Oil Market Report: 11 April 2008

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Highlights

  • Crude futures set new records above $110/bbl in early April, driven by tight distillate markets, strong non-OECD imports and a weaker dollar.  Refining margins remain extremely volatile, reverting into positive territory in recent weeks following a large US gasoline stock draw, which has tightened regional supplies.
  • Global oil product demand has been revised down by 310 kb/d in 2008 to 87.2 mb/d following the downgrading of global GDP prospects by the IMF, coupled with a change in FSU methodology and baseline data revisions.  By the same token, 2007 demand is up by 140 kb/d over last month's report to 86.0 mb/d.  As a result of these divergent shifts, demand growth in 2008 is now expected at almost 1.3 mb/d or 1.5% over 2007.
  • Global oil supply fell by 100 kb/d in March to 87.3 mb/d, led by lower supplies last month from OPEC, the North Sea and non-OPEC Africa.  Non-OPEC supply growth in 2008 is trimmed to 815 kb/d on a broad swathe of adjustments in the Americas, Africa and Europe.
  • OPEC crude supply fell by 265 kb/d in March to 32.1 mb/d, on field maintenance in UAE, Nigeria and Venezuela.  Pipeline/power outages highlighted ongoing risks to production in Iraq and Nigeria amid effective spare capacity of just 2.3 mb/d.  Weaker economic growth cuts the 2008 call on OPEC by 0.3 mb/d to 31.6 mb/d.
  • OECD total industry stocks fell by 48.9 mb in February, to 2,579 mb, offsetting a similar rise in January.  The February draw leaves inventories At 53.3 days of forward demand.  With preliminary data indicating a build of just 4.1 mb in March, OECD end-1Q08 stocks remain close to end-December levels.
  • Global refinery throughput weakened in March, as poor margins curbed crude runs in all OECD regions.  Estimated 1Q08 global throughput is unchanged at 74.0 mb/d.  However, 2Q08 estimates have been cut by 0.2 mb/d to 73.7 mb/d, in line with weaker demand.

Market overview

The latest GDP projections from the IMF suggest less robust oil demand growth in the coming months.  With the multitude of variables currently at play in the oil market, is it a step too far to infer a weakening of prices?

Year-to-date investment fund inflows have, by some estimates, exceeded $30bn, but in recent weeks these flows have been particularly erratic. Falling open interest in NYMEX light sweet crude (WTI), and a similar trend in non-commercial net longs and derived estimates of index fund inflows raise questions as to the weight of money argument on recent price moves.  The impact these flows have had in recent years also remains unclear.  An IEA Expert Roundtable in March discussed the many aspects that feed the current oil price.  There were vastly different views on the effects of money flows on the oil market.  In the IEA's opinion, the limited information available makes it impossible to account meaningfully for the cross-market interactions that routinely take place between different futures exchanges and over-the-counter (OTC) markets.  Further, what information there is fails to capture the true split between commercial and non-commercial activity.



However, while the weight of money debate remains open, there is an almost unanimous agreement among analysts that the oil price has recently been compensating for the weakness of the US dollar - indeed, stripping out the currency impact since 2007 shows a much closer fit between oil prices and global balances.  But, aside from the weaker dollar, the latest rise in oil prices also coincides with record distillate cracks and strong demand from China and other non-OECD regions - with the market in reality perhaps even tighter due to non-OECD stock changes.  This could explain why prices have not declined despite a backdrop of weakening US GDP and lower projected global economic growth.

Given the multitude of variables that form the oil market, the spot price inevitably has a narrow, short-term focus.  The future, painted by the latest IMF economic forecast, depicts a deteriorating economic environment this year and next, and has largely contributed to a 460 kb/d reduction in 2008 oil demand growth, now seen at 1.3 mb/d.  But while the global economy remains a dominant part of the landscape, the supply-side risks - stemming from above-ground and geopolitical issues - also remain critical.  A spate of disruptions in recent weeks, pipeline sabotage in Nigeria and Iraq and a strike in Gabon bring these issues to the fore.  Individually, none of these are particularly serious, but together they illustrate the potential for downside supply risks.

This report projects April and May oil balances tipping towards a supply surplus.  If that sounds familiar, it should.  Stocks rose throughout the first half of 2007, but that did not stop WTI rising from $60 to nearly $80/bbl at the same time - as the market correctly anticipated a tight second half of the year.  That perhaps explains why, in the face of weakening economic growth, prices continue to remain high: there is concern that projected stockbuilds may not materialise, or may not be high enough to cushion against low spare capacity and geopolitical risks.  Faced with evidence of rising stocks and easing distillate tightness, the mid-year situation may be different, but presently neither the data nor market spreads show that is a sure bet.

Demand

Summary

  • Global oil product demand has been significantly revised for both 2007 and 2008.  World demand is now estimated at 86.0 mb/d in 2007 (+1.3% or +1.1 mb/d over the previous year and +140 kb/d over last month's report).  In 2008, demand is expected to reach 87.2 mb/d (+1.5% or +1.3 mb/d over 2007, and -310 kb/d compared with the last report).  These revisions are due to a confluence of factors: firstly and most importantly, a significant downward adjustment to global GDP forecasts, notably in the US, based on the most recent IMF assessment; secondly, the introduction of a new FSU methodology, based on primary rather than apparent demand figures, which results in a higher base; and thirdly, baseline adjustments and revised data submissions.
  • OECD oil product demand has been lowered by some 320 kb/d to 48.9 mb/d in 2008 (-0.3% or -0.2 mb/d over 2007).  The changes result from the IMF's considerable adjustment of its US GDP forecast (from 1.5% to 0.5% in 2008) and from a large downward revision to US January data, which largely offset strong demand for heating and power generation fuels in Europe and the Pacific.  Given the virtual stagnation of the US economy and the prevalence of historically high oil prices, US demand is expected to contract by as much as 2% in 2008, to 20.4 mb/d.


  • Non-OECD oil product demand has been revised up by roughly 150 kb/d to 36.9 mb/d in 2007 (+3.8% or +1.4 mb/d over the previous year) but kept unchanged at 38.3 mb/d in 2008 (+3.9% or 1.4 mb/d).  The 2007 revision was almost entirely related to the adoption of the new FSU methodology, which implied adjustments in all quarters.  Meanwhile, in 2008, minor downward adjustments in Africa, China, Europe and the Middle East offset upward changes in the FSU, Latin America and Other Asia, due both to stronger than expected monthly submissions and alterations in baseline data.

Global Overview

This month's report includes several key adjustments that have noticeably altered both 2007 oil demand levels and the 2008 forecast.  Global oil product demand is now estimated at 86.0 mb/d in 2007 (a growth rate of +1.3% or +1.1 mb/d over the previous year) and is expected to reach 87.2 mb/d in 2008 (+1.5% or +1.3 mb/d over 2007).  These new figures imply significant revisions versus last month's report, and result from several factors.

1.     GDP adjustments.  The IMF released the latest edition of its World Economic Outlook on 9 April, revising down its previous assessment of global economic growth - upon which this report's econometric demand model is based.  This was particularly dramatic in the case of the US (growth in 2008 was cut from 1.5% to 0.5%), but most OECD countries were also adjusted down.  More interestingly, although most emerging economies were also revised, such changes were somewhat less pronounced relative to their growth trends: some were slightly down, such as China (from 10.0% to 9.3%), while others were up, such as Brazil (from 4.5% to 4.8%).  This suggests that the case for 'decoupling' has some merits (see text box below); for the first time, a sharp US economic downturn is not expected to cause such significant impact in key emerging countries as in the past.

2.     New FSU methodology.  As often highlighted in previous reports, estimating apparent FSU demand based on supply and trade data was sub-optimal, notably because of the volatility of trade figures, which often led to large revisions.  We have been able, however, to finally obtain reliable oil demand data for several key FSU countries, notably Russia, and as such FSU demand has now become the sum of oil use among regional countries.  Overall, this new and more detailed methodology indicates that FSU demand grew by 0.9% in 2007 (implying a +150 kb/d revision versus the previous report), and that it should further expand by 1.6% in 2008 (a +70 kb/d revision).  This contrasts with implied demand data, which suggested a contraction in demand during 2007 despite buoyant GDP growth.

3.     Baseline adjustments and revised data submissions.  We are integrating new annual non-OECD demand figures for 2006 as they become available, in addition to systematically including revisions to previously submitted data.  We have adjusted up both Latin America and Other Asia demand (collectively by +80 kb/d in 2007 and +120 kb/d in 2008), and more significantly, US demand in 1Q08 (-390 kb/d) given a massive revision to weekly estimates in January.

Weaker-than-expected economic growth has the greatest implications for global oil demand.  There is the question of OECD demand growth, which has basically been sustained by North America in recent years.  As oil prices began their relentless rise in 2004, many observers predicted a significant contraction in OECD oil demand - which did not materialise until late 2007.  Such an assessment, however, ignored that OECD oil demand is essentially driven by transportation fuels.  These are both highly price inelastic, notably in areas such as North America where public transportation alternatives are limited, and relatively stable in terms of consumption, reflecting the fact that developed economies are mature and that changes in income must be quite large to elicit significant variations in oil demand.



Short-term changes in OECD oil demand tend to reflect weather patterns and power generation needs, which can prompt very large swings in consumption levels.  Indeed, the unusually mild winter temperatures observed in the past two years largely explain why OECD oil demand contracted slightly in both 2006 and 2007.  In the medium term, by contrast, oil demand is clearly affected by income variations (there is usually a time lag between changes in income and oil demand).  The US economic slowdown began in mid-2007, and gasoline demand has finally started to contract.  And yet this decline has been relatively moderate so far, considering that the economic outlook has worsened markedly.  This is not to say, however, that a US downturn is inconsequential.  As the latest revisions suggest, total oil demand has contracted by more than expected and should continue to fall in the months ahead, as consumers adapt their consumption patterns to the less benign economic circumstances.

Given the weight of US demand, we have adjusted down our 2008 prognosis for OECD North America by 270 kb/d.  Elsewhere in the OECD, transportation fuels demand is essentially flat, reflecting the fact that economic conditions appear to be less bleak than in the US, but demand for other types of fuel remains strong.  Indeed, oil demand in Europe and the Pacific has largely been supported by heating needs (late heating oil buying in Germany and a strong kerosene rebound in both Japan and Korea) and electricity requirements (residual and direct crude deliveries in Japan as a result of continued nuclear power plant outages).  Overall, OECD oil product demand has been revised down by 320 kb/d, compared with the previous report, to 48.9 mb/d in 2008.



By contrast, oil consumption in two key non-OECD areas (the Middle East and Asia, which together account for over 80% of global oil demand growth) is likely to continue expanding apace, largely offsetting marginal declines in other non-OECD regions.  In both areas, demand is driven by strong economic momentum and continued urbanisation, industrialisation and population growth, coupled with favourable end-user administered price regimes.  This last point is particularly true in the Middle East, where high international oil prices have led to rising incomes (the IMF has actually revised up its GDP forecast for this region), not to mention the fact that energy prices there are among the lowest in the world.

Within Asia, China remains the single most important driver.  In this country, the determinants of oil demand are more complex; oil use has indeed risen with income, but at a slightly slower pace.  Although the difference can be partly explained by its relatively more efficient oil use, a key aspect behind this dichotomy is China's pricing policy.  Capped end-user prices do indeed encourage demand, notably for transportation fuels, by shielding Chinese consumers from the vagaries of the international oil market.  However, they also prompt widespread shortages whenever international prices rise sharply, since local refiners find that supplying the domestic market becomes unprofitable.  In that sense, pent-up demand in China is arguably significant, only limited by supply constraints, which since last year have become a usual occurrence.  Paradoxically, even if economic growth were to slow down slightly and/or if end-user prices were to be liberalised (the main constraint being further inflationary pressures), Chinese oil demand could potentially increase, if only supplies were sufficient to meet such a surge.  In the meantime, we have only slightly adjusted down the country's demand in 2008 (-70 kb/d) to account for the 1Q08 weather disruptions and slightly lower economic growth projections, but an Olympics-driven upward revision cannot be discarded.

Decoupled Globalisation?

As the United States slips into a sharp economic slowdown, some observers predict that this will inevitably affect the rest of the world.  The argument behind this view is that globalisation has synchronised the world's main economies via trade and financial flows.  However, even though a US downturn will likely affect other countries, there is some evidence that the so-called 'decoupling' effect - understood as a more limited impact on developing economies than that observed in the past - is actually taking place.  As such, the outlook of global economic activity and oil demand growth is brighter than commonly assumed - a conclusion that is tacitly shared by the IMF, whose 2008 global GDP growth forecast is still a relatively healthy 3.7%, despite the woes of the US economy.

Three key structural factors support the decoupling case: 1) emerging countries trade increasingly among themselves, rather than with developed economies; 2) domestic investment and demand, as opposed to net exports, have become the main driver of economic growth in the largest emerging economies; and 3) the price of commodities - a key export from developing economies - is no longer mainly sustained by demand from rich countries, but mostly by emerging ones, engineering in turn a boom among commodity exporters.  China is the exemplary incarnation of these trends.  Half of its exports go to other emerging countries, notably Brazil, India and Russia; its domestic consumption and investment (of which almost half is devoted to infrastructure and property) contribute to roughly 80% of nominal GDP growth; its domestic demand is boosted by productivity gains and growing wages; and its insatiable appetite for commodities, ranging from oil to coal and soy, has helped sustain price booms in other emerging (and a few developed) countries.

A protracted US recession is not yet on the horizon, according to the IMF forecast, which still sees low but nonetheless positive US growth in both 2008 and 2009, despite the continuing problems in the country's financial and housing sectors, the fall of the dollar, signs of weakening activity in manufacturing and services, and rising inflationary concerns.  Yet the course of the global economy is arguably increasingly dependent upon Chinese developments.  What is then the outlook for China's economy?  As noted, China's export sector can arguably weather falling US demand, as long as demand elsewhere remains buoyant.  This, in turn, is likely to have a supportive effect for other developing economies, particularly primary commodity producers (strong Chinese demand for commodities => higher income in exporting countries => growing demand for Chinese goods => further Chinese demand for commodities).

A bigger uncertainty concerns the Eurozone, which has become China's main trading partner and which is arguably more prone to be affected by a US slowdown, as the IMF predicts.  Yet Europe may manage to hold its ground, as long as capital exports from Germany - which is the main engine of the European economy - remain relatively strong.  Perhaps more crucially, as long as the yuan remains undervalued vis-à-vis the euro, China's exports to Europe should also remain reasonably buoyant.  And even if exports to Europe were to fall dramatically, China's significant foreign currency reserves - resulting from its huge current account surpluses - gives it leeway to conduct a countercyclical fiscal policy if needed.

OECD

According to preliminary data, total OECD inland deliveries (oil products supplied by refineries, pipelines and terminals) contracted by 0.8% year-on-year in February, with North American losses largely offsetting gains in Europe and the Pacific.



Oil product demand in OECD North America (which includes US Territories) plummeted by 4.1%, dragged down by the US; only gasoline posted marginal gains (+0.1%), given the resilience of Canadian and Mexican demand.  In OECD Europe, demand growth (+1.7%) was as expected supported by a rebound of heating oil deliveries, notably in Germany, given somewhat colder weather.  Continued strong demand for residual fuel oil and direct crude for power generation in Japan, together with higher deliveries of kerosene in both Japan and Korea following sharply colder temperatures, boosted demand in OECD Pacific (+4.5%).





North America

Preliminary data indicate that oil product demand in North America (including US Territories) contracted by 4.1% year-on-year in February, mostly as a result of a general weakness in all product categories in the US.  Regional gasoline (+0.1%) and diesel (+11.4%) demand was largely supported by Canadian and Mexican needs.  The contraction in deliveries was particularly marked in the case of high-sulphur gasoil (heating oil), which fell by 34.3% (although this is partly related to reclassification issues in the US, since low-sulphur non-road, locomotive and marine gasoil is now counted as diesel) and residual fuel, which plummeted by 27.5%.  Given current trends, OECD North American demand is expected to average 25.2 mb/d in 2008 (-1.5% when compared with 2007).

Adjusted preliminary data indicate that inland deliveries in the continental United States - a proxy of oil product demand - contracted by 5.3% year-on-year in February.  The fall was related to weak demand across the key product categories (gasoline: -0.6%; jet fuel/kerosene: -2.3%, gasoil/diesel: -5.1%; residual fuel oil: -41.0%).  To a large extent, this contraction - notably with respect to transportation fuels - reflects a deteriorated economic environment, as the country's marked economic slowdown is compounded by high oil prices.



Even though these figures are in line with previous estimates, the significant downward revisions to January demand statistics (660 kb/d) were much larger than expected.  Revisions are usual (given the inherent differences in the ways that the US Energy Information Administration collects monthly and weekly data), but they have rarely been so large.  Although it could be tempting to attribute January's adjustment to worsening economic conditions, it should be noted that two-thirds come from changes to preliminary weekly estimates for oil products that are mostly related to heating and power needs (high-sulphur gasoil, residual fuel and 'other products', which together account for some 18% of US demand).  By contrast, the adjustment to those products that are more sensitive to the level of economic activity (gasoline, jet fuel/kerosene and diesel, which account for 69% of US demand) was relatively limited (that is, relative to the size of US demand and compared with historical revisions).  Overall, the revisions may suggest that interfuel substitution in favour of natural gas has been higher than expected, despite relatively cold weather (the number of US heating-degree days in January was both higher than the 10-year average and than in the same month of the previous year).  This is particularly true for residual fuel oil, but in the case of propane and distillates it is likely related to a postponement of tank refilling due to high prices.



Nevertheless, as expectations that the credit crisis that erupted in mid-2007 risks becoming a prolonged slump take hold, US consumers have begun to adopt a more energy-conscious lifestyle.  Consumers are acting on several fronts: 1) reducing discretionary driving (fewer random drives in the countryside and more walking to shops, according to a New York Times online survey); 2) increasing their usage of public transportation, notably in urban areas (according to the American Public Transit Association, mass transit use increased by more than 2% in 2007, reaching the highest level in half a century); and 3) switching to more efficient vehicles (sales of large SUVs fell by some 25% year-on-year in early 2008, while those of the smallest cars jumped by almost 40%).  Admittedly, the fall in pickup sales is partly related to the virtual halt of home construction activity.  Nevertheless, the change in vehicle purchasing patterns, if sustained, will have far-reaching consequences in the medium to longer term.  Given these developments, we anticipate that gasoline demand will decline in 2008 (-0.9%), for the first time since the mid-seventies.  Total US oil product demand, meanwhile, is poised to contract by as much as 2% in 2008, to 20.4 mb/d.



By contrast, transportation fuels demand in Canada and Mexico continues to roar ahead.  In Canada, both gasoline and diesel demand rose by an estimated 1.7% year-on-year in February, according to preliminary data.  In Mexico, the rise was even more spectacular: +6.5% and +7.8%.  These growth rates are the more remarkable considering that the US economy - the main market for both countries' exports, which account for a big share of their respective GDPs - has markedly slowed down.  Arguably, as discussed earlier, the economic resilience of both Mexico and Canada is grounded in two key elements: strong internal demand and high earnings from commodity exports - notably energy.  As such, the IMF still sees both countries growing three to four times faster than the US in 2008 - an unprecedented occurrence in the case of Mexico, where the strength of domestic demand is a relatively new feature.  Nevertheless, the pace of oil demand growth is both countries will probably be somewhat slower than in recent years.



Europe

Preliminary inland delivery data show that European demand rose by 1.7% year-on-year to 15.6 mb/d in February.  Across the continent, however, diverging trends emerged, with Germany growing by 8.3%, France remaining relatively flat at +0.8% and Italy and the UK contracting by 5.4% and 2.8%, respectively.  Heating oil, in particular, grew strongly (+13.6%) in Europe as a whole, with German demand rebounding by 35%.  Diesel demand remains surprisingly robust in the main economies, expanding by 3.2% despite a moderation in economic growth and high end-user prices.  Residual fuel oil, meanwhile, was very weak (-9.8%), contracting in all main countries (France, Germany and Italy).



Despite February's poor weather (colder than last year and than the 10-year average), the rebound in demand was less strong than anticipated, leading to a downward revision of about 100 kb/d for the month.  This suggests that continued high prices are starting to have a real effect on consumer behaviour.  Moreover, the IMF's new economic projections have entailed further downward adjustments to our 2008 oil demand forecasts for several key countries.  Although GDP growth in the Eurozone has been only revised down by 0.2% to 1.4%, this masks more substantial revisions.  For example, GDP growth projections in Italy and Spain are sharply down (to 0.3% and 1.8%, respectively), those for France and Germany are minimally changed (1.4% each) and that for the UK is slightly up (1.6%).  Coupled with weaker-than-expected January final data across most countries (with the major exception of Turkey, as discussed below), oil demand in 2008 has been revised down by 41 kb/d to 15.4 mb/d (+0.4% over 2007).

German demand has been adjusted down slightly in both 2007 and 2008, following revisions to the 2007 monthly submissions, as well as for January 2008 (demand for both diesel and heating oil was weaker than expected, leading to a downward adjustment of 50 kb/d for total gasoil).  February preliminary data, however, was very much in line with our forecast (+8.3% on a yearly basis).  Despite temperatures close to the 10-year average in both February and March, heating oil demand was below the historical average in February, suggesting a consumer response to high prices.  Meanwhile, Germany's demand for transportation fuels (particularly diesel) continues to grow at a surprisingly fast pace.  Total transportation demand (including motor gasoline, diesel and jet fuel) grew by 9.9% in January and 3.4% in February.



German end-user stocks of heating oil declined in line with seasonal trends in February, falling to 49% of capacity (from 52% by end-January).  This represents a stock draw of about 200 kb/d, just slightly below the five-year average.  Looking ahead, it remains to be seen whether German consumers will be comfortable with such a low level of stocks, given the increasing tightness in European distillate markets (and subsequent continued pressure on prices), or whether they will choose to resume filling their household tanks.  In the latter case, the timing of such purchases would arguably have a significant impact on demand and prices.

Final January data led to a downward adjustment of 106 kb/d in French oil demand, as heating oil, residual fuel oil and LPG turned out to be lower than expected given warmer-than-average temperatures.  February preliminary data were also slightly weaker (-26 kb/d).  Deliveries of residual fuel oil, in particular, declined by 13.5%, in contrast to the strong growth seen since late 2007.  Indeed, higher use of natural gas for power generation largely explains why fuel oil deliveries to both industry and electricity plants declined (-10% and -27%, respectively).  Meanwhile, transportation fuel demand grew by a robust 3.2%, (jet: +2.1%; diesel: +5.4%; gasoline: -3.0%), mirroring the German trend.  Overall, oil demand has been cut by 25 kb/d in 2008 as a result of revised data and lower GDP growth expectations.



Italian demand fell by 5.4% year-on-year in February, according to preliminary data, mostly as a result of lower fuel oil deliveries (-30.8%) and despite higher electricity demand and lower hydro generation.  As in France, natural gas made up the difference (total thermoelectric generation was up by 6% on a yearly basis).  Meanwhile, all other product categories bar gasoline and naphtha posted gains, with diesel increasing by 4%, jet by 3.5% and heating oil by 2.9%.  As with other countries, our 2008 demand forecast has been adjusted down slightly given lower Italian GPD growth figures.

January Turkish demand was revised up by 288 kb/d - an extraordinarily large annual increase (+42.5%).  Motor gasoline is reported to have grown by 59.6%, gasoil by 62.6% (the diesel and heating oil breakdown is not available), fuel oil by 45.0%, LPG by 22.7% and 'other products' by 29.8%.  Only naphtha demand was weaker (-28.2%).  These figures, however, should be treated with caution: a new reporting system was put in place last January, and these very high growth rates could indeed be related to reporting errors.  Moreover, oil demand in January 2007 was very weak, further inflating growth rates.  It should be noted that December demand was also weak, suggesting that some deliveries may have been delayed until early this year.

Belgium's 4Q07 demand for residual fuel oil, gasoil and naphtha were revised up.  Heating oil demand, in particular, recorded strong growth (+24.7% year-on-year) in December - for the first time since January 2007.  Fuel oil growth (+20.7%) turned out also to be much stronger than expected, essentially given buoyant bunker demand (which accounts for 85% of total Belgian residual fuel oil demand and which rose by 16% in 2007); by contrast, the use of fuel oil for power generation declined by 13% as natural gas made further inroads.  Finally, given persistent anomalies in submitted data for Norway (LPG) and Iceland (all product categories), we have decided to apply a six-month rolling average to reported figures.  Indeed, Norway tends to report sharp fluctuations in LPG use (from virtually none to as much as 150 kb/d), while Iceland reports reflect port deliveries rather than end-user consumption.  The rolling average smoothes the series and gives a better sense of actual demand for both countries.



Pacific

February preliminary data indicate that oil product demand in the Pacific jumped by 4.5% year-on-year.  Demand was largely supported by strong consumption of jet fuel/kerosene for heating in both Japan and Korea, and by fuel oil and direct crude for power generation in Japan.  Temperatures were indeed sharply colder in February (the number of heating degrees was 87 higher than the 10-year average and 135 higher than in the same month of the previous year).  Given the boost provided by this cold spell, OECD Pacific oil demand is slightly revised up, when compared with last month's report, at 8.4 mb/d in 2008 (+1.8% on a yearly basis).



According to preliminary data, oil product demand in Japan - which accounts for about two-thirds of OECD Pacific's total - soared by 8.1% year-on-year in February, driven by much colder-than-normal temperatures.  Jet fuel/kerosene demand (used as a heating fuel) rose by 7.5% year-on-year, while fuel oil and direct crude for power generation (included in 'other products', which rose by an unprecedented 89.3% on a yearly basis).  This reflects the heavy toll of the nuclear power outages that have plagued the country since last year - the average utilisation rate of nuclear power generation stood at roughly 53% in March, against 71% in the same month of 2007.  Given that Japan's largest nuclear power plant - Tepco's Kashiwazaki-Kariwa - is poised to remain shut at least until March 2009, if not longer, oil demand is expected to reach 5.1 mb/d (+1.7%) in 2008, reversing the declining trend observed in the past years.



It should be noted, however, that this forecast does not yet take into account the effect of the removal of Japan's gasoline tax. The so-called Special Taxation Measure, which had been levied in response to the oil price shocks of the 1970s on a 'temporary' basis to fund a road-building programme, expired on 31 March.  The opposition Democratic Party of Japan (DPJ), which holds a majority in the upper house of parliament, refused to vote in favour of what, until now, had been a customary two-year renewal, arguing that the proceeds have been spent wastefully by local and central government officials.  As such, Japan's tax burden has shrunk from being the sixth-lowest among OECD countries to become the fourth-lowest, higher only than the taxes prevailing in Mexico, the US and New Zealand (in that order).  In theory, were retailers to pass on the tax cut in its entirety, regular gasoline prices would fall by about 20%.  In practice, at the time of writing, retail prices have fallen by about 12%.

At this point, given that there is no precedent for such a sharp drop in gasoline prices, it is highly difficult to forecast exactly how gasoline demand may evolve (it should also be noted that it will take at least two weeks to clear stocks that had been delivered to retailers at the tax-inclusive ex-refinery price).  Indeed, it remains to be seen whether the tax removal, if not reversed, offsets the structural decline in Japanese gasoline demand.  Some observers reckon that April's demand could be some 5-10% higher than previously expected.  So far, there have been reports of long queues outside service stations.  The real test, however, will take place in July and August - the peak of the country's summer driving season.  Over the next few weeks, the outlook should be clearer and we may reassess our Japanese gasoline demand prognosis for 2008 if warranted.

In Korea, preliminary data indicate that total oil product demand contracted by 2.0% year-on-year in February.  Although both LPG and jet fuel/kerosene demand jumped by 14.1% and 10.3%, respectively, on the back of freezing temperatures, this failed to offset losses in other product categories, notably naphtha (-3.8%), which accounts for over a third of total Korean demand.  Meanwhile, the 2008 outlook remains largely unchanged at 2.2 mb/d in 2008 (+1.8% over 2007).

Only a few weeks after decreeing a 10% temporary reduction in oil product taxes, the new government of President Lee Myung-Bak decided to cut tariffs on imported oil products and petrochemicals.  The move, intended to further reduce the burden of high prices, became effective on 1 April.  Import tariffs on gasoline, kerosene, diesel and residual have fallen from 3% to 1%, while those on petrochemical products have been cut from roughly 5% to 4%.  By contrast, the tariffs on crude oil, LNG, LPG and naphtha remain unchanged.  Crude import tariffs were reduced from 3% to 1% in early 2004; last January, meanwhile, the duties on the other products were also sharply reduced (LNG: from 3% to 1%; LPG: from 3% to 1.5%; naphtha: from 3% to none).  However, some local players contest the effectiveness of the measure, at least for some products.  Indeed, since July 2007, no gasoline has been imported into South Korea; the country's needs have been met by local refiners.  Meanwhile, imports of kerosene, diesel and residual account for less than 1% of the total demand for these products.  Only petrochemical demand is likely to rebound given cheaper imports.



Non-OECD

China

Preliminary data indicate that China's apparent demand (refinery output plus net oil product imports, adjusted for fuel oil, direct crude burning and stock changes) rose by an estimated 7.8% year-on-year in February, a much higher pace than previously estimated (+5.3% in last month's report).  Growth was sustained by significant gains in transportation fuels demand: gasoline rose by 22.8%, gasoil by 8.3% and jet fuel/kerosene by 3.5%.  Meanwhile, January figures were revised down following the release of refining data for that month; as runs were some 150 kb/d lower than anticipated, apparent demand in January increased by about 4.2%, instead of a previous estimate of 6.1%.

These strong figures are indicative of the importance of the Lunar New Year holiday - which generally is the only opportunity for millions of migrant workers from the country's southern industrial heartland to return home for a few days - despite the severe weather conditions that wrought havoc to infrastructure and grounded travellers across the country from late January to mid-February.  The surge in demand was met by higher refinery runs (+3.1% over January) and by steeper net imports of both crude (+359 kb/d versus the previous month) and products (+30 kb/d).  Net gasoil imports reached yet another record high at 210 kb/d, and perhaps more significantly, net gasoline exports sharply fell for the second month in a row to about 10 kb/d - compared with roughly 100 kb/d on average during 2007.  Given the prevailing high cracks for gasoline and gasoil, both PetroChina and Sinopec have reportedly applied for an exemption of the product import tax (although it remains to be seen whether the government will oblige, since it cut customs duty on gasoline, gasoil and jet fuel last January).

It is worth noting that runs by the larger independent refineries were slightly higher in February (about +2.9% month-on-month, according to our estimates), suggesting continued access to subsidised crude provided by state-owned Sinopec and PetroChina.  By contrast, most 'teapot' refineries continue to be squeezed out of the market: residual fuel oil demand - their feedstock of choice - contracted by an estimated 6.8% year-on-year in February, for the seventh month in a row.  Since mid-March, however, and despite higher refinery runs (the majors are reportedly running at full capacity, presumably because of strong government pressure), PetroChina and Sinopec have interrupted fuel deliveries to independent dealers and even to some of their own flagged outlets in several key eastern cities (Beijing, Tianjin and Shanghai).  Since then, events have unfolded according an already well-honed script: a) gasoil shortages and rationing at service stations have spread to other regions, notably northern and southern China; b) there have been renewed rumours of an impending hike in retail prices; c) officials have strenuously denied that end-user prices will be altered; and d) the oil majors have claimed that they are committed to supply the market and that shortages are variously due to refinery maintenance, stock rebuilding, transportation bottlenecks and hoarding by independent players.





As in previous episodes, the structural roots of these recurrent crises - capped end-user prices - have barely been cited.  As the gap between domestic and international prices widens, state-owned companies are tempted to cut their losses by reducing domestic deliveries (until forced by the government to meet domestic demand regardless of the cost), while independent refiners and dealers are encouraged to hoard supplies with the expectation of cashing in if retail prices are raised.  (Interestingly, the government decided in the end to compensate Sinopec for its losses; the company has been granted a $1.74 billion subsidy covering 2007 and 1Q08.)  More crucially, the shortages may probably worsen in the short term, as China is on the verge of entering its spring farming season, which generally signals a significant surge of gasoil demand (normally met by off-spec product from teapot refineries).  Perhaps anticipating this unwelcome eventuality, the government is reportedly considering slashing the VAT on crude oil imports from the current 17% to as little as 4%, in order to provide some relief to the majors and boost independent production - a second-best option to the removal of retail price caps.

A Chinese Riddle:  Where Will Oil Demand Head To In 2008?

Looking ahead, forecasting China's 2008 demand has become a particularly difficult and perilous exercise, as it will be subject to both bullish and bearish forces, at least until the third quarter.

1.   The full consequences of the 1Q08 severe winter weather disruptions and power cuts are yet to be ascertained.  As noted, February's strong preliminary data essentially offset January downward revisions, leaving quarterly estimates largely unchanged - but this may be reappraised as detailed February data are released (given the lunar New Year holidays, the average of January and February data generally provides a better idea of demand trends).  In any case, as we have previously argued, further disruptions to coal supplies could well entail a surge of oil-fired power generation, particularly if the summer months are hot.  At the moment, independent oil-fired power generators are reportedly operating at full capacity in the southern Guangdong province, which was severely affected by the weather emergency.

2.   The renewed wave of gasoil shortages suggests that pent-up demand remains significant.  As noted earlier, even if end-user prices were liberalised (an unlikely occurrence at this point), Chinese oil demand would probably rise sharply as long as supplies proved to be sufficient.  In the meantime, domestic needs will likely continue to depend on a high level of imports, both of crude (particularly if the VAT is cut) and products (notably of diesel).

3.   There is talk of closing down industrial sites around Beijing and Shenyang (the capital of the northern Liaoning province and a co-host city) a month ahead of the Olympics, which are scheduled to begin on 8 August, in order to improve air quality.  This may happen in the case of small and medium factories with poor environmental standards, in addition to coal-fired cement factories west of Beijing, which generate much of the city's pollution.  However, it is highly unlikely that local refiners will be shut down, given the country's product supply constraints, and coal-fired power generators - there are simply no alternatives to provide electricity to the capital, which will be crowded with tourists during a hot summer.  (Most local refineries, though, are reportedly reasonably well equipped in terms of pollution controls; in that sense, the net reduction in pollution would be minimal if they were actually shut down.)

4.   The Games themselves will lead to a surge of transportation fuels demand as tourists, spectators and athletes fly into the country and travel to the different venues and around China.  Moreover, it remains to be seen whether the government will be successful in encouraging Beijing residents to leave their cars at home to prevent excessive congestion, as has been reported.

5.   There is a significant degree of uncertainty regarding the country's economic activity.  In the past, China has confounded critics by growing much faster than forecast by major institutions.

In the meantime, our 2008 forecast has been minimally revised down to 7.9 mb/d (+4.7% year-on-year), since 1Q08 demand could potentially be lower than expected given the weather emergencies, lower GDP projections  and the current shortages.  However, as the issues raised above become clearer, we may have to revisit this prognosis again, particularly for the second half of the year.

Other Non-OECD

According to Indian preliminary data, oil product sales - a proxy of demand - soared by 10.9% year-on-year in February, the highest pace since November 2006.  All product categories registered significant gains, but it should be noted that transportation fuels - gasoline, jet fuel/kerosene and gasoil sales - jumped collectively by 13.4% year-on-year, while the rest of the product demand matrix rose by 'only' 8.4%.  As such, we have slightly revised up our 2008 forecast to 2.9 mb/d (+4.8%).

A major factor supporting the strength of Indian demand, aside from the country's buoyant economic growth (forecast by the IMF at +7.9% this year, only slightly down from previous assessments), is the policy of capping retail fuel prices far below international levels.  In this sense, India follows China's footsteps - and the consequences are similar: a squeeze of the domestic refining and marketing sector, which has become increasingly unprofitable as international oil prices continue to rise.  However, as opposed to China, India has big private players that are not compensated for their mounting domestic losses (only state-owned companies qualify).  Last month's timid end-user price increases were seemingly not enough: in late March Reliance Industries, one of the country's largest private holdings, announced it will shut down in April the 900 service stations it directly controls and instead focus entirely on exporting oil products (however, some other 500 Reliance-flagged outlets, independently-owned, will continue to be supplied if they choose to carry on with their business).



The government is thus facing a difficult dilemma.  On the one hand, maintaining capped prices is likely to lead to further closures of private outlets (totalling some 2,500 before Reliance's shut-down announcement) and may also increase the annual subsidy bill (currently $2.3 billion), since state-owned companies will have to hike imports to avoid supply shortages.  On the other hand, freeing prices would probably result in an inflationary spike and, ultimately, would be politically unpopular.  Furthermore, given India's rising income from its large agricultural exports, providing subsidies on fuel and other inputs effectively stimulates overall growth.

Reassessing Former Soviet Union Demand

Following a careful and lengthy review of available oil product data sources for the fifteen countries - Armenia, Azerbaijan, Belarus, Estonia, Georgia, Kazakhstan, Kyrgyzstan, Latvia, Lithuania, Moldova, Russia, Tajikistan, Turkmenistan, Ukraine and Uzbekistan - that are grouped under the 'Former Soviet Union' regional category (FSU), we have decided to implement a major methodological change in the way we estimate the region's demand.  As of this report, FSU demand will be the sum of actual inland deliveries and end-user demand in each of these countries.

Until now, FSU apparent demand was defined as domestic crude production minus net exports of crude and oil products.  However, this methodology often resulted in substantial demand swings, mostly because of large trade data revisions - but not for reasons intrinsically related to internal consumption patterns.  Our FSU demand estimates for 2007, in particular, were counter-intuitive: given high export data, demand appeared to have sharply contracted while the region's economy expanded by 8.5% in that year, according to the IMF.  A change in inventories could arguably explain such divergence; unfortunately, however, stock figures for the region are unavailable.  Moreover, the use of aggregate regional trade data made it impossible to establish of a proper oil product and country breakdown, nor did it allow a meaningful analysis of regional trends.

Our new product- and country-based methodology draws from a variety of sources.  First, we have revised our historical series according to the Annual Statistics of Non-Member Countries, 2007 edition (commonly referred to as the 'Green Book'), which includes annual data up until 2005, by country and product.  This compilation is the result of extensive work undertaken by the IEA's Energy Statistics Division in cooperation with national administrations and statistical agencies across the region.  It should be noted, though, that Green Book naphtha data for Russia has been adjusted in this report, as the country's statistics do not currently include petrochemical feedstocks.  Second, for 2006 and beyond, we use data from consultancies, the Joint Oil Data Initiative (JODI) database, trade press and other market reports.  For Russia, which accounts for 70% of total FSU demand, data are being provided by Petromarket Research Group Ltd, a Moscow-based consultancy.

To sum up, we now have detailed product demand until February 2008 on a product-by-product basis for Azerbaijan, Latvia, Lithuania, and Russia.  These countries account for roughly 75% of total estimated FSU demand.  We may eventually add other countries to the pool: we are in the process of assessing the quality of monthly Estonian and Kazakh data, and we are conducting further research on Belarus and Ukraine.  The change in methodology has resulted in historical and current revisions, as detailed in the table.  As such, the region's total oil product demand is now estimated at 4.1 mb/d in 2007 (+0.9% year-on-year), and is expected to reach 4.2 mb/d in 2008 (+1.6%) on the back of strong Russian demand.



Admittedly, there is still much work to be done regarding the coverage and quality of national oil statistics.  Yet we believe that this methodological change will contribute to enhancing the understanding of this key region.  After all, FSU demand accounts for almost 5% of global oil consumption - Russia alone is the fourth-largest oil consumer after the US, China and Japan.

Supply

Summary

  • Global oil supply is estimated to have fallen by 100 kb/d in March from February, to 87.3 mb/d.  Month-on-month supplies from OPEC, the North Sea and Africa declined, with main increases from North America, China and Latin America. However, global supply growth has rebounded, rising in excess of 1 mb/d for 4Q07 and 1Q08, after three prievious quarters of near-static or declining supply.
  • Non-OPEC production in March gained 165 kb/d to average 50.3 mb/d, after latest January and February data came in 0.2-0.3 mb/d below preliminary indications. Except for a temporary surge to 50.6 mb/d in July, non-OPEC production will remain constrained until the fourth quarter as seasonal outages and maintenance limit output.  A sharp rise to 51.4 mb/d is expected for 4Q08 as field maintenance draws to a close and as new project start-ups, amounting to 1 mb/d in total, take effect.
  • Non-OPEC supply growth in 2008 is trimmed to 815 kb/d, nonetheless some 50% above 2006 and 2007 levels and the strongest since 2004. The FSU, Asia Pacific and biofuels drive 2008 growth, with more modest contributions also from Latin America and Africa. However, expectations for Sudan, Canada,  Colombia, Mexico, Kazakhstan, the UK and Brazil are scaled back after weak recent performance.  Project slippage remains a key uncertainty for 2008, notably given heavy post-June start-ups.  OPEC gas liquids growth, incremental to non-OPEC levels, is revised up to 385 kb/d for a 2008 total of 5.2 mb/d.
  • OPEC crude supply in March came to 32.1 mb/d, a drop of 265 kb/d from upwardly-revised February levels. February supply from Iraq, Angola and Nigeria was a combined 200 kb/d higher than earlier estimates.  In March, Nigeria and Iraq saw supply hit by insurgent-related attacks, with UAE, Nigerian and Venezuelan supply also trimmed by maintenance.  Higher Iranian supply is estimated to have provided a partial offset.  Effective spare capacity on a wellhead basis came to 2.3 mb/d for March.
  • The call on OPEC crude and stock change (including Angola and Ecuador) has been cut by 0.3 mb/d on average for 2008, with a new midpoint call of 31.6 mb/d.  Revisions centre on substantial adjustments to OECD demand data following latest IMF economic forecasts.  OPEC 1Q production of 32.3 mb/d came in close to the observed 1Q call, while the 2Q call drops seasonally by some 1.2 mb/d.


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

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

OPEC

OPEC crude supply in March averaged 32.1 mb/d, around 265 kb/d lower than upwardly-revised February levels. February supply from Iraq, Angola, UAE and Nigeria was a combined 260 kb/d higher than earlier estimates, with evidence of higher refinery throughputs in the case of Iraq and Nigeria (supply estimates comprise the sum of exports and local crude use for these two producers).  In March however, both Nigeria and Iraq saw supply hit again by insurgent-related attacks, with the UAE, Nigerian and Venezuelan supply also trimmed by oil field and processing facility maintenance.  Higher Iranian supply is estimated to have provided a partial offset in March.  Effective OPEC spare capacity on a wellhead basis came to 2.3 mb/d last month, concentrated in Saudi Arabia and UAE.

OPEC officials in March stressed what they see as adequate crude supply, and reiterated their view that current high prices derive from dollar devaluation, refinery upgrading shortages and geopolitical risks.  Ministers generally played down the likelihood of any formal meeting to discuss output policy at the International Energy Forum meeting in Rome on 20-22 April.  The next ordinary OPEC Ministerial meeting is scheduled for 9 September in Vienna.



Refilling the Tank

Last November we differentiated OPEC production trends on the basis that key producers appeared set on a policy of drawing down stocks from the perceived inflated levels of 2006.  We have extended the analysis now through to March 2008, plotting year-on-year growth in supply from different constituencies within OPEC (excluding Ecuador) to see if anything has changed.  Key producers since November appear to have loosened the taps once again, allowing stock cover to rise.  With producers now apparently targeting inventories rather than prices, actual OPEC 2Q output will provide clues as to OPEC's view of what constitute balanced stocks against a backdrop of rising demand and low spare capacity.

We previously noted sustained annual production growth from Iraq and Angola, something that has persisted through March, despite late-March's southern Iraqi export disruption.  Mature field decline and unscheduled stoppages impede supply from Venezuela, Indonesia and Nigeria, with output persistently lagging year-earlier levels.  This leaves a residual core of seven OPEC producers who, since November 2007, have been expanding supply versus late-2006/early-2007 levels.  In reality, the Middle East Gulf states of Saudi Arabia, Kuwait, UAE and Qatar have acted as the real swing suppliers.  With Atlantic Basin refinery maintenance drawing to a close, and marker crude prices remaining above $105/bbl, the core has so far been disinclined to announce any official curb on crude supplies. Seasonal demand down-turn in 2Q may highlight differences between official pronouncements and actual output.



Iran's output in March, based on exports and local crude runs, is assessed up by 70 kb/d at 4.02 mb/d.  This is based on higher domestic refinery crude use, with exports stable at some 2.46 mb/d.  Modest upward adjustment accrues to February's initial supply estimate, centred on revised data for crude imports via the Caspian port of Neka.  With absolute February refinery throughput estimates unchanged, lower Neka imports automatically suggests that throughput of domestically-produced crude was correspondingly higher.  Our assessment of Iranian crude production capacity is revised up by 40 kb/d to take account of a number of small field developments entering service in late 2007 and early 2008.

Our original estimate for February Angolan supply was revised up by 60 kb/d to 1.82 mb/d based on latest available production data, with March output estimated largely unchanged.  Sonangol expects production to attain 2.0 mb/d in the final quarter of 2008 and for this level to be maintained until 2014, reinforcing our own projection for stable Angolan capacity through 2012, as contained in the last MTOMR.

Venezuelan crude supply for March at 2.32 mb/d is 90 kb/d below a downward-revised February.  As noted last month, the Petrocedeno heavy oil upgrader went offline for maintenance in late-February, and is not expected to be back online until later in April.  Ongoing Atlantic Basin refinery maintenance is likely to have worked against sales of un-upgraded Orinoco heavy oil during the stoppage.

State PDVSA and ENI of Italy signed an agreement in March to develop and upgrade 300 kb/d of heavy Orinoco crude at the Junin 5 block.  Pilot production of 30 kb/d could start in 2010, with commissioning of the full project by 2014.  The agreement came prior to the country's national assembly passing proposals for a new windfall profits tax for oil producers.  Current tax take for foreign companies operating in Venezuela is estimated at over 80%.  PDVSA also succeeded in overturning by appeal a UK court freeze on $12 billion of its assets, in a dispute with ExxonMobil over the former Cerro Negro heavy oil project.

Saudi Arabia's supply in March is estimated unchanged at 9.1 mb/d.  Reports emerged that full 500 kb/d crude output from the Khursaniyah project would now be deferred to late in 2008, although initial production is scheduled for April or May.  Early crude output will be constrained to avoid gas flaring, as delays affect the project's gas processing facilities rather than wellhead units.  We have revised up our Saudi crude capacity estimate to 10.9 mb/d to capture initial Khursaniyah volumes, but have deferred attainment of 11.3 mb/d to 4Q08 in line with the expected new plateau date for Khursaniyah.

Output from the UAE appears to have slipped from upward-revised February levels, averaging 2.52 mb/d in March, 140 kb/d below the previous month's total.  Extended maintenance at gas processing facilities connected to the onshore Murban field is believed to underpin the March drop.

Nigerian production in March is estimated at 1.95 mb/d, 110 kb/d lower than February.  The deepwater Bonga field was offline for two weeks for maintenance and there were also reports of production shortfalls affecting the Forcados and Qua Iboe export streams.  Pipeline fires affecting supplies to both the Port Harcourt refinery and the Bonny export terminal in late March/early-April were not believed to have materially affected production or exports, but are symptomatic of the constant background level of industry disruption. March and April scheduled crude exports show successive declines from February, partly on production outages, but also due to the restart of the long-idled Warri and Kaduna refineries. 

Intensifying conflict in southern Iraq resulted on 26 and 27 March in damage to two pipelines feeding the Fao storage terminal and, indirectly, the Basrah and Khor Al-Amaya export facilities.  The earlier attack caused a fire which shut in some 100 kb/d of production from the Buzargan, Majnoon and Bin Umar fields.  However, by 3 April, the affected production was being reinstated.  A combination of a separate attack on a larger pipeline from Zubair to Fao and power outages saw exports from southern ports briefly halved to 0.8 mb/d, although average liftings from Basrah and Khor al-Amaya in March are estimated at 1.62 mb/d, up from 1.54 mb/d in February.

Liftings from Ceyhan in Turkey however were assessed off by 70 kb/d in March, at 325 kb/d.  Total exports averaged 1.96 mb/d compared with 1.95 mb/d in February.  Domestic crude consumption by refineries and for power generation is now estimated at a higher 0.51 mb/d in February, but this may have eased to 0.47 mb/d in March.  Total supply levels of 2.45 mb/d and 2.43 mb/d respectively are the highest since February 2003.

Non-OPEC Overview

Non-OPEC March production is estimated at 50.3 mb/d, a gain of 165 kb/d from February.  Monthly growth came from the USA, Mexico, the Caspian republics, China and Brazil.  All told however the non-OPEC 2008 forecast has been cut by 85 kb/d this month to 50.5 mb/d, as Canada, Mexico, Colombia, Kazakhstan and Sudan all see downward adjustments of around 20 kb/d or more.  Slippage is concentrated in the first half of the year, and is offset in part by upward revisions for the USA, Norway, China and Syria.



Non-OPEC growth averages some 815 kb/d in 2008, after 545 kb/d in 2007, representing a potential resurgence in growth to the highest non-OPEC level since 2004.  The FSU (+395 kb/d), Asia Pacific region (+365 kb/d), global biofuels (+425 kb/d) and Brazil (+190 kb/d excluding ethanol) are key drivers for 2008.  Non-OPEC supply could level off at 50.1-50.3 mb/d for the next two quarters as seasonal production outages in the northern hemisphere offset new production build-up from a number of sources.  Sharp growth is expected in 4Q08 as maintenance eases and new project start-ups totalling around 1.0 mb/d in the second half of the year take effect.

While 4Q typically shows the strongest quarterly supply growth, this year looks exceptional, based on the 'business as usual' assumptions underpinning the forecast.  A seasonal rise of nearly 1 mb/d is nearly double the seasonal average of 550 kb/d, and a level last seen in 2003, when recent constraints in the upstream operating environment were less intense.  Extended maintenance and outages, stronger-than-expected decline and project slippage could all undermine this expected 4Q supply rebound.  Last month we discussed the issue of non-OPEC decline rates for mature fields, recently averaging a surprisingly constant 7-8% per year after stripping out non reservoir-related issues.  There is little reason to expect that industry-wide decline rates will accelerate in 2008, as drilling tightness begins to ease and with company spending continuing to increase.  So the biggest threats to the 4Q rebound in non-OPEC supply, and 2008 growth overall, are new project slippage and heavier-than-expected unscheduled field outages.  For now we retain our methodology of netting 0.4 mb/d off OECD supply to account for unscheduled field shut-ins.  Time will tell whether this remains a realistic level of adjustment.

We also avoid the temptation to arbitrarily slip all new project start-up dates in the face of service, fabrication, drilling and construction bottlenecks, preferring to work on a project-specific, balance-of-probabilities basis.  However, with recent weeks seeing further examples of project slippage affecting Saudi Arabia, Kuwait, the US GOM, UK, Philippines and Sudan, the bunching of new project starts in 2H08 renders this year's forecast prone to further revision.  For example, if December's expected 970 kb/d of new production which derives from project starts in the second half of the year were all to suffer start-up delays of six months (an unlikely eventuality), then some 285 kb/d would have to be deducted from our 2008 non-OPEC supply estimate of 50.5 mb/d.  Moreover, this would also transform modest 3Q quarter-on-quarter supply growth into 200 kb/d contraction, and halve 4Q growth to 0.6 mb/d.  The scale of forecast uncertainty deriving from potential project slippage is therefore substantial, although what was lost from 2008 in such a scenario might be made up, wholly or partly, in 2009.

Longer-term production trends will also be driven by the investment environment being put in place today by host governments.  This month's report itemises a mixed bag of developments in this regard.  Marginal tax changes in the UK and in Russia have received cautious welcome from producers and financial analysts, although Russia is seen as having much further to go if upstream investment is ever to recover to early-decade levels.  In Kazakhstan, a new export tax from May this year could hit state producer KazMunaiGaz hardest, as major ongoing foreign investments appear to be exempt. Canada has addressed its GHG emission reduction commitments by proposing mandatory carbon capture and storage for all new oil sands projects entering service in 2012 and beyond.  Although this will undoubtedly raise costs, capital allowances and carbon trading schemes will likely cushion the impact.

OECD

North America

US - March Alaska actual, others estimated:  The forecast for US oil production in 2008 is revised up by 60 kb/d to 7.51 mb/d, comprising 5.0 mb/d of crude, 1.8 mb/d of NGL and 0.7 mb/d of other oils (including ethanol).  The static overall production level versus 2007 sees mature field declines from Alaska and onshore lower-48 offsetting growth from Gulf of Mexico (GOM) crude, from NGLs and ethanol. Data for January came in 115 kb/d higher than expected, while preliminary indications for February and March were respectively 105 kb/d and 85 kb/d above expectations.  Ethanol (see below) and lower-48 crude production are the main causes of the 2008 upgrade.  We have noted before that investment in enhanced recovery at older or marginal fields onshore US may be one of the few volumetric signs of what has been, so far, laggard price elasticity on the supply side.



GOM production is seen rising by 50 kb/d in 2008, to 1.38 mb/d.  This is some 25 kb/d lower than last month's forecast, in part due to lower baseline supply suggested by January-March aggregate US production data.  However, we have also pushed back start-up at Chevron's 45 kb/d Blind Faith project from April into May.  Reports that BHP's Neptune production facility, previously expected to start in April, has been hit by structural problems have caused us to remove the 50 kb/d project from our 2008 forecast entirely.  Subsequent reports have variously estimated start-up at 2Q08 and 2009, and we have erred on the side of caution by pushing Neptune into our 2009 forecast.

Ethanol Leads Where Conventional Oil Lags

Monthly data from the EIA show US ethanol production consistently surging ahead of our expectations.  This comes despite increasingly vocal criticism of the role the increased use of maize (corn) feedstock is having on global food prices, as well as a growing question mark over ethanol's supposed capacity to curb CO2 emissions.318

Prompted by incoming data, this report has been gradually nudging up the total US oxygenates production figure each month. Therefore, this month's 45 kb/d upward revision of 2008 US output (40 kb/d of which is ethanol) may not seem substantial.  But compared with the July 2007 MTOMR, when biofuels were last assessed in depth, this is a more impressive 115 kb/d upward revision to 2008 production, after a 40 kb/d revision for 2007.  For the year as a whole, US ethanol production grows by 125 kb/d to total 545 kb/d.

What are the reasons behind this rapid and unanticipated growth?  Detailed analysis shows firstly that installed US ethanol capacity has been growing faster than expected.  A reappraisal of individual production facilities shows that several plants have come online faster than assumed last year and there are several new plants on the horizon.  In addition, the industry is beginning to see a degree of consolidation, with plants - especially those operated by larger enterprises - becoming bigger.  As a result, we have also been prompted to revise our 2008 capacity figure up by over 80 kb/d (to around 660 kb/d).

In addition, our forecast is based on the assumption that the economics of ethanol production, including subsidies, remain broadly profitable in 2008.  Following a bumper US corn crop and high oil prices, at the very least US plants should be able to run at 2007's 82% utilisation rate (considerably higher than many biodiesel production plants in parts of Europe).  Lastly, in December 2007 the US finally passed into law a new and ambitious renewable fuels mandate, which calls for an approximate five-fold production increase in the next 15 years (though not all of this is to be corn-based ethanol).  Coupled with a subsidy of currently around ¢50/gallon, this clearly keeps investment in ethanol production capacity attractive.



The July 2008 edition of the Medium-Term Oil Market Report will review other sources of biofuels supply, which may not benefit from the same specific circumstances as US producers - bar Brazil, which continues to have substantial economic, climatic and infrastructural advantages over all other biofuels producers.  At 1.1 mb/d in 2007, or 1.3% of total global oil supply, biofuels may remain marginal in absolute terms.  But, despite all the current bad press, they represent one of the most significant components of 2008 non-OPEC supply growth, on a par with expected conventional oil growth from individual countries such as Azerbaijan, Brazil, Australia and China.

Canada - Newfoundland and synthetics February, others January:  Forecast Canadian oil output for 2008 is trimmed by 35 kb/d to 3.31 mb/d, largely flat compared with 2007.  Downward revisions affect 1Q08 Albertan synthetic crude production (excluded from the graphic below) and offshore East Coast production.  These are partly offset by upwardly-revised Alberta bitumen supply, where our earlier projections looked low in comparison to latest project assessments and local forecasts.

We have trimmed expected output from Syncrude Canada's mining/upgrading project in line with the company's own expectations following outages on freezing weather early in the year.  Production from this unit is now seen averaging 295 kb/d in 2008 from 285 kb/d last year, out of total mined syncrude supply this year of 705 kb/d.  In a similar vein but on the other side of the country, early April saw a brief ice-related outage at Husky's offshore Newfoundland White Rose project, but output for the month is unlikely to be materially affected.  Husky is proceeding with satellite developments at White Rose that



will sustain output into the next decade.

Mexico - February actual:  February proved another disappointing month for Mexican production, slipping by 25 kb/d from January levels.  Exports remained stuck at the sub-1.5 mb/d levels evident since November, although seasonal loading difficulties in part explain this.  We have trimmed 20 kb/d from last month's 2008 production forecast, giving a revised crude output projection of 2.95 mb/d, compared with the 3.08 mb/d achieved in 2007.  Natural gas liquids output is assumed steady at 395 kb/d.  Rising supplies from the Ku-Maloob-Zaap complex partly offset near-20% decline from the Cantarell field.

Mexico's congress is studying proposals from President Felipe Calderon which would establish service contracts for upstream activities, but stop well short of any form of direct equity participation.  Fiscal reforms could liberate some $4-$5 billion of extra export revenue for Pemex, with variable tax rates being introduced for oil and gas fields.  The measures fall well short of the degree of liberalisation some analysts see as necessary if Mexico is to halt production decline.

Canadian Oil Sands Face CCS Mandates

Canada's Federal Government has proposed new rules requiring oil sands and coal-fired power plants entering service after 2011 to include CO2 capture and storage equipment.  Three tiers of remediation are proposed, part of Canada's commitment to reduce greenhouse gas emissions by 20% by 2020. Existing plants and those starting up before 2012 will face less onerous limits so long as emissions can be reduced by 18% versus 2006 levels by 2010 and by 2% per year thereafter.  Post-2011 plants will have until 2018 to install CCS, with the possibility of buying carbon credits or investing in a technology fund in the interim. Investments in CCS may be fully offset against tax in the period to 2017.141

The proposals come on top of earlier plans for increased royalty rates to be introduced from 2009.  Neither proposal on its own is seen by analysts as being sufficient to derail currently planned projects.  However, a combination of fiscal take and environmental investment mandates, if accompanied by lower oil prices, could make a difference to expected production levels.  Our MTOMR from July 2007 envisaged total Canadian oil supply growing by a healthy 3.5% per year through 2012.  Canada's National Energy Board (NEB) reference scenario was for more buoyant growth of nearer 5% per year through 2015.  NEB's scenario for tighter environmental regulation and weaker post-2010 prices was seen slowing supply growth to just 1.6% per year.

North Sea

Norway - January actual, February provisional:  An upgrade to expected 1Q08 performance for Norway adds 10 kb/d to the 2008 forecast.  1Q production is revised up by 30 kb/d as a combination of output data for January/February and loading schedules thereafter point to higher supplies from the Statfjord/Gullfaks and Oseberg/Troll systems.  Our forecast now shows Norwegian liquids production declining by 190 kb/d in 2008 to 2.37 mb/d, although NGL and condensate volumes within this total rise by some 55 kb/d.  Output from Norway has declined by some 0.2 mb/d in each of the past three years.



Trade unions have called off a strike that was due to begin on 2 April, which would potentially have affected 20% of Norway's service sector employees.  Mid-March saw the renewed shut-down of the Snohvit gas and condensate field after renewed technical problems with the gas liquefaction plant. Early phase condensate production from Snohvit could reach 20 kb/d, although output has yet to attain 5 kb/d after teething problems. In the longer term, independent producer Detnor has submitted a redevelopment plan for the Froy field which was closed in 2001, having earlier attained peak production of 35 kb/d.

UK - January actual:  December/January data came in close to preliminary estimates, leaving the 2008 total oil forecast little changed at 1.47 mb/d, and offshore crude at 1.21 mb/d.  Like Norway, the UK faces decline of some 200 kb/d in 2008, having temporarily stabilised output in 2007 at 1.66 mb/d. Last year's prop for UK output, the newly-started Buzzard field, contributes again in 2008, adding some 45 kb/d with a full year of plateau output.  But with only this and the Tweedsmuir project likely to add in excess of 20 kb/d incremental supply in 2008, mature field decline again predominates.

Producing companies broadly welcomed a series of fiscal measures announced in March's government Budget statement.  Reforms affected Petroleum Revenue Tax, capital allowances for older assets and the treatment of de-commissioning costs.  However, the industry has said it still wishes to see the government address what it believes to be excessive tax take from new projects.

Pacific

Australia - January actual:  January data came in 75 kb/d below this report's expectation, at 495 kb/d for total oil production.  Output suffered a stronger-than-anticipated impact from early-year mechanical and weather outages. Partial recovery to 600 kb/d is estimated for February, although electrical pump repairs kept the 25 kb/d Mutineer-Exeter field offline from early-February until the last week of March.  Late March also saw re-start at the Woolybutt field, which had been closed for three months after unscheduled maintenance was followed by weather delays.  New production from the Puffin and Stybarrow fields is expected to underpin growth of 85 kb/d in 2008 Australian crude production, augmented by gas liquids.

Neighbouring New Zealand is also likely to see growth of some 35 kb/d in offshore production this year from the Tui and Maari fields, taking total liquids supply to 85 kb/d in 2008 from 45 kb/d in 2007.

Former Soviet Union (FSU)

Russia - February actual, March provisional:  First-quarter Russian supply dropped below year-ago levels for the first time this decade, averaging 10.0 mb/d, some 90 kb/d below 1Q07.  However, caution needs to be applied before extrapolating this trend.  Mild weather in 1Q07 may have distorted growth patterns by minimising habitual, temperature-related seasonal production shut-ins.



Secondly, tentative steps have been taken in fiscal reform, raising the production tax threshold from $9/bbl to $15/bbl, albeit only from 2009.  However, this is widely seen as a first, modest step, with more potentially to come later in 2008.  Thirdly, one of the key drags on 2008 supply, an expected drop in output from the Sakhalin 1 project to around 170 kb/d, has yet to materialise.  1Q production from Sakhalin 1 has been around 220 kb/d, close to the 2007 average.  While we have factored in a drop in supply to 170 kb/d for 2H08, government drilling restrictions may be having less impact than field partners suggested late in 2007.  Nonetheless, Russian oil production in 2008 is forecast to show growth of only 0.8% (80 kb/d), compared with an average 2.5% in the last three years and double-digit growth earlier in the decade.

Kazakhstan - February actual:  Early 2008 data for Kazakhstan show robust output from the Tengiz and Karachaganak fields, but lower-than expected crude supplies elsewhere.  Lower production from smaller producers is carried through the forecast for 2008, resulting in a net 15 kb/d downward adjustment to projected supply, to an average 1.46 mb/d this year from 1.38 mb/d in 2007.  The net downward adjustment for total production is moderated by stronger first-half output now for the Tengiz field.

That said, we retain a cautious outlook regarding Tengiz expansion in 2008, given ongoing delays in expanding the CPC pipeline.  Operator TCO expects Tengiz capacity to reach 540 kb/d late in 2008, although we have assumed production attains only 420 kb/d in 4Q, for an annual average of 355 kb/d.  If recent export diversification continues (with the possibility for initial volumes to be moved via the BTC pipeline as early as this year currently being discussed), a subsequent upgrade to our Tengiz forecast is possible.  Russian opposition to CPC expansion however is likely to prove a longer-term constraint on both Tengiz and the long-delayed Kashagan field.  Failure to commence work on CPC expansion before autumn 2008, when approval for the project's feasibility study expires, would likely entail further delays.

Further questions over Kazakh supply have been raised following the Energy Ministry's announcement that it will introduce a new crude export duty of $109/tonne (nearly $15/bbl) from May 2008.  Although the key Tengiz, Karachaganak and Kashagan projects will reportedly be exempt, the proposals could affect up to 40% of 2008 production, notably that of state-owned KazMunaiGaz. Some analysts have seen the new tax as a parallel of Russia's attempts to boost domestic crude refining at exports'expense.



Azerbaijan - February actual:  Forecast 2008 Azeri oil production remains at just below 1.1 mb/d, despite a downgrade for April supply based on lower scheduled BTC pipeline export volumes.  Overall, production continues the 200 kb/d annual growth trend seen in 2006 and 2007.  The BP-operated ACG complex underpins 2008 growth, augmented by higher expected condensate volumes from the Shah Deniz project.  BP has also reported that it aims to boost BTC pipeline capacity by 20% to 1.2 mb/d by the end of 2008 through the use of drag reduction agents.  Later phase expansion to around 1.5 mb/d may be implemented by 2012/2013.

FSU net oil exports rose by 130 kb/d in February, as a significant monthly rise in product exports overshadowed a drop in crude exports.  Product exports rose by 235 kb/d in February, from a downwardly-revised January, including monthly increases of 114 kb/d and 92 kb/d in fuel oil and gasoil exports respectively.  Record-high distillate prices in Europe provided an incentive for FSU refiners to maximise gasoil exports.

As expected, February FSU crude exports were down by 110 kb/d on the month, to 5.84 mb/d, the lowest seen since late 2006.  Export volumes via Transneft fell by 120 kb/d on average, 90 kb/d of which was the reduction in flows to Germany implemented by Lukoil (which extra transits to Hungary and the Czech Republic were unable to offset).  Maintenance on the pipeline to Primorsk reduced exports of Russian crude via this route by 110 kb/d.  Further disincentive derived from a 20% increase in Russian crude export duties from 1 February.

FSU net exports in March are expected to have risen by up to 100 kb/d as Primorsk volumes recovered, although Caspian CPC and BTC exports collectively are likely to have stabilised. Lower Caspian April volumes may pressure overall FSU exports this month.



Other Non-OPEC

Brazil - January actual:  We have moderated forecast 2008 Brazilian production in line with both lower actual January data and state company Petrobras' own latest expectations of around 2.0 mb/d of crude for the year.  Oil production growth is nonetheless seen accelerating to 190 kb/d in 2008 plus around 50 kb/d for ethanol production, taking total ethanol output to some 360 kb/d.  Oil increments centre on output from the Roncador and Golfino projects which started-up in late-2007, as well as a number of smaller 2008 developments.  Foreign company participation offshore Brazil is likely to grow, with existing production from Shell's Bijupira Salema field likely to be augmented by new production in 2008 from Devon Energy, and later by  StatoilHydro and Chevron.



Revisions to other non-OPEC estimates begin with Sudan, where we have deferred expansion above current 200 kb/d output levels at Blocks 3 and 7 from 2Q08 to 2009 after comments from government sources.  Last month's upward revision to Colombian 2008 production has been reversed, but not because of any downgrading of expectations for continued JV production growth.  Rather, with our baseline forecast having converged with actual production levels for some months now, we have removed a +20 kb/d adjustment factor previously included to account for an earlier tendency to understate total Colombian supply.  Philippines production estimates are adjusted down by 15 kb/d in 2H08 to account for the slippage of start-up at the Calauit field into 2009 or 2010.  Philippines supply will nonetheless benefit from imminent start-up at the 17 kb/d Galoc field.

On a more positive note, recent reports on Syrian crude and condensate production for calendar 2007 add 6 kb/d to the 2007 estimate and 14 kb/d to the 2008 forecast.  Total oil production, still on a declining trend, therefore averages 400 kb/d in 2007 and 380 kb/d in 2008, compared with 420 kb/d in 2006.

OECD stocks

Summary

  • OECD total industry stocks fell by 48.9 mb in February, to 2,579 mb.  A counter-seasonal draw of 9.1 mb in OECD crude inventories accompanied a 42.8 mb product draw which was more in line with normal winter trends.  'Other oils' stocks built by 3.0 mb.  The crude draw occurred in OECD Europe, where German crude stocks decreased by 4.4 mb following a halt in pipeline supplies from Lukoil in Russia, and in the OECD Pacific, on lower crude imports to Japan and Korea.
  • Total OECD industry product stocks drew by 42.8 mb in February.  A shallower-than-normal decrease of 2.7 mb in European distillate stocks was countered by a very steep 12.1 mb draw in the OECD Pacific, on lower refinery throughputs.  Draws in OECD North American distillates and 'other products' were more in line with winter expectations at 13.0 mb and 10.3 mb respectively, although a 6.1 mb counter-seasonal build in motor gasoline inventories moderated the regional product draw.
  •  January OECD oil stocks were revised up by 10.3 mb and now total 2,628 mb.  Revisions were largest in US 'other products', adjusted up by 8.8 mb, while Canadian crude stocks were revised up by 7.2 mb and Japanese and the Netherlands' crude stocks were revised down.  The total January OECD stock build now measures 48.7 mb, almost exactly offsetting the total draw in February, suggesting that the 1Q08 OECD stock change relies entirely on March trends.  Preliminary March data for US, Japan and EU-16 indicates a 4.1 mb stock build.
  • End-February OECD forward demand cover is calculated to be 53.3 days, a slight drop from the upwardly-revised 53.4 days for end-January.  OECD total stocks remain above the 2003-07 average in terms of absolute levels and forward demand cover.  Regionally, the above-average stocks position for most products in OECD North America and Europe contrasts with historically low crude and motor gasoline stocks and tight distillate cover in the OECD Pacific.


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

A 48.9 mb draw in February took total OECD industry stocks to 2,579 mb.  This is almost 45 mb above the 2003-07 average, but around 48 mb below last February's closing stock level.  In a month when forward demand cover usually rises, it was reduced to 53.3 days, down 0.1 days from the upwardly-adjusted end-January figure.  Still, it remains well above the five-year average of 52.2 days.

The OECD Pacific region saw the most notable changes in stock levels in February, led by significant drops in crude and middle distillates.  Economic refinery run cuts dented product stocks in a very cold February, while a drop in crude imports was large enough to reduce crude inventories as well.  Total industry stocks for the OECD Pacific are now at their lowest level on record in absolute terms, at 385.1 mb.  In terms of forward demand cover, they are below the five-year range for crude oil, motor gasoline, 'other products' and near the bottom of ranges for middle distillates.  Elsewhere, OECD Europe crude cover (in terms of forward throughput) dropped from above the 2003-07 range at end-January to near the five-year average of 24.1 days in February, following a counter-seasonal crude draw largely prompted by a halt in supplies from Lukoil to Germany.  Also counter-seasonal was the 0.6 day improvement in forward cover for European distillates, up to 34.3 days, which helped keep total OECD Europe forward cover above the five-year average, at 62.3 days.  OECD North American total forward demand cover is near the top of the five-year range, at 50.2 days, and is above average in all products except the 'other products' category.



Upward revisions to OECD industry oil stocks for January totalled 10.3 mb.  The main adjustments were in US 'other products' stocks, increased by 8.8 mb, while Canadian crude stocks were revised up by 7.2 mb.  In partial offset, Japanese and Netherlands end-January crude stocks were revised down by 4.4 mb and 4.3 mb respectively. The overall January OECD stock build now measures 48.7 mb, almost exactly matching the magnitude of the total draw in February, implying that the first quarter OECD stock changes is now entirely contingent on trends in March OECD stocks (revisions notwithstanding).  Preliminary weekly US and Japanese data plus monthly Euroilstock data show a combined stock build of 4.1 mb in March.  This included a 17.4 mb draw in US products, overwhelmingly gasoline and distillates, which was more than offset by builds of 12.4 mb and 7.3 mb in US and European crude stocks, plus an unexpected 2.1 mb rise in European products.  Japanese stocks only fell by 0.2 mb, all in products.



OECD Industry Stock Changes in February 2008

OECD North America

OECD North America stocks only fell by 2.3 mb in February, to 1,254 mb, despite a 17.7 mb draw in products stocks.  US refinery throughputs were very low in the first half of February as refiners faced unplanned outages, a low margin environment and spring maintenance.  Still, the February US crude stockbuild of 6.3 mb was no larger than seasonal norms, as US crude imports also slowed in February after the high levels seen in January.  However, US 'other oils' stocks rose counter-seasonally, by 5.6 mb, in February.  A clear decrease in 'other oils' supplied was reflected by US weekly data in February, suggesting that demand for NGLs and other gas liquids, for example in the petrochemical sector, weakened.  Meanwhile, port closures at Dos Bocas and Coatzacoalcos restricted crude exports, prompting a 3.4 mb increase in Mexican crude stocks in February, leaving them at their highest ever level, of 26.4 mb.

Builds in crude, 'other oils' and US motor gasoline stocks almost completely offset the typical winter draws in distillates, residuals and 'other products' in OECD North America.  US 'other products' stocks decreased by 11.2 mb in February, slightly ahead of February norms.  Demand in this category is linked to LPG use for heating in certain regions of the US, and heating degree days have generally been above 10-year averages in the first quarter of 2008.  Absolute and forward demand cover for US 'other products' is now near the bottom of the five-year range.  North American middle distillate stocks decreased by 13.0 mb in February, matching seasonal trends, while a 1.4 mb draw took Mexican middle distillates stocks to the bottom of the five-year range, amid strong demand.  US motor gasoline stocks rose again in February, this time by 7.0 mb, the fourth consecutive monthly rise but the first of these to directionally differ from seasonal expectations.  Whether this build was due to muted demand or an earlier-than-normal start to spring refinery maintenance is not yet clear.  However, weekly US data in March has revealed extremely low refinery throughputs already eroding much of this gasoline inventory surplus.



OECD Europe

Total oil stocks in OECD European countries fell by 18.4 mb in February, closing at 940 mb.  A surprise decrease of 9.1 mb in regional crude oil inventories overshadowed news of a surprisingly shallow February draw in middle distillates.  Crude stocks fell most notably in Germany, where a drop of 4.4 mb was prompted by the interruption of supplies of Lukoil's Russian crude arriving via the Druzhba pipeline.  French crude stocks also fell by 1.9 mb in February, while the Netherlands' crude stocks rose by 1.5 mb.



Middle distillate inventories decreased by 2.7 mb in OECD Europe, a shallower drop than is normally seen in February.  This actually led to a rise in forward demand cover (with the draw slighter than the spring dip in demand) from 33.7 days at end-January, near the bottom of the five-year range, to 34.3 days one month later.  German and French distillate stocks actually rose counter-seasonally in February, by 3.0 mb and 0.8 mb respectively.  This is surprising, given that European distillate cracks rose to over $25/bbl in February.  Also, weekly independent storage levels in the ARA region indicated that middle distillates fell below 9 mb in late-February, nearing three-year seasonal lows, before a late-March rebound to just below average levels of 9.4 mb.  Still, there was a large monthly increase in FSU gasoil exports in February and distillate demand came in marginally below expectations.  Otherwise, OECD Europe residual fuel oil stocks fell by 3.2 mb in February, including a 1.9 mb decline in the Netherlands, contributing to the total monthly draw in OECD European products of 8.5 mb.

OECD Pacific

OECD Pacific total oil stocks decreased by 28.2 mb in February, to 385 mb.  This was a very large decrease compared with previous years, taking absolute levels and forward cover below the five-year range.  A crude draw of 9.8 mb, of which 6.2 mb was in Japan, was highly counter-seasonal.  METI data showed that Japan imported 4.4 mb/d of crude in February, 300 kb/d less than January.  Also, demand for direct-burn crude rose to 350 kb/d in February, up 120 kb/d on the month, as nuclear outages persist.  Korean crude stocks fell (atypically) by 3.6 mb, as monthly crude imports reportedly sunk by 350 kb/d to 2.35 mb/d, their lowest level since April 2007.  The fall in crude imports overshadowed a 150 kb/d drop in refinery runs amid economic run cuts and a Caltex hydrocracker outage.  While OECD Pacific crude demand cover (in terms of days of forward crude throughputs) usually rises by 1.2 days at this time of year, it fell by 0.9 days to 22.4 days and is now below the five-year range.



Lower refinery runs and a very cold February contributed to draws in Japanese and Korean middle distillates stocks by 10.7 mb and 1.4 mb in February, respectively.  Heating degree days in February were around 20% below 10-year averages in these countries, which drove up demand for regional heating fuel, kerosene.  These significant draws took regional forward demand cover for distillates close to the bottom of the five-year range and pushed absolute levels below range.  The 3.6 mb regional drop in 'other products' stocks was driven overwhelmingly by Japan.  Total OECD Pacific product inventories fell by 16.6 mb in February.  As well as in the crude category, forward demand cover at end-February was below the five-year range for total products, at 19 days, and significantly short of the five-year average of 20.7 days.

Recent Developments in Singapore Stocks

Weekly data showing independent stock levels in Singapore once again showed hikes in light distillate and residual fuel oil stocks related to storage capacity additions in March.  Averaging 7-9 mb over the last five years, independent stocks of light distillates in Singapore surged to 11 mb in late March.  At the same time, fuel oil stocks approached 22 mb, compared with five-year averages of 10-12 mb.  Independent storage capacity additions at Singapore are expected to top 25 mb in 2008, according to reports.  Middle distillate stocks remained within historical ranges, however, and were close to five-year averages in early April, at 7.7 mb.



Prices

Summary

  • Crude prices surged to new record highs around $110/bbl in early April due to a strong refined product market, a weaker dollar, a flare-up of tension in southern Iraq and OPEC producers' continuing reluctance to add crude to the market.  Prices had previously dipped on a steady stream of bearish economic data from the US and indications of resulting demand weakness.
  • Surging product cracks were probably a greater market driver than crude in March and early April, buoyed by lower OECD product stocks, below-average refinery runs and sustained tightness in global distillate markets.  Gasoline cracks recovered in late March as the market tightened following a dip in yields after refineries tried to maximise distillate output, leading to a draw in US stocks.
  • Refinery margins mostly increased on gasoline's recovery and strong distillate cracks.  Brent and Es Sider hydroskimming margins in Europe even edged their way towards positive territory.  The greatest gains month-on-month were in Singapore, albeit from the lowest base.  US margins were mixed, being more dependent upon gasoline cracks, which despite their recovery remain well below those of distillates.
  • Dirty tanker rates rose in the second half of March as vessel fundamentals tightened on rising long-haul tanker demand, following increases in both eastbound West African trades and westbound volumes leaving the Middle East Gulf.  Clean rates were almost flat on high Asian vessel availability and low US gasoline imports.


Overview

Crude futures trended down in the second half of March, dragged down by further signs of weakness in the US economy.  But a disruption to exports due to fighting in southern Iraq, as well as renewed strength in refined product markets helped push back crude prices to new record highs in early April.  In particular, gasoline cracks regained strength due to lower US stocks, apparent secondary restocking and the switch to harder-to-make summer specifications.  Gasoline's strength, together with sustained high distillate cracks, pushed up refining margins from lows in late January/early February.

The Bear Stearns problems in mid-March triggered a steep sell-off as stock markets tumbled, with the NYMEX RBOB crack briefly turning negative for the first time ever.  Disappointing jobs and other data emanating from the US, as well as Fed Chairman Ben Bernanke's admission that the US could see negative GDP growth in the first half of this year, pressured oil prices, though this was somewhat offset by a further weakening of the dollar.  But the Fed also cut interest rates further in mid-March, adding to a fiscal stimulus package which, together with a weaker dollar, could have an impact on economic growth in the second half of the year.

Resilient oil prices in the face of prevailing macroeconomic uncertainty leave analysts two explanations: fundamental strength or pressure from fund flows.  The weight of anecdotal evidence of heavy fund flows is important, but recent trends in open interest and a reduction in non-commercial longs (the net position has halved since early March) suggest other factors are at play.  Certainly credit problems have been reducing available finance for producers or traders who want to hedge, and as they are predominantly short, this could have an upward impact on prices.  From a fundamental perspective, we have seen little change in 1Q08 nominal stock levels since their fall in the second half of last year; China has been stepping up imports of crude and products; the distillate upgrading spread has seen an unprecedented widening; and traders remain confident that OPEC will step in to reduce production should prices fall - thought by some to be effectively providing a 'free' call option for speculators and a 'free' put option for producers.



With global seasonal refinery maintenance peaking in April (OECD maintenance culminated in March), tighter refined products have driven markets.  Crack spreads for all products bar high-sulphur fuel oil have risen since mid-March, boosting refining margins, which had previously been very weak.  Notably, gasoline improved sharply, with RBOB futures even hitting an all-time high in early April.  US refinery utilisation fell to its lowest since after Hurricane Katrina hit in 2005, partly as a response to the weak margin environment, but also on unexpected outages.  The distillate market remains supported by strong global demand and regional tightness - China has again seen product shortages in some provinces - while structurally, the world faces a distillate crunch.

Lastly, geopolitics served to underpin prices once again, as the battle for Basra resulted in pipeline outages, which briefly cut southern Iraqi crude exports.  Month-on-month, Iraqi exports actually rose in March, and the situation in Basra and elsewhere appears to have calmed down, but the worry remains that the previously smooth flows to the southern ports may become less secure.  A pipeline was set ablaze in Nigeria, where the tension in the Niger Delta continues to smoulder, but this did not lead to lower exports either.  An oil workers' strike in Gabon was eventually resolved, but temporarily shut-in as much as 80-90 kb/d of crude production.

Spot Crude Oil Prices

The spot crude market was influenced by the renewed interest in gasoline-rich grades for the US market, while elsewhere, crudes with a high distillate cut were more sought after.  Light sweet Nigerian crudes saw premia to Dated Brent rise to over $4/bbl since a low point in mid-March, also taking some strength from political tensions.  WTI increased its margin over Dated Brent, but on a net product worth basis, domestic sweets such as LLS looked more attractive, thus likely curbing transatlantic flows of North Sea grades.  Weak fuel oil margins pulled down medium sour Gulf Coast grades, such as Mars and Poseidon, which saw their discounts to WTI widen.

West African crudes were popular in Asia too, with a record 1.6 mb/d fixed to travel east for April.  Of this, some 1.2 mb/d were reportedly heading for China, by far the largest volume it has ever imported from that region and some 370 kb/d up from March.  In China's case, its need is mainly for distillate-rich grades to compensate for a domestic shortfall, which has also caused record-high gasoil imports in recent months.  Reportedly, the Qingdao refinery, which is due to start up this month, was planning to initially run on light sweet crudes before changing its diet to heavier, more sulphur-rich barrels.



In Europe, refining margins indicated a growing advantage for complex plants to run medium sour Urals and its discount to Dated Brent narrowed sharply in both the Northwest European and Mediterranean markets.  Urals also benefited from the strong surge of ICE BWAVE versus Dated Brent since mid-March, implying a disadvantage to those Mideast Gulf grades which compete with Urals in the Mediterranean and are priced off the former.  As a consequence, Saudi Arabia reacted by cutting official selling prices (OSPs) in early April (the same applies to OSPs to the US, where Gulf Coast sour benchmark Mars is showing weakness).



Refining Margins

Refining margins mostly improved in March and early April as gasoline recovered, but chiefly as distillates showed sustained strength.  Month-on-month, the greatest increase was in Singapore, but from the lowest base.  European cracking margins also improved significantly, especially for Urals, and early April even saw Brent and Es Sider hydroskimming edging towards positive territory.  In the US, margins were mixed, with the West Coast largely seeing downturns on greater relative gasoline weakness.  On the Gulf Coast, coking and some cracking margins improved on better RBOB margins.



Spot Product Prices

As flagged above, the biggest refined product story was gasoline, which improved strongly relative to crude (albeit from a very low base), and saw the greatest percentage change since mid-March.  Unseasonably low OECD refinery throughputs in February and March - partly as a result of economic run cuts - resulted in general product tightness.  Above-average US gasoline stocks have consequently fallen more sharply than usual from an early-March peak.  In Japan, the suspension of a highway-construction tax on road transport fuels appears to be causing increased consumer purchases in April, though the tax reportedly might be reinstituted at the end of the month.  Meanwhile, China - until recently a net gasoline exporter - imported around 40 kb/d in March, adding some tightness to the Asia-Pacific market.

But middle distillates crack spreads saw the greatest gains in absolute terms, in most cases rising to record-high premia over benchmark crudes.  Jet fuel cracks remain highest, but diesel and heating oil are close behind.  Rather than any particular regional issue, the global market remains structurally tight, exacerbated by recent low refinery throughputs.  Europe, which is short distillate, saw lower imports from the US and elsewhere, as cargoes were diverted to Latin America, South Africa and the Middle East, and Amsterdam-Rotterdam-Antwerp (ARA) gasoil stocks remain below average.  In Asia, China again imported a high 150 kb/d of gasoil in March to cover shortages, while diesel sales in Japan were reportedly up in early April due to the road tax reduction (though mild weather meant lower kerosene sales).  Meanwhile, Indonesia will reportedly import 5.8 mb of gasoil in May, 1 mb more than in May last year.  Lastly, S-Oil's Onsan refinery outage in South Korea meant lower regional supplies.



Fuel oil discounts to crude remained low by historical standards, but narrowed again after record-wide differentials in mid-March.  Low-sulphur fuel oil picked up generally, and low-sulphur waxy residue (LSWR), predominantly used as boiler fuel by Japanese power utilities, saw its discount narrow to within $2.25/bbl versus Dubai - its strongest position since October 2005 on increased Japanese use.  Overall, Japanese utilities are expected to use 50% more fuel oil and direct crude burn in the coming financial year (totalling around 400 kb/d), as nuclear power plants remain offline pending repair work and security verification.  High-sulphur crack spreads were relatively unchanged on the month.





End-User Product Prices in March

End-user product prices denominated in US dollars, ex-tax, increased on average by around 10% in IEA countries surveyed in March.  However the depreciation of the US dollar accounted for a large part of this increase as the euro and the yen rose by almost 5% and 6%, respectively vis-à-vis the dollar in March.  Diesel and gasoline ex-tax prices in national currencies rose on average by 8.8% and 4.3% respectively.  US consumers experienced a significant jump of 16.6% in the price of automotive diesel and 7.8% in the price of gasoline, in contrast to Japan where the end-user prices of diesel as well as gasoline remained unchanged in March 2008, expressed in yen.  In Canada, the diesel price in domestic currency also grew sharply by 13.5% in March.  In Europe, heating oil prices rose by 8% and low-sulphur fuel oil prices rose by 3.3%, both in euros, ex-tax.

Freight

Dirty tanker rates rose in the second half of March, most notably in the Mediterranean, North Sea and Atlantic basin.  Vessel fundamentals tightened on rising long-haul tanker demand, following increases in both eastbound West African trades and westbound volumes leaving the Middle East Gulf.  Rates reportedly corrected downwards in early April, however, as vessel supply increased in these areas.  Clean rates were almost flat in March on high Asian vessel availability and low US gasoline imports.

Demand for crude tankers in the Atlantic basin rose in March, supported by record-high purchasing of West African crude by Far Eastern refiners in March and April.  Chinese refiners reportedly bought 38 West African cargoes for loading in April (equivalent to 1.2 mb/d, the highest volume ever), compared with 30 for March.  US refiners may have also been looking to spot charter extra vessels of gasoline-rich West African crude during recent periods of maintenance.  Suezmax rates from West Africa to the US Atlantic coast increased from $21/tonne at the end of February to over $29/tonne in the last week of March, although early-April reports suggest that rates subsequently softened as vessel supply increased.



Vessel fundamentals were also extremely tight in the Mediterranean in March.  Tanker supply was impeded by minor transit delays in the Turkish Straits, and competition for tonnage was fierce.  With limited ballasting from the Mediterranean, North Sea vessel availability was also reduced as a result.  Benchmark Aframax charter rates for North Sea to North Europe peaked at $12.64/tonne in late-March, having started the month nearer $7/tonne.

VLCC rates in the Middle East Gulf were firmer in late-March, rising from a mid-March low of $16/tonne to finish the month over $23/tonne on the benchmark route to Japan.  Tanker movement reports suggested that westbound volumes from the Gulf rose significantly in March, possibly as a result of lower formula prices for all Saudi grades heading to the US.  Swings to longer-haul western destinations translate into aggregate increases in tanker demand which support all rates in the region.  Higher vessel supply reportedly led a downward correction to rates in early April.  Reports in March of the first VLCC being sold for scrap since 2004 were the first signs that scrapping economics may have become more favourable than conversion (for example into dry bulk carriers).  A new phase of deletions could eat into the large growth in fleet capacity foreseen in the medium term and add long-term support to freight rates.

Clean tanker rates were almost flat in March.  Demand for product imports remains high in China, but the notable March rise in light distillate stocks seen in independent storage in Singapore may have been indicative of an influx of clean vessels into the region.  With US gasoline imports below average throughout March, 33,000-tonne clean tanker rates dropped nearly $2/tonne in March to finish at just over $25/tonne.

Refining

Summary

  • Global refinery throughput weakened in March, as poor margins curbed crude runs in all OECD regions.  Estimated 1Q08 global throughput is unchanged at 74.0 mb/d, as stronger-than-expected February crude runs were offset by weaker January and March throughput estimates.  Crude throughputs in 2Q08 are forecast to average 73.7 mb/d, 0.2 mb/d lower than last month's report.
  • OECD crude throughput averaged 38.4 mb/d in 1Q08, 0.1 mb/d higher than estimated last month.  Upward revisions to January and February data more than offset the weaker-than-forecast March US throughput.  OECD throughput in 2Q08 is pegged at 38.1 mb/d, 0.1 mb/d lower than last month's projection as the lower demand forecasts are partly offset by reduced maintenance assumptions.


  • OECD gasoil/diesel yields declined slightly in January from December levels, but remain well above the five-year range.  Weaker jet/kerosene yields in January in the OECD Pacific and North America, were the corollary of the stronger gasoil/diesel yields.  In Europe fuel oil yields suffered as recently commissioned upgrading capacity returned to full service, increasing light product yields.  Similarly fuel oil yields slipped below the five-year range in North America, driven by declines across-the-board, most noticeably in Mexico.
  • Chinese state oil companies continue to operate refineries close to capacity to meet strong demand growth and are increasingly relying on product imports to address shortages.  At current oil prices, 2008 will see a deterioration in refining economics compared with last year, without further action by government to raise prices or reduce import costs.

Global Refinery Throughput

Refining activity remained weak in OECD regions during March, compared with seasonal norms, as the poor margin environment continued to deter refiners from maximising crude runs.  North American refineries were particularly hard-hit, but reports suggest that economic run cuts affected crude runs in OECD Europe and the Pacific and in some non-OECD Asia countries.

2Q08 global crude throughput forecasts have been revised down, reflecting a mixture of lower demand forecasts and higher maintenance estimates in some regions (notably China and the FSU).  The quicker-than-expected recovery in Nigerian crude runs, following the re-start of two mothballed refineries, and a reassessment of Japanese maintenance plans in 2Q08 partly offset these downward adjustments to our forecasts.

In the US, refiners cited the combination of unplanned outages and economic run cuts, brought on by poor gasoline cracks and high gasoline stocks, for much of the slowdown in crude runs.  However it is noteworthy that the build in gasoline stocks, which reached 15-year highs in February, also reflected preparations by refiners to cut throughputs in March because of planned maintenance.  Crude run cuts in the US (and elsewhere) restrict not only gasoline production, but also middle distillate supplies, at a time when diesel, gasoil and jet fuel cracks are at, or near, record levels.  Hence the move by some US refiners to limit catalytic cracking throughputs, which will have a greater impact on gasoline supplies than middle distillates.

Furthermore, the increased volume of ethanol blending in the US (see Ethanol Leads Where Conventional Oil Lags) would also appear to be have exerted downward pressure on margins in recent weeks.  However, the switch to lower-volatility summer specification gasoline will reduce the range of gasoline components available to refiners to produce gasoline blend stock for use with ethanol.  Consequently, US gasoline yields will seasonally come under pressure as fuel volatility constraints tighten the US domestic gasoline pool.  Ultimately this could, in turn, support margins over the summer months and lead to increased imports of low volatility gasoline blending components.



The poor state of hydroskimming refinery margins, estimated in this report to have averaged -$4/bbl on a full-cost basis for Urals crude in Europe during March, kept the pressure on less complex refiners to minimise crude throughputs.  At this level even marginal economics do not support incremental crude runs by hydroskimming refineries.  Offsetting weak gasoline (and a heavily negative fuel oil) crack has been the continued strength in middle distillate cracks.  These have been supported by the continued strength of demand for diesel and the tighter sulphur specifications for heating oil in Europe.  The recovery in gasoline cracks in late March and early April further bolstered already strong complex refining margins, suggesting that cracking refineries in Europe and Asia will maximise runs where possible.

1Q08 global refinery crude throughput is largely unchanged from last month's report, at 74.0 mb/d.  The weaker-than-forecast US crude throughput in March is offset by increased Middle Eastern and OECD Pacific crude throughputs in February.  OECD crude runs are expected to decline by 0.3 mb/d year-on-year, driven by economic run cuts and heavy US maintenance.  Non-OECD crude runs are forecast to register an annual increase of 1.0 mb/d during 1Q08, largely driven by China (+0.4 mb/d) and other Asia (+0.3 mb/d).

2Q08 global refinery crude runs are forecast to average 73.7 mb/d, 0.2 mb/d lower than estimated in last month's report.  Year-on-year growth is trimmed to 0.5 mb/d, half the level of the first quarter, on the back of the lower demand estimates for North America and upwardly revised maintenance estimates for the US and China.  The impact of these adjustments is partially offset by lower maintenance estimates for Japan and the faster-than-expected ramp-up in Nigerian refinery throughput.



OECD North American crude throughput has been revised down by 0.3 mb/d for March as weekly data for the US, showed that percentage utilisation rates hovered in the low 80's for much of the month.  US refiners trimmed crude throughput progressively through the first half of March, reaching a low of 14.1 mb/d for the week ending 21 March, the lowest weekly level of throughputs since March 2006.  Downtime at upgrading units, both planned and unplanned, and the poor economics for cracking refineries until late in the month left refiners with little reason to return units quickly from shutdown, with economic run cuts accounting for up to 400 kb/d of the reduction in crude runs.  Comments by Valero indicated that by mid-March, 255 kb/d of its cracking capacity was offline, of which we estimate around 150 kb/d was planned



Operational problems eased in Canada with both ExxonMobil and Shell refineries completing repairs which have hampered product supply in recent weeks.  Gulf and West Coast throughputs held up above February lows, while Midwest throughputs fell mid-month to their lowest level in nearly four years.  East Coast March crude runs revisited the four-year lows seen in mid-February.

2Q08 North American crude throughput forecast has been reduced by an average of 0.4 mb/d, to 18 mb/d, which is 0.2 mb/d below year-ago levels and reflects the weaker demand outlook, and small adjustments to the forecast levels of planned maintenance.  Maintenance on coking units is expected to increase in April with Valero, Chevron, and CITGO, amongst others, undertaking work to improve reliability, energy efficiency or expand coking capacity.  Regional crude runs are forecast to reach 18.2 mb/d by June as US throughputs recover to 15.3 mb/d.

1Q08 OECD Pacific crude runs have been revised up following higher-than-expected Australian crude throughput.  Despite the widely reported operational problems at several refineries, provisional data suggest that Australian refineries averaged 0.6 mb/d in February, slightly ahead of our 0.5 mb/d estimate.  January crude throughput was also stronger than last month's provisional data indicated.  Run cuts remained a constraint during March at Japanese and Korean refineries, although the tight distillate market in Asia eased the impact of weaker gasoline and fuel oil cracks.  This may have allowed refiners to raise runs in late March, ahead of planned seasonal maintenance in the second-quarter.

The unplanned shutdown of S-Oil's 520 kb/d Onsan refinery in late March has further tightened regional distillate markets and should support margins over the coming weeks, following its declaration of force majeure on over 50 kb/d of April gasoil exports.  Also contributing to the higher 1Q08 estimate, weekly Japanese data for March suggest that crude runs averaged around 4.1 mb/d slightly ahead of our forecast of 4.0 mb/d.



2Q08 OECD Pacific throughputs are forecast to average 6.9 mb/d, up 0.2 mb/d from last month's report, following reduced maintenance assumptions for April and May in Korea and Japan and despite the continued operational problems at S-Oil's refinery into early April.  2Q08 Korean maintenance is now expected to peak in June and we have lowered our crude throughput estimates for the month accordingly.  Furthermore, Nippon Oil has reported it will increase processing of crude on behalf of PetroChina by 40% to 70 kb/d, for the business year commencing April 2008, from 50 kb/d in the previous business year.  This is but one of the many indications of the changing nature of the Japanese refining industry, which includes:

  • The continued rise in jet fuel exports;
  • the fast-approaching industry consolidation and rationalisation and;
  • the entry of new operators (such as the purchase by Petrobras of the Okinawa refinery).

European crude throughput fell in February to 13.5 mb/d, according to preliminary data, as run cuts and maintenance reduced activity levels.  Estimated March crude throughputs have been revised slightly higher, following a reappraisal of maintenance during the month.  We have carried forward this assumption of lower maintenance through April and May, raising average 2Q08 forecast crude runs by 0.1 mb/d to 13.3 mb/d.  The strength in European distillate markets, highlighted last month, has increased following a fire at the residue hydrocracker at Neste's Porvoo refinery, with reports suggesting it may be out of service until late May. 





The improvement in European distillate cracks (to record levels) also reflects the low gasoil stocks in the ARA and French markets and could allow some refiners who previously reduced throughputs to raise them again to meet the need for incremental distillate supplies in the region.  German refinery crude throughput remains steady at around 2.2 mb/d in March, despite ongoing supply problems for some refineries connected to the Druzhba pipeline. Currently, there appears to be ample availability of seaborne Urals cargoes to offset the shortfall, while refineries on the southern leg of the pipeline are also reported to be well supplied.

Chinese crude runs in January and February were 0.1 mb/d below our estimates, at 6.8 mb/d.  Some refiners suggest this was the result of the cold weather seen in late January and early February, which disrupted operations.  Consequently, we have revised down our 1Q08 forecast to 6.8 mb/d, which represents growth of 0.4 mb/d on the previous year.

Chinese 2Q08 forecasts have been similarly reduced by 0.1 mb/d to 6.6 mb/d following upward revisions to our forecast for maintenance during the quarter.  2Q08 growth will turn negative in the face of the expected maintenance programme, which we estimate to average 0.2 mb/d. Consequently we expect that it is likely to necessitate increased imports of gasoil, jet and gasoline over the coming months.  However, it remains possible that government pressure will reduce actual maintenance during this period if recent product shortages worsen.

Asian crude throughput forecasts are largely unchanged for the first half of the year.  Indian crude runs slipped slightly in February from January's record level, while reports indicate that CPC implemented run cuts at its 500 kb/d refinery in Chinese Taipei because of weak margins. 

The Burden of Maintaining Supply in China's Regulated Market

Despite the many protests by Chinese refiners that they are suffering from the impact of controlled product prices, the results for China's largest refiner Sinopec suggest that conditions are not all that dire.  Sinopec reported a full-year loss in refining of $1.5bn.  Against this loss the government is reported to have paid about $1.7bn in subsidies.  In 2007 Sinopec refined 1.1 billion barrels of oil, suggesting the average loss was around $1.3/bbl.  Over the same time period complex refineries in liberalised markets have seen margins average from $4-11/bbl, suggesting that the lost profits are in the order of $5-12bn.  However, much of the loss occurred in the fourth-quarter 4Q07, suggesting the loss was around $5/bbl.  Given the development of crude prices over 1Q08 the refining operating losses for 1Q08 could increase to $3bn.

However, not all refiners have benefited from such government largesse.  Many independent and teapot refineries have stopped processing crude and fuel oil because of unfavourable economics.  The product shortages that have re-emerged in recent weeks are partially a result of the lack of supplies by these marginal units.  Although the Chinese government has long sought the closure of such small-scale capacity, it is ironic that lower fuel oil imports are effective being replaced with stronger diesel imports, adding to distillate market tightness.  State oil companies have provided subsidised feedstock and crude to independent refiners, or alternatively have guaranteed the purchase of refined products at price levels that are high enough to encourage incremental crude runs.  However, this is also reported to be part of a wider move to consolidate the refining sector, with some suggestions that CNOOC, in particular, is looking to increase its refining assets to balance its upstream portfolio.  Given the poor economics that some independent refiners face, the opportunity to combine their business with a larger partner may seem an attractive proposition, especially if the buyer effectively controls the access to crude supply.

The product shortages that have re-emerged in recent weeks are raising the prospect of continued, and most likely, increased product imports over the course of 2Q08 and in the run up to the Olympics.  Unsurprisingly, the two state refiners are pushing for an extension of the suspension of VAT on product imports beyond the end-April deadline for its expiry.  To fulfil the mandate to maintain inland supply some state refiners have resorted to blending petrochemical feedstock, such as toluene, into the gasoline pool to meet demand.  Within a liberalised market place this can be an expensive process (last seen in the US just after the rapid switch to ethanol blending to offset the increased volatility of the ethanol) but in a market where gasoline, gasoil and jet/kerosene prices are regulated, while petrochemical feedstock prices are not, this represents a significant mark-down in value and signals a strong commitment to boost supplies where necessary.

If current world oil prices are maintained and the government resists pressure to further increase the regulated domestic prices because of inflationary pressures, then Sinopec's 2008 refining operating loss could exceed $14bln.  This is far in excess of the levels seen in previous years, and a significant increase in the subsidy faced by the Chinese government.

Middle East crude runs continue to exceed our forecasts, as Iran and Iraq reported stronger-than-expected results for February.  Iranian data shows runs slightly higher at 1.7 mb/d, as planned maintenance work at the Bandar Abbas refinery slipped into April from January/February.  Similarly, Iraqi data puts domestic crude runs at almost 0.5 mb/d, ahead of our 0.4 mb/d estimate.  Consequently, we have carried forward the stronger crude throughputs to March, which results in a 0.1 mb/d increase in the 1Q08 estimates. 

African throughput forecasts are revised higher for much of 1H08, following the quicker-than-expected re-start of the two mothballed Nigerian refineries.  The re-start of the Warri and Kaduna refineries follows two years spent idle after sabotage shut the crude lines supplying them.  With the phased re-start in January and February of the pipelines, crude processing has again commenced and is thought to have averaged 120 kb/d in February, rising to 230 kb/d in March.  The fire in late March on the line supplying the 210 kb/d Port Harcourt refinery has reduced our estimate for April crude throughput, but overall 2Q08 throughputs are revised up by 0.1 mb/d, although further disruption could re-emerge if social unrest flares up again.

OECD Refinery Yields

OECD gasoil/diesel yields remained above the five-year range in January, but declined slightly when compared with December levels in all three regions.  In the Pacific problems with Caltex's residue hydrocracker reduced Korean gasoil/diesel yields and simultaneously raised fuel oil yields, while in Japan the switch away from gasoil to kerosene appeared the main driver.  European gasoil yields were only marginally weaker when compared with December, but up 1.2 percentage points on an annual basis to 37.7%.  Lower yields in the UK, Hungary, France, Denmark and Finland, due to a combination of maintenance, and unplanned outages, were offset by higher yields in Spain, Sweden and Portugal.



Fuel oil yields were significantly weaker in North America and Europe, compared with previous year levels, reflecting the exceptionally weak fuel oil cracks. However, North American data may be subject to upward revision in coming months, as Mexican fuel oil yields appear too far below the five-year-range. OECD Pacific fuel oil yields were not as weak as January 2007, reflecting the impact of the operational problems in Korea, and possibly the increased demand for fuel from Japanese utilities.