Oil Market Report: 13 February 2008

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Highlights

  • Crude oil prices are little changed from mid-January at just over $90/bbl.  Weaker projections for global economic growth are offset by low stocks, forecast cold weather in the US and parts of Asia, supply disruptions (Nigeria/North Sea) and concern about Venezuelan supplies.  Products have underperformed crude, leading to weak refining margins.
  • Global oil product demand has been revised down by roughly 200 kb/d to 87.6 mb/d in 2008, following weaker GDP growth figures in an interim report by the IMF.  Weaker OECD growth, however, stands against still-robust projections for GDP growth in China and the Middle East, the key oil demand growth centres.
  • January world oil supply rose 745 kb/d to 87.2 mb/d on new output from Brazil, and recovering non-OPEC output elsewhere.  However, a reassessment of 2008 prospects lowers OPEC gas liquids growth by 250 kb/d to 365 kb/d.  Rising FSU, Asia-Pacific, Brazil and biofuels supplies generate 2008 non-OPEC growth of 0.97 mb/d.
  • January OPEC crude supply remained close to 32.0 mb/d, on higher output from Angola, UAE, Saudi Arabia and Kuwait, offset by lower Iraq, Nigeria and Qatar volumes.  Effective spare capacity increased to 2.4 mb/d in January but revisions to both supply and demand lift the 2008 call on OPEC crude and stock change by 0.1 mb/d.
  • Economic refinery run cuts in January and February were the most extensive for five years.  Coupled with seasonal maintenance, February global refinery crude throughput should average 74.0 mb/d, down by 0.6 mb/d from January.  However, higher runs in China, Other Asia and Russia underpin year-on-year throughput growth of 0.9 mb/d in 1Q08.
  • OECD industry stocks fell by 39.5 mb in December, driven by constrained crude supplies and peak seasonal refinery runs.  The 4Q07 stock draw of 1.15 mb/d was substantially higher than the 750 kb/d 10-year average and reduces OECD industry stock forward cover to 50.7 days - its lowest since December 2004.  Preliminary data for the US, Japan, the EU-15 and Norway indicate a 22.1 mb stock build in January.

A period of adjustment

Changes are taking place in the oil market - not just to demand, but also to the supply-side and the refining industry.   The economic environment is clearly paramount: just as the demand shock of 2004 shaped the oil market for the next three years, so too could the pending slowdown.  We have made further adjustments to demand growth projections in this report, reflecting the changes for key countries published in the latest IMF forecasts.  As a result, global oil demand in this report has been revised down by about 200 kb/d in 2008, leaving global oil demand growth - which was projected at 2.2% last July - at 1.9%.  Considering that a proportion of that demand growth represents a weather-related rebound in the OECD, the underlying trend is even weaker.

Lower demand growth affects other sectors of the oil market - particularly the refining sector.  In the July 2007 Medium-Term Oil Market Report (MTOMR), one major shift was an improvement in gasoline supply potential in the Atlantic Basin.  Globally there have been minor downward revisions to transportation fuel demand projections since the MTOMR release, but the changes have been more significant in the Atlantic basin (compounded by faster-than expected ethanol supply growth) - hence the currently weak gasoline cracks.  Low margins are forcing US refiners to cut runs despite pending seasonal maintenance, filling the gap with European imports.  Ample European gasoline supplies (as drivers switch to diesel cars) are also highlighted by an exceptionally high price differential between Europe and Singapore.  However, that does not mean we have avoided the usual summer supply tightness - that will depend on the level of refinery runs over the coming months (which are in turn subject to crude availability and price) and the seasonal difficulty of blending in ethanol to meet summer volatility requirements.

Upstream, new capacity additions over the next two years should lift spare capacity, but this will only provide comfort if the market feels it will be available when needed.  Geopolitics will also play a role.  It is still not clear whether Iraq can sustain its recent strong performance; hopes of a rapid return of Nigerian capacity have been set back by recent disruptions, and Venezuela and Iran are back in the headlines.  The tight non-OECD supply-side environment and the impact of service-sector cost inflation has been highlighted in recent quarterly results, with corporate analysts suggesting companies are preparing for a sustained $60-$80/bbl oil world.

The power sector is also creating upward price pressures.  In the Atlantic basin, generators use fuel oil as the feed of last resort, leaving the surplus to be shipped to Asia to compete against LNG and coal in the power market.  Fuel oil prices look expensive when compared with Henry Hub natural gas prices, but when compared with recent spot LNG deals in Asia, they have been far more competitive.  Coal prices have also soared dramatically, driven by strong global demand, particularly from China - which has had to withdraw from the coal export market for the next two months.  While weak fuel oil cracks suggest that the coal market is acting independently of oil and gas, undoubtedly the strong demand for coal-generated power stems partly from high oil and gas prices over the past few years (also a desire for energy independence).  For oil, the strength of coal and LNG prices certainly serves to provide a price floor.

The demand shock of 2004 was largely responsible for shaping the oil market we have today, but equally importantly, it was followed by three more years of strong growth.  In a similar vein, an economic slowdown has the potential to change the landscape over the next few years: depending on how deep it is and how long it lasts.  Volatility, particularly in refining margins, will be a natural consequence, but it would be a mistake to see this as a one-way influence on oil prices.  As the last three years have shown, the markets are looking to sustainability for the future as well as the present.  Although stocks have recovered slightly in January, they remain low, as does spare capacity.  Given the rapid upside recovery of prices following a resurgence of geopolitical issues in Nigeria, Venezuela, Iraq and Iran there is clearly, despite demand side risks, the need to rebuild stocks.

Demand

Summary

  • Global oil product demand has been revised down by roughly 200 kb/d to 87.6 mb/d in 2008 (+1.9% or +1.7 mb/d).  This change results from minor downward adjustments to 3Q07 and 4Q07 in the OECD, which have been carried through to 2008, and most importantly, from a lower prognosis of US economic growth by the IMF, which nonetheless continues to see strong GDP growth in both the Middle East and China.  In 2007, by contrast, global demand has been adjusted up by roughly 110 kb/d to 86.0 mb/d in 2007 (+1.4% or +1.1 mb/d over 2006), because of baseline revisions to several non-OECD countries in Asia and Latin America.
  • OECD oil product demand has been marginally lowered in 2008 by almost 300 kb/d to 49.5 mb/d (+0.6%), given data revisions and downward adjustments to GDP predictions in several key countries by the IMF, notably the US.  Approximately half of OECD oil demand growth in 2008 is expected to come from heating use; transportation fuel growth, by contrast, is seen dropping compared with previous years because of weaker economic activity and higher oil prices.  In 2007, our demand estimate has been adjusted down (-50 kb/d) to 49.2 mb/d (-0.3% year-on-year), compared with last month's report, given revisions to 3Q07 data and lower-than-expected 4Q07 figures.


  • Non-OECD oil product demand has been revised up by about 160 kb/d in 2007 and 90 kb/d in 2008.  The changes were related to the baseline reappraisal of Chinese Taipei and Brazil, where data submissions have been somewhat erratic over the past few months.  Only part of the Asian revisions were carried through to 2008, given concerns that the region could be hurt by the US economic slowdown.  In China, by contrast, demand remains largely unchanged but could be revised up given uncertainties regarding coal-fired power generation.  Overall, non-OECD demand is expected to average 36.8 mb/d in 2007 (+3.7% on an annual basis) and 38.2 mb/d in 2008 (+3.8%).
  • China's power crisis has once again highlighted the economic and social disruptions of capped end-user prices.  Attempting to contain inflation, the government effectively promotes robust energy demand growth, which eventually led to shortages and further price controls (since energy shortages tend to feed inflationary pressures elsewhere in the economy).  Although the magnitude of the power shortages has encouraged the use of diesel- and fuel oil-fired electricity generators, this is likely to be temporary.  As opposed to what happened in 2004, the country's generation capacity itself is adequate, with the main problem at this point being logistical and likely to be solved once the weather improves.  Moreover, despite price controls, diesel-powered generation is now almost twice as expensive as coal.  Nevertheless, the power grid may again be tested this summer, particularly if it turns out to be exceptionally warm and if coal stocks prove to be insufficient, which could entail an eventual resumption of oil-fired electricity generation.


OECD

According to preliminary data, total OECD inland deliveries in December (oil products supplied by refineries, pipelines and terminals) rose by 0.6% year-on-year.  The relative strength of oil product demand in North America (+1.8% on a yearly basis) and Europe (+0.6%) largely offset demand weakness in the Pacific (-2.5%).  Transportation fuel deliveries, notably of diesel, contributed to support oil product demand in OECD North America (including US Territories).  OECD Europe demand growth was largely supported by a rebound of heating oil and residual fuel oil as a result of slightly colder-than-average temperatures.  In OECD Pacific, meanwhile, demand contracted as mild weather conditions depressed jet fuel/kerosene deliveries, failing to offset strong residual fuel oil and direct crude consumption for power generation in Japan.



OECD demand has been marginally revised down in 2007 (-50 kb/d) to 49.2 mb/d (-0.3% year-on-year), compared with last month's report, given revisions to 3Q07 data and lower-than-expected 4Q07 figures.  In 2008, the forecast has been lowered by almost 300 kb/d to 49.5 mb/d (+0.6%).  The changes are related to both data revisions and downward adjustments to GDP predictions in several key countries, following the release in early January of the IMF's World Economic Outlook Interim Update.

As illustrated in the chart below, in the OECD roughly half of the oil demand growth in 2008 is expected to come from heating use, even though 1Q08 temperatures are expected to be relatively mild once again - for the third year in a row (but nonetheless somewhat colder than 1Q07).  By contrast, transportation fuel growth is seen dropping sharply as a result of weaker economic activity and higher oil prices.





North America

Preliminary data indicate that oil product demand in North America (including US Territories) rose by 1.8% year-on-year in December, underpinned by stronger-than-expected diesel and residual fuel oil growth (+13.0% and +14.0% year-on-year, respectively).  Diesel demand has been particularly resilient in all three North American countries, although in the case of the US this could be related to classification issues (as suggested by the very weak deliveries of 'other gasoil').  Relatively cold temperatures in the US and Canada, meanwhile, supported regional fuel oil deliveries.  Following downward adjustments to US GDP growth in 2008 in the IMF's World Economic Outlook Interim Update, OECD North America demand has been revised down by roughly 180 kb/d compared with last month's report.  It is expected to average 25.6 mb/d in 2007 (+1.0% on a yearly basis) and slightly decline to 25.5 mb/d in 2008 (-0.2%).



Inland deliveries in the continental United States - a proxy of oil product demand - rose by 1.8% year-on-year in December, according to adjusted preliminary data.  The strength of demand growth was mostly due to higher-than-expected deliveries of distillates (diesel: +12.7% year-on-year) and residual fuel oil (+22.9%).  As previously noted, the resilience of diesel demand is partly attributable to the change in sulphur specifications since mid-2006 (whereby some off-road, locomotive and marine gasoil is now counted as diesel).  The gains in residual deliveries are related to a return to normal temperatures in December: the number of heating-degree days was identical to the 10-year average, but 15% higher than in the same month of the previous year.

More surprisingly, given continuing high pump prices and increasing evidence of an economic slowdown, notably in 4Q07, gasoline deliveries managed to rise by 0.2% year-on-year in December.  Some observers, such as the American Petroleum Institute (API), argue that such a slow pace suggests that US end-users, having concluded that high gasoline prices have become a permanent feature, are thus gradually adjusting their driving habits - by telecommuting, car pooling, using public transportation if available and even replacing their current cars with more efficient vehicles.  This may indeed be the case for the marginal consumer, but it should be noted that gasoline demand grew by an estimated 0.8% in 2007, within the average of the previous two years, when prices were much lower and when economic growth was buoyant.  However, even though US gasoline demand may be highly price inelastic in the short term, it is still responsive to economic dynamics in the medium term:  higher unemployment would likely reduce driving (and congestion) and hence soften gasoline demand.  On the basis of the IMF's new GDP forecast for 2008 (+1.5%, instead of 1.9%), we expect US gasoline demand to increase by only 0.2% this year.



Overall, US50 total oil product demand in 2007 is virtually unchanged at 20.8 mb/d (+0.6% year-on-year) when compared with last month's report.  However, given the IMF's downward adjustment of its 2008 GDP prognosis, demand is now seen averaging 20.7 mb/d in 2008 (170 kb/d lower than in the last report and representing a 0.5% contraction over 2007).

According to preliminary data, oil product demand in Mexico grew by 1.5% on a yearly basis in December.  All product categories bar LPG and residual fuel posted positive growth rates.  Transportation fuel growth continues unabated: gasoline deliveries expanded by 5.5% year-on-year, jet fuel/kerosene by 1.8% and diesel by 4.3%.  So far, oil demand in Mexico is being supported by the country's domestic market, despite the slowing economy of its main export market, the US.



A new Law for the Promotion and Development of Bioenergy was passed by the Mexican Congress in late January, following President Calderón's veto of a first draft in late 2007.  The new legislation seeks to promote feedstock production from domestic agricultural resources - and hopefully stem the flow of economic migrants to the United States.  However, the law is also explicit regarding the need to ensure food security, since the country has already experienced rising - and socially disruptive - corn prices as a result of strong US ethanol demand.  The Energy Ministry will eventually issue permits for the production, transportation and sale of biofuels, as well as regulations establishing fuel quality standards for gasoline and diesel blends containing biofuels.



Europe

Demand in OECD Europe increased by 0.6% annually in December, as heating oil demand posted its first annual increase (+13.2%) since October 2006.  Preliminary inland delivery data and JODI submissions were nevertheless weaker than anticipated, leading to a downward revision of 220 kb/d to our forecast.  Deliveries in France and Italy were particularly weak, accounting for most of the changes.  Demand in 4Q07 is now seen at 15.7 mb/d, 0.2% above 4Q06; for 2007 as a whole, demand in OECD Europe is estimated at 15.3 mb/d (-1.9%).  In 2008, oil demand is seen rising by 1.2% to 15.5 mb/d, largely pulled up by heating needs.

Final monthly oil statistics (MOS) for November were largely in line with expectations, as lower figures for the UK, Greece, the Netherlands and France were offset by higher estimates for Switzerland, Slovakia, Poland and Turkey.  The structural weakness in motor gasoline and residual fuel oil, which declined annually by 5.4% and 6%, respectively, was offset by increasing LPG and ethane demand.  While total gasoil demand was unchanged from November 2006, lower heating oil deliveries (-6.4%) were offset by higher diesel demand (+3.5%).

By contrast, preliminary inland delivery data for major consumer countries and JODI submissions for December were weaker than expected.  Motor gasoline declined by a stronger-than-expected 6.4% year-on-year, while LPG, naphtha and other products also contracted by 2%, 5.1% and 2.7%, respectively.  Heating oil deliveries were also weaker than expected in both France and Italy, but German deliveries were in line with expectations.  More interestingly, heating oil deliveries posted a strong annual growth of 13.2% compared with a warm December 2006 - demand, however, is still below its five-year average.



German heating oil demand - whose weakness largely explains the fall in European demand in 2007 - posted a year-on-year increase in December, for the first time since October 2006.  After 13 consecutive months of contraction - in some months by more than 40% on a yearly basis - demand seems finally to be moving in line with expectations.  As the large overhang in consumer stocks due to pre-tax buying and subsequent mild weather in 2006/2007 has now been largely eroded, consuming patterns will most likely be less influenced by end-user stock holding behaviour.  However, as stocks are currently at the bottom of their historical range (and at their lowest seasonal level in 20 years, according to Reuters), consumers may rebuild inventories if they expect that prices will rise further - or if prices dip.

Meanwhile, motor gasoline and residual fuel oil deliveries were in line with expectations, contracting by 16.8% and 18.4%, respectively.  Germany's residual fuel oil demand posted its lowest level since 2000, and is expected to have increased by only 0.5% in 2007.  This declining trend, which is explained by the commissioning of new gas- and waste-fuelled power plants (some 2,400 MW of electricity generation capacity were added during 2007), is expected to continue in 2008 (-2.1%).  Meanwhile, naphtha deliveries were weaker than anticipated, possibly due to maintenance in the petrochemical sector.  Overall, total German demand contracted by 3.4% in December.



In France, preliminary inland delivery data were weaker than expected, with the exception of residual fuel oil.  Fuel oil deliveries increased by as much as 72% year-on-year in December, due to stock building by large industrial users, rather than stronger demand.  Indeed, JODI submissions (which measure real demand and upon which we based our December estimate) indicate that demand was relatively unchanged compared with last year.  By contrast, according to final monthly statistics, residual fuel oil demand was particularly high in both October and November, given very low hydropower output in both months and reduced nuclear generation in November.  Heating oil deliveries, meanwhile, were slightly weaker than expected in December, but nevertheless rose by 20% from the previous year as temperatures were somewhat colder than the 10-year average.  Finally, despite having posted robust annual gains for most of 2007, diesel demand was relatively subdued in December, at 630 kb/d.

Italian deliveries were weaker than expected in December, leading to a downward revision of 94 kb/d.  Naphtha and other products contracted by 11.6% and 13%, respectively, offsetting gains in LPG, jet fuel/kerosene, heating oil and residual fuel oil deliveries.  Although diesel and heating oil deliveries were lower than expected, fuel oil demand was in line with our forecast, posting a 9.1% year-on-year increase (December 2006 had been exceptionally warm).  Finally, the country's electricity demand increased by 1.2% due both to colder weather and to an extra working day compared with 2006.



Spain continues to show strong oil demand growth, as economic activity remains robust despite concerns about its housing sector.  Oil demand in 4Q07 is seen growing by 3.5% annually, pulled up by strong gasoil and jet fuel/kerosene demand.  Turkey's demand was again revised up following the submission of official data for November, as higher gasoil and kerosene demand added 45 kb/d to our forecast.  Turkey's demand is now seen 1.4% higher in 2007 as a whole, as gasoil posted a 16.5% increase.



Pacific

According to December preliminary data, oil product demand in the Pacific fell by 2.5% year-on-year.  Strong Japanese demand for fuel oil and direct crude for power generation failed to offset losses in all product categories.  Indeed, Japan's demand - some two-thirds of the region's total - was weaker than expected, as temperatures became much milder than in November - the number of heating-degree days in December was 7% lower than the 10-year average (and 1% lower than in the same month of the previous year).  Moreover, the IMF's World Economic Outlook Interim Update has revised down its forecast of Japanese GDP growth in 2008.  As such, the estimate of OECD Pacific oil demand in 2007 has been slightly adjusted, compared with last month's report, to 8.3 mb/d in 2007 (-1.4% on a yearly basis) and to 8.4 mb/d in 2008 (+1.9%).



According to preliminary data, oil product demand in Japan fell by 1.7% year-on-year in December.  All product categories registered losses, with the exception of fuel oil and direct crude burning (included in 'other products'), which rose by 18.3% and 69.5% on a yearly basis as a result of strong electricity demand amid continued nuclear shortfalls.  In particular, demand for kerosene (used as a heating fuel) shrank by 16.1% year-on-year.  Although part of this decline is probably related to October's stock build-up by end-users (in anticipation of November's wholesale price increase), temperatures were much milder than a year ago.  In fact, there have been reports that Japanese refiners are producing less kerosene for lack of heating demand.  Japan's Meteorological Agency is actually predicting average or warmer-than-average weather from February to April.  In addition, a structural factor may be also at play - Japanese households may be choosing to use electricity for heating rather than more expensive oil-fired systems.



A full set of annual data also indicates that oil product demand in Japan - the world's third largest oil consumer after the US and China - plummeted by 3.4% year-on-year to 5.0 mb/d in 2007.  The overall contraction - for the second year in a row - is largely due to lower gasoline demand (-2.0%), which had already fallen in 2006 for the first time in almost three decades.  This is due to both structural and short-term issues: on the one hand, the country's population is aging, while the younger generation is purchasing smaller and more fuel-efficient cars; on the other hand, high retail prices have also contributed to put a lid on demand (gasoline consumption is expected to fall by about 0.9% in 2008).  In addition, an industrial structural change - the switch from fuel oil (notably the so-called fuel oil 'A', a blend of gasoil and fuel oil in a 90 to 10 ratio) to natural gas for environmental reasons - has also contributed to curb Japanese demand.  Nevertheless, the nuclear woes seen in 2007 (and expected to last until late 2008) have somewhat reversed that trend, as utilities have been obliged to greatly increase purchases of fuel oil and direct crude for power generation, which will support overall oil demand growth.  These factors, coupled with the IMF's downward revisions of its forecast of Japanese GDP growth in 2008 (from +1.7% to 1.5%) suggest that Japan's oil demand will rise this year by a modest 1.7% to 5.1 mb/d.

In Korea, preliminary data indicate that total oil product demand contracted by 6.9% year-on-year in December, mostly because of relatively mild temperatures, which softened heating and power demand.  Although naphtha deliveries, which account for the largest share of total Korean demand, rose by 3.8%, they failed to offset the weakness in transportation fuel deliveries (gasoline deliveries were down by 2.7% and those of diesel by 2.8%), heating-dependent jet fuel/kerosene (-23.9%) and fuel oil demand (-19.1%).





Non-OECD

China

Preliminary data indicate that China's apparent demand (refinery output plus net oil product imports, adjusted for fuel oil and direct crude burning and stock changes) rose by an estimated 6.1% year-on-year in December, with all product categories bar LPG, naphtha and residual fuel oil registering gains.  Demand for gasoline, jet fuel/kerosene and gasoil remains very strong (+6.1%, +30.3% and +12.6%, respectively).  In the case of gasoline and particularly gasoil, this suggests that shortages have receded and that the domestic market is better supplied, mostly thanks to higher refinery runs and massive net product imports.

At roughly 6.9 mb/d, refinery runs were almost 100 kb/d higher than in November (and almost 8% higher than in December 2006).  Yet runs by 'teapot' refineries - which act as the country's swing producers - appear to have remained stable month-on-month.  This could be related to limited feedstock availability.  On the one hand, residual fuel oil remained expensive: demand contracted by 3.4% year-on-year in December, while net imports, at 165 kb/d, reached their lowest level since February 2000.  On the other hand, net crude imports were much lower in December (2.9 mb/d, roughly as much as in October, which was the weakest month in 2007), which suggests that state-owned Sinopec and PetroChina have been drawing down stocks for the third month in a row in the face of high oil prices, in order to boost their own refinery runs and provide subsidised crude to the teapots (draws are estimated at about 800 kb/d in December).



Net gasoil imports, meanwhile, jumped by 363% month-on-month to 191 kb/d, the highest level ever registered.  Interestingly, though, total net product imports in 2007 were much lower than in the previous year (-24%), given higher gasoline exports and much weaker fuel oil imports.  Nevertheless, product imports are likely to be a significant source of supply during 2008: the government cut import taxes on several refined products to 1% across the board (with the exception of fuel oil, which remains at 3%), effective on 1 January.  The measure means that the import tax on gasoline, gasoil and jet fuel was halved from 2% to 1%, while the tax on naphtha was cut from 6% to 1%.  The previous round of import tax cuts dated back to November 2006 (the tax on gasoline and jet fuel was then reduced from 5% to 2%, while that on gasoil fell from 6% to 2%; as for fuel oil, its import tax was halved from 6% to 3% last June).  Still, given domestic price controls, imports continue to be unprofitable - but the NOCs will likely continue to be prompted to supply the domestic market at any cost.



Overall, our Chinese forecast remains largely unchanged, with oil demand growing by 4.5% year-on-year in 2007 to 7.5 mb/d (a weaker pace than in 2006, mostly because of the transportation fuel shortages of the past few months) and by 5.8% in 2008 to 7.9 mb/d.  Yet recent and unexpected events have cast a shadow over the 2008 prognosis, namely the widespread power shortages and inclement weather that have hit the country since January.  The former could herald a surge in oil demand for power generation - although, as discussed below, this is likely to be temporary - while the latter has severely disrupted the key Lunar New Year holiday (when millions of migrant workers based in the country's southern industrial heartland return home), which will probably weigh down on transportation fuel demand.  Therefore, the 2008 forecast is liable to be revised over the next few months as data for the current quarter become available.

Frozen Prices + Freezing Weather = Energy Shortages

In early January, several southern Chinese provinces were struck by severe power shortages.  Coupled with unusually bad weather, the electricity shortages unfolded into a national crisis over the next several weeks, extending to provinces and municipalities across the country, including Chongqing, Guangdong, Guangxi, Guizhou, Hainan, Hubei, Hunan, Henan, Jiangxi, Shaanxi, Shanxi, Sichuan and Yunnan.  At the peak of the shortages, in late January, the power deficit nationwide had reportedly reached some 40 GW, almost 6% of China's total power generation capacity of 713 GW (by end-2007).  Although at the time of writing the emergency had largely receded, it has brought again to the fore a key issue: the lack of price signals in China's energy markets.

Several factors combined to bring about the current power crisis.  These include:

  • the shutdown of some 550 small coal mines in 2007, notably in the provinces of Shanxi and Yunnan, following more stringent safety and environmental standards, which reduced the available feedstock for power generation (China relies on coal for about 83% of its electricity needs);
  • labour scarcity in coal mines, as millions of migrant workers returned home for the Lunar New Year and Spring Festival (which began on 7 February);
  • a drought in the south, which led to lower hydropower capacity (which accounts for roughly 15% of the country's total installed capacity);
  • the country's aging power grid, which limits regional inter-connectivity (which would allow regions with surplus power to supply deficit-prone areas);
  • extremely poor weather (widespread snow, heavy rain and cold temperatures across the country, which had not been seen in half a century), which a) contributed to coal transportation bottlenecks (deliveries from coal producing regions to key consuming areas have been hampered), b) damaged power lines and other transmission facilities and c) boosted power demand for heating;
  • rising passenger rail traffic as a result of the holiday season, which meant that passenger trains were competing against freight trains, notably with respect to coal deliveries (even though hundreds of thousands were stranded and unable to travel); and
  • China's energy pricing policy, both regarding oil products (the recent gasoil shortages affected the transportation of domestic coal supplies, as approximately 50% of deliveries are made by truck) and coal (wholesale prices, which were liberalised in 2006, have risen to historically high levels, but retail prices remain capped, thus squeezing power plants' margins and discouraging electricity generation).

Beijing initially reacted to the emergency by imposing administrative measures - centralizing emergency and relief efforts, halting all domestic coal exports for two months from 25 January in a bid to boost supplies and restricting power to manufacturing industries, in order to supply households and other key sectors.  In addition, the government vigorously denied that current policies - such as the closure of small mines and the cap on retail power prices - are the cause of the power shortages.  Instead, it has attributed most of the blame to power generators, which allegedly failed to acquire adequate supplies of coal ahead of the winter peak demand.  However, as with the recent gasoil shortages, price controls arguably nurtured the seeds of the current power scarcity.  Unable to pass on cost increases to end-users (ironically, part of coal's cost increase is related to last November's 9% diesel price hike, which raised transportation charges), some generators simply decided to sharply reduce their electricity output, while others opted to draw down their coal stocks or even shut down their operations.

Do the current power shortages herald a repeat of 2004, when similar problems boosted China's distillate and fuel oil demand?  Admittedly, the magnitude of the shortages have encouraged the use of diesel- and fuel oil-fired electricity generators - some 2,670 mobile back-up units by households cut off from the grid as a result of heavy winter storms, according to the State Electricity Regulatory Commission (SERC), and probably an even larger number by industries in the worst affected areas.  However, the resumption of oil-fired power generation will arguably be temporary, for two reasons:

  • as opposed to the situation in 2004, the country's generation capacity itself is adequate; the main problem at this point is logistical - i.e., to ensure that coal reaches power plants in sufficient quantity.  Once the weather improves, supplies will likely be fully restored - although the National Development and Reform Commission (NDRC) has indicated that shut coal mines will not be re-opened.  Similarly, depleted stocks are poised to build up again (the government aims to increase coal stocks at key power plants to guarantee power generation for at least two weeks).
  • oil presents a sharp cost disadvantage vis-à-vis coal: despite price controls, diesel-powered generation is now almost twice as expensive as coal.  Fuel oil is also more expensive, as well as LNG.  Unless existing subsidies are increased, oil-fired power generators, particularly in southern Guangdong province, will remain reluctant to run at full operating rates, despite having been asked to do so by the provincial government.  Diesel is relatively scarce as well, as evidenced by the recent shortages; moreover, given the poor weather, oil companies have reportedly also been struggling to deliver oil products across the country.

The power crisis illustrates a pattern that has seemingly become a permanent feature of China's energy sector, with all the economic and social disruptions that it entails.  By capping end-user prices in order to contain inflation - which has become a policy priority - the government encourages strong demand growth, be it diesel or electricity.  Eventually supply struggles and fails to catch up and shortages emerge, leading to an administrative response and a further entrenching price controls - since energy shortages tend to feed inflationary pressures elsewhere in the economy.

Looking ahead, the power grid may again be tested this summer.  At present, although coal supplies and logistical networks are presumably able to cope with expected demand, the overall supply picture will remain tight - and could worsen considerably if the summer months were exceptionally warm.  Should the government fail to curb power demand growth, either through price adjustments, efficiency improvements or even blackouts, coal imports from an already tight Asian market may be required, as well as an eventual resumption of oil-fired electricity generation.

Other Non-OECD

According to preliminary data, oil product sales in India - a proxy of demand - increased by an estimated 4.1% year-on-year in December.  Transportation fuels continue to be the main driver of oil demand growth, with gasoline, jet fuel/kerosene and gasoil sales rising by 10.0%, 3.4% and 10.7%, respectively.  Naphtha's slow decline carries on, with demand contracting by 13.9%.  Our forecast for India's oil demand has been slightly revised upwards from last month's report.  Total demand is now seen rising by 5.7% in 2007 to roughly 2.8 mb/d, and by 4.1% in 2008 to 2.9 mb/d.



As in other countries, the strength of India's demand is largely related to end-user subsidies.  Once again, New Delhi was abuzz with rumours regarding whether the Group of Ministers (GoM) would raise retail prices of transport and cooking fuels at a meeting on 7 February (following an inconclusive gathering in mid-January), while slashing government duties to offset the adverse impact of the rises.  Such a move would attempt to balance the burden to consumers against the losses incurred by state-owned downstream oil companies - because of the subsidies (so-called 'under-recoveries') these are projected to lose as much as Rs 718 billion ($18.4 billion) on fuel sales in fiscal year 2007-2008 (April-March).  However, even though the proposed price hikes are marginal (Rs 2-4/litre for gasoline and diesel), the Communist Party has once again threatened to bring down the government coalition if they were to pass.  As such, the cost of subsidies will continue to be borne by the government (43% of the total, in form of bonds), upstream companies (ONGC, OIL and GAIL, with a combined 33%) and downstream players (IOC, HPCL and BPCL with 24%).

Baseline demand in Chinese Taipei was revised upwards in both 2007 and 2008 by roughly 100 kb/d on average.  This change is related to recent adjustments in JODI submissions, which suggest that 'other products' demand had been undercounted.  However, since the 2006 baseline was left unchanged, growth rates are now somewhat distorted.  Total oil product demand is estimated at almost 1.2 mb/d in 2007.  These figures, however, could be revised again as annual submissions are received.

FSU apparent demand - defined as domestic crude production minus net exports of crude and oil products - has been slightly revised in both 2007 and 2008 given adjustments to production and trade data.  Demand was weaker than expected in 4Q07, owing to buoyant exports.  The region's total oil product demand is seen averaging 3.9 mb/d in 2007 (-4.5% year-on-year) and rebounding to 4.0 mb/d in 2008 (+2.0%).

Following the submission of October and November data, oil demand in Argentina has been revised upwards slightly, on the back of stronger-than-expected growth in transportation fuels.  This is likely to continue, as the main private downstream companies - the local units of ExxonMobil, Petrobras, Shell and Repsol-YPF - have been forced by the government to lower end-user prices.  In exchange, the temporary ban on gasoline and gasoil exports, which are the only avenue to profitability open to refiners, will be lifted.  Even the local unit of Royal Dutch Shell, which had refused to abide to the government's call to return prices to end-October 2007 levels, in the end accepted to lower its fuel prices by between 5.1% and 14.9%.  As such, total oil product demand is expected to average 560 kb/d in 2007 (+9.2% versus 2006) and 600 kb/d in 2008 (+6.0%).



As flagged in last month's report, Brazil's oil demand data for 2007 has been revised once again given that the National Petroleum Agency (ANP) published new series for all oil products bar LPG and jet fuel/kerosene over the March-November period.  This would appear to suggest that the reporting issues that had prevented the timely release of demand data since early 2007 are being gradually solved.  Interestingly, the new figures indicate that ethanol demand, included in the 'other products' category, has been particularly strong; by the same token, gasoline demand turned out to be almost flat during most of the year.  Brazilian flex-fuel motorists arguably sought to benefit from ethanol's lower price.  Total oil demand is estimated at 2.3 mb/d in 2007 and 2.4 mb/d in 2008 (implying a year-on-year growth rates of 4.8% and 3.6%, respectively).



The rise in oil product demand in South Africa has been fuelled by strong economic growth, notably in the province of Gauteng, which includes Johannesburg and Pretoria (the country's GDP has expanded by roughly 5% per year on average since the early 2000s).  As in other non-OECD countries, demand has been pulled up by transportation fuels (gasoline, jet fuel/kerosene and gasoil), which collectively account for 80% of the total.  Gasoil demand, in particular, has risen strongly (over 6% per year on average since 2003).  It is important to note that retail prices are not subsidised; prices are set monthly according to the Basic Fuels Price formula (BFP), which is linked to international spot product prices (the government, however, is debating whether to control the end-user price of LPG, which is the staple fuel for the poor).



Yet the outlook of South Africa's oil demand is uncertain.  Based on current trends (August 2007 is the last available data point), total oil demand is forecast to increase by 4.4% year-on-year in 2007 to 520 kb/d, and should expand by 5.3% in 2008 to almost 550 kb/d.  However, over the past few weeks the country has been experiencing repeated and widespread power blackouts, which are largely related to poor planning and underinvestment in capacity expansion, and has coincided with maintenance work at coal-fired plants (over 80% of total domestic power generation).  If shortages worsen (rationing has already been introduced), they could eventually hurt economic growth and thus weigh down on overall oil consumption.  The mining sector, a pillar of South Africa's economy, has for the first time ever been affected; meanwhile, the refining industry (so far largely spared) is reportedly preparing for eventual power cuts,  which could lead to fuel shortages (and higher product imports).  Nevertheless, as in China, oil demand could begin to be supported by rising gasoil use if households and industries resort to oil-fired generators.  The power deficit is poised to ease only by the end of the decade at the earliest, as new generation capacity comes online (built both by Eskom, the state-owned utility, and by the private sector).

Supply

Summary

  • World oil supply averaged 87.2 mb/d in January, a rise of 745 kb/d from downward-adjusted December levels of 86.4 mb/d.  New output from Brazil, and assumed recovery after December outages in Azerbaijan, China and Mexico, underpin the increase. Despite a weaker-than-expected December total, 4Q07 global supply rose by 1 mb/d versus 4Q06, largely due to higher OPEC supplies.
  • Non-OPEC January production is estimated at 50.2 mb/d, a rise of 0.7 mb/d from December, when output from Mexico, the FSU and China was substantially below preliminary estimates.  Preliminary information suggests a January rebound in output from these countries.  Overall, non-OPEC totals for 2007 and 2008 (net of Ecuador) remain largely unchanged at 49.7 mb/d and 50.6 mb/d respectively.
  • Non-OPEC supply growth in 2008 averages 0.97 mb/d, heavily weighted to the second half of the year.  In contrast, 2007 saw front-end loaded growth.  The FSU, Asia-Pacific, Brazil and biofuels underpin rising non-OPEC supply in 2008.  Growth in OPEC gas liquids is revised lower for 2008 after reassessing Saudi Arabian start-up schedules.  OPEC NGL growth (over and above the non-OPEC total) is now 365 kb/d in 2008, up from 190 kb/d in 2007, but well below earlier 0.6 mb/d estimates.
  • January OPEC crude supply was unchanged from December, at 32.0 mb/d.  Angola, UAE, Saudi Arabia and Kuwait boosted supply, but were offset by lower volumes from Iraq, Nigeria and Qatar.  With output close to the latest 29.7 mb/d target, OPEC's 1 February ministerial meeting saw no change in production policy, with the group due to meet again on 5 March.  Effective spare capacity increased to 2.4 mb/d in January, but February has seen Nigerian production outages rise to 0.7 mb/d.
  • A review of OPEC installed crude capacity reveals current levels 300 kb/d higher than in last month's OMR, at 35.0 mb/d, with revisions centred on Angola and the Mid East Gulf producers.  Capacity is expected to increase by some 0.8 mb/d during 2008, with Saudi Arabia and Angola driving the increase.  Nonetheless, expectations for end-2008 capacity are now 350 kb/d lower than those made earlier.
  • The call on OPEC crude and stock change (including Angola and Ecuador) has been revised up by 0.1 mb/d to 31.5 mb/d for 2007 and by 0.1 mb/d to 31.8 mb/d for 2008.  Higher non-OECD demand underpins the 2007 revision, while weaker OPEC NGL supply outstrips lower OECD demand for 2008.


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

January OPEC crude supply was barely changed (-20 kb/d) from December, at 32.0 mb/d.  Angola, the UAE, Saudi Arabia and Kuwait boosted supply, but were offset by lower volumes from Iraq, Nigeria, Qatar and Indonesia.  After recent improvements, disruptions to Nigerian and Iraqi supply caused by insurgent attacks increased once more.  Production estimates for both are based initially on a supply proxy, built up from observed exports and an assessment of domestic crude use.  At one stage in January, all three refineries in Iraq were closed, constraining 'supply' under the OMR definition.  Nigerian supply has also been limited by the involuntary mothballing of two of the country's refineries, Warri and Kaduna, although there are reports that both may resume normal operations again soon following pipeline repairs.  This may not result in a corresponding increase in Nigerian 'supply' however unless the security of onshore production and export infrastructure can be assured.

OPEC's 1 February ministerial meeting held production allowances unchanged. News that the group's market monitoring committee would not report ahead of ministerial deliberations only added to analyst perceptions that official target levels would be held steady.  With OPEC output (excluding Iraq) in January close to the existing 29.7 mb/d target, and concerns growing over a global economic slow-down, the scene was set for the resultant roll-over. The group is due to meet again on 5 March, although any further deterioration in supply from Nigeria and Iraq in the next couple of weeks could lead OPEC to again leave official targets unchanged.  Intriguingly, Ecuador stated it will ask for a higher quota during 2008, reflecting higher government production targets.  The past few months have been notable for a slew of comments from oil ministers, talking up their respective output capacities.  In the current environment, these may be designed more to protect existing quota shares than to argue for increases per se.



Effective OPEC spare capacity is assessed higher at 2.4 mb/d in January, based on revisions to prevailing installed capacity rather than monthly changes in production.  However, the increase needs to be put in context, with potentially escalating risks once more in Nigeria and Iraq, plus the ongoing geopolitical uncertainties for supply from locations such as Iran and Venezuela. February saw Nigerian outages rise close to 700 kb/d, and northern pipeline exports from Iraq once more became sporadic.  While it is difficult to make a watertight case for today's supply risks being greater than in years past, the perception of heightened geopolitical and security risks means that an easing in market sentiment requires both inventory and spare capacity to move higher on a sustained basis.

OPEC Capacity Growth to Gain Ground in 2008

New facility start-ups, and increments from existing fields scheduled for 2008 could ultimately add around 3.1 mb/d of gross new OPEC liquids capacity, compared with around 1.25 mb/d from projects starting up in 2007. Ramp-up to plateau from last year's projects also augments 2008 capacity. The quality profile of new output also changes, with 42% of the 2008 increment coming from gas liquids (NGL and condensate), compared with 20% in 2007. Not all of this new production will reach the market in 2008, with ramp-up to plateau output varying from one to two months in some cases, to 24 months or more for others. The net change in OPEC capacity in 2008 is of course markedly less than implied by gross additions starting up in 2008 because of the lag before plateau output is attained and also the offsetting impact of mature field decline. Moreover, stretched drilling capacity and installation and service crew availability will likely continue to strain project deadlines again this year. OPEC members themselves may defer project start-ups if they perceive global demand growth to be slowing markedly. Nonetheless, the proliferation of potential additional liquids volumes in 2008 holds forth the prospect that tight OPEC spare capacity could temporarily ease, even if not everything comes to fruition on schedule.

Gas liquids additions this year centre on the Khursaniyah and Hawiyah projects in Saudia Arabia, belated completion of phases 6-10 of Iran's South Pars gas development project and new production trains at Qatar's North Field (the same geological structure as South Pars). Lesser contributions come from Nigeria's offshore Akpo condensate project and Kuwait's onshore Sabriyah gas and condensate development. Despite a still-impressive increment in NGL and condensate supply in 2008, this month's report actually scales back expected net additions from OPEC gas liquids due to the later expected start for the Khursaniyah project's gas phase (now assumed for mid-year 2008). This adjustment offsets a faster liquids build-up from Qatar's Dolphin project. OPEC gas liquids are now seen increasing by 365 kb/d in 2008, to average 5.18 mb/d, compared with a previous forecast increment of 620 kb/d.

As regards crude oil, our latest review of current installed capacity results in modest upward revisions for Saudi Arabia, Iran, UAE, Kuwait, Qatar and Libya but downward adjustments for Algeria, Indonesia and Venezuela. This month's assessment pegs total OPEC-13 installed capacity at 35.0 mb/d, versus 34.7 mb/d in the report dated 16 January 2008. But these occasional updates of capacity are, at best, a highly imperfect snapshot of current physical supply potential, such is the paucity of consistent, field-specific data. Definitional issues also cloud analysts' perceptions of capacity. The OMR definition of sustainable capacity is that level of production that can be attained within 30 days and sustained for 90 days. Ideally therefore, surge capacity is excluded. We try also to exclude condensate volumes and, for example, Saudi crude accruing to Bahrain from the Abu Safah field (hence our relatively low Saudi capacity number).

These caveats aside, OPEC crude capacity could rise by some 840 kb/d, net of decline, between now and end-2008. The increase comes overwhelmingly from Saudi Arabia (400 kb/d) and Angola (320 kb/d). However, while we have assumed a fairly static crude capacity profile for Iraq, Nigeria, Iran and Venezuela, there is the risk that if recent security problems (Iraq and Nigeria), shortages of gas for reinjection (Iran) and uncertain investment climate (Venezuela) persist through the year, capacity in these producers could come in lower than shown here. As ever, we will be watching these developments closely, and where appropriate, adjusting capacity estimates accordingly.

Iran's oil minister reported in early February that oil production had reached a post-revolution record of 4.18 mb/d.  Assuming this refers to crude oil only, this is rather higher than our assessment for average January supply, flat at December levels of 3.93 mb/d.  Although January exports are believed to have moved higher to around 2.45 mb/d, this was likely offset by a reduction in domestic crude runs owing to maintenance at the Bandar Abbas refinery.  That said, previous months' estimates of Iranian crude supply have been revised up by some 20 kb/d for 2006 and 45 kb/d for 2007 to reflect higher domestic crude runs.

A spell of extreme cold weather in January, allied to disrupted gas imports from Turkmenistan reduced January gas reinjection at several oilfields, focussing attention again on the competing calls within the Iranian system for limited gas supplies. Maintaining current oil production will require both extensive gas reinjection at mature fields to offset decline, and timely implementation of new field investment.  Gas reinjection requirements are expected to treble by 2020, to levels around 280 mcm/d.  Early production of some 25 kb/d from Iran's giant Azadegan field (8 billion bbls of recoverable reserves) was due to start in mid-February, with 50 kb/d attainable by end-year.  Iran's buy-back model of service contracts has generally proved unpopular with foreign investors.  Attaining Azadegan's ultimate 250 kb/d potential within a decade will require both easing geopolitical tensions and improved upstream investment terms.

January supply from Iraq fell by an estimated 125 kb/d compared with December, averaging 2.23 mb/d.  The total comprised exports of 1.93 mb/d (20 kb/d higher for the month) and 0.3 mb/d of domestic crude use in refineries and power plants (sharply lower than December's 445 kb/d).  Export liftings from Ceyhan were marginally higher at 315 kb/d, with shipments from the southern ports of Basrah and Khor al-Amaya unchanged at 1.6 mb/d.  A series of power outages restricted refinery operations at the Baiji and Daura plants in January, also affecting production and pipeline exports from Kirkuk.  However, these refineries, and northbound crude shipments, had resumed in the first week of February.  The Basrah refinery was closed for the second half of January after a fire, and was reportedly still offline in early February.

The government is negotiating technical support agreements with western companies aimed at boosting production capacity by 500 kb/d in the short term at a number of fields (although for now we have excluded these projects from our assessment of 2008 capacity, above).  These agreements would cover the Kirkuk field (Shell), Rumaila (BP), Zubair (ExxonMobil), and West Qurna (Total and Chevron).  It is not certain to what extent participation in the West Qurna project will be affected by a recent agreement between Russia and Iraq, whereby the former writes off Iraqi debt in return for Iraqi commitment to revisit earlier oilfield development contracts.  Bagdad has also reacted to what it views as uncompetitive bidding in upstream contracts between companies and the Kurdistan Regional Government (KRG).  Term crude sales to SK Energy and OMV have been terminated following unilateral exploration deals signed with the KRG.

Venezuelan crude output nudged higher to 2.44 mb/d in January, with upgraded heavy oil from the Orinoco basin comprising 590 kb/d of the total.  This volume will fall during 25 February to mid-April, as PDVSA shuts down the 180 kb/d Petrocedeno (formerly Sincor) upgrader for maintenance.  Output of 200 kb/d of heavy crude feedstock may be partly sustained during the shut-down however.

At writing, ExxonMobil had obtained court orders freezing PDVSA assets worth over $12 billion worldwide.  The freeze was sought in support of ExxonMobil's arbitration case against PDVSA after the latter took over the oil major's stake in the Cerro Negro heavy oil project (now renamed Petromanagas) in the Orinoco.  Analysts have said that while day-to-day operations at PDVSA, and downstream affiliate Citgo's US facilities, are unlikely to be affected, any resultant block on the sale assets might ultimately affect PDVSA's ability to fund other investments.  Venezuela's President Hugo Chavez also resurrected earlier threats to halt oil exports to the USA if actions against Venezuela continue.  ExxonMobil and ConocoPhillips both refused to negotiate reductions in their previous 40-50% stakes in heavy oil projects, although Total, StatoilHydro, BP and Chevron appear to have accepted the compensation packages offered for their stakes.  The ExxonMobil action comes after signs of some thaw in the recently frosty relations between Venezuela and foreign investors:

  • PDVSA and CNPC of China will reportedly soon embark on the Sinovensa Orinoco joint venture aimed at producing up to 300 kb/d from the Orinoco belt by 2012;
  • Minority partner Shell will expand production at the 45 kb/d Urdaneta West field in Lake Maracaibo to 80 kb/d, and draft a proposal for development of the nearby Urdaneta Lago field;
  • StatoilHydro and Total signed agreements to appraise reserves and prepare a development plan for the Junin 10 block of the Orinoco belt;
  • Brazil's state Petrobras recently completed evaluation of 10 billion bbls of heavy oil in the Orinoco's Carabobo I block.

Nigerian January supply is assessed down by nearly 100 kb/d from December, at 2.07 mb/d.  Shell had already declared force majeure on Forcados exports in early January after pipeline sabotage and this subsequently led to the renewed shut in of 100-150 kb/d of Forcados production during the month.  Early February then saw force majeure declared on Bonny Light crude exports for February and March and the loss of 130 kb/d of crude production after leaks on the recently reinstated Nembe Creek pipeline.  Security concerns were reported to be impeding Shell repair efforts.

Total Nigerian crude production outages have now risen to around 0.7 mb/d once again, albeit remaining below the near-1.0 mb/d highpoint seen in May 2007.  Nonetheless, total output looks likely to remain curtailed in February.  And without reinstatement of some of the currently shuttered production, Nigerian crude availability could fall further in March.  Maintenance at the deepwater Bonga field will curb monthly average supply there by some 100 kb/d, while exports may be further curbed following the recent restart of the 125 kb/d Warri refinery.

Non-OPEC Overview

Non-OPEC January production is estimated at 50.2 mb/d, a rise of 0.7 mb/d from December, when output from Mexico, the FSU and China was substantially below preliminary estimates.  However, there were signs of a January rebound in output from these countries.  Overall, Non-OPEC totals for 2007 and 2008 (net of Ecuador and Angola) remain largely unchanged at 49.7 mb/d and 50.6 mb/d respectively.  Downward revisions for Brazil, Russia, China and Canada are countered by upward revisions for the UK, USA and Kazakhstan.

A weaker-than-expected December supply level reinforced the sharp slow-down in non-OPEC growth apparent over the course of 2007.  While early-year growth stood at around 1.0 mb/d compared with 1Q06, 4Q supply was barely 0.1 mb/d above end-2006 output levels.  Last year's overall non-OPEC growth came to some 530 kb/d.  This year is expected to be a mirror image of 2007, with the annual increment accelerating from 345 kb/d in 1Q08, to nearly 1.7 mb/d in 4Q, averaging 975 kb/d for the year as a whole.  New production from Brazil, the FSU and China appears to be heavily back-end loaded for 2008.  This raises the possibility that project slippage could to some extent ultimately diminish growth for 2008.

Biofuels supply continues to rise in 2008, despite tenuous basic economics, with growth of 370 kb/d (including US and Brazilian ethanol) to 1.5 mb/d incorporated within the non-OPEC supply total.  We also expect a temporary surge in liquids supply from Australasia and SE Asia in 2008 as light crude and gas liquids projects are brought on stream from Australia, New Zealand, Malaysia, Vietnam, the Philippines and Thailand.   South East Asian regional supply growth is expected to amount to 270 kb/d this year, compared with around 25 kb/d in 2007, taking production to nearly 3.6 mb/d in 2008.



Biofuels supply continues to rise in 2008, despite tenuous basic economics, with growth of 370 kb/d (including US and Brazilian ethanol) to 1.5 mb/d incorporated within the non-OPEC supply total.  We also expect a temporary surge in liquids supply from Australasia and SE Asia in 2008 as light crude and gas liquids projects are brought on stream from Australia, New Zealand, Malaysia, Vietnam, the Philippines and Thailand.  South East Asian regional supply growth is expected to amount to 270 kb/d this year, compared with around 25 kb/d in 2007, taking production to nearly 3.6 mb/d in 2008.

OECD

North America


US - Alaska January actual, others estimated:  Estimates for total US oil production are revised up by between 20-40 kb/d for the period 4Q07 to 4Q08, averaging 7.41 mb/d for 2008.  Stronger November NGL supply in November contributes, although this is not carried into 2008, with this year's NGL total remaining at 1.79 mb/d.  Another strong month for US ethanol supply causes an upgrade to 2008 production, to 490 kb/d.  This is a rise of 70 kb/d compared with the 2007 total.  US crude oil output is now assessed at 5.1 mb/d for 2007 and 5.0 mb/d in 2008, with upward revisions of 15 kb/d this month reflecting a stronger performance from smaller producing states.  In 2008, the US Gulf of Mexico (GOM) sees supplies repeat 2007's growth of 55 kb/d, to average 1.41 mb/d.  Another relatively storm-free autumn in 2008 would boost this by around 85 kb/d, as we currently apply a downward forecast adjustment in line with typical five-year average hurricane outages.

Alaskan January crude production again lagged this report's initial estimates, crude coming in at 725 kb/d, or 30 kb/d weaker-than-expected.  2008 supply is seen falling below 700 kb/d for the first time since 1977.  However, shallow water developments worth around 60 kb/d may help to stem Alaskan decline, with expected start-up over the next two years of Eni's Oooguruk and Nikaitchuq fields.

Canada - Newfoundland December actual, others November actual:  December and January Canadian supply is revised sharply lower, by 145 kb/d, with renewed weather-related and mechanical outages affecting the Alberta oil sands, and operator Husky advancing maintenance at the offshore White Rose field from August into January.  Total Canadian oil supply for 2008 is now expected to remain flat at 2007 levels of 3.31 mb/d, with increases in bitumen and syncrude output of a combined 100 kb/d offset by declines elsewhere.  Despite concerns over costs, energy supplies, pipeline capacity and changing fiscal regime in Alberta, oil sands expansion is progressing.  Suncor has now formally approved plans to boost synthetic crude production by 200 kb/d to 550 kb/d by 2012 under its Voyageur project.  This follows agreement with the Albertan authorities over increased royalties.




Mexico - December actual:  Weather-related delays dented Mexican crude supplies in December. Although crude production showed modest recovery versus November to reach 2.95 mb/d, it remained well below recent peak levels closer to 3.2 mb/d.  Exports matched October lows around 1.5 mb/d compared with November's 1.87 mb/d. This report assumes further production recovery in January, although brief port closures are again likely to have impeded exports. Once again, Cantarell production remains the focus of concerns about future output, with Pemex announcing in January that Cantarell output this year will likely fall by 200 kb/d, in line with this report's prevailing forecast.   However, some offset is coming from rising supply from the Ku-Maloob-Zaap fields (see below).

Which Path Ahead for Mexican Crude Production?

Mexico's Energy Ministry in December set out two starkly different scenarios for Mexican crude production and exports through 2016. Outside observers see a lighter fiscal burden on Pemex, combined with organisational reform of the state producer and the opening of the upstream to foreign/private investment as fundamental to halting the recent slide in Mexican production. As shown below, the choice appears to be between 'business-as-usual' in which production slips towards 2.1 mb/d from a current 3.1 mb/d, or a more optimal, reform-based scenario in which Pemex attains both the funding and technology to significantly expand onshore, but complex, Chicontepec reserves and to begin exploiting deepwater resources in water depths of 500 metres or more, for mid-decade production. The optimal scenario envisages upstream spend of 157 billion pesos annually ($15 billion) - close to Pemex's allocated 2008 levels, while the low case assumes 100 billion pesos ($9 billion) per year through 2016. Both scenarios see mature Cantarell production continuing to decline, by as much as 15% a year.



Last July's Medium-Term Oil Market Report (MTOMR) assumed a continuation of the prevailing investment climate in Mexico's upstream, with no contribution expected from deepwater in the period through 2012. The latest Ministry forecasts also envisage no initial contribution from deep-water before mid-decade at the earliest under the optimal investment scenario. Contributions from both the Chicontepec and offshore Ku-Maloob-Zaap fields were also later, and more limited, in the MTOMR scenario than in the Energy Ministry equivalents. The complexity of exploiting the Chicontepec onshore reserves was seen in the MTOMR as limiting their contribution to some 150 kb/d by 2012. Chicontepec is reportedly currently producing 20-30 kb/d, with Pemex aiming for up to 0.6 mb/d by the middle of the next decade, and between 0.2 mb/d and 0.4 mb/d for 2012, depending on the investment environment. Clearly, Pemex's access to capital in the next five years will be critical in determining the extent to which the drilling-intensive Chicontepec project can offset Cantarell decline.

Latest OMR Mexican projections, while lower for 2007 after storm-related offshore outages at end-year, have nevertheless been raised for 2008. Development of the offshore Ku-Maloob-Zaap (KMZ) complex has been more rapid than we had assumed. Both the MTOMR and earlier issues of the OMR foresaw KMZ attaining 600 kb/d only by 2010, but in fact, these fields have already broken through the 600 kb/d mark. But Ministry expectations suggest KMZ could decline from 2011, again focussing attention on Chicontepec and the deepwater as longer-term sources of growth to offset Cantarell decline.

North Sea

Norway - November actual, December provisional:  Final December Norwegian data showing field-specific detail was released too late to be included in this report, but will be incorporated in the March OMR.   However, indications of aggregate production and loading schedules through February, leave our forecast for Norwegian liquids output largely unchanged for 2008 at 2.37 mb/d.  Weather-related stoppages and mechanical outages continue to plague North Sea supply in general, but have generally been captured within our field reliability adjustment.  Kvitebjorn, Snohvit and Ormen Lange condensate supplies have all been affected in December and January, while February has seen renewed stoppages at the Njord field and within the Ekofisk system.  All told, this forecast sees Norwegian crude production falling 0.2 mb/d in 2008 to 1.82 mb/d, a repeat of the trend seen in the past three year.  Some offset derives from gas liquids and condensate supplies, which grow by 50 kb/d combined to attain 550 kb/d in 2008.

The Norwegian Petroleum Directorate (NPD) has released a lower production outlook for 2008-2012, although these appear to be in line with our own MTOMR expectations as regards likely 2012 output.



UK - November actual:  Preliminary UK data for November turned out 160 kb/d higher than this report's estimates.  Moreover, field-specific data for October points to higher output from the Forties system and for a number of fields including Schiehallion, Captain and Blane.  These adjustments are carried through the 2008 forecast.  The Thistle field also restarted on 12 January after a seven week stoppage following a November turbine fire.  Upward adjustments to the UK outlook amount to 80 kb/d for 4Q07 and 65 kb/d for 2008.  Preliminary numbers for 2007 suggest a temporary flattening off in UK oil output (at 1.66 mb/d) brought about by the ramp-up of Nexen's 200 kb/d Buzzard field.  However, 2008's upward adjustment is insufficient to reverse a renewed decline in UK oil production, now seen falling by 0.2 mb/d to 1.48 mb/d (1.22 mb/d of offshore crude).

Former Soviet Union (FSU)

Russia - December actual, January provisional:  December and January Russian supply came in lower than expected to the tune of 55 kb/d and 10 kb/d respectively.  December's lower output resulted from weaker performance from the Sakhalin 1 project than indicated by preliminary data.  Indeed, having scaled back 2008 expectations for Sakhalin 1 in last month's report, subsequent expectations from Rosneft suggest even lower output in 2008.  Natural decline is now seen reducing supply from 225 kb/d in 2007 to 175 kb/d in 2008.  The government earlier refused to allow operators ExxonMobil to tap extra reserves at the Chayvo field which would have offset decline.  As a result, Sakhalin 1 output is likely to fall until later phases centred on the Arkutun Daginskoye and Odoptu fields enter production. 

In all, Russian crude and gas liquids output for 2008 is trimmed by 35 kb/d compared with last month's forecast, now averaging 10.19 mb/d (of which 9.7 mb/d is crude).  Growth in 2008 is halved relative to the 2.4% (+235 kb/d) achieved in 2007.  Aside from Sakhalin 1, we have also trimmed expected supply for Rosneft and Lukoil in line with revised company expectations.



Kazakhstan - December and January actual:  Revised data for smaller producers for the full 12 months of 2007 add 35 kb/d to baseline Kazakh supply and offset lower-than-expected output from the Karachaganak and Tengiz projects in December and January.  A similar upward adjustment is carried through 2008, resulting in total supply this year of 1.47 mb/d (including 1.2 mb/d of crude), which is 90 kb/d higher than in 2007.  Some 75% of 2008's growth comes from the Tengiz project.  However, we have limited actual Tengiz production to 420 kb/d for 4Q08, well below expected capacity of 540 kb/d, until it becomes clear how resultant export expansion will be accommodated.  With reports in late January that production from Tengiz was already testing 400 kb/d, there may well be scope for revising output projections higher if sufficient sustainable export capacity is available.



Net oil exports from the FSU in December gained rather more ground than we anticipated last month, increasing by 360 kb/d versus November.  At 8.95 mb/d total net exports stood fully 770 kb/d higher than in December 2006.  A 200 kb/d increase in crude exports versus November, to 6.27 mb/d, was driven by Baltic seaborne trade, notably a rebound in Primorsk liftings after earlier pipeline maintenance.  Crude exports on other routes were flat-to-down modestly compared with November.  December products exports were also up by 160 kb/d on the month, reaching 2.72 mb/d.  Gasoil was the driver here, exports breaching 1.0 mb/d again after a lull in October/November

A 55 kb/d rebound in BTC shipments in January may have been enough to offset lower scheduled Russian Transneft crude volumes, potentially sustaining FSU crude exports close to December levels.  A further rise in export duties scheduled for February also suggests that Russian exporters may have tried to boost sales ahead of the duty increase.  Despite further likely Caspian increases in February however, these are likely to be overshadowed by sharply lower Transneft seaborne volumes from Gdansk and Primorsk.

Other Non-OPEC

Brazil - November actual, December provisional:  Some 50 kb/d is cut from our estimate of Brazilian production for the 4Q07-4Q08 period.  Weaker baseline supply in November, and the deferral of the Marlim Leste project from the 2008 forecast into 2009, underpin this adjustment.  Crude production edged higher to 1.71 mb/d in November, but preliminary Petrobras data suggest a more substantial December increase to 1.8 mb/d on average, with Petrobras reporting at end-December that record production levels of 2.0 mb/d had been achieved.  In all, crude output is expected to gain some 280 kb/d in 2008, with biofuels growing by a further 50 kb/d.  Our field reliability adjustment nets 35 kb/d off the 2008 total, suggesting total liquids production this year of 2.44 mb/d.



Other Asia - Data through November/December:  Last month's report highlighted the trebling in oil supply growth expected from Australia and New Zealand in 2008, incremental supplies of 155 kb/d taking total OECD Pacific production to 785 kb/d this year, from 630 kb/d in 2007.  Other regional producers are also increasing supplies of generally light, sweet crude and gas liquids in 2008.  Non-OECD Asian production, net of China, is expected to increase by 115 kb/d in 2008, to average 2.8 mb/d.

Despite a 20% increase in costs, the Galoc project offshore the Philippines is due on stream in March.  This will be followed shortly thereafter by the Calauit project, with the two fields generating an incremental 30 kb/d later in 2008. Thailand sees incremental gas liquids projects generating a net 15 kb/d increase in oil output in 2008, the fourth straight year of rising production.  In Malaysia, further build up towards peak 120 kb/d is expected from the deepwater Kikeh project, which entered service in August 2007.  Meanwhile, Vietnam could see a temporary production surge as the Ca Ngu Vang, Song Doc, Su Tu Vang and Bunga Pakma projects (the latter shared with Malaysia) start up.



OECD stocks

Summary

  • OECD industry stocks fell 39.5 mb in December, mainly on a 30.3 mb draw in crude oil, as supply remained relatively constrained amid peak seasonal refinery runs.  'Other oils' fell 9.0 mb, while product stocks remained virtually unchanged.  This brings the 4Q07 stock draw to 1.15 mb/d, substantially higher than the 10-year average of around 750 kb/d and lowers OECD industry stock forward cover to 50.7 days - its weakest since December 2004.
  • Regionally, inventories are particularly low in the Pacific (relative to previous years' averages), with crude stocks falling to their lowest level in at least 20 years.  This is likely due to curtailed OPEC exports to the east, a strong rise in throughputs around the end of the year and a structural shift towards lower stock holding due to efficiency and higher costs.
  • Preliminary January data for the US, Japan and the EU-15 and Norway indicate a 22.1 mb stock build.  Crude stocks in the US rose as refinery maintenance set in and some discretionary run cuts were made.  In Europe, distillate stocks increased, largely due to warmer-than-expected weather.


OECD Inventories at End-December and Revisions to Preliminary Data

Total OECD industry stocks fell 39.5 mb in December, to 2,555 mb, led by a 30.3 mb draw in crude inventories.  Product stocks were virtually unchanged at 1,357 mb and 'other oils' fell by 9.0 mb.   This pattern corresponds with refineries running at a seasonal peak in December, but with demand for heating fuels, in particular, remaining relatively robust.  In terms of forward demand cover OECD inventory stocks fell to 50.7 days, their lowest since December 2004.

The crude stock draw was spread across all three regions, while product stocks fell in North America and the Pacific.  In Europe, unusually high diesel prices after an early-November fire at the UK's Coryton refinery and other outages tightened the market and subsequently attracted strong arbitrage flows from all around the globe, pushing up stock levels.





The overall revision to end-November stock data (-2.1 mb) was relatively minor, with downward adjustments in North America and the Pacific of -9.1 mb and -5.9 mb respectively offsetting an upward correction of 12.8 mb in Europe.  On a net basis, 'other oils' saw the greatest change, being revised downward by -6.2 mb, while crude and product stock levels were adjusted upwards by 3.1 mb and 1.0 mb respectively.



OECD Industry Stock Changes in December 2007

OECD North America

Total North American industry stocks fell 28.7 mb, with a 31.5 mb drop in the US only slightly offset by a small build of 2.8 mb in Mexico.  Total North American crude stocks fell 17.9 mb, while products and 'other oils' fell by 5.1 mb and 5.7 mb respectively.  A US crude stock draw of 19.3 mb offset a Mexican build of 1.4 mb.  Besides a seasonal high in refinery runs and WTI's contango, which encourages a stock draw, refiners typically try to run down crude stocks at the end of the year for tax purposes, and weather disruptions also had an impact.  Preliminary weekly US data for January indicate a crude build of 12.3 mb, as imports rose again while refinery crude inputs declined due to the onset of seasonal maintenance and some discretionary run cuts.



While total North American product stocks fell by 5.1 mb, movements for individual products were quite divergent. Gasoline stocks rose by 8.8 mb and residual fuel oil by 0.8 mb, while middle distillates and 'other products' fell by 2.9 mb and 11.8 mb respectively.  US stock changes dominated the shifts, particularly a 9.8 mb increase in gasoline stocks in December.

Preliminary January data for the US based on weekly figures show total products falling by 3.9 mb.  However, an early-year peak in refinery throughputs and high imports, combined with anaemic demand saw gasoline stocks increase by 16.9 mb, thus rising from mid-range to their highest level in a decade.  In terms of forward cover, the picture is similar, having moved to the top of the range in late January.  But in contrast, stocks of other products fell, with distillates and fuel oil down 0.7 mb and 2.3 mb respectively.

OECD Europe

European industry stocks rose 5.8 mb in December, as a 9.0 mb product stock build was offset by draws in crude and 'other oils' of 2.4 mb and 0.9 mb respectively.  Crude draws were observed in the Netherlands (-2.2 mb) and Italy (-0.7 mb), while France and Germany saw small increases.  Preliminary January Euroilstock data for the EU-15 & Norway show crude stocks effectively unchanged.



Product inventories in Europe rose by 9.0 mb in December, as refinery throughputs increased and high diesel prices drew in imports from around the world.  Distillate stocks increased by 6.7 mb despite winter heating demand, while gasoline and fuel oil added 1.6 mb and 0.6 mb respectively.  The biggest distillate stock build was in France, where levels increased 4.8 mb, while in the Netherlands, they rose 1.9 mb.  Meanwhile, Germany and the UK saw small offsetting draws of 1.5 mb and 0.8 mb respectively.  Despite the December increase, total European distillate stocks remain near the bottom of their five-year range in contrast with above-range levels for the first half of 2007.  The IEA has been notified of an under-counting of Swedish distillate stocks, which will be included when a full historical perspective is available.

Preliminary January data for the EU-15 and Norway show a strong product stock build, largely of distillates, as temperatures were warmer-than-average.  Distillate levels rose by 12.1 mb, while gasoline and fuel oil saw smaller increases of 2.5 mb and 1.2 mb respectively.  Product stocks in the Amsterdam-Rotterdam-Antwerp region rose by 2.4 mb in January, mainly on a large gasoline stock build.  Indeed, gasoline stocks are now at their highest level ever recorded, following strong output and lower-than-average exports to the US and elsewhere.

OECD Pacific

Industry stocks in the Pacific region fell by 16.6 mb in December.  While the fall was driven by crude stocks, which were 10.0 mb lower, total products and 'other oils' fell by 4.1 mb and 2.5 mb respectively.  In crude, the draw was mainly in Japan, where stocks fell by 9.2 mb, which, if confirmed, would be a fall to the lowest level in at least 20 years.  The Japanese crude draw partly stems from above-average refinery throughputs in November and December.  Total Pacific crude stocks at end-December have now fallen to 150 mb, 10 mb below their five-year range and nearly 20 mb below their five-year average.  Preliminary Japanese data for January from the Petroleum Association of Japan (PAJ) show a further crude stock draw of 1.7 mb.  In part these developments appear to show a reluctance of refiners to hold large crude stocks when weak margins are causing discretionary run cuts.  But it also reflects the structural shrinking of Japan's overall crude refining capacity.



In contrast, most of the product stock draw took place in Korea, where levels were down 3.3 mb.  'Other products' fell by 2.3 mb, distillates by 1.3 mb and gasoline by a mere 0.1 mb.  Residual fuel oil inventories increased by 0.4 mb.  In Japan, total product stocks fell by 0.9 mb despite above-average refinery runs.

Preliminary January product stock data for Japan from PAJ show a small draw of 1.1 mb as refinery runs fell again, partly due to the weak margin environment.  Notably, kerosene stocks fell by 3.7 mb, with a smaller dip in residue stocks.  Gasoil/diesel inventories rose 1.2 mb, while there were smaller increments for gasoline, naphtha and jet fuel.

Recent Developments in Singapore Stocks

Product stocks in Singapore, as reported by International Enterprise, rose by 3.4 mb in January.  The increase was dominated by a strong rise in residual fuel oil stocks of 2.8 mb to their highest level ever.  While in part this stems from lower regional demand, notably from China, and a steady influx from outside the region, the picture is somewhat distorted by new large fuel oil storage capacity commissioned in December.  Light distillate inventories rose by 540 kb, while middle distillates were flat in January.  Both remain in line with five-year averages.





Prices

Summary

  • Crude oil prices are little changed from mid-January at just over $90/bbl, pressured by bearish US economic data, warmer weather in Europe and Japan and a stock build in OECD regions (based upon preliminary data).  But some countervailing support came from interest rate cuts, a $150 billion stimulus package for the US economy and crude production shut-ins in Nigeria and the North Sea.
  • Refined product prices fell more than crude on rising gasoline stocks in the US and warmer weather in Europe and Japan.  Chinese import needs have declined from December/January highs as fuel shortages eased and pre-Lunar New Year buying ceased, leading to weaker Asian fundamentals.
  • Already-weak refining margins fell further due to product prices' relative weakness, causing economic run cuts in all three OECD regions.  The exception was the US Gulf Coast, where margins rose due to a slight rebound in gasoline cracks - but there too, cracking margins remain negative.
  • Freight rates in January continued their dramatic fall from December highs, as seasonal refinery maintenance and some discretionary run cuts curbed VLCC demand in the Middle East.  Clean tanker rates softened slightly in January and remain around seasonal averages.


Overview

Crude oil prices are little changed from mid-January at just over $90/bbl, although economic worries, stemming mainly from the US, continued to cast a pall over the prospects for demand growth.  The IMF revised down GDP growth figures for the US, while a steady stream of bearish data on consumer and business confidence, jobless claims and the housing market emanated from the world's largest oil consumer, pressuring prices and causing large day-to-day swings.

To offset the negative economic trend, the US Federal Reserve made two aggressive interest rate cuts totalling 125 basis points, eventually followed by the Bank of England.  The US is also set to implement a $150 billion economic stimulus package.  Moreover, February weather appears so far to be relatively mild in parts of the OECD.  Japan is expected to see warmer-than-average temperatures in February-April while in much of Europe weather is currently warmer than average.

Some price support came from crude production outages in Nigeria, where Shell's inability to access pipelines made repairs impossible and caused the company to declare force majeure on some 130 kb/d of Bonny Light exports.  This brings total shut-in capacity in Nigeria to around 700 kb/d.  Rough weather conditions forced production shut-ins in the North Sea in early February.  On the geopolitical front, the question of a nuclear Iran has been prominent in the media again in recent weeks, as have security issues in Iraq and a spat between Venezuela and ExxonMobil over the renationalisation of the latter's holdings in Venezuela.  Meanwhile, OPEC decided in early February to keep its production levels unchanged, and comments by officials will likely revolve around the supposed need for a cut at the early-March meeting rather than an output increase.



After a 40 mb OECD stock draw in December, preliminary data for the US, Japan, the EU-15 and Norway indicate a 20 mb rise in January.  Several large weekly stock build headlines in the US had tempted talk of a loosening of markets, but a step back and a more global perspective show that this is only really true for US gasoline.  However, the onset of seasonal refinery maintenance generally results in rising crude stocks ahead of the peak summer demand.  Additional economic run cuts over the past few weeks amid weak refining margins should only accentuate this tendency (though conversely, product stocks should fall).  As a consequence, near-month WTI futures contracts occasionally slipped into a shallow near-month contango in early February.

Spot Crude Oil Prices

Crude prices have remained relatively steady compared with product prices.  The onset of refinery maintenance and some economic run cuts will ultimately impact upon demand for crude.  On the other hand, China's recent oil and electricity supply shortages have caused it to seek record-high volumes of West African and other high-distillate-yield grades, which were needed to offset apparent crude stock draws.



As a consequence of lower refinery runs in the US, as well as sustained high imports and rising crude stocks, WTI and Mars have occasionally flipped into near-month contangos.  Also, with Brent supported by North Sea and Nigerian outages, the North Sea benchmark has risen to a slight premium over WTI.    Within the US, WTI has remained quite steady overall versus common US Gulf Coast grades such as Mars, LLS and even far heavier crudes such as Maya.

West African and other light sweet Atlantic Basin crudes are benefiting from the above-mentioned outages as well as Asia's thirst for transport fuels.  Nigerian premia to Brent have risen since early January, as have Mediterranean grades such as Azeri Light and Saharan Blend.  The prospect of a restart of Nigeria's Warri and Kaduna refineries, which would leave less domestic crude for exports, would serve to further underpin West African crude strength.  In the Far East, crude production outages in Australia and Papua New Guinea have served to support Tapis prices, again making inflows from the west more attractive.



As for sour grades, DME Oman futures prices recently rose to a strong premium to spot Dubai.  There is concern that this reflects the imbalance of market participation, with most Asian refiner trade still linked to term deals.  Russian Urals saw discounts to Brent widen on lower demand for the former from European refiners and higher Iraqi output.  Conversely however, Urals slipped into a discount versus Oman, due to the latter's strength, increasing the viability of shipping Urals to Asia.

Refining Margins

Refining margins were almost all down in January, bar a mild recovery on the US Gulf Coast.  Sustained outperformance of crude over products - despite a slight downtick in outright prices - has kept margins very weak or even negative in key refining areas.  This has prompted run cuts on the US West Coast, Northwest Europe and the Mediterranean, and Japan and Korea.  The greatest downturn was on the US West Coast, where weak gasoline crack spreads in particular have dragged once-high cracking margins into negative territory.  The US Gulf Coast saw margins improve briefly, but cracking margins all remain negative.  Europe and Asia saw a similar deterioration.





Spot Product Prices

Most product crack spreads declined as gasoline stocks rose in the US and weather in Europe and Japan turned warmer in late January and early February.  US weather is currently colder, but is not reflected in year-on-year comparisons, as February 2007 was unusually cold there.  In Europe, surging gasoil/diesel prices in December caused an influx of barrels from around the world, but German domestic heating oil stocks still fell to their lowest level in 20 years, partly because of high prices.  Chinese thirst for gasoil/diesel appears to have declined for the time being, following record-high imports in December and January.  February diesel net imports are expected to be around 25 kb/d, far lower than the 190 kb/d seen in December and January following fuel shortages and ahead of Lunar New Year celebrations.  The Asian jet/kerosene market too has weakened, as warmer weather in Japan and elsewhere has seen excess volumes exported.  China is set to buy only 1.7 mb of jet fuel for March, following 3 mb purchases for February.

Gasoline markets have weakened due to surging stocks in the US and Europe, and cracks have remained relatively flat in January/early February.  The US is drawing in high import volumes, and US West Coast gasoline's premium over Singapore barrels has recovered from a weak patch in mid-January, thus opening up further arbitrage possibilities.  On the other hand, European gasoline stocks held in the Amsterdam-Rotterdam-Antwerp (ARA) region rose to their highest ever after export flows to the US and elsewhere dipped.  In Asia, gasoline cracks gained some strength due to the absence of regular Chinese exports for February, following greater domestic needs due to the recent fuel shortages there.  Naphtha cracks meanwhile declined further as large parts of the Asian petrochemical sector headed into maintenance and India looks set to increase exports even further.



Fuel oil discounts to crude widened on growing stocks and weak fundamentals.  China has continued to limit imports after redirecting domestic crude to independent 'teapot' refineries.  As a consequence, independently-held Singapore fuel oil stocks surged to their highest level ever in January.  Strong inflows from the west assisted this development, but it is also due to substantial new storage capacity being commissioned at the end of last year.  What remains to be seen is how the electricity shortages in China develop, and to what extent this requires fuel oil or diesel imports to serve utility needs.  To a large extent this will depend on the restoration of coal stocks at power generators over the coming months and the availability of coal supplies during peak demand periods (see Frozen Prices + Freezing Weather = Energy Shortages on page 14-15).





End-User Product Prices in January

End-user product prices were mixed in January, but were mostly up, lagging December's surge in spot prices.  Gasoline retail prices were up 2.0% on average, in US dollars, ex-tax, though this masks some divergent movements.  Germany saw end-user gasoline rise by 10.4% in December, in US dollars, ex-tax, and France had an increase of 5.5%, while Italy, Spain and the UK saw dips in the 1-3% range.  Average diesel prices were up 0.5%, with rises of over 3% in France and Japan offset by a similar dip in Italy.  Heating oil prices on average rose 1.8% in US dollars, ex-tax, while low-sulphur fuel oil for industry saw strong gains of 5-10% in Europe.

Freight

In January, crude tanker rates completed their dramatic fall from the multi-year highs of December to below five-year seasonal averages.  Westbound VLCC demand in the Middle East has decreased as the arrival horizon for long-haul voyages now falls well within the spring refinery maintenance period.  Discretionary refinery run cuts in several regions may also have undermined dirty rates in January, while transit delays in the Turkish Straits remain very low compared with previous years.  Clean tanker rates softened slightly in January and remain around seasonal averages.

With refinery maintenance typically hitting a seasonal peak in March, prompt westbound crude tanker demand has fallen in the Middle East.  This has been exacerbated by discretionary run cuts in the US, Europe and the Far East, further undermining demand for dirty vessels.  Middle Eastern tanker availability has consequently risen, easing freight rates.  From the Middle East to Japan and the US Gulf respectively, VLCC rates were at $17/tonne and $25/tonne in early February, down from $34/tonne and $60/tonne at the start of 2008.  By the end of January, Suezmax and Aframax rates also fell from December highs to within seasonal ranges.  Early February did however see a small uptick in dirty rates from the Middle East Gulf to Japan.



Intra-Asian clean rates softened in January on signs of continued weak regional kerosene demand and ample vessel availability in the region.  High Chinese product imports remained supportive in January, although sales dropped off at the start of the Lunar New Year holiday, prompting a hiatus in chartering.  Transatlantic clean rates improved slightly until mid-January, but weakened again as less gasoline flowed towards the US.

Refining

Summary

  • Refinery throughputs in January and February have been pressured by the most extensive economic run cuts in five years.  Coupled with seasonal maintenance, February global refinery crude throughput is therefore forecast to average 74.0 mb/d, down 0.6 mb/d from January.  Consequently, estimated 1Q08 crude throughput at 74.2 mb/d, is down 0.3 mb/d from last month's projection. However, runs are still 0.9 mb/d higher year-on-year, driven by increases in China, Other Asia and Russia.


  • December crude throughputs have been revised upwards by 0.5 mb/d on the back of much stronger-than-anticipated Middle East crude throughput, and higher-than-expected Russian and Chinese runs. Provisional data for OECD regions indicate that crude throughput was 39.8 mb/d, marginally below expectations.
  • November OECD gasoil/diesel yields reached another record level, following the installation of new upgrading capacity.  The increase in US distillate yields continues apace, as refiners concentrate on the production of ultra-low-sulphur diesel rather than boosting gasoline supplies ahead of the spring - preferring instead to import gasoline blendstocks from Europe.
  • Russian refinery throughput averaged 4.6 mb/d in 2007, significantly ahead of the five-year average of 4.0 mb/d.  Increased crude throughput has come from a mixture of complex and hydroskimming refineries, which, given the poor state of hydroskimming margins, suggest that upstream and export tax regimes are partly responsible for the growth.  However, the current tax system appears to penalise investment in upgrading capacity, which may become an issue for the medium term.

Global Refinery Throughput

January saw reports of refiners trimming crude runs in response to the weak margin environment in Europe, the Pacific and the US.  European refiners are reported to have cut runs by 150 kb/d, including Preem's Gothenburg, Conoco's Wilhelmshaven and Whitegate, and Petroplus's Belgian refineries in Northwest Europe and Hellenic Petroleum's Elefsis refinery in the Mediterranean.  Other refineries are likely to have also implemented cuts where possible, given that the January Urals hydroskimming margin was negative $5.41/bbl in NWE.

US refineries cut runs in most regions in January and early February, although the reported cuts appear heavier on the West and Gulf Coasts.  Poor margins, driven by weakness in gasoline cracks, have forced several refiners, notably Valero, Tesoro and Alon, to cut back runs by around 5% at some plants.  Run cuts are also likely on the US East Coast, as warmer weather in the US Northeast reduced demand for heating oil, which normally drives winter margins.  Furthermore, the weakness in margins has already prompted some refiners to re-evaluate planned capital spending programmes, with a view to delaying or cancelling projects.

In the Pacific, Japanese refiners have moved quickly to curtail runs, dropping crude throughput by 7% from the December peak.  Some refiners are planning to raise exports to offset the weakness in domestic kerosene demand.  Conversely, four of the five refiners in Korea have cut runs to reduce export volumes; while the fifth, GS Caltex, is preparing for a turnaround at its plant, following operational problems with its recently commissioned heavy oil upgrading unit.

First-quarter global refinery crude throughput is projected to average 74.2 mb/d, 0.3 mb/d lower than in last month's report, on the back of a weak margin environment and widespread economic run cuts.  Further downward revision to 1Q08 estimates is possible if the current weak margins persist.  Annual growth of 0.9 mb/d is concentrated in China, Other Asia and the FSU.  Weaker Latin American throughput reflects the operational problems at the Aruba refinery and some Venezuelan refineries.  Offsetting the impact of weaker margins, renewed pressure from the Chinese central government on state oil companies looks likely to result in higher-than-forecast crude throughput in China, lifting our forecast by 0.2 mb/d for the quarter.

December global crude throughput is estimated to have averaged 75.5 mb/d, 0.5 mb/d higher than estimated in last month's report, given a reported surge in Middle East crude runs, largely due to higher Saudi Arabian crude throughput.  Furthermore, crude throughput in Iran and Kuwait continued to run 50-100 kb/d ahead of our forecasts in December.  Consequently, fourth-quarter global crude throughput is revised upward by 0.3 mb/d to 73.8 mb/d, after factoring in smaller upward revisions to November (+0.1 mb/d) and October (+0.3 mb/d), following upwardly revised Belgian crude throughput and higher-than-forecast fourth quarter crude runs in Indonesia.



US crude runs averaged around 14.9 mb/d in January, significantly below our estimate.  Having started the month at 15.8 mb/d, crude runs declined rapidly over the course of the month to end at 14.5 mb/d, as a result of the factors discussed above.  Further weakness in February is likely, depending on the evolution of margins.  Should margins deteriorate from current levels, run cuts may be more prevalent at cracking refineries as these also seek to curtail crude runs. The purchase of cheaper atmospheric residue would allow them to continue running upgrading capacity, which remains profitable, and simultaneously purchase distillate requirements from the market.  However, such a strategy entails significant costs in terms of additional freight and refiners have not had the need to consider such strategies since 2002, the last time there was a protracted period of poor margins.  The switch to summer grade gasoline in the coming months is seen as a possible catalyst for boosting margins, due to the increased complexity of blending summer grade gasoline with ethanol, the use of which continues to rise in the US.  Furthermore the restoration of full operations at BP Texas City, likely to be completed in the second quarter, will significantly improve the supply picture for Gulf Coast gasoline.



Japanese weekly data point to a declining trend in crude runs in January, although not as dramatic as in the US.  Nevertheless, crude runs were off 7% from their mid-December peak by month-end and are estimated to average 4.2 mb/d for the month.  We forecast crude runs to decline further in February, to an average of 4.1 mb/d, as the aforementioned economic run cuts curtail crude throughput.  Nippon Oil, the largest refiner in Japan, recently highlighted the weakness in kerosene demand relative to historic heating requirements, pointing towards a breakdown of the relationship between demand for kerosene and heating degree days, due to the high price of kerosene relative to gas and electricity.



The relative importance of independent refiners in the US (and similarly Japan) suggests that average run-rates will be more responsive to the margin environment than in areas where refineries are predominantly owned by integrated or national oil companies.  Independent refiners generally have no upstream business with which to offset the weakness in refining profitability, and consequently will react more vigorously to restore profit margins in the face of over-supplied markets.





Provisional December data for the OECD show that crude runs reached 39.8 mb/d, up 1.1 mb/d from November and flat on December 2006 level.  Stronger year-on-year crude runs in the Pacific, relative to both seasonal norms and the previous year reflect stronger demand for heating-related products and a small increase in Korean refining capacity.  European crude throughput recovered in December from a weak November, driven by higher throughput in Germany, Italy, the Netherlands and Spain.

December Middle East crude runs were significantly ahead of our estimate, driven by a strong rebound in Saudi Arabian crude throughput.  Reported Saudi Arabian crude throughput was exceptionally strong, at nearly 2.1 mb/d, 0.2 mb/d above nameplate capacity of 1.9 mb/d.  This level of crude throughput is 0.8 mb/d higher than November, when the 0.4 mb/d Rabigh refinery was reported to be under maintenance.  Pending confirmation of the level of crude throughput, we have left forecast Saudi crude runs in the range of 1.8 mb/d.  Elsewhere, crude throughput in Iran and Kuwait continued to run 50-100 kb/d ahead of our forecasts in December, and we have lifted forecasts by 50 kb/d for each country.  Conversely, operational problems at Iraqi refineries in January have cut forecasts by around 150 kb/d, following fires at refinery units and electricity supply problems which reduced crude throughput.

Latin American crude throughput in January is revised down by 0.1 mb/d, with further operational problems at PDVSA refineries reducing throughputs in Venezuela.  Similarly, a fire and operational problems at Valero's Aruba refinery also reduced our estimate for February by 0.1 mb/d, with a prolonged outage of the vacuum tower likely to tighten US Gulf Coast vacuum gasoil markets.  While reports suggest the Valero refinery has restarted some crude processing, the problems at PDVSA refineries seem more entrenched, possibly linked to reports of minimal spending on preventative maintenance.

Chinese December crude throughput hit a new record level of 6.9 mb/d, up by 0.1 mb/d on the month, and by 0.5 mb/d on previous year levels.  Chinese state oil companies have raised crude throughput in response to renewed political pressure from central government to alleviate product shortages.  The unattractive economics of refining crude as a result of capped domestic prices has been partly offset by the rising value of the Chinese currency against the US dollar and reports of payments by the Chinese government to at least partly compensate Chinese state oil companies for losses incurred.  The continued supply of crude by state oil companies to independents, who have shunned processing fuel oil as part of their normal feedstock in recent months, and increased guidance from state refiners, suggest that 1Q08 crude throughput could average 6.9 mb/d.  Diesel imports are estimated at 170 kb/d for January, down slightly from December's record 200 kb/d, while February imports are currently estimated at just 25 kb/d as weaker demand has cut the need to import such large volumes.

OECD Refinery Yields

OECD middle distillate yields reached a new record level in November, as European yields bounced back with the restart of hydrocracking capacity in France and despite the operational issues with Neste's Porvoo residue hydrocracker during the month.  December data on gasoil/diesel yields could see further increases, given the restoration of the Neste hydrocracker and the continued premium of ULSD cracks to gasoline.  North American middle distillate yields also reached record levels, driven by the continued trend of rising US diesel/gasoil yields.  OECD Pacific gasoil/diesel yields were steady at 28%, following the start-up of LG Caltex's heavy oil upgrading unit.  First-quarter gasoil/diesel yields will be depressed if recent reports of operational problems with this unit are accurate, but as was the case in early 2007, economic run cuts may depress overall fuel oil yields in the Pacific as refiners scale back crude throughput to limit exposure to weak hydroskimming margins.



The corollary of the strengthening gasoil/diesel yield has been pressure on fuel oil yields which have been at or below the bottom of the five-year range for the OECD for much of 2007. This continues the long-term trend seen for many years.  More recently it has been Europe and the Pacific that have driven the reduction. Year to date fuel oil yields have averaged 14.9% in Europe and 15.6% in the Pacific, a decline of 0.8 and 1.4 percentage points (5% and 8% respectively) from their respective five-year averages.  North American fuel oil yields, already the lowest of the three OECD regions, have not witnessed such a move, largely as lower petroleum coke yields, possibly linked to increased downtime, has resulted in higher fuel oil yields compared with 2006.

Russian Refining - Driven by Economics or Taxes?

The Russian petroleum tax structure heavily incentivises the industry to export refined products, rather than crude oil.  As a result, Russian crude throughput averaged 4.6 mb/d in 2007, a new post Soviet era record and an increase of 4% on 2006 and 15% above the five-year average.  However, while this 'value added' strategy is common among oil producing countries, in Russia the tax structures may result in strategies which fail to properly promote the necessary long-term investment in the industry.



The 2004 change to the tax code has contributed to sharply higher product exports, concentrated in the six plants detailed above, which accounted for more than half the increase in Russian throughputs in 2007.  As these refineries are owned by upstream producers, they face a clear choice between selling crude domestically, exporting it or refining it, taking into account a variety of factors, including:

  • domestic refining capacity and domestic product sales;
  • crude and product pipeline capacity, (both domestic and export);
  • access to alternative export infrastructure, e.g. rail or barge shipments; and
  • the incentive provided by the Russian tax code to optimise between domestic and export sales of both crude and products.

The revenue flows to these companies are heavily influenced by the Russian tax code and can change dramatically depending on the evolution of world oil prices, providing significant incentives to integrated Russian oil companies to adjust their sales methods. Russian oil companies pay three separate taxes on their activities:

  • Royalty on crude production; taxed at 22% after certain allowances.
  • Export tax; based on the market price of Urals crude in the preceding two months.  Light products attract a 30% discount on the tax charged and fuel exports benefit from a 60% discount.
  • Corporate profit tax of 24%, charged on net income, in common with other industries.

At the time of writing, Russian government tax revenues were around $65/bbl while integrated oil companies report net income closer to $10/bbl.  The lagged nature of the current tax structure can also significantly distort the economic incentive to refine crude oil, and at times, sell products into the domestic market, rather than export them.  The lower tax burden on fuel oil reduces the incentive to invest in upgrading capacity, with the post-tax margin between hydroskimming and cracking refineries much narrower than in Europe.  The graphs below show the incentives created by the tax system.



The  tax structure is clearly effective in incentivising the running of crude through a refinery, targeting products either for domestic or export sale, against the alternative of exporting the crude.  However, the increase in refining crude runs has also been influenced by other factors such as pipeline capacity constraints and local demand for transportation fuels and the imperative to sustain gas availability for export.



These factors aside, it is apparent that the net income per barrel that companies achieve is quite dramatically affected by the overall price trend, i.e. in a falling market the lagged nature of the export tax can materially depress net income.  Similarly, in a rising market, the impact of the export tax is offset as revenues rise ahead of the calculated tax burden. 

Whereas in Europe refinery throughput has been expanded in complex refineries, or simple refineries have been upgraded to a more sophisticated configuration, in Russia it would appear that more than half of the refiners who have increased runs would be categorised as hydroskimming operators rather than catalytic cracking, based on fuel oil yields.  This is partly driven by the current tax structure, which appears to reduce the incentive to invest in upgrading equipment by a refinery over the medium term.

In the short term, this is not necessarily a problem as long as the market is able to absorb or reprocess partly refined fuel elsewhere. The tighter fuel specifications coming into force in many countries around the world may make it harder for importing countries to be in a position to readily process partly refined fuel. In particular, given the uncertainty of sustainable supplies from Russia in a fluctuating oil market and the high cost of installing upgrading and desulphurisation equipment, European or American refiners may be less-than-enthusiastic about installing surplus additional capacity to handle Russian exports. The potential for Russia in future to require greater domestic fuel oil use as a substitute for tightening gas supplies complicates matters further.

The Russian tax system has clearly incentivised the export of products over crude oil. However, with an eye to the future, the structure as it currently stands may fail to deliver long-term benefits to the refining industry. A simpler tax system could have provided Russian refiners with the same incentive to boost crude throughput, while investing in upgrading capacity, as has been seen in the OECD and that has delivered significant results.