports that improved reservoir management techniques employed by former Yukos subsidiary Yuganskneftegaz are also being employed more widely across Rosneft's other producing assets.



Kazakhstan - October actual:  Assumed maintenance downtime at the Karachaganak field appears to have been focussed more on October than our assumption of September.  Total Kazakh oil output for September is revised up by 45 kb/d to 1.35 mb/d (of which 1.1 mb/d is crude oil), while flat October production represents a 90 kb/d downward adjustment from last month's forecast.  Growth of 100 kb/d in Kazakh supply in 2008 to 1.46 mb/d derives largely from improved recovery at the Tengiz field.

Kazakhstan's President Nursultan Nazarbayev suggested in October that the country's 2010 and 2015 production targets had been revised down as a result of delays at the Kashagan project.  Output around 1.6 mb/d is now expected for 2010, marginally higher than the 1.56 mb/d forecast in July's MTOMR. Government sources have admitted that 2010 may be an ambitious target data for Kashagan start-up.  State oil company Kazmunaigaz is to see its equity stake in Kashagan increased from a current 8.3% to 17-18%, with other shareholders seeing a proportional cut in their stakes.

Preliminary data show total FSU net oil exports of 8.55 mb/d in September, down 240 kb/d from the August total of 8.79 mb/d.  As expected, September crude exports were dented by maintenance at the Azeri field which prompted a 300 kb/d drop in exports via the BTC pipeline.  Other notable reductions were seen in fuel oil and gasoil exports, down 120 kb/d and 80 kb/d respectively.  Total September product exports of 2.52 mb/d were 280 kb/d lower than August and at their lowest point since January.  These lower outflows were partially offset by higher seaborne crude exports in September from Black Sea and Baltic ports (up 110 kb/d and 160 kb/d respectively) and an extra 100 kb/d via the Druzhba pipeline.



Higher BTC pipeline flows were likely in October after Caspian production maintenance wound down.  However, Russian Baltic oil exports were temporarily constrained by maintenance on the pipeline to Primorsk in late October and will likely be so again in late November.  Furthermore, Russian export duties increased from 1 October to over $250/t for crude and around $190/t for light products.  So net FSU exports probably rose only modestly in October, likely trending down again in November and December.

Other Non-OECD



Brazil - August actual:  Brazilian crude production is trimmed by 25-30 kb/d for both 2007 and 2008, now averaging 1.8 mb/d and 2.1 mb/d respectively.  Adjusted timings and production profiles for the Roncador, Golfinho and Espadarte fields underpin the slightly lower outlook, with state producer Petrobras admitting that infrastructure bottlenecks are leading to delays of six months to one year for certain projects.  However, Petrobras was able to announce in mid-October that the 30 kb/d Piranema field had started up, a month ahead of this report's assumed date.  Piranema is lighter than much of Brazil's deepwater production, at 44°API.  The company also announced the discovery of significant new deepwater reserves in the Santos Basin (see below).

China - September actual:  September Chinese production came in some 200 kb/d lower than anticipated at 3.72 mb/d, partly due to outages affecting offshore producer CNOOC.  These are assumed to be temporary, with national production expected to recover to 3.9 mb/d in 4Q07 and through 2008.  Growth in supply from China has been steady, if unspectacular, overshadowed by rapid demand growth and stable or declining output at its traditional baseload onshore eastern fields Daqing and Shengli, which account for nearly 40% of production.  Significant new discoveries are being made however onshore western China and in the Bohai Bay area (see below).

Still Some Big Fish Lurking Offshore

Two recent, near-five billion barrel discoveries offshore Brazil and China suggest that a long overdue uptick in global exploration may yet generate significant incremental supplies outside the Middle East Gulf. Neither is in the super-league of Middle East giant fields (Saudi Arabia's offshore Safaniyah has an estimated 35 billion barrels, with onshore Ghawar still good for an estimated 70 billion barrels). However, reports suggest that combined, the two new discoveries could generate 1.5 mb/d of output by the end of the next decade. The discoveries were made by state firms Petrobras and PetroChina.



Petrobras' Tupi discovery in the deepwater Santos Basin holds an estimated 5-8 billion barrels of oil equivalent, with 85% of this expected to be crude of 28 degrees API. This is the largest discovery ever made in Brazil. However, development will likely be very high-cost, as in addition to being in water depths of 2,000 metres or more, producing wells will need to cut through 6,000 metres of sediment and salt. With initial estimates based on only two wells, further appraisal drilling will be necessary before proven reserve levels and a feasible production schedule can be developed. Petrobras is already suggesting an initial 100 kb/d of production in the early part of the next decade, although analysts suggest full field development for up to 1 mb/d would possibly take several years on top of that.

PetroChina has announced that the offshore blocks of the Jidong Nanpu oilfield in the northern Bohai Bay may contain up to 1.6 billion tonnes of oil equivalent, suggesting close to 12 billion barrels. However, more conservative estimates from China's Ministry of Land and Resources put proven oil in place at 3.2 billion barrels and proven, probable and possible (3P) oil reserves at 4.6 billion barrels. There are definitional uncertainties as regards China's classification of reserves, and some analysts have questioned whether the reported 'proven' levels may overstate recoverable oil. However, this remains a hugely significant discovery, and PetroChina plans to produce 200 kb/d of 32 degrees API oil from 2012, with ultimate production seen at anything between 300 and 500 kb/d.



OECD stocks

Summary

  • OECD industry stocks fell by 29.5 mb in September, as crude levels drew by a total of 24.6 mb, spread over all three regions.  Pacific crude stocks in particular decreased sharply, as Japanese crude levels fell to their lowest in at least 20 years.  OECD product stocks decreased by only 1.6 mb and 'other oils' by a further 3.3 mb.  A counter-seasonal third-quarter stock draw of -230 kb/d has brought down total OECD inventories to the level of their five-year average, or to 52.8 days in terms of forward demand cover at the end of September.


  • End-August stock data were revised up by 14.0 mb, though increases in 'other oils' and product inventories of 9.4 mb and 7.9 mb respectively were set against a downward move of 3.3 mb for crude stocks.  While overall OECD crude stocks remain higher relative to the five-year average than product stocks, it is crude inventories that have seen the steepest declines over the past few months, lifting crude prices and narrowing product to crude price differentials in the process.
  • Preliminary October stock data for the US, Japan and the EU-16 show a further draw of 20.9 mb, underpinning the tight supply/demand balance.  The draw was split evenly between crude and products, with strong crude falls in the US and Europe.  In products, the downturn was almost wholly due to a near-10 mb draw in European middle distillates, which supported a sharp rise in diesel prices in late October and early November.

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

Total OECD industry stocks fell by 29.5 mb in September, to 2,648 mb, and were 113.9 mb lower year-on-year.  Crude inventories fell by 24.6 mb to 931 mb, or 34.0 mb lower than end-September last year.  Total products drew by 1.6 mb to 1,411 mb, or 78.0 mb lower year-on-year.  'Other oils' fell by 3.3 mb.  In terms of forward cover, end-September stocks fell to 52.8 days, or just in line with their five-year average.  In both OECD Europe and the Pacific, forward cover is at the bottom of their respective five-year ranges, while in the US, it is one day higher than its five-year average.





End-August stock data were revised up by 14.0 mb in total.  9.4 mb of this was in 'other oils' and a further 7.9 mb were due to an upward revision in product stocks, while crude inventories were revised down by 3.3 mb.  Geographically, most of the changes took place in Europe, where product stocks were revised higher by 14.0 mb and 'other oils' by 3.8 mb.  Again however, this was offset by a substantial downward revision to crude, of 8.4 mb, leaving total stocks 9.4 mb higher.



OECD Industry Stock Changes in September 2007

OECD North America

Total North American industry stocks rose by 1.0 mb in September, as draws in crude and 'other oils' of 3.1 mb and 0.3 mb respectively partially offset a 4.4 mb product build.  Nearly half of the product build was in middle distillate stocks, which rose by 2.1 mb, with 'other' products increasing a further 2.1 mb.  US crude stocks fell by 7.6 mb in September, a drawdown of 37.7 mb since their end-June high of 366.6 mb, albeit in line with the seasonal trend.  Meanwhile in Mexico, crude stocks rose by 4.5 mb in September.



Preliminary October numbers for the US, based on weekly data, show a further crude draw of 9.2 mb.  This has seen US crude stocks falling to approach their five-year average and reflects the tightening of the crude market due to lower supplies, but also high oil prices and to some extent the backwardated market structure of crude futures (see Falling Crude Stocks - It's All Down to Perceptions in report dated 11 October 2007).  Significantly, in October, crude stocks at Cushing fell again by 4.6 mb, to their lowest level since November 2004 and to less than half of where they stood in April and May of this year.  As we have pointed out before, low Cushing crude stock levels have supported WTI's price rise relative to other crudes.

Total North American product inventories rose by 4.4 mb by end-September, with 2.1 mb gains for middle distillates and 'other' products respectively.  Gasoline stocks built by 0.6 mb, while residual fuel oil fell by 0.4 mb.  As with crude, US and Mexican stocks developments diverged.  The US saw a 7.0 mb product build, with increases in middle distillates (+3.0 mb), gasoline (+1.0 mb) and residues (+0.6 mb) respectively.  In Mexico, total product stocks fell by 2.6 mb, with draws in all four main product categories.

For products, US weekly October data saw a modest counter-seasonal stock build of 1.9 mb.  Gasoline stocks rose by 2.7 mb and fuel oil by 0.9 mb.  Unfinished product stocks fell by 1.4 mb and total distillates by 0.4 mb.  However, the latter hid the fact that while heating oil inventories built by 3.7 mb, diesel fell by 4.1 mb.  Heading into the winter, crucial PADD 1a, or New England, heating oil stocks are above their five-year average, while for overall distillates, slightly weaker demand has improved forward demand cover to 32 days in early November.

OECD Europe

In Europe, total industry stocks fell by 13.4 mb in September, to 23.8 mb lower than end-September last year.  Crude stocks drew by 7.9 mb which, combined with end-August's downward revision of 8.4 mb, brought levels down below their five-year average.  Crude inventories fell in Germany (-3.7 mb), the UK (-3.0 mb), the Netherlands (-1.5 mb) and France (-0.5 mb), but stayed unchanged in Italy.  Preliminary October data from Euroilstock for the EU-15 and Norway indicate a further crude draw of 4.7 mb.



Total European product stocks drew by 4.7 mb in September, largely due to a middle distillate fall of 3.8 mb.  Distillate stocks fell in all major countries reviewed, except in Germany, where they increased by 1.5 mb.  European gasoline stocks rose by 0.6 mb, while 'other' products and residual fuel oil stocks fell by 1.1 mb and 0.3 mb respectively.

Preliminary Euroilstock data for October show that product stocks in the EU-16 fell by a further 11.5 mb, largely due to a 9.8 mb downturn in middle distillates.  Refinery problems in Northwest Europe in particular tightened the market, leading to a sharp rise in diesel prices and in early November even a French heating oil loan from emergency stocks to keep the market balanced.  Meanwhile, product stocks for the Amsterdam-Rotterdam-Antwerp region showed a 2.0 mb draw in October.  Gasoil and jet/kerosene stocks each drew by around 1 mb, while gasoline, naphtha and fuel oil remained more or less unchanged.

OECD Pacific

Total Pacific industry stocks fell by 17.0 mb in September to 35.3 mb lower year-on-year.  13.5 mb of this was due to a draw in crude oil.  OECD Pacific crude stocks at end-September stood at 154.8 mb, which represents a 20 mb drop since end-July, and leaves them at their lowest level since February 1995.  September's crude stock draw was wholly due to a 13.7 mb drop in Japan, where levels have now fallen to their lowest in at least 20 years.  Meanwhile, in Korea, crude stocks were virtually unchanged.  Preliminary October data for Japan published by the Petroleum Association of Japan (PAJ) show a slight crude build of 3.4 mb, but this still leaves levels below their five-year range.



Total industry product stocks in the Pacific fell by 1.3 mb and stand 14.2 mb lower than end-September last year.  A middle distillate draw of 3.7 mb was equally shared by Korea and Japan, while a gasoline draw of 1.3 mb was offset by a similar increase in residual fuel oil stocks.  Total Pacific middle distillate stocks fell below their five-year average in September, while gasoline levels have been below their historical average since the end of June - both partly due to below-average Japanese refinery runs this year.  Preliminary October data for Japan from PAJ show a 0.8 mb dip in total products, largely due to falling 'unfinished' products.  Of note is Japan's level of kerosene stocks, which in October stayed more or less flat, counter to their usual seasonal build ahead of winter heating demand.  Thus they have fallen to 5.2 mb below their four-year average or to their lowest end-October level since PAJ data has been available.

Recent Developments in Singapore Stocks

Product stocks in Singapore, as reported by International Enterprise, rose by 175 kb in October.  Residual fuel oil stocks built by 1.0 mb, which offset draws in light and middle distillates of 650 kb and 210 kb respectively.  Fuel oil stocks remain at the top of their five-year range, despite lower volumes of eastbound oil and sustained record-high high-sulphur fuel oil prices.  Lower middle distillate stocks partly reflect below-average Japanese kerosene stocks and underpin tight Singapore jet/kerosene crack spreads versus Dubai.
















Prices

Summary

  • Crude futures surged in October and early November, with WTI hitting a new record above $98/bbl on a further tightening of the market.  Strong fundamentals, including lower crude stocks, constrained supplies and new geopolitical tensions supported markets, offsetting worries about economic downside risks to demand.
  • Spot markets were buoyant and predominantly crude-driven, though the distillate complex showed strong gains on tight supplies and healthy demand ahead of the winter.  Northwest European refinery problems triggered a diesel price spike in late October and jet/kerosene crack spreads surged in Asia, not least due to tight kerosene stocks in Japan.  ICE Gasoil and NYMEX Heating Oil futures contracts hit new record highs.
  • Refining margins were mostly weaker or flat in October.  US Gulf Coast cracking margins in particular remain depressed on high light sweet crude and weak gasoline prices. Asian refining margins picked up on rising crack spreads, after a period of below-average refinery throughputs.  In Europe, refining margins were down slightly, but remain higher in the north.


  • Middle East Gulf freight rates firmed slightly in October, prompted by increased OPEC production.  Sharper increases were seen for crude tanker rates in both West Africa, on stronger vessel demand, and especially in the Mediterranean, following delays in the Turkish Straits and higher Ceyhan loadings.  However, all crude tanker rates continue to underwhelm in seasonal terms.

Overview

Crude futures again set new records well above $90/bbl in October and early November as all indications are that the market is tightening further.  Crude stocks fell in the OECD in September and October, as demand stayed strong and supplies remained constrained.  Storms caused production outages in Mexico and the North Sea, while Russia curbed October exports on pipeline maintenance to Primorsk.  OPEC's production rose ahead of its pledged increase from 1 November, though this was largely due to higher exports from Iraq and Angola, the two countries that do not have production targets.  Geopolitical tensions increased in Pakistan even as the situation on the Turkey/Iraq border improved.  Nevertheless, markets remain jittery against a background of tighter stocks, for the moment at least shrugging off concerns about a downturn in the US and, by extension, the global economy.

Falling stocks in October and early November continue to reflect a fundamentally tight market.  Despite this report's downward revision to fourth-quarter demand, supplies are likely to remain constrained through to the end of the year.  Weather outages also contributed to tight conditions: late October saw Mexico forced to shut in crude production due to storms, and the same happened to a lesser extent in the North Sea in early November.  While OPEC apparently raised output in October, there is little indication so far that output targets will be reassessed ahead of OPEC's regular early-December meeting in Abu Dhabi.



The tight crude market reflects in part refinery buying ahead of the end of seasonal maintenance and peak winter throughputs.  However, refinery performance has been sub-par, notably in Europe, where there have been difficulties at some of the region's largest plants.  In particular, the European middle distillate market is tight ahead of the 1 January 2008 switch to 1,000 ppm sulphur heating oil.  Protracted maintenance and unplanned outages at French refineries and limited supplies in the Northwest European market prompted French authorities to loan 285,000 tonnes of heating oil (~2.13 mb) from strategic stocks.  In China, weak refining margins kept refinery throughputs low and product markets tight as a result, encouraging authorities to raise retail prices on 1 November.

Spot Crude Oil Prices



Markets remain crude driven, with refining margins mostly down or flat in October.  Physical prices tracked futures, and spot WTI in the US remains supported by Cushing crude stocks falling to their lowest level since November 2004 at 13.9 mb.  Tight Cushing stocks also contributed to the squeeze on prompt WTI, briefly widening its premium to Brent to as much as $7.50/bbl in late October.  WTI also widened versus Gulf Coast sours such as Mars or Poseidon, again illustrating the disconnect between the two markets, especially as refining margins on the Gulf Coast fell sharply in October.  Gulf Coast sours weakened due to new output in the region, as well as extra Urals and Iraqi barrels offered into the market.  But early November saw a reversal of this situation.  WTI also widened its premium against heavy sours such as Maya, despite the Mexican outages.

In the European market, Brent remained strong compared with other regional crudes, despite a decline in Northwest European cracking margins in October.  North Sea shut-ins of up to 500 kb/d due to storms appeared to have limited impact on prices at the time of writing.  Brent versus Dubai remained in the $6/bbl range though volatile.  Nigerian premia weakened slightly versus Brent, as Bonny Light cracking margins in the US Gulf fell to nearly zero in October.  On the other hand, Brent gained versus Mediterranean light sweets Azeri Light and Saharan Blend.  European medium sour Urals strengthened on lower exports in October, though its discount to Brent remained flat.  Arbitrage options to west and east weakened, as Urals gained versus Mars and Oman.  Ukraine's Kremenchug refinery saw itself forced to tender for replacement cargoes into Odessa after its regular pipeline supplies from Russia's Tatneft were cut off due to a dispute.  In the Mediterranean, Iraq tendered further Kirkuk supplies from Ceyhan, with October liftings calculated at 260 kb/d.



In Asia, Dubai and other medium sours strengthened on strong fuel oil prices.  Japanese crude stocks fell to their lowest level in at least 20 years, indicating, among other things, tight regional supplies, though Saudi and other Gulf producers' official selling prices for December (and the offer of full-term volumes) appeared to indicate a willingness to direct any additional OPEC volumes towards the east.  Malaysian Tapis, a light sweet Asian crude benchmark, actually hit the $100/barrel level in early November.

Refining Margins

Strong crude prices continued to pressure refining margins in October.  US Gulf Coast full-cost cracking margins fell towards zero or below on weak gasoline cracks and high light sweet crude prices.  In contrast, rising gasoline and middle distillate cracks lifted margins slightly on the US West Coast.



European margins all fell in October as gasoline and gasoil/diesel crack spreads, on average, declined.  Margins remain higher in Northwest Europe than the Mediterranean, but in both regions, hydroskimming margins stayed in negative territory in contrast to positive cracking.  In Singapore, Dubai hydrocracking rose by around $2/bbl, as did Dubai hydroskimming margins, which turned positive during the month.  In Asia, all cracks except low-sulphur fuel oil increased.  Korean refiner SK Energy, which had cut crude throughputs in October on weak margins, announced it would lift runs again in November, anticipating a recovery in margins.



Spot Product Prices

Spot product prices largely increased in tandem with crude, except middle distillates, which saw a strong rise in crack spreads.  The onset of winter temperatures, tighter stocks in the OECD Pacific and Europe, low refining margins, and refinery problems in Europe have all contributed to price strength.  Delayed return from maintenance at France's major Gonfreville refinery, coupled with ongoing maintenance at the Feyzin plant, caused French authorities to release 285,000 tonnes (~2.13 mb) of heating oil from strategic stocks into the market in early November, albeit only as a four-month loan.  Europe's heating oil market is strained due to the requirement from 1 January 2008 to halve its sulphur content to 1,000 ppm.  When a fire broke out at the UK's Coryton refinery in early November, forcing it to declare force majeure on product deliveries, Northwest European ultra-low-sulphur diesel cracks shot up.  The UK's decision to voluntarily reduce sulphur content in diesel to 10 ppm from December (ahead of a general European Union switch from 2009) has temporarily reduced supply flexibility.  Jet/kerosene crack spreads also surged in Europe, partly because of the Coryton refinery's need to obtain prompt supplies to meet the needs of London's busy airports.



In Asia too, middle distillate cracks were strong, as lower-than-usual refinery throughputs on weak margins have tightened the market, notably in China, where fuel shortages were reported and the government put pressure on refiners to crank up output.  The Chinese government also unexpectedly raised retail prices by around 9% from 1 November in order to raise the incentive for refiners to increase output.  Furthermore, China trimmed gasoil exports in October, tightening the regional market.  Meanwhile, stocks of Japanese heating fuel kerosene slipped below their four-year range in October.  Further strong demand came from regional importers Indonesia and Vietnam.



Fuel oil prices made steady gains in October and high-sulphur fuel oil in Singapore reached new record highs above $500/tonne.  Japanese demand was strong in order to compensate for lower nuclear power.  In addition, the situation of lower Iranian exports, as outlined in last month's report, remained unchanged, keeping regional supplies tight, as some eastbound cargoes were diverted to bunker hub Fujairah and elsewhere.  Total volumes heading to Singapore in November were estimated at only 1.3-1.4 million tonnes, this year's low.  Elsewhere, crack spreads remained more or less flat.



Gasoline cracks remained flat in October and early November in all regions.  China again curbed exports -approximately halving outflows to around 100,000 tonnes for November - on strong demand and tighter supplies.  Europe's supplies also suffered from the outages outlined above, but the region remains structurally long in gasoline.  Naphtha cracks meanwhile were further depressed, especially in Europe.  In Asia, India continues to keep exports high, raising outflows in October to around 240 kb/d, up by an average of 190 kb/d for the January-September 2007 period.  Asian naphtha crackers are however already cranking up throughputs ahead of the festive season, which could curb losses.



End-User Product Prices in October

In US dollars, ex-tax, most end-user prices reached record highs in October, after a 3.4% rise on average from September.  In national currency terms, ex-tax end-user prices overall gained 1.8% in October, with diesel prices in France and Germany, and LSFO in the UK and Japan reaching record highs.  Year-on-year gains in dollar terms were very strong, with retail prices up around 20-40%.  As for individual products, in dollar terms, ex-tax gasoline prices rose by 1.1% on average, with only the US declining (-0.8%).  Diesel prices ex-tax, in US dollars, increased by 4.0% on average, while heating oil prices in Europe and Canada rose by 5-6% ahead of the winter.  LSFO ex-tax prices in US dollars rose 4.6% month-on-month.

Freight

Increased OPEC production prompted a slight firming in Middle East Gulf tanker rates in October, but they continue to underwhelm in seasonal terms.  A sharper rise was seen in West African rates, bringing them closer to fourth-quarter norms, as vessel interest for eastbound exports increased.  Mediterranean dirty rates spiked dramatically on higher Ceyhan loadings and delays in the Turkish Straits.  Clean tanker rates were mixed, but higher naphtha trade heading to Eastern Asia could lend support in the coming weeks.

VLCC rates from the Middle East Gulf firmed slightly on apparent increases in OPEC output from October.  For Japan-bound trades, 250,000-tonne rates rose from around $7.20/tonne in mid-October to $8.50/tonne in early November, but remain well below seasonal averages.  Tanker movement reports foresee higher eastbound Middle East Gulf liftings through mid-November, though this uptick may be offset by sluggish westbound flows.  VLCC rates to the US Gulf rose from just over $13/tonne in the second half of October to finish the month nearer $15/tonne.  Corresponding rates to the US Gulf in October 2006 averaged around $20/tonne.  Without an upturn in regional vessel demand, the potential for ship owners to mitigate the cost of extremely high bunker prices by raising charter rates remains limited.

Crude freight rates rose sharply in the Atlantic basin in October on higher vessel demand.  Asian purchases of West African grades in November were 100 kb/d higher than October and there were reports of increased US spot purchases of West African crude.  VLCC rates from West Africa to US Atlantic rose from under $8/tonne in early October to almost $11/tonne at the start of November, before falling back to $9/tonne.



More dramatic increases in freight rates were seen in the Black Sea and Mediterranean region in October.  Exports via the Baku-Tbilisi-Ceyhan pipeline rebounded after a period of Caspian production maintenance.  Several tenders for Iraqi crude for almost immediate loading at Ceyhan added further sporadic pressure to regional vessel demand.  At the same time, transit delays in the Turkish Straits of up to four days squeezed vessel supply.  Black Sea to Mediterranean Aframax rates rose from under $8/tonne in early October to peak at almost $17/tonne near the end of the month, before subsiding to around $14/tonne at the time of writing.

In the clean sector, Asian rates were mixed in October.  Singapore to Japan clean rates for 30,000-tonne vessels fell by a couple of dollars to finish the month around $12/tonne, while Middle East Gulf to Japan 75,000-tonne rates rose by a similar amount to $16/tonne.  Reports of petrochemical plants in Japan, Korea and Taiwan switching back to naphtha feedstock, rather than LPG (due to a run-up in butane prices), should support clean freight rates in the coming weeks.  Naphtha trade has also been supported by high Indian exports for the last three months.  Transatlantic clean rates were boosted by refinery problems in Europe which supported backhaul diesel trade from the US in early November.  Rates for 33,000-tonne charters rose by almost $4/tonne to nearly $20/tonne in the first week of November.

Refining

Summary

  • Global refinery crude runs are forecast to average 73.1 mb/d in November, as throughput recovers from the seasonal low point of 72.3 mb/d in October.  Fourth-quarter throughput is expected to average 73.5 mb/d, 0.7 mb/d lower than last month's report, on the back of weaker demand, increased offline capacity and higher planned maintenance.


  • November OECD throughput is estimated to average 39.0 mb/d, as refineries recover from peak seasonal maintenance in October and a series of unplanned shutdowns in all three OECD regions.  Fourth-quarter OECD crude throughput is estimated at 39.0 mb/d, 0.3 mb/d lower than last month's report.
  • Gasoil/diesel yields remain strong in all three OECD regions.  However, diverging trends for jet/kerosene yields between OECD regions suggest that while European refiners continue to benefit from recent upgrading investments, North American refiners are still under pressure from strong demand growth in diesel.  Interestingly, Japanese refiners appear to have boosted jet fuel production at the expense of kerosene production, possibly to avoid the voluntary run cuts seen late last year.
  • European distillate markets have tightened dramatically in recent weeks ahead of the UK's move to 10 ppm sulphur diesel and the Europe-wide introduction of 0.1% (1000 ppm) sulphur heating oil.  Heavy and protracted refinery maintenance and unplanned outages have restricted the European refining system's ability to accommodate strong demand for distillates that meet the tighter specifications.

Global Refinery Throughput

Global refinery crude throughput is projected to recover from the October low point of 72.3 mb/d to 75.0 mb/d by December, as refineries return from seasonal maintenance.  Fourth-quarter throughput is estimated to average 73.5 mb/d, a downward revision of 0.7 mb/d from last month's report, on the back of expectations of weaker fourth-quarter OECD demand, heavier-than-expected maintenance and higher unplanned refinery downtime.  Distillate markets remain tight, particularly in Europe and China.  The UK's voluntary move to 10 ppm sulphur diesel in early December and the introduction of a 1000 ppm sulphur limit for heating oil from 1 January 2008 across Europe, (see European Distillate Pinch), have raised diesel and gasoil cracks in the region.  In China strong demand growth and the impact of capped, albeit higher, domestic prices on refining economics, reportedly resulted in supply shortages for diesel and gasoil and to a lesser extent gasoline.

European Distillate Pinch

Recent price differentials in the North West European distillate market point to a rapid tightening of supply availability, particularly for 10 ppm sulphur material. Although the price of diesel is affected by both supply and demand factors, arguably it is supply side constraints that currently appear to be driving the price. The demand for ultra low sulphur distillate in Europe is being affected by two legislative changes. Firstly, European heating oil specifications will tighten at the beginning of next year to 0.1% (1,000 ppm) sulphur. This change has forced some refineries to upgrade their hydrotreating capability to comply with the new specification, increasing seasonal maintenance and boosting the need for imports to supply the marginal barrel of ULSD. Secondly, the UK is voluntarily switching to 10 ppm sulphur diesel from the existing 50 ppm sulphur from 4 December, some 13 months ahead of the mandatory tightening required by the European Commission.

However, while the market may be temporarily distorted by these lower sulphur specifications, the recent market tightness has been compounded by several unplanned production outages and delays to the restarting of refineries, following heavier than normal maintenance. This has reduced the ability of the European refinery system to provide incremental supplies of diesel at short notice. September and October witnessed several large refineries undergoing maintenance, notably Preem's Lysekil refinery in Sweden, Total's Gonfreville refinery in France and BP's Nerefco refinery in the Netherlands. Refineries reported to have suffered production upsets include Neste's Porvoo refinery, where the residue hydrocracker has been shutdown following the discovery of faulty valves; ExxonMobil's Fawley refinery in the UK and, perhaps most notably, the fire at Petroplus's Coryton refinery in the UK. These unplanned shutdowns have forced refinery operators to cover their supply requirements on the spot market, at a time when the refining system is already fully stretched to meet the tighter product specifications highlighted above.

Arguably, until late July the small premium that 10 ppm sulphur diesel had commanded over 50 ppm material reflected a degree of spare hydrotreating capacity in the European refining system. However, during August and into September this flexibility appears to have been eroded, with 10 ppm sulphur material commanding an ever greater premium, (as shown in the left hand graph).



From an historical perspective the step change in sulphur limits in Europe has tended to result in temporary price spikes for the better quality material (as shown in the right hand graph). Price differentials against gasoil tend to rise just ahead of the change date, as buyers pay a premium for prompt delivery. This was most clearly evident ahead of the introduction in 2005 of 50 ppm sulphur diesel across Europe, also a time when refinery problems disrupted some refiners' preparations for the new specifications. Similar price trends were also evident ahead of the move to 350 ppm sulphur diesel in 2000. Furthermore, the overall premium for diesel over gasoil has tended to increase, reflecting the higher manufacturing costs required to meet the tighter specification. The price moves seen so far may be exaggerated, but are not wholly unexpected given the changes occurring in the diesel and gasoil markets.

OECD fourth-quarter crude runs are estimated to average 39.0 mb/d, -0.3 mb/d below last month's forecast.  The heavier-than-expected offline capacity in North America in October, plus an upward revision to offline capacity estimates over the balance of the quarter, accounts for the majority of the decline in throughputs.  However, on an underlying basis we expect refinery utilisation in the US to improve over the course of the first half of next year as refineries currently suffering prolonged outages, (BP's Texas City and Whiting refineries and Chevron's Pascagoula refinery), resume normal operations.  The operational problems reported in Europe and Japan have similarly reduced estimated throughput levels.  However, higher crude runs in November are expected to come from Korea, where maintenance has been completed.



Weekly data for October point to crude runs in the US remaining constrained by operational issues and heavy maintenance, falling to the bottom of the five-year range by the end of the month.  Throughputs have been particularly hard hit in the US Midwest, with reports indicating planned maintenance affected crude units at six refineries, with a further three refineries working on upgrading units; this is in addition to the long-term outage at BP's Whiting refinery.  Gulf Coast crude throughput is likely to be similarly constrained in the coming months with Chevron's Pascagoula refinery looking to complete repairs on its 160 kb/d crude unit in the first half of next year.  Japanese crude runs have picked up in recent weeks, despite a higher-than-normal level of unplanned outages, largely related to problems with upgrading units.  Barring further problems, refinery crude throughput in Japan should recover over the course of November.



Forecast Middle East crude runs have been reduced for the fourth quarter following the announcement of a shut down at Saudi Aramco's 400 kb/d Rabigh refinery for the whole of November.  The maintenance work is partly to prepare for the integration of new petrochemical production capacity in 2008.  Elsewhere in the region, the partial shut down of Iran's Abadan refinery for maintenance in November starts a period of planned work at several Iranian refineries that will extend into the first half of 2008, with the Bandar Abbas refinery set to undergo two partial shut downs to allow the expansion of crude distillation capacity.  Lastly, the reported closure of a 120 kb/d crude unit and upgrading capacity at ADNOC's Ruwais refinery will limit the rebound in December crude runs in the region.

Forecast fourth-quarter crude throughput in the FSU has been reduced following the delay to restarting Lukoil's Odessa refinery in the Ukraine to the first quarter of 2008 from October, following a multi-year shut down to upgrade the refinery.  Additionally, the restart to PKN Orlen's refinery at Mazeikiu, following work to complete repairs following the refinery fire there in 2006, has also been put back slightly.  Lastly, the disruption to supplies at the Kremenchug refinery is also likely to curtail throughput over the balance of the fourth quarter.  However, crude runs are still expected to increase over the course of the quarter following the completion of work at several refineries in Russia which curtailed throughputs by around 250 kb/d in October.  Latin American crude runs in October are estimated to have been affected by a number of operational problems that affected Venezuelan refineries during October and the fire at ENAP's Aconcagua refinery in Chile.  Consequently, we have reduced our October forecast by 0.2 mb/d.

Chinese crude throughput was stronger than estimated in September.  Data released by the National Bureau of Statistics indicate that September crude throughput averaged 6.6 mb/d, an increase of 0.1 mb/d from August.  However, the September estimate for offline distillation capacity is 0.5mb/d, an increase of 0.2 mb/d from August's level.  It would, therefore, appear that other refineries in China pushed capacity utilisation up by around 0.3 mb/d.  Driving this increase in crude throughput would appear to be Chinese government pressure on both national refiners to increase runs to ensure that diesel and gasoline is available across the country.  This follows numerous reports of increasingly widespread product shortages, notably in diesel.  Furthermore, reports indicate that net exports declined heavily for gasoline and diesel.  In late October the government has raised domestic prices in an attempt to increase runs at independent (teapot) refineries, to further boost domestic supplies.  Consequently, we have raised our estimates for the fourth quarter, given the continuing reports of product shortages affecting China and the improved (although still unattractive) refining economics.

OECD Data for September

OECD September crude throughput averaged 38.7 mb/d, in line with our forecast.  Crude runs were approximately 0.1 mb/d lower than expected in North America, 0.1 mb/d higher in Europe and in line with expectations in the OECD Pacific.  Crude runs in September were 1.0 mb/d lower than in August with the onset of seasonal maintenance in the US and Japan reducing throughputs.







However, the resumption of crude runs at refineries in Germany provided a slight offset against the downturn.  Compared with September 2006, OECD crude runs were 1.1 mb/d lower, with the US down 0.5 mb/d year-on-year, Europe down 0.3 mb/d (partly due to the turnaround at Total's Gonfreville refinery) and a decline in Korea due to maintenance at refineries operated by Hyundai and SK Corp.

OECD Refinery Yields

Middle distillate yields remain robust at OECD refineries, thanks to the recent investment in upgrading capacity.  However, problems at Neste's Porvoo refinery, where the residue hydrocracker was shut down in mid-September to replace faulty valves, is expected to reduce European distillate yields until its expected mid-November restart.  Despite gasoil/diesel yields continuing at the top of their five-year ranges in each of the OECD regions, jet/kerosene yields show a different picture between regions.  In Europe jet/kerosene yields are above the five-year range, due to the recent additions of hydrocracking capacity. Conversely, North America jet/kerosene yields remain under pressure at the lower-end of the five-year range, suggesting that the rise in demand for ULSD continues to exert pressure on the middle distillate part of the barrel.



Perhaps more interestingly jet/kerosene yields in the Pacific, (shown above), remain above the five-year average, but mask an apparent switch by Japanese refiners to produce relatively more jet fuel at the expense of kerosene.  Recent months have seen rising volumes of jet fuel exports from Japan, at a time when domestic kerosene stocks have reached a low plateau of 27mb, below the four-year range for the time of year, according to weekly PAJ data.  This move by refiners should allow them to maintain a higher level of throughput than was seen last year when high kerosene stocks forced some refiners to voluntarily cut runs.

North American Product Market - 2008 Outlook

As part of a series of more in depth looks at regional forecasts from our medium-term global product supply model, this month we consider prospects for North America in 2008.

The North American product market is expected to ease in 2008 with upgrading capacity expansions expected to keep pace with demand growth. However, perhaps the most important factor in the overall picture will be the potential for refineries to improve on recent poor utilisation rates and the return of several key refineries from prolonged outages.

The region's gasoline net imports should decrease in 2008 by 112 kb/d as investments in crude distillation and upgrading additions boost supply. Upgrading additions forecast to improve gasoline supply next year include new fluid catalytic cracking and alkylation capacity plus additional gasoline hydrotreating units. Ethanol production is forecast to grow by 63 kb/d in 2008, contributing to the easier gasoline market. Furthermore, in 2008, European exports are expected to increase as local demand weakens further. As a result we expect the Atlantic Basin gasoline balance to improve markedly.

Gasoil/diesel net imports are expected to increase due to strong diesel demand even as hydrocracking additions marginally improve North American refineries' distillate yields. The region's import requirements are expected to grow as demand is forecast to remain robust. Off-road diesel specifications have been tightened in 2007 to a sulphur content of 500 ppm, with further tightening expected in 2010, bringing it into line with on-road ULSD at 15 ppm sulphur. To meet this growing low and ultra low sulphur diesel demand, refineries continue to invest in diesel hydrotreating capacity. We expect the jet/kerosene balance to remain largely unchanged in 2008, with output increasing inline with crude runs. The increased need for diesel output will continue to limit the improvement in jet/kerosene yields.

The region's net fuel oil imports are expected to decline as natural gas substitution continues to weaken fuel oil demand and additional investment in coking capacity is anticipated to be offset by refiners switching to a heavier crude slate.

The US refinery system's ability to meet product demand has been undermined by an increase in planned and un-planned shutdowns in recent years. Refinery utilisation rates have been gradually declining since they peaked at 95.6% in 1998, reaching 89.7% in 2006. This year, runs have averaged 88.5%, highlighting the ongoing operational issues at several US refineries. The evolution of utilisation rates will remain a key uncertainty behind the region's product supply flexibility.