Oil Market Report: 10 July 2008

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  • Crude oil futures fell back from their early-July $145/bbl peak, but remain high, supported by a meagre 2Q08 stockbuild, tight distillate markets and ongoing geopolitical risks.  Refiners are paying record premiums for distillate-rich crudes in an effort to bolster yields; however, weak gasoline and fuel oil cracks are keeping refining margins low.
  • Non-OPEC supply is seen rising 640 kb/d to 50.6 mb/d in 2009, following a late-year increase in 2008, with Asia, the Caspian, Brazil, Canada and the US adding to supplies.  In addition, NGLs from Saudi Arabia, Qatar, the UAE, Nigeria and Iran underpin the 810 kb/d expansion in OPEC gas liquids in 2009.
  • OPEC crude supply increased by 350 kb/d in June to 32.4 mb/d, as Saudi Arabian supply rose to 9.45 mb/d and exports from floating storage lifted Iranian supply to 3.8 mb/d.  Although higher supply lowers effective OPEC spare capacity to 1.7 mb/d, increases from Saudi Arabia, Angola, Iraq and Nigeria lift overall capacity by around 1.0 mb/d by end-2008.
  • Global oil product demand is expected to grow by 1.1% or 860 kb/d to 87.7 mb/d in 2009, on a par with 890 kb/d growth in 2008.  High oil prices contribute to a contraction in OECD oil product demand, offset by robust growth in developing economies.  Strong non-OECD consumption also offsets downward revisions elsewhere, lifting 2008 demand by a modest 80 kb/d.
  • A counter-seasonal US crude stock draw restricted the May OECD total oil stockbuild to 23.9 mb, only half its usual gain.  Preliminary June data suggest a total 2Q08 OECD stock change of around +100 kb/d, well below the five-year average 2Q build of 900 kb/d.
  • 3Q08 global refinery throughput is revised down by 0.4 mb/d to 75.3 mb/d on weak OECD demand and poor margins.  The addition of 2 mb/d of crude distillation capacity and significant investment in upgrading units elsewhere should keep gasoline markets well supplied and slightly ease middle distillate tightness during early 2009.

An easier time in 2009?

The IEA's Medium-Term Oil Market Report, published on 1 July, highlighted the ongoing supply-side constraints in the world oil market; this month's Oil Market Report provides the opportunity to look at the shorter term as we rollout the forecast to 2009.

Data for the first five months of this year reflect the tighter market balance exemplified by current high prices.  OECD stocks built by 24 mb in May, with product stocks broadly rising in line with seasonal norms.  But with crude stocks seeing an unusually large draw in the US, leaving the monthly oil build around half normal levels.  Together with preliminary data for June we can take a first glance at second quarter stocks, which appear to have built by just 100 kb/d, well below the 900 kb/d five-year average, and our balances suggest that there was little opportunity for stocks to rebuild globally.

Forecasting uncertainties are always present, but arguably have increased in recent years.  With economists debating the length of the current US slowdown, superficially the risks to demand appear to be on the downside.  However, while that may be true for the OECD, robust near-term oil demand in developing countries has led to some upward revisions in the non-OECD.

Similarly, supply-side issues are ever-present.  While we always try to take a cautious stance on new project start-ups, slippage has been a major cause of supply-side revisions over the past few years.  Additional uncertainties can stem from weather and field reliability issues, but these may swing both ways.  Within our numbers we have allowances for both field reliability (400 kb/d) and seasonal hurricane outages (300 kb/d in September/October), which help to moderate all but the most severe outages.  But of course to these we also need to add ongoing geopolitical concerns.

Keeping OPEC output steady at June levels until the end of the year implies an improvement in global stock levels.  Allow for forecasting risks and it becomes less certain that we will see a stockbuild.  For that reason, the additional 250 kb/d pledged by Saudi Arabia from July provides insurance that the crude market should improve.  Moreover, as we head into early 2009, the bunching of new projects should lead to an increase in crude oil spare capacity.

But current high prices are not just about crude oil tightness.  In the MTOMR we argued that refinery tightness is a major contributor to high prices, exemplified by the current diesel market.  Recently, emergency power generation needs in Australia, South Africa and South America, coupled with a surge in China's middle distillate imports, have exacerbated diesel tightness.  Of these problems, only the Australian outage looks set to improve significantly by the end of this year.  China's recent shifts in retail prices seem unlikely to make the teapot sector profitable in the short term, but regional supplies should increase over the second half of the year and into 2009 as new refining capacity comes on stream in both China and India (notably the Jamnagar refinery).

Looking at diesel and middle distillate balances on a quarterly basis, there is the potential for the current tightness to start to ease slightly in 3Q08, but that may be over-optimistic.  Given the potential for demand surges in China in the hot summer months, the need to build stocks ahead of the winter, new low-sulphur diesel specifications from 1 January 2009 in Europe and potential refinery start-up problems, it would seem more likely that product markets will only truly ease once weather risks from the 2008/09 winter have diminished.  In other words, both crude and middle distillate markets may see some respite in the second half of 2008, but more likely by early next year.



  • Global oil product demand is expected to reach 87.7 mb/d in 2009, compared with 86.9 mb/d in 2008.  This represents an annual increase of 1.0% or 860 kb/d, very similar to the growth forecast for this year (890 kb/d).  In terms of revisions, demand in 2008 is adjusted up slightly (+80 kb/d), as upward changes in non-OECD countries offset downward revisions in the OECD.  It should be noted, however, that this report does not include the customary July edition revisions to annual OECD data, given some late submissions.  The new figures will be included in next month's report.
  • OECD oil product demand is seen averaging 48.0 mb/d in 2009 (1.2% or 0.6 mb/d below 2008), as rising oil prices continue to take their toll.  The contraction in demand is expected to be particularly marked in North America (-380 kb/d), given the weakness of the US economy and high oil prices.  Demand in both Europe and the Pacific is seen falling by roughly 100 kb/d each, as structural trends are amplified by high prices.  Regarding the prognosis for 2008, demand is lowered by about 50 kb/d.  A large revision of April's figures in the US, coupled with weaker-than-expected demand in Germany and Italy, offset stronger Japanese demand for residual fuel oil and crude for power generation.  In addition, Australian gasoil imports are expected to be higher in the months ahead following an accidental disruption in natural gas supplies.

  • Non-OECD oil product demand is forecast at 39.7 mb/d in 2009 versus 38.3 mb/d in 2008.  At +3.8% (+1.4 mb/d), annual growth is expected to match that of 2008.  Sustained economic growth in key areas (notably Asia, the Middle East and Latin America) will drive most of the increase in demand.  Moreover, despite a recent wave of adjustments in administered price regimes, notably in Asia, retail prices in many countries continue to be much lower than international benchmarks.  Meanwhile, demand in 2008 is revised up by 130 kb/d, largely as a result of upward adjustments in the Middle East (given stronger-than-expected demand for transportation fuels and residual fuel oil in Iran and Saudi Arabia) and, to a lesser extent, China (where the outlook for naphtha demand was reappraised).
  • This forecast faces several risks.  These include: 1) the global economic outlook, particularly with respect to the US and several large emerging countries; 2) the evolution of oil prices, whose rise is fuelling worldwide inflation; 3) sudden and large, as opposed to our assumption of gradual and moderate, increases in capped prices across most of the developing world; 4) weather conditions in the northern hemisphere; 5) interfuel substitution in favour or away from natural gas or renewables; and 6) data uncertainties, notably in non-OECD countries.


According to preliminary data, total OECD inland deliveries (oil products supplied by refineries, pipelines and terminals) contracted by 0.7% year-on-year in May, with losses in North America and Europe offsetting gains in the Pacific.  In OECD North America (including US Territories), oil product demand fell by 2.0%, as the US economy continues to weaken amid continually rising oil prices.  In OECD Europe, demand fell by 1.0%, pulled down by Germany, the UK and Italy.  In OECD Pacific, by contrast, demand rose by 3.9%, supported by strong Japanese growth.

April data were only slightly revised in both Europe (-40 kb/d) and the Pacific (+20 kb/d).  In North America, by contrast, demand was sharply revised down in the US (almost -600 kb/d, partially carried forward through to end-2008).  OECD demand is now forecast at 48.6 mb/d in 2008 (-1.0% or -0.5 mb/d versus 2007, and 50 kb/d lower than estimated in our last report).  The prognosis for 2009, meanwhile, follows a similar trend: demand is expected to contract by 1.2% on a yearly basis (roughly -0.6 mb/d) to 48.0 mb/d, on the back of continued high oil prices and a weakening US economy.  Overall, all demand drivers (transportation, heating, power generation and other usages) in the OECD are set to contract in 2009.  Needless to say, if prices continue to rise and/or if the economic outlook worsens, this forecast could trend lower.

North America

Preliminary May data indicate that oil product demand in North America (including US Territories) fell by 2.0% year-on-year, mostly because of continued weakness in the US.  The contraction in regional deliveries was particularly marked in the case of high-sulphur gasoil (-23.4%, even though this is related to US reclassification issues, since low-sulphur non-road, locomotive and marine gasoil is now counted as diesel), residual fuel oil (-14.6%), and 'other products' (-5.5%).

OECD North America demand is thus expected to average 25.0 mb/d in 2008 (-2.2% when compared with 2007).  As a result of the economic slowdown in the US and high oil prices, this decline is seen continuing in 2009: demand is forecast at 24.6 mb/d, 1.5% or 380 kb/d lower than in 2008.

Adjusted preliminary data indicate that inland deliveries in the continental United States - a proxy of oil product demand - contracted by 2.7% year-on-year in May and by 2.3% in June, with all product categories bar gasoil registering losses.  It is worth noting that demand for gasoline and jet fuel/kerosene shrank for the seventh consecutive month, providing further evidence of the effects of the ongoing economic slowdown and rising oil prices.  Moreover, April data were sharply revised down (-600 kb/d).  Our revision, however, was much lower than the EIA's (about -870 kb/d, of which 500 kb/d for 'other products'), since this report attempts to anticipate weekly-to-monthly data adjustments.  US oil demand is now seen contracting by about 2.8% to 20.2 mb/d in 2008.  This contraction is expected to be less pronounced in 2009 (-1.9%, equivalent to an average demand of 19.8 mb/d) given a slightly improved economic outlook.

As this report has noted over the past few months, the most striking feature of the US oil market is the sharp contraction of gasoline demand.  According to the US Federal Highway Administration, American motorist are driving less as the economy slows down and retail prices continue to increase (gasoline has surpassed the highly symbolic $4/gallon threshold).  Preliminary figures (likely to be revised) indicate that the number of vehicle-miles travelled (VMT) fell by 0.9% year-on-year in April for the fifth month in a row.  In fact, the pace of growth of VMT had begun to slow down significantly since 2006, as prices started to bite.  Over the past two years, the seasonal rebound during the summer (the so-called 'driving season') was unusually weak.  These data are backed by an array of anecdotal indicators, including high levels of public transport usage in big cities like New York, Chicago, Washington, Boston and Los Angeles, the increasing use of bicycles in urban areas, and the continuing fall of SUV and light truck sales, among others.

The demand outlook in both Canada and Mexico looks less bleak; in both countries demand is expected to remain essentially flat, but not contract as in the US.  Canadian demand is expected to average 2.3 mb/d in both 2008 and 2009, largely supported by resilient gasoline consumption - the largest component of demand.  Similarly, transportation fuels demand in Mexico will offset the sharp decline in residual fuel oil and, to a lesser extent, LPG and naphtha; as such, overall demand is seen averaging 2.1 mb/d this year and next.  Admittedly, in Mexico subsidies are contributing to sustain the high pace of growth in transportation fuels demand, but at this point it is highly unlikely that they will be removed, given inflationary concerns and despite their high fiscal cost (estimated at some $20 billion in 2008, up from $5 billion in 2007).


According to preliminary inland delivery data, European oil product demand shrank by 1.0% year-on-year in May.  This implies a downward revision of our estimates of almost 120 kb/d, as demand for gasoil and residual fuel oil turned out to be weaker than expected.  April estimates were revised down by roughly 40 kb/d following the submission of official oil statistics.

European demand, expected to average 15.3 mb/d in 2008 (virtually unchanged when compared with 2007), is seen contracting by 0.6% (-90 kb/d) to 15.2 mb/d in 2009.  This decline is largely structural, driven by trends in the largest countries (France, Germany, Italy, Spain and the UK): modest economic growth, shrinking populations (notably in Germany, Italy and Spain), the ongoing 'dieselisation' of vehicle fleets, and the gradual substitution of residual fuel oil and heating oil in favour of natural gas and renewable energy sources.

Inland deliveries in Germany contracted by 4.1% year-on-year in May.  Gasoline, diesel, heating oil and residual fuel oil deliveries were particularly weak (-7.7%, -3.4%, -6.9% and -19.3%, respectively), partly because of the strong restocking observed in the previous month (with the exception of heating oil) but also due to relatively mild temperatures.  High prices are also taking a toll: German consumer stocks of heating oil, which are usually replenished during the summer, remain at record lows, averaging 44% of capacity by end-May (from 45% a month earlier and 53% a year before).

Demand in France soared by 5.8% year-on-year in May, with all products bar gasoline registering gains.  By contrast to Germany, heating oil demand was 34.8% higher than last year, largely because of very weak sales in May 2007, which was particularly warm.  Fuel oil deliveries, meanwhile, rose by 13.4%, boosted by strong electricity demand.  In Italy, demand shrank by 6.4% year-on-year in May, dragged down by subdued diesel sales (-3.5%) and weak residual fuel oil deliveries (-16.5%).

Oil product demand in the UK rebounded by +2.6% in April (the latest month for which data are available), driven by strong distillates deliveries (jet fuel/kerosene soared by +9.2%, while gasoil rose by 3.4%).  More importantly, at 9.9% below last year's level, the structural decline in gasoline demand is more in line with the average trend of the past few months.

The sharp fall seen in March (-19.6%) prompted some alarmist headlines in the British media, despite warnings that March was unusual because of Easter, which normally occurs in April (and when demand typically weakens sharply), and that extrapolating from a single data point is meaningless.  The dieselisation of the vehicle fleet explains over half of the current rate of decline; only the rest can arguably be attributed to high prices and growing worries about the state of the British economy.  Anecdotal evidence suggest that British consumers are indeed becoming more cost-conscious: Internet shopping appears to be on the rise, while retail sales in out-of-town centres - which are usually reached by car - are sliding.


Preliminary data for May show that oil product demand in the Pacific jumped by 3.9% year-on-year, largely driven by buoyant growth in Japan and Korea.  In particular, given stronger-than-expected demand in Japan for residual fuel oil and direct crude for power generation, OECD Pacific oil demand has been revised up by 280 kb/d in May.  Looking forward, Australian diesel demand has been nudged up following a natural gas outage in the western part of the country.  Regional demand is now seen averaging 8.4 mb/d in 2008 (+1.1% or +90 kb/d on a yearly basis).  By contrast, it is expected to contract slightly in 2009 to 8.2 mb/d as Japan resumes its structural decline.

According to preliminary data, oil product demand in Japan - which accounts for about two-thirds of OECD Pacific's total - rose by 4.1% year-on-year in May, as all product categories bar naphtha and gasoline posted gains.  Relatively cold temperatures (HDDs were higher than both the 10-year average and compared with last year) supported demand for jet fuel/kerosene (+8.7%), as well as fuel oil (+18.0%) and direct crude for power generation (included in 'other products', which rose by 33.0%).  Gasoline deliveries predictably plummeted by 5.4% following the reinstatement of the gasoline tax; as such, gasoline demand has resumed its briefly interrupted structural year-on-year decline.  Therefore, even though oil-fired power generation is expected to remain strong at least until late 2009 given the ongoing problems of the domestic nuclear industry, Japanese demand is expected to shrink to 4.9 mb/d in 2009 (compared with 5.0 mb/d this year).

In Korea, preliminary data show that oil product demand rose by 4.9% year-on-year in May, mostly boosted by distillates and naphtha demand.  By contrast, demand for transportation fuel is either flat (gasoline) or declining (diesel) as a result of high prices.  In fact, rising energy prices have set the stage for a full-blown political crisis.  Over the past few weeks, the country has gone through numerous demonstrations, a costly trucker strike, the implementation of fuel subsidies and tax rebates, a freeze of electricity and gas prices, and more recently, the announcement of a multi-stage contingency plan aimed at reducing energy consumption in the public sector.  Given these woes, Korean oil demand is expected to grow modestly this year (2.2 mb/d on average) and next (2.3 mb/d), essentially supported by strong naphtha demand, which accounts for over a third of total consumption.

Australian demand is set to increase strongly this year (to almost 1.0 mb/d, +2.7% over 2007), largely as a result of buoyant domestic diesel needs, which have been further compounded by a recent accident.  In early June, a pipeline blast at Apache Energy's Varanus Island oil and gas facility in Western Australia shut in about 30-40% of the country's natural gas supply.  Given that the area is home to large mining concerns that are heavy power consumers, the accident led to a surge in diesel imports in order to fuel on-site generators.  We estimate that this will translate in about 50 kb/d of additional diesel demand over June-August (equivalent to roughly 210,000 tonnes per month), which should then gradually diminish (all the gas production lost should be back by December, according to the company).


Our prognosis for non-OECD oil product demand in 2008 has been revised up by 130 kb/d, largely as a result of upward adjustments in the Middle East (given stronger-than-expected demand for transportation fuels and residual fuel oil in Iran and Saudi Arabia), and to a lesser extent, China (where the outlook of naphtha demand was reappraised).  As such, non-OECD demand is seen averaging 38.3 mb/d in 2008 (+3.8% or 1.4 mb/d over 2007).  This pace of growth is expected to prevail in 2009, bringing demand to 39.7 mb/d on average.

Sustained economic growth in key areas (notably Asia, the Middle East and Latin America) will drive most of the increase in demand, together with low prices.  Despite a recent wave of adjustments in administered price regimes, notably in Asia, retail prices in many countries continue to be much lower than international levels.  Demand is thus expected to increase by 5.8%, 5.0% and 3.8%, respectively, in China, the Middle East and Latin America.

Nevertheless, this forecast faces several risks, largely related to rising oil prices, which could lead to a sudden and large - as opposed to a gradual and moderate - unwinding of administered price regimes in key emerging countries, which would have severe economic and social consequences.  Another issue is related to data uncertainties, notably in the case of China.


Preliminary data show that China's apparent demand (refinery output plus net oil product imports, adjusted for fuel oil and direct crude burning and stock changes) rose by an estimated 1.6% year-on-year in May.  This relatively modest rise was mostly related to sustained weakness in residual fuel oil demand - the feedstock of choice for 'teapot' refineries - which contracted by 9.3% compared with last year, and to a lower-than-expected increase in gasoil, which rose by 'only' 7.4%.  Demand for gasoline, by contrast, was actually stronger than previously thought, soaring by 13.7%.

Demand growth has continued to be met by strong net oil product imports (+120 kb/d in May versus the previous month), as refinery maintenance curbed runs by 0.4% from April.  Following a reappraisal of Chinese naphtha prospects, the country's total oil demand is seen averaging almost 8.0 mb/d (+5.6% over 2007).  In 2009, demand is expected to grow at a similar pace to 8.4 mb/d.

Economics 101 versus Pent-Up Demand

Our forecast of Chinese demand may seem too bullish, especially in the light of the sharp gasoline and gasoil price hike of mid-June 2008 (about 15%, taking the average of the largest Chinese cities).  Surely, demand should fall if prices increase?  China, however, is not an economy where such a mechanistic approach can be easily applied.  In fact, pent-up demand in China is arguably significant, only limited by supply constraints.

Oil demand is fuelled primarily by strong economic growth, not by artificially low retail prices.  This has prompted a surge in mobility: the country's vehicle fleet of 160 million units (by end-2007, of which 76% are privately owned) accounts for over 80% of total gasoline consumption and around 40% of diesel demand, according to data from Sinopec, the National Bureau of Statistics and the Ministry of Public Security.  Car owners from the country's affluent middle class are unlikely to cut back on car usage because of the rise: fuel prices in China's main cities currently average about ¢80/litre, only slightly above the cheapest country in Asia - Indonesia (¢65/litre) - but well below the most expensive one - Japan ($1.85/litre).  In a previous attempt to reduce fuel demand, in April 2006 the Chinese government had sharply increased the consumption tax on large vehicles (with engines of two litres or higher) from 9% to 20%, but to little avail: sales of large cars continued unabated.  Last year, for example, sales of gas-guzzling SUVs rose more than twice as fast (+50% versus +22%) as purchases of smaller cars, many of which maintain a reputation for poor manufacturing quality.  Meanwhile, many other sectors will receive handouts to cushion the impact of the latest move, including farmers, fishermen, forestry workers, taxi drivers, the public transportation sector and truckers.

In fact, the price adjustment became unavoidable in order to ensure adequate supplies in the face of localised shortages and their potential negative consequences upon economic activity.  (Contrary to some assertions, shortages have not been limited to Guangdong or Beijing, but have also occurred in several south-eastern provinces and in several major cities across the country, including Shanghai, Nanjing, Guangzhou and Changsha.)  Before the recent hike, the government had resisted calls for further price adjustments beyond the 9% raise in November 2007, citing the threat of additional inflationary pressures and preferring to adopt other measures to ensure adequate supplies, especially ahead of the Olympic Games in August 2008.  These measures, implemented over the past few months, included 1) an explicit monthly subsidy policy aimed at state-owned refiners PetroChina and Sinopec, as a way to cushion their downstream losses; 2) a temporary refund of the value-added tax levied on gasoline and gasoil imports; and 3) a mandate for wholesalers to hold minimum stocks.

While the combined impact of these measures and the recent price hike cannot be predicted at this time, this forecast assumes that capped prices will continue to be further adjusted, albeit gradually (by some 10-15% per year).  This would be consistent with China's long-held pledge to bring product prices in line with the global market and would encourage domestic refiners, both independent and state-owned, to increase runs, and hoarders to release stocks.

Yet June's new 'guidance' prices are probably still unprofitable.  According to local estimates, domestic gasoline and diesel ex-refinery prices (which are allowed to fluctuate by +/-8% vis-à-vis guidance prices) are respectively 37% and 44% below the price of imported fuel from Singapore (including taxes and transportation).  There are reports that many independent refiners continue to operate at some 30% of capacity, given soaring feedstock prices and mounting cash flow problems.  And even some officials from the state-owned giants, PetroChina and Sinopec, argue that the price move has failed to improve margins - at best it will only help minimise refining losses.

Following last month's increase in gasoline and gasoil prices, which as noted above was mainly intended at easing shortages, the country is abuzz with rumours of new policy moves, which could have an important effect on product supplies.  On the one hand, it would appear that the government is set to repeal a value-added tax (VAT) rebate on monthly crude, gasoline and gasoil imports, which was established in April in an effort to boost imports and offset the refining losses of state-owned oil Sinopec and PetroChina.  Under the deal, which was not officially renewed at expiration (end-June), the government refunded both companies all of their 17% VAT on product imports and three-quarters of the VAT on crude imports (also 17%).  Removing the exception would probably be justified if the price hike had been sufficient to restore downstream profitability.  As this is not the case, the refiners could again seek to minimise their losses and foster a fresh round of shortages - unless the government increases it direct subsidies or allows further price adjustments.  On the other hand, it is said that the government is about to cut the fuel oil import tax from 3% to 1% to boost imports and reduce losses, notably among 'teapot' refineries (the last tax cut, from 6% to 3%, had taken place last January).  This rumour, however, has had an unintended consequence: many independent refiners have delayed feedstock imports, a move that is unlikely to ameliorate the supply picture in the short term despite higher retail prices.

Other Non-OECD

According to Indian preliminary data, oil product sales - a proxy of demand - rose by 4.0% year-on-year in May.  Gasoline and gasoil sales continue to be the main contributors to demand growth, rising by 15.4% and 16.5%, respectively.  Although the pace of growth for both products is expected to moderate in the months ahead following June's retail fuel price rise, overall demand is poised to grow to 3.1 mb/d in 2008 (+4.6% over 2007) and almost as much in 2009, to 3.2 mb/d.  As we have argued, Indian demand has been driven primarily by income growth, rather than by artificially low prices.  On the basis of a continued economic expansion, the price hike will only slow down the pace of oil demand growth.

A new element, however, could alter the outlook.  Over the past few weeks, there have been localised gasoil shortages across the country.  This is largely due to last month's price rise: many consumers have reportedly switched to cheaper unbranded gasoil - ranging from truckers unwilling to purchase more expensive premium grades and utilities switching away from expensive fuel oil (which is not subsidised) to other users seeking to mix gasoil with subsidised kerosene (fuel adulteration is a common practice in India).  Moreover, the country's state-owned refiners have also stopped supplying unbranded gasoil to commercial establishments (such as hospitals, hotels and cinemas) in an attempt to cut losses.  As a result, demand for unbranded fuel is vastly exceeding supply and creating new problems: in early July some four million truckers went on strike, pressing for uniform gasoil prices - which in practice would mean subsidising premium gasoil as well.  Given inflationary concerns (most food is transported by truck) and looming elections, it remains to be seen whether the government will backtrack or not with regards to its recent price hike.

Finally, oil product demand in the Middle East continues to expand unabatedly, pulled by buoyant economic growth, favourable demographics, very low retail prices and occasional shortages in alternative energy sources (natural gas).  Demand is set to average 6.9 mb/d in 2008 and 7.2 mb/d in 2009, compared with 6.5 mb/d in 2007.  Several countries provide clear examples of this trend.  In Iran, gasoline demand, which averaged 480 kb/d in April, is on course to reach its pre-rationing levels.  Although this spike is mostly related to the Iranian New Year holiday period (which began in mid-March), it illustrates the fact that consumers are willing - and able - to purchase volumes above quota at market prices.  In Saudi Arabia, the story is similar: transportation fuels demand has grown about 7% on average over the past year.  Moreover, demand for other fuels is also quite strong.  Residual fuel oil is becoming a key source for power generation given the lack of commercially available gas (demand in Iran, for example, has risen by almost 38% on average since September 2007), while LPG and naphtha are fuelling ambitious petrochemical plans in the region.

Further afield, Latin American oil product demand is also robust, driven by similar factors.  Total demand is expected to average 5.9 mb/d and 6.1 mb/d in 2008 and 2009, respectively, against 5.6 mb/d in 2007.  The pace of growth may appear to be somewhat less brisk than in the Middle East as economic activity in countries which currently feature runaway demand - notably Argentina and Venezuela - is expected to gradually slow down, but it is not inconsequential.  Argentinean consumption, for example, is soaring: transportation fuels demand has increased by almost 14% on average over the past year.  The country's energy appetite is so voracious that it is even causing regional shortages (although, admittedly, capped prices and insufficient investment have also played a major role).  Chile, having lost natural gas supplies from Argentina, has been forced to ramp up its gasoil imports significantly, contributing to tighten the global distillate market.



  • Global oil supply during June increased by 285 kb/d from May to reach 86.5 mb/d.  The increase came largely from OPEC, as non-OPEC output slipped by 65 kb/d overall.  North Sea maintenance and unscheduled outages curbed production there by 325 kb/d, with only partial offsets coming from Latin America, China and the FSU.  July could see a sharp rebound in non-OPEC supply before further maintenance stoppages affect August, and higher July OPEC crude supply also appears likely.
  • Non-OPEC production estimates for 2008 are trimmed by 40 kb/d, due to a weaker profile for biofuels supply outside of Brazil and the USA. Mexico and Malaysia also see slightly lower forecast oil output, while higher baseline supply from the UK and USA boosts those countries' 2008 output.  Total non-OPEC growth averages 420 kb/d for 2008 (giving a total of 50.0 mb/d), close to the 450-500 kb/d growth seen in 2006 and 2007.  Expansion is heavily back-end loaded, with new project starts concentrated later in 2008. OPEC gas liquids supply grows by 325 kb/d this year to reach 5.1 mb/d.
  • The roll-out of the non-OPEC forecast to 2009 has growth rising to 640 kb/d, taking production to 50.6 mb/d.  OECD and non-OECD Asia, the Caspian republics, Brazil, Canada, and the USA are the main contributors.  Ongoing decline affects the North Sea, Mexico and non-OPEC Middle East, while Russian production also slips in 2009.  Much of a previously expected 2008 surge in OPEC gas liquids has been pushed back into 2009 on project delays.  OPEC NGL and condensates rise by 810 kb/d in 2009 to 5.9 mb/d, with Saudi Arabia, Qatar, the UAE, Nigeria and Iran all showing strong growth.
  • OPEC crude supply in June increased by 350 kb/d to reach 32.4 mb/d.  An increase in Saudi Arabian supply to just under 9.5 mb/d, together with a rebound in Iranian supply to 3.8 mb/d, underpinned the June gains.  Iraqi supply eased slightly from May's post-war record of 2.5 mb/d. Effective OPEC spare capacity is estimated at only 1.7 mb/d, although capacity increases from Saudi Arabia, Angola, Iraq and Nigeria could add around 1.0 mb/d to OPEC nameplate capacity by end-2008.
  • The 'call on OPEC crude and stock change' for 2008 is revised up by 0.2 mb/d for 2H08 to around 31.6 mb/d on stronger non-OECD demand and marginally lower non-OPEC supply.  Sub-1 mb/d global demand growth in 2009, together with combined non-OPEC oil and OPEC NGL growth of 1.4 mb/d, limit next year's call to 31.1-31.2 mb/d.  Unless project slippage proves to be worse than expected, OPEC spare capacity looks likely to rise for 2009 as a whole.

  • 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.

    The non-OPEC supply overview this month focuses on the roll out of our forecast to 2009, with discussion of key changes in production.  However, to avoid duplication, several of the themes underpinning this analysis are elaborated upon in the Medium-Term Oil Market Report (MTOMR), which was released on 1 July 2008.  Readers should consult MTOMR for more detailed discussion of factors affecting supply in 2009 and beyond.

The 2009 Outlook for Non-OPEC Supply


Non-OPEC supply growth in 2009 is estimated at 640 kb/d, sustained by a temporary levelling-off in recent steep OECD production decline, plus strong growth from the Caspian republics, Brazil, Asia and global biofuels.  Total non-OPEC supply is seen hitting 50.6 mb/d next year.  However, this maintains the trend of comparatively muted non-OPEC growth averaging 400-500 kb/d seen each year since 2005.  Stronger early-decade growth driven by resurgent Russian production has given way to an upstream market characterised by cost inflation, project slippage, access constraints and tighter government fiscal and regulatory terms.  With ongoing net decline in base load non-OPEC supply estimated at over 6%, or 2.6 mb/d, annually, it has become increasingly difficult to deliver new capacity on schedule as an offset.

This report and the MTOMR are based on bottom-up supply projections, undertaken on a field-specific basis wherever possible.  As such, our forecast takes the best available information on individual new project schedules at the time.  Despite endemic project slippage over the past three to four years, we resist the temptation to apply an across-the-board slippage assumption for all new projects.  This is despite an observation that some major supply increments have been coming in 12-15 months behind schedule in both OPEC and non-OPEC locations.  But while the risks and extent of slippage look to be increasing, not all projects are similarly affected.  Indeed, many projects still hit or exceed target.  Our forecast therefore represents a view of normalised supply potential, and will be prone to adjustments as and when delays for individual projects begin to look more likely than not.

On top of this expected non-OPEC growth, a further 800 kb/d of extra liquids supply potential comes from OPEC NGL and condensate, with output reaching 5.9 mb/d in 2009 from an expected 5.1 mb/d in 2008.  Against a back-drop of slowing demand growth and rising OPEC crude capacity, there is therefore the prospect that recently wafer-thin levels of spare crude capacity could ease in 2009.

Looking at the expected pattern of non-OPEC supply through the remainder of 2008 and over the course of 2009, it is clear that a bunching of new project start-ups (amounting to over 1.0 mb/d) boosts second-half 2008 production.  Production in 3Q08 is seen rising contra-seasonally, by around 0.5 mb/d, while 4Q08 production gains a further 1.3 mb/d, a level of growth not seen since 2001.  This compares with a 'normal' seasonal rise in 4Q of 550 kb/d, in part as seasonal maintenance and outages draw to a close.  Obviously, project slippage and unscheduled production outages present downside risks for this forecast, although we already try to adjust for field reliability and traditional weather outage levels.  Moreover, the scope for extended delays on projects as they approach completion should, in theory, be less than for those in the early stages of development.


Production from OECD countries will likely remain in decline in 2009, albeit at a slower pace than is expected for 2008 (-385 kb/d).  All told, OECD supply is seen falling by 120 kb/d next year to 19.3 mb/d. This year's trend of 350 kb/d decline for OECD Europe production is expected to be repeated.  A number of comparatively small scale crude oil and gas liquids developments in both the UK and Norwegian sectors of the North Sea due on stream in 2008/2009 will be insufficient to offset mature field decline which is running at 15-20% per year.

In contrast, Australia and New Zealand could enjoy a mini-surge in output, taking OECD Pacific output from 720 kb/d in 2008 to 825 kb/d in 2009.  Developments offshore Australia due on stream in second-half 2008 include Skua, Vincent and Angel, while New Zealand will see a ramp-up of production from the Tui and Maari projects.  As noted in the MTOMR however, regional supply growth could prove short-lived as most of the new projects are small scale and are being developed with a view to rapid build-up to peak production, followed by sharp decline.

Mexico is expected to see continued sharp decline from the Cantarell field, which in 2007 accounted for nearly half of 3.1 mb/d national crude production.  Cantarell decline is now seen averaging 20-25% annually, which incremental supplies from the adjacent Ku-Maloob-Zaap fields can only partly offset.  This year sees a drop in Mexican crude output of some 250 kb/d, with production expected to drop by a further 200 kb/d to 2.65 mb/d in 2009.  Decline is seen continuing through the medium term unless substantive fiscal reform and oil sector reorganisation and improved access terms are implemented in the interim.

Prospects for output elsewhere in OECD North America look rather brighter, at least for 2009. After a two-year lull in growth from heavy oil mining/upgrading output in Alberta, the CNRL Horizon project drives an expected 130 kb/d increase in total Canadian oil supply in 2009.  This is augmented by continued growth of in-situ bitumen supplies.  Meanwhile, the US Gulf of Mexico (GOM) represents the key source of an anticipated doubling in US oil supply growth next year (+205 kb/d in 2009 compared with +95 kb/d in 2008).  Some 160 kb/d of growth also derives from US ethanol supplies in 2009, helping to offset widespread declines in crude oil supply expected for onshore US areas.  Total US supply reaches 7.8 mb/d in 2009 from an expected 7.6 mb/d in 2008, with crude oil accounting for over 5 mb/d of the total.


After levelling off at 10.1 mb/d in 2008, Russian oil production is expected to slip to 10.0 mb/d in 2009, the first year-on-year decline since 1996. This is also a weighty 400 kb/d less than last year's MTOMR forecast for 2009, partly the result of project slippage, partly of an investment-related decline at existing, brownfield sites. The slow-down in upstream investment, resulting from a punitive tax regime and continued uncertainty over foreign company participation, is well documented.  Although proposals are transiting the Russian parliament that will begin upstream fiscal reforms from January 2009, there may be a time lag before the effects of a lightening fiscal burden become apparent.  Continuing uncertainty over the status of foreign company joint ventures such as TNK-BP and the three existing production sharing agreements at Sakhalin and Kharyaga only reinforces a tendency towards caution in forecasting Russian output.  However, we will watch for signs of a more rapid-than-expected turnaround in Russian upstream investment, potentially rendering this as one area of upside supply risk in our 2009 forecast.

Offsetting the expected slip in Russian production however is combined growth of some 320 kb/d in 2009 from Azerbaijan and Kazakhstan, with Azerbaijan potentially seeing a fourth consecutive year of 200 kb/d growth.  Azerbaijan's production is buoyed by the attainment of plateau 1.1 mb/d output for the Azeri-Chirag-Guneshli (ACG) complex of offshore fields, a level which operator BP now expects could be sustained through late in the next decade. A comparatively cautious view on short-term Kazakhstan production prospects sees total oil output attain 1.55 mb/d in 2009 compared with 1.45 mb/d for 2008.  Onshore Tengiz field growth underpins the increase, although questions over export outlets cause us to lag official production targets of some 540 kb/d for Tengiz.

Latin American supply growth remains dominated by deepwater developments offshore Brazil, where crude output has grown by nearly 100 kb/d each year over the past 10 years.  Supplies are expected to gain 165 kb/d in 2008 and 190 kb/d in 2009, to average 2.1 mb/d.  The increases come largely on the basis of state operator Petrobras' expansion plans.  Here again, the complexity and capital intensity of deepwater developments has resulted in project delays, with both absolute 2007 production and expected 2008 growth now around 100 kb/d less than we envisaged a year ago.  Nonetheless, significant increments come from the Roncador field, from Marlim Leste and Marlim Sul and from the Golfinho facility in 2009. Strong growth in Brazilian ethanol supply also runs through 2008/2009, with output seen averaging 360 kb/d in 2008 and 415 kb/d in 2009, from 310 kb/d in 2007.

China continues to show steady production growth, albeit unspectacular in relation to surging domestic demand growth.  Supply growth both this year and next averages just over 100 kb/d, taking 2009 production to 3.95 mb/d.  Offshore expansion continues, with increments in 2009 coming from the Penglai and Bozhong fields.  A subsidiary of China National Offshore Oil Corporation (CNOOC) recently bought Norwegian service company Awilco Offshore in a bid to boost access to drilling technology, notably for offshore areas. Onshore increases for China come from the Changqing field, where output has already increased from 100 kb/d in 2001 to nearly 300 kb/d in May 2008.  Around 20 kb/d of coal-to-liquids output is also included in the 2009 production forecast, from initial phases of the Shenhua CTL project.

Elsewhere in Asia, slowing production growth from Thailand, and an expected dip in supplies from India in 2008/2009 is offset by growth from Malaysia and Vietnam, both of which see net increments of around 45 kb/d in 2009.  Malaysia benefits from ramp-up at the country's first deepwater field, Kikeh, which attains 120 kb/d plateau production in 2009. Further growth comes from the Bunga Pakma condensate project (shared on a 50:50 basis with Vietnam).  For Vietnam, incremental light crude and condensate is expected from Song Doc, Ca Ngu Vang and Su Tu Vang, as well as Bunga Pakma.

While regular production data remain scarce for much of Africa, it appears that baseline 2007 production came in nearly 200 kb/d lower than expected.  This was in part due to downward revisions for Equatorial Guinea and Sudan.  Moreover, the strong growth expected for 2008 when we made our roll-out last year now appears overambitious.  Regional supply in 2008 now looks likely to grow by some 50 kb/d, compared with the 130 kb/d envisaged one year ago.  This looks likely to be followed by a broadly static regional output level, at 2.6 mb/d for 2009.  Growth this year centres on Sudan, Congo and the Ivory Coast (despite weaker-than-expected 2007 production in the latter due to well silting), while 2009 growth centres on the latter two.  Rising output from the Thar Jath project drives this year's growth from Sudan, while Congo's Moho Bilondo field builds gradually to 80 kb/d in the second half of 2009.

Non-OPEC Middle East oil production continues to decline, with expected falls of 70 kb/d in both 2008 and 2009 taking regional output next year to 1.52 mb/d.  At least half of the decline comes from Yemen, despite positive contributions expected from the Nabrajah and An Nagyah fields.  Decline at mature fields, political instability deriving from recent al-Qaeda attacks on oil infrastructure, and the need for accelerated exploration and infrastructure investment underpin our weaker Yemeni supply profile.

Other Sources of Supply Growth - Biofuels

Global biofuels are set to grow sharply in 2008 and 2009, contributing a large proportion of net incremental non-OPEC supply.  In this report, national oil production totals for both Brazil and the US have historically included, and continue to include, ethanol, whereas biofuels output for all other producers combined is included as a single line item in our global balance. Total global fuel ethanol and biodiesel production (in volumetric terms) will rise from 1.35 mb/d in 2008 to 1.69 mb/d in 2009.  Of this growth, around one half and one quarter respectively stem from US and Brazilian ethanol, the world's two largest producers by far.  Brazil will continue to enjoy unique advantages in terms of production costs, agriculture and infrastructure and is set to expand its role as the world's largest exporter of fuel ethanol.  In the US, a combination of consistently higher-than-expected actual monthly production numbers, surging production capacity and the ambitious alternative fuels mandate passed in December 2007 have seen us revise up 2008 and 2009 output significantly.  US ethanol capacity is expected to rise from around 650 kb/d in 2008 to 880 kb/d by 2009, albeit actual 2009 production is forecast closer to 700 kb/d.

Other Sources of Supply Growth - OPEC Gas Liquids (NGL and Condensates)

OPEC NGL and condensate supply growth in 2008 now looks likely to average 325 kb/d, giving an annual total of 5.1 mb/d.  Key contributions in 2008 come from Qatar (+150 kb/d), Saudi Arabia (+70 kb/d) and Kuwait (+35 kb/d).  Next year growth is expected to accelerate, assuming a number of new project-start ups deferred over the course of 2008 finally come on stream.  Annual growth in 2009 could attain an unprecedented 810 kb/d, for an annual average production level of 5.9 mb/d.  Saudi Arabia and Qatar again predominate, although significant increments also come from the UAE, Nigeria and Iran.  While upstream and midstream gas projects are subject to many of the same bottlenecks as those facing upstream oil, the imperative to harness hitherto frequently flared associated gas is clear.  And although export-related projects in Qatar and Iran have seen deadlines slip, there nonetheless remains intense pressure to boost domestic gas production for oil field reinjection, power generation, industrial and petrochemical use.  Non-associated gas streams and gas condensate are also increasingly being tapped.

OPEC Crude Oil Supply in June

OPEC crude supply for June was an estimated 350 kb/d higher than in May, at 32.4 mb/d.  The May total was itself revised down by 245 kb/d to just under 32.1 mb/d to reflect markedly lower May Iranian exports.  This report employs a supply-based proxy (exports plus domestic crude runs) for production for Iran as well as a number of other OPEC producers.  Generally, oil in floating storage will not be counted as an export until it sails for a specific destination.  Evidence in April and May that Iran was storing crude in tankers offshore Kharg Island, reportedly due to a lack of buyers during refinery turnarounds, depressed the assumed export level and with it, May's supply estimate for Iran.  In June however, there were indications that some of the earlier stored oil left Kharg for export destinations.

Higher exports from both Iran and Saudi Arabia underpinned the overall increase in June OPEC supply.  Saudi supply is estimated up by 250 kb/d at 9.45 mb/d.  In contrast, Nigeria saw continued crude production outages, which constrained supply to around 1.9 mb/d, while lower Iraqi southern exports due to weather delays trimmed supply there to 2.4 mb/d from 2.5 mb/d in May.  Having seen production drop below levels of a year ago for the first three quarters of 2007, OPEC has pushed output well ahead of previous year levels for the past nine months.  June supply stood 1.8 mb/d higher than June 2007, on a like-for-like basis including Ecuador.

Effective OPEC spare capacity (excluding notional volumes for Indonesia, Iraq, Nigeria and Venezuela, each of which might arguably struggle to boost short-term production) remains low, at less than 2.0 mb/d.  However new project developments could potentially boost OPEC installed capacity by around 1.0 mb/d to 36 mb/d by the end of 2008.  Saudi Arabia, Nigeria, Angola and Iraq are the key sources of expansion running through to the end of this year.  This presupposes that:

  • the 500 kb/d AFK (Khursaniyah) project in Saudi Arabia enters service in 3Q;
  • the 200 kb/d Agbami project offshore Nigeria starts in 3Q and continued progress is made in restoring Forcados production to around 300 kb/d;
  • Iraq sees a measure of success in boosting production via a series of short-term technical service agreements (TSAs) for existing fields;
  • Angola brings the next phase of the Kizomba C project, the 100 kb/d Saxi field, onstream in 3Q.

We would tend to be more confident of the Saudi and Angolan developments, bearing in mind security-related issues which have affected supply from Nigeria and Iraq for many months.

Recent international forums, including the 22 June Jeddah meeting called by Saudi Arabia's King Abdullah and the World Petroleum Congress in Madrid on 29 June - 3 July, focussed attention on prevailing high crude oil prices and their likely causes.  From a supply perspective, all sides have agreed that accelerated upstream and downstream investment (alongside improvements in energy efficiency) will be required in the future.  Producers are of course wary of signing any 'blank cheque' as regards future capacity expansion until the likely extent and duration of any global economic slow-down can be gauged. Most analyses, however, (including our own recent MTOMR) envisage sustained demand growth for the next five years, driven by strong growth in developing economies, notably Asia and the Middle East.  While indications from producers such as Saudi Arabia that the next generation of capacity expansions may already be being prepared are welcome (see below), capacity expansions both within and outside OPEC look prone to prolonged delays and cost over-runs.  Notwithstanding a potential easing in 2009, this could keep underlying levels of spare capacity tight for some time to come.

Saudi Arabian crude supply for June is estimated at 9.45 mb/d, up from 9.2 mb/d in May, and the highest production level since March 2006. The apparent increase came in the aftermath of Saudi claims of higher post-maintenance demand from US refiners.  The Kingdom's representatives have said that July production could be raised to 9.7 mb/d, but have ruled out heavy discounting of this extra oil to make it more palatable to customers.  Preliminary reports of regional tanker sailings and a run-up in crude freight rates however do tend to support, at least directionally, some further increase in July Saudi production.  There are suggestions that some of these incremental volumes are going to Reliance Petroleum of India, whose new 580 kb/d refinery at Jamnagar is due on stream later this year.

Oil Minister Ali al-Naimi has also suggested that the Kingdom is considering a second phase of upstream capacity expansions, which could potentially take capacity to 15 mb/d after the phase one target of 12.5 mb/d is reached at end-2009.  However, a key proviso was that there should be clear signs of long-term demand for the extra volumes. The Minister suggested that each of these capacity expansions could be completed within three years of project sanction.  The projects envisaged to take Saudi target capacity from 12.5 mb/d to 15.0 mb/d were listed as follows:

  • Zuluf (Arab Medium) - 900 kb/d;
  • Safaniyah (Arab Heavy) - 700 kb/d;
  • Berri (Arab Extra Light) - 300 kb/d;
  • Khurais (Arab Light) - 300 kb/d;
  • Shaybah (Arab Extra Light) phase 3 - 255 kb/d.

These come in the aftermath of major increments from AFK (500 kb/d) expected in 2008, Khurais (1.2 mb/d) in 2009 and Manifa (900 kb/d, seen as sustaining, not increasing, total capacity) in 2011/2012.

Iraq's crude supply for June (net of reinjection and storage) is estimated at 2.4 mb/d, down from May's post-war record level of 2.5 mb/d.  While June exports from the Turkish port of Ceyhan were marginally higher than in May (at 465 kb/d compared with 440 kb/d the previous month), southern liftings from Basrah were impeded by weather-related loading delays, coming in 120 kb/d lower than in May at 1.45 mb/d.  Cross-border pipeline deliveries to Syria are estimated flat at 10 kb/d, giving total June exports of 1.93 mb/d.  Domestic refinery crude use by refineries and power stations is estimated unchanged from May at 485 kb/d.

There was much discussion during June of impending plans to boost Iraqi export, refining and production capacity, now that regular output levels close to current production capacity of 2.5 mb/d have been attained.  An initial boost may come from twin-pronged expansion through short-term Technical Service Agreements (TSAs) and the potential for higher exports from the northern Kurdish region.  The TSAs are due to be signed imminently for six producing fields, which are expected to see increases of around 100 kb/d each.  However, the deals had still not been signed by the original end-June deadline, and there are concerns that the Oil Ministry's curbing of the TSAs' duration from two years to one might be delaying agreement.  The Kurdish Regional Government meanwhile has suggested that exports could attain 250 kb/d in 2009 subject to agreement being reached with Baghdad on outlets for crude from the Taq Taq and Tawke fields.  Ministry plans envisage total Iraqi capacity of 4-4.5 mb/d by 2012, based in part on a just-announced licensing round that will cover the Kirkuk, Bai Hassan, Rumaila, Zubair, West Qurna and Missan fields.  Our own recently released MTOMR assumed underlying capacity over the next five years of a more conservative 3.0 mb/d, although this was based solely on the short-term TSAs and the Kurdish developments, not the still-to-be awarded licenses for longer-term development.

Nigerian crude supply in June averaged a largely unchanged 1.9 mb/d.  High-profile attacks on Shell's deepwater Bonga FPSO (225 kb/d) and pipeline-related outages affecting the Bonny Light, Escravos and Brass River export streams pushed total Nigerian production below 1.7 mb/d in the third week of June, but month-average production came in close to May levels (since early-May had seen constrained output as supplies recovered from ExxonMobil strike stoppages).  Total short-term and longer-term outages hit 900 kb/d at one stage in June, but were believed back at around 550-600 kb/d late in the month.

At the time of writing, force majeure clauses remain in place for exports from Bonny Light, Brass River and Escravos.  June's attack on the deepwater Bonga facility by the Movement for the Emancipation of the Niger Delta (MEND) represents a new departure, as onshore and shallow water infrastructure have previously been the key targets.  Speed boats attacked Bonga's FPSO on 19 June, and although production resumed on 24 June, subsequent damage to a loading buoy saw force majeure on exports reinstated on 4 July.  With further-offshore and deepwater developments expected to provide the bulk of capacity increases for Nigeria in coming years, the government has been quick to bolster offshore security patrols.  For its part MEND declared a cease-fire after the Bonga attacks, although only after saying that offshore facilities and international shipping will increasingly be targeted in future.  Chevron had earlier announced that its 200 kb/d Agbami project, also located some 70 miles offshore, was due to start in June, but perhaps with one eye on security issues, this now looks to have slipped to later in the year.

Iranian supply became a renewed focus of attention in June following suggestions that Israel was planning a military strike against Iranian nuclear targets.  Although subsequent international statements have stressed diplomatic channels as the preferred option for solving the Iranian nuclear issue, a representative of Iran's Revolutionary Guard suggested in late June that any attack on Iran would inevitably lead to the imposition by Iran of controls on shipping using the Mideast Gulf and Straits of Hormuz.  The latter handles tanker traffic equivalent to nearly 20% of total global oil demand.

Actual Iranian supply for May was revised down markedly to 3.64 mb/d, reflecting lower Iranian exports (now seen as having averaged 2.05 mb/d compared with around 2.5 mb/d in recent months).  A combination of domestic and international refinery maintenance was reportedly behind Iran's deployment of around 28 VLCCs for floating storage in April and May.  Trading sources suggested up to 28 mb was held in floating storage offshore Kharg Island and Soroosh at end-May, although the Iranians themselves insisted volumes were much lower, at below 20 mb, citing a requirement for segregated storage as meaning that tankers were not fully laden.  This report uses a supply proxy for Iranian production, comprising crude exports (excluding volumes in floating storage until they sail for a specific location) plus domestic refinery runs of Iranian crude (in turn net of crude swaps through the Caspian port of Neka).  With throughputs at Iranian refineries just under 1.6 mb/d in May and June, the swing in Iranian supply came from exports, assessed at 2.05 mb/d in May and 2.2 mb/d in June.  This results in total Iranian supply of 3.64 mb/d in May, rising to 3.78 mb/d in June.  Iranian crude oil production capacity is estimated at just over 4.0 mb/d.

OECD stocks


  • OECD total oil stocks built by 23.9 mb in May to reach 2,588 mb.  This substantially lagged the five-year average May increase of around 50 mb, due mainly to a significant and unseasonal 19.3 mb draw in US crude stocks.  Preliminary June data suggest a 4.5 mb draw which would leave the total 2Q08 OECD stock change at around +100 kb/d, well below the five-year average 2Q build of 900 kb/d.
  • The large 19.3 mb draw in US crude stocks in May, a result of both lower imports and higher refinery throughputs, took OECD North American oil inventories below their five-year average for the first time since 4Q04.  European and Pacific crude stocks rose seasonally, by 3.3 mb and 8.4 mb respectively.
  • A seasonal May rise of 7.7 mb in OECD European distillate inventories was led by Scandinavian and Benelux countries, but still left regional cover below the five-year range.  While distillate stocks in OECD North America also saw a typical May rise of 6.8 mb, they were unusually flat in the OECD Pacific.  A draw of 2.4 mb took US gasoline stocks below the five-year absolute average in May, completing the erosion of a huge winter surplus.
  • OECD total oil stock cover equalled 53.5 days of forward demand at the end of May.  This marked a below-normal increase of 0.1 days from end-April and leaves cover just above the five-year average.  Distillate cover remains the biggest concern at 28.8 days, or 1.3 days below the 2003-07 average.  Preliminary end-June total oil cover is slightly lower at 53.4 days.

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

The large 19.3 mb draw in US crude stocks left the total May OECD stockbuild of 23.9 mb well short of the typical seasonal increase of 50 mb-plus.  Barring a large rebound in June, which looks unlikely from preliminary data, the usual post-winter rebuilding of OECD stocks is now unlikely to materialise before the onset of peak summer demand.  End-May OECD oil stocks were 2,588 mb and below the five-year average for the first time this year.

Still, demand weakness means that OECD total oil stock cover remains near seasonal norms at 53.5 days of forward demand, having risen by 0.1 days from end-April.  Preliminary data for the US, Japan and EU-16 suggest that this level of cover was only marginally lower at the end of June.  With cover still above average, one could argue that the failure of OECD stocks to rebuild at the same pace as previous springs is therefore less significant.  However, this would gloss over some key areas of stock tightness.

Forward demand cover for distillates remains below average in all three OECD regions, despite some slight improvements in May.  European distillate cover rose by 0.4 days to 32.6 days of forward demand but remains significantly short of the five-year average of 34.4 days.  Inflated cover in other, structurally long product categories (namely gasoline, fuel oil and 'other products'), means that European distillate tightness is masked within the products' total.  North American distillate cover is also at the bottom of the five-year range, despite a seasonal stockbuild in May.  In the OECD Pacific, there was no sign of the usual May increase in distillate inventory, which remained flat compared with end of April data.  Anecdotal evidence of distillate shortages in South America (a result of substitution away from a tight regional gas sector), China (prompting several months of record-high gasoil imports) and other non-OECD areas continually affirm that this tightness extends to a global scale.

OECD crude stock cover (in terms of forward refinery throughputs) failed to rise in line with seasonal trends in the first quarter.  Following the headline May draw in the US, it is now at 24.4 days and back at the five-year average for the first time since late 2004.  North American crude cover fell by over a day in terms of forward crude runs in May and would look tighter still without Canada's brimming crude inventories, now over 25 mb above the 2003-07 average at 115.8 mb.  OECD Pacific crude cover remains the lowest of all the regions, well adrift of five-year ranges, despite a May build (almost all of which was provisionally in Japan).  Should OPEC Gulf members release extra volumes of crude onto the market in the next few months, it remains to be seen how much of this oil will ultimately boost OECD crude inventory rather than ending up in the opaque stockholdings of non-OECD countries.

OECD total stocks were revised up by 1.5 mb for April and 2.8 mb for March.  The April revision incorporated larger offsetting adjustments between North America (corrected up 10.3 mb, including 5.4 mb in US NGLs/Feedstocks and 2.9 mb in US 'Other products') and the OECD Pacific (-9.5 mb in Japanese crude, discussed further in the regional analysis below).  In OECD Europe, downward revisions of 8.7 mb to 'total products' (including 3.4 mb in the UK) and 3 mb to 'other oils' stocks were offset by an upward correction of 11.8 mb in crude (of which 5 mb was related to Dutch stocks held bilaterally in Germany).

OECD Industry Stock Changes in May 2008

OECD North America

A 19.3 mb decline in US crude stocks was the big story for OECD inventories in May.  At a time when US crude inventory is usually near its yearly peak, this draw potentially represented a significant shift in the US commercial stockholding mentality.  It also single-handedly offset a large part of the seasonal May build in other OECD oil stocks.  OECD North American total oil inventories actually drew counter-seasonally as a result, by 3.6 mb, falling short of their five-year average for the first time since 4Q04.  EIA weekly data show that US crude imports dropped by 740 kb/d over the course of May, with tanker data showing the largest decreases from Mexico, where production is struggling.  At the same time, refinery crude runs rose by 780 kb/d.  Anecdotal evidence suggests that the crude draw reflects a desire by refiners to run down stocks as a means to free up capital in a high-price environment at a time when refinery profitability is dropping.  However, it could also just partly be an indication of lower supplies or in anticipation of weaker prospective demand.  A 1.4 mb build in Mexico made up the balance of the OECD North American crude stock change of -17.9 mb.

Gasoline stocks in OECD North America dropped by 2.7 mb in May to below their five-year average in absolute terms, completing the erosion of a huge winter surplus.  US weekly data showed a slight improvement in gasoline stocks in June, with the summer driving season underway.  Although end-May forward demand cover was below average, the continued incursion of ethanol into the finished gasoline pool may allow stock cover to suffice for the summer months of peak demand.  Distillate and 'other products' stocks in OECD North American countries increased by 6.8 mb and 11.3 mb respectively, both in line with seasonal trends.  The increase in regional distillate inventories included a build in the US of 7.7 mb overshadowing a drop of 0.9 mb in Mexico.  Mexican distillate and gasoline stocks are below the five-year range in terms of forward demand cover while North American distillate cover as a whole remains very low.

OECD Europe

Total oil stocks in OECD Europe built by 11.5 mb in May.  This seasonal increase included a healthy 7.7 mb rise in middle distillate inventories led by a combined build of 4.9 mb in Finland, Norway and Sweden, as winter demand subsided.  With OECD European refinery throughputs dipping by 230 kb/d in May, transatlantic trade into Europe may have been behind rising distillate inventory in certain countries.  EIA data showed US product exports hitting an all-time high of 1.5 mb/d in the final week of May.  Certainly, higher imports could have driven the provisional May increase of 2.25 mb in distillate stocks in the Benelux countries.  In addition, end-May distillate stocks in France, Germany and the UK each showed a monthly rise of around 0.8 mb.

Independent distillate stocks in the ARA region also increased in May and, by a greater amount, in June.  Still, independently held distillate stocks at the end of June remain well short of the five-year average and those held by industry at end-May were at the bottom of the five-year range in terms of forward demand cover.  European gasoline stocks were flat in May, while residual fuel oil stocks increased by 1.3 mb.

Crude inventories in OECD Europe rose by 3.3 mb in May, marking their third consecutive monthly build and allowing stocks to reach their seasonal second-quarter peak.  A drop of 90 kb/d in refinery runs in the Netherlands contributed to a May build of 5.9 mb in crude.  German crude stocks for the whole of 2008 have been revised up by 4-5 mb due to a revision in the amount of crude Germany is holding for the Netherlands on a bilateral basis.  OECD European stocks of gas liquids (NGLs, other feedstocks, additives and oxygenates) fell by 0.9 mb in May.  With April's total revised down by 3 mb, stocks in this category are well below the five-year range at 66.3 mb.

OECD Pacific

OECD Pacific oil inventories rose by 16.1 mb in May, an increase slightly behind seasonal norms.  The largest monthly change was a reported increase of 8.0 mb in Japanese industry crude stocks.  However, it should be noted that preliminary data for Japanese crude includes an estimate of volumes in Japanese waters waiting to be unloaded.  As VLCCs hold around 2 mb each, the timing of their discharge can be very influential in monthly stock changes.  For April, a stockbuild of 7.6 mb was reported last month.  However, it was subsequently revealed that the amount of crude waiting to be discharged from tankers in April had been overestimated by 9.5 mb.  This prompted this month's notable downward revision to the April stock change into a 1.9 mb draw.  For this reason, the May increase of 8.0 mb must be treated as a preliminary figure.

Korean crude stocks built by 0.4 mb in May, following a 200 kb/d rise in imports which outpaced the 170 kb/d in refinery runs, but remain well below the five-year range.  In fact, this year's April and May Korean crude stocks are two of the three lowest end-month crude stock levels to have been reported in the last 10 years.

On the products side, OECD Pacific middle distillate stocks were flat on the month at just under 59 mb, compared with a typical May rise of around 6 mb.  They now lag the five-year average in absolute and forward cover terms.  In the OECD Pacific's other major product category, a build of 1.1 mb in 'other products' (which include LPG and naphtha) left inventories near the bottom of the five-year range at 62.1 mb,, eroded by an unseasonal 1.2 mb drop in Japan.  By contrast, Japanese gasoline and Korean fuel oil stocks saw healthy May builds, driving regional inventory in both of these categories above five-year averages in forward cover terms.

Recent Developments in Singapore Stocks

June saw an easing by 1.2 mb of independent middle distillate stocks held in Singapore.  However, middle and light distillate stocks remain near the top of five-year ranges.  Residual fuel oil stocks rose by 4.0 mb in June, as fuel oil cracks remained low and storage capacity for the product continues to increase.  The $10/bbl-plus premium of Singapore HSFO to Rotterdam seen in mid-May may have prompted some loading of long-haul fuel oil cargoes heading east.



  • Crude oil futures rose further in June, breaching $145/bbl in early July, but had slipped below $140/bbl again at the time of writing.  Markets remain supported by a meagre 2Q OECD stockbuild and by a tight global distillate balance.  Saudi Arabia's pledge to pump more crude was countered by outages in the North Sea, Nigeria and Iraq.  Tight spare capacity is another supportive factor, especially against the background of rising tension over Iran's nuclear activities.
  • Benchmark physical crude prices rose in tandem with futures, overshadowing product price gains, despite the absence of shortages in the near-term market.  But with the global refining system struggling to profitably supply the right distillate-focused product slate, diesel and jet-rich crudes are in demand and in many cases command significant premia.
  • Refining margins mostly fell in June and early July as record-high product prices failed to offset new crude records.  Margins continue to suffer from unseasonably low gasoline cracks, which turned negative in Northwest Europe in early July, while on average, distillate crack spreads fell too.  In the refined product market, jet/kerosene prices have overtaken diesel ahead of the summer travel season.  But diesel/gasoil remains supported by outage-related power generation needs in Australia, Argentina and South Africa.

VLCC tanker rates in the Middle East rose even further above seasonal expectations in June, approaching all-time records, due to higher OPEC exports and constrained vessel supply.  West African rates retreated in June while Aframax rates were volatile due to weather and port disruptions.  Clean tanker rates also surged to extreme highs on firm distillate trade in the Atlantic and Asian refinery maintenance.


Crude oil futures breached $145/bbl in early July as a Saudi pledge to pump more oil was offset by actual crude outages in Nigeria, the North Sea and Iraq, while product and especially distillate markets remained tight and the usual 2Q stockbuild failed to materialise.  Additional Saudi volumes are expected to be offered to the market in July, but it is unclear at this stage whether they will be priced at a level which makes them competitive in a weakening refinery margin environment.  As is often the case, Saudi Arabia has indicated it will not heavily discount below similar crudes, but with prices at very high levels, additional discounting may be required to incentivise stockbuilding.  At the same time, tensions over the Iranian nuclear programme served to increase risk-management buying.

Even ahead of the Jeddah summit on 22 June called by Saudi Arabia's King Abdullah, the Kingdom had indicated its willingness to hike output from 9.45 mb/d in June to upwards of 9.7 mb/d from July.  Participants at the meeting - producers and consumers alike - concurred that oil prices are damagingly high.  But around the same time, first the fire-related shut-in of Statoil/Hydro's Oseberg A platform in the North Sea and then the unexpectedly audacious attack on the deepwater Bonga production facilities, offshore Nigeria added a counter-balance to the market.  The latter marked a new degree of escalation in insurgent attacks, as previously, only onshore or shallow-water oil facilities were deemed to be at risk.  Soon after, an oil workers' strike was narrowly avoided in Nigeria.  Lastly, one of the first hurricanes of the year - Bertha, currently forming over the Atlantic - served as a reminder that the hurricane season in the Gulf of Mexico has begun.

Despite a decline in some crack spreads, distillate strength remains a market driver, though jet/kerosene has now overtaken diesel's previous role.  Regional pockets of demand strength due to technical or weather-related outages have multiplied to maintain global market tightness, especially as some of the areas with additional needs are in markets far removed from global refining hubs, such as Argentina, Australia and South Africa.  But gasoline's relative weakness - crack spreads in Northwest Europe have turned negative and are depressed in the Mediterranean - mean that refining economics are poor and several plants have announced economic run cuts.

Moreover, prices were generally supported by a rise in geopolitical tension.  Besides the Bonga attack, concerns increased over a possible military confrontation between Israel and Iran after military manoeuvres on both sides.  Iran warned of shipping restrictions in the Straits of Hormuz, the gateway to the Middle Eastern Gulf, which shook markets.  More than 15 mb/d of oil pass through this choke-point, the world's most important tanker route.  Moreover, Iran is once again in the international spotlight after being offered a new range of incentives in return for suspension of its alleged uranium enrichment activities.  Prices also responded to a Libyan threat to cut off supplies after the passage of a bill in the US that could in theory enable legal claims against OPEC.  Saudi Arabia also announced it had prevented major attacks on its oil facilities by arresting 500 suspects in the Kingdom since the beginning of the year.

Crude futures curves remained more or less flat, while higher overall, pushed up by the range of short and long-term concerns.  If anything, the near-term contango widened slightly.  US crude futures have recently traded at a discount to ICE Brent, the latter taking strength from North Sea and Nigerian outages, while the former is pressured by crude stocks levels at delivery point Cushing, which in recent weeks have risen to average levels again.  The 'speculation' argument was dealt another blow by CFTC Commitment of Traders data, with peak prices coinciding with the lowest open interest in WTI since March 2007, and falling net non-commercial positions.

Spot Crude Oil Prices

Spot crude oil prices were supported by a tight short-term market, especially for distillate-rich crudes.  US Light Louisiana Sweet (LLS) maintained its premium over WTI of around $4/bbl on strong diesel demand.  US refinery distillate yields are at their highest ever, despite overall refinery utilisation remaining at the bottom of its five-year range.  Total US crude stocks have fallen to around 50 mb below last-year and 20 mb below their five-year average, apparently as US refiners, mostly on the Gulf Coast, prefer to draw down stocks in tune with weaker demand than buy more highly priced oil.  In addition, an unseasonable surge in dirty freight rates may be partly hampering the flow of crude across the Atlantic.

In Europe, as a result of North Sea and Nigerian outages, Dated Brent's discount to WTI narrowed in July, albeit remaining very volatile.  Nigerian grades maintain their strong premia around $6/bbl over Brent due to distillates' strength, as well as to some extent the new outages and further insecurity after the Bonga attack.  Russian Urals meanwhile has sharply narrowed its discount to Brent on lower Russian production and exports.  Expected lower Primorsk outflows in July especially have seen Urals NWE halve its discount to Brent since early June, to its lowest level since February.  In the Mediterranean, Urals is still suffering from competing Middle Eastern medium sours and lower refinery interest among reports of some economic run cuts.

With refineries in Asia ramping up runs to peak post-maintenance, plants will be on the lookout for any additional crude offered by Saudi Arabia, especially for new plant start-ups in India and China.  Much uncertainty still surrounds how much Iranian crude remains in offshore storage, with reports that Iran is having difficulty finding buyers for some grades due to its pricing policy.  In the sweet market meanwhile, Indonesia is reportedly raising its 3Q08 term import volume by around 20% to 3.4 mb in order to raise runs and avoid costly product imports.

Refining Margins

Refining margins were mostly down in June as both distillate and gasoline cracks fell.  Despite record-high outright product prices in most cases, crude's volatility and support from geopolitical and other headlines is squeezing margins.  In addition, gasoline continues to suffer from relative seasonal weakness, with European crack spreads near or below zero in late June and early July.  Nonetheless, cracking margins in Europe are still comfortable, given higher typical regional distillate yields.  Hydroskimming margins in Europe remain poor, leading to reports of economic run cuts at Wilhelmshaven, Elefsis and other plants.  In the US, Gulf Coast margins weakened even further in June, with only coking margins remaining positive by early July.  The West Coast was the only region to see a pick-up in margins in June after gasoline cracks rose due to regional tightness on refinery outages.  Asian margins fell too on lower Chinese import requirements and the return of many plants from maintenance.

Spot Product Prices

Falling US demand, an increased share of ethanol and Europe's structural shift towards diesel are keeping the gasoline market depressed.  A closed arbitrage to the west saw pressure on European crack spreads, which declined to zero or below in late June and early July.  On the US West Coast, despite rising gasoline cracks in July, premia over Asian prices have shrunk to next to nothing since early June, hampering trans-Pacific flows.  Unlike gasoline, Asian naphtha discounts to crude narrowed in mid-June but have subsequently plummeted again, with the prospect of around 500,000 tonnes of European product heading east for August.

Distillate crack spreads in all major regions fell during June, but picked up again slightly in early July.  Asian markets are becoming slightly less tight as refineries return from maintenance and Chinese product import demand has weakened somewhat.  Reportedly, China will only import 450,000 tonnes of gasoil/diesel in July, down from June, as pre-Olympic stockbuilding perhaps nears completion.  Importers may also be hesitant after the decision not to extend VAT tax breaks that expired at the end of June.  But other regional pockets of demand strength remain, notably in the southern hemisphere, which is entering winter.  Problems at Western Australia's Varanus Island gas production have required increased diesel imports - reportedly up by around 80 kb/d - and are set to last several months.  South Africa's 1Q diesel imports show nearly 10% growth year-on-year, to 180 kb/d on continuing power problems.  Chile and Argentina are maintaining stronger-than-usual imports due to natural gas shortages, and Turkey was buying higher volumes of gasoil 0.1% ahead of a tightening in specifications from 1 July.  Jet/kerosene has actually slightly overtaken diesel in crack spread terms, reflecting a tighter market ahead of summer travel, and after a strong focus on maximising diesel yields tightened jet supply.

More unusually, fuel oil discounts to benchmark crudes narrowed quite dramatically - both for low and high-sulphur barrels.  Strong demand from Argentina - again on power problems heading into the winter - has boosted low-sulphur residue in Northwest Europe and the Mediterranean, while discounts for low-sulphur waxy residue - most commonly used for Japanese direct burning - have widened slightly.  Northwest Europe, where the surge has been most marked, saw independent fuel oil stocks fall back within their five-year range in June.  Meanwhile, the high-sulphur market is reportedly taking some strength from greater bunker demand, as especially dirty freight rates surged in June, possibly reflecting higher tanker demand.

End-User Product Prices in June

End-user product prices on average increased by 8.6% in June in surveyed IEA countries - in US dollars, ex-tax.  Transport fuel prices on average rose by 8.1%, but moved even higher in the UK and Japan, where gasoline prices jumped by 11.0% and 10.5% and diesel prices by 12.4% and 10.2%, respectively (again, in US dollars, ex-tax).  Heating oil retail prices on average rose by 8.2% and low-sulphur fuel oil prices increased by 10.8% in June 2008.  Compared with June 2007, retail prices are now 70% higher than a year ago, with the largest increases in heating oil (+85%), low-sulphur fuel oil (+81%) and diesel retail prices (+76%).  Gasoline prices on average rose by 45% year-on-year.


VLCC tanker rates in the Middle East Gulf rose even further above seasonal expectations in June, approaching all-time records towards the end of the month.  Signs of higher OPEC Gulf exports and continued constraints on tanker supply boosted charter rates at a time of year when they are usually at their lowest.  West African rates retreated from mid-May highs as vessel supply improved, while Aframax rates were volatile in June due to various weather and port disruptions.  Clean tanker rates increased as Asian refinery maintenance gathered pace and distillate trade in the Atlantic remained firm.

Despite an estimated halving of the earlier-reported 14 tankers storing crude offshore Iran in June, regional tanker supply apparently trailed demand in the Middle East Gulf as rates rose throughout the month.  On the benchmark route to Japan, spot VLCCs chartered for around $42/tonne at the end of June compared with $32/tonne at the start of the month.  Westbound long-haul VLCC rates also increased in June, but by less.  Tanker reports suggest that Middle East sailings could rise through most of July.  However, it is questionable whether the pricing of Saudi Arabia crude for July and August will support additional summer purchases by refiners, especially with processing profitability ebbing in certain regions.

Despite disruptions to Nigerian loadings in June, aggregate supplies appear to have been broadly sustained.  Asian purchases of West African July-loading crude were reportedly higher than those loading in June, including large volumes bought by Indian refiners.  However, West African tanker rates fell in June, possibly as a result of increased tanker supply in the Atlantic.  Benchmark Suezmax rates from West Africa to the US Atlantic dropped from a mid-May high of almost $40/tonne to under $28/tonne by the end of June.

By contrast, Aframax rates have been volatile over the last two months, with a number of factors quickly changing the tonnage situation.  Weather disruptions in the Caribbean and discharging problems at Chiba in Japan (necessitating the use of Aframaxes instead of VLCCs) tightened Aframax vessel fundamentals.  However, lower exports from Primorsk due to pipeline maintenance may have had an offsetting effect.  North Sea to Northwest Europe dirty rates for 80 kmt vessels started June below $9/tonne, before rising to $19/tonne mid-month and then easing below $14/tonne by the month's end.

Clean tanker rates rose in June and are at multi-year highs.  In the Atlantic basin, 33 kmt marker rates from UK Continent to US Atlantic topped $43/tonne towards the end of June.  This coincides with the EIA showing high volumes of US product exports of over 1.4 mb/d for all of May and June.  Anecdotes of off-specification material heading to South America and Asia alongside increased Australian imports all point to firm clean trading activity and consequently high vessel demand.  Refinery maintenance and reportedly higher petrochemical throughputs have kept clean tanker rates high in 'East of Suez' markets as well.



  • Global crude throughput averaged 74.6 mb/d in June, a month-on-month increase of 0.8 mb/d.  Much of the increase was in the Atlantic Basin, China and Russia as refineries completed planned maintenance. Only the OECD Pacific saw materially weaker crude runs, due to seasonal maintenance.  However, crude throughput levels are vulnerable to economic crude run cuts, as margins remain under pressure from weak fuel oil and weak gasoline cracks.
  • The 3Q08 global crude throughput forecast is cut by 0.4 mb/d to an average of 75.3 mb/d, on the weaker refining margin outlook.  3Q08 forecast year-on-year growth is lowered to 0.6 mb/d, as non-OECD growth of 1.1 mb/d more than offsets the 0.4 mb/d decline in the OECD.  Conversely, 2Q08 crude throughput is revised up by 0.2 mb/d, as stronger reported May crude runs in the OECD, Asia and the Middle East boost the quarterly average.

  • The OECD bears the brunt of the downward revisions to the 3Q08 crude throughput forecast, as weak gasoline cracks and hence cracking margins, in the US and Europe reduce our forecasts.  Some independent refiners, in the US and elsewhere, are reportedly facing financial problems from the weaker margin outlook combined with rising crude and operating costs.
  • New refinery capacity will add 2.0 mb/d of crude distillation capacity in 2009, largely in China and Other Asia.  In addition, significant investment in upgrading capacity is expected in OECD and non-OECD regions.  The outlook for product markets over the course of 2009 is for a continuation of the trend towards increased gasoline supply potential, while distillate markets will remain relatively tight.

Global Refinery Throughput

Global crude throughput in June of 74.6 mb/d is forecast to increase to 75.2 mb/d in July.  Higher runs in the OECD (+0.4 mb/d) and a rebound in Chinese throughput (+0.1 mb/d), following the completion of planned maintenance drive much of the increase.  Chinese runs may weaken if unconfirmed reports of the abolition of VAT rebates on imports are correct, but July runs are nonetheless expected to remain near record levels.

As highlighted last month, the overall profitability of refining remains crucial to global crude runs.  The emergence of economic run cuts in several regions, notably Europe, the Pacific and North America, highlights the current difficult conditions facing some refiners, despite distillate cracks remaining at exceptionally high levels.  Hydroskimming refineries in the Mediterranean and Northwest Europe have seen margins deteriorate to -$7/bbl on processing Urals - the region's typical medium-sour crude.  The weakness in gasoline cracks in the has weighed heavily on gasoline-biased US cracking margins and we estimate that some US refineries may have implemented economic crude run-cuts.  Similarly, refiners in Japan say sluggish demand is forcing them to cut throughput.

Global crude throughputs for 3Q08 are estimated at 75.3 mb/d, 0.4 mb/d lower than in last month's report.  The weaker margin environment has resulted in lower estimates for crude throughput, primarily in North America, but also Europe.  This is partly offset by higher estimates in China, where the increase in domestic prices and the start-up of new capacity should result in 3Q08 crude throughput averaging 6.9 mb/d, 0.1 mb/d higher than last month's report.

Forecast OECD 3Q08 crude throughput averages 38.8 mb/d, 0.4 mb/d lower than last month's report, due to weak demand, the poor margin environment and the fundamental factors underpinning the low gasoline cracks.  This level of crude throughput is 0.7 mb/d below the five-year quarterly average, highlighting the current weak margin environment, and contracting regional demand.

However, it would be wrong to conclude that refiners are producing less refined product than previously, despite lower margins.  Rather it merely illustrates that the use of crude is declining in favour of other, cheaper feedstocks, such as atmospheric residue, VGO, and NGLs. Overall, total OECD refinery inputs (of crude and other feedstocks) are 0.7 mb/d above the five-year average for the January to April period, compared with a 0.7 mb/d shortfall for crude runs.  Hence, refiners are running closer to capacity than indicated by merely considering crude throughput levels, but economics dictate that the crude competes for its place within a range of potential feedstocks 

3Q08 crude throughput in OECD North America accounts for much of the reduction in this month's OECD forecast.  US runs are cut by 0.2 mb/d, to an average 18.3 mb/d, which is slightly lower than 3Q07.  The current weak margin environment is hurting the financial health of some US refiners.  Several independent US refiners have reported the need to either rearrange debt facilities or cut inventory levels to cope with the impact of high oil prices on their cash flows and balance sheets.  The outlook for the industry's earnings has been materially downgraded by some investment banks, who are predicting second-quarter losses for some players, while others may only be slightly better than break even during the second quarter.

US refinery crude throughput averaged 15.4 mb/d in June, according to provisional weekly data, some 0.2 mb/d below our expectations.  Crude runs reached the highest levels since the beginning of the year in the Midwest and West Coast regions, but fell in the US Gulf Coast following a series of power-related outages during the latter half of the month.  July crude throughput is forecast to increase to 15.5 mb/d and again to 15.6 mb/d in August.  Higher crude runs are certainly possible given the lack of reported planned maintenance, but the weak margin environment leaves us sceptical they will occur.  Conversely, we do not explicitly adjust our forecast for potential hurricane-related outages during the third quarter, leaving forecasts vulnerable to any repeat of the significant operational problems seen in 2004 and 2005.

The 3Q08 OECD Pacific throughput forecast is unchanged at 6.8 mb/d, despite the reprots of run cuts at Nippon Oil and Showa Shell in Japan.  Weekly data for June suggest that crude runs were 3.4 mb/d, in line with our forecast, and should represent the seasonal low point in refinery activity as refineries complete maintenance.  The re-emergence of run cuts in Japan mirrors the weak margin environment in the Atlantic Basin, although high gasoline stocks following changes to gasoline taxation earlier in the year may also be a factor in refineries' decision to trim runs.  One positive note for Japanese refiners is the continued need for additional fuel oil supplies within Japan to meet power generation needs, following the long-term problems with nuclear generation plants. This has forced net imports to the highest level since 2003, cutting losses on fuel oil sales, compared with export alternate value.

Korean runs were stronger than expected during May at just over 2.4 mb/d.  The commercial start-up of a second residue fluid catalytic cracker at SK Energy's 840 kb/d Ulsan refinery should improve Korea's ability to maintain runs in a weak margin environment as it converts fuel oil into gasoline, distillate and petrochemical feedstock.

OECD Europe crude throughput in May fell by 0.2 mb/d to an average of 13.2 mb/d, slightly above our forecast. Crude runs remain below the five-year range, reflecting the weak margin environment with run cuts reported in Germany and Greece. However, it is apparent from the data that other European refineries have also trimmed runs in May, but that these run cuts are unreported.  Consequently, we have revised down our 3Q08 forecast to 13.6 mb/d, 0.2 mb/d lower than last month and 0.1 mb/d below 3Q07 levels.

Chinese crude runs registered a 0.1 mb/d dip in May to average 6.5 mb/d, slightly above our forecast for the second month running.  We have revised up 3Q08 runs by 0.1 mb/d to an average of 6.9 mb/d, on the back of stronger-than-expected level of crude throughput and the increase in domestic prices announced in June.  At the time of writing it remains unclear whether the VAT rebate offered on crude imports would remain in place for the third quarter, possibly indicating that the Chinese government considers it has done enough for refineries to maintain domestic supplies by raising product prices.  Furthermore, July diesel imports, estimated at almost 110 kb/d, are at the lowest level since February, suggesting that state refiners see the potential for higher domestic crude runs to ease shortages as refineries meet an increased proportion of demand.

In addition to the increased domestic pricing, July crude runs at the recently commissioned Qingdao refinery are expected to be 20 kb/d higher than previously forecast as the refinery increases utilisation towards full operating rates.  Furthermore, the completion of additional crude distillation and distillate hydrotreating capacity at Sinopec's Wuhan refinery will allow a 30 kb/d increase in crude throughputs.  However, elsewhere in China the increase in domestic prices, announced in June, appears to have been insufficient to entice higher activity levels among the independent refiners.  Reports suggest that the cash flow crisis faced by some independent refiners has been aggravated by delays to payments by Sinopec under buyback arrangements agreed earlier this year.

Refinery Capacity Additions and Product Supply in 2009

Refining capacity is set for a period of substantial growth over the course of 2009.  New refineries in Asia account for the majority of the forecast 2.0 mb/d increase in crude distillation during 2009.  In addition, significant investment in upgrading capacity is expected in OECD and non-OECD regions. The outlook for product markets over the course of 2009 is for a continuation of the trend towards increased gasoline supply potential, while distillate markets are likely to remain tight, although not as tight as currently.  Fuel oil markets should start to tighten as on the back of the start-up of upgrading capacity at existing refineries.

The majority of refinery capacity additions in 2009 are concentrated in the start-up of half a dozen large grassroots refineries in Asia.  The largest project expected on stream in the next 18 months is the 580 kb/d Jamnagar II refinery in India. This full-conversion, export-orientated refinery is expected to be operational at the end of 2008 and is designed to process heavy, sour crudes and produce a range of transportation fuels that meet the most demanding quality standards.  Elsewhere in India, expansions at several Indian refineries also contribute to Asian growth.  Similarly, the completion of Vietnam's Dung Quat refinery and additional upgrading capacity projects in Thailand will also raise the region's output of light and middle distillates.

Chinese projects in 2009 continue to increase the size, complexity and output quality of the domestic refining industry.  These follow several large-scale projects in 2008, including Sinopec's 200 kb/d Qingdao refinery, which entered service in 2Q08, and expansions at Sinopec Wuhan and CNPC's Yumen and Dalian facilities.  Growth in 2009 is driven by CNOOC's new 240 kb/d Huizhou refinery and CNPC's 200 kb/d Qinzhou plant.  In addition, the expansion of CNPC's Fushun and Dushanzi facilities, plus the 160 kb/d expansion of the Sinopec Quanzhou refinery, as a joint venture with Saudi Aramco and ExxonMobil, underpins forecast growth of over 700 kb/d in 2009.

Elsewhere, growth in refining capacity comes from the start-up of Qatar's 146 kb/d condensate splitter in Ras Laffan, which we assumed would start in late 2008, although recent comments by some of the project sponsors indicate that it will not start until early 2009.  OECD regions contribute a combined 300 kb/d over the course of 2008 and 2009.  Pacific expansions are driven by additional condensate processing capacity in Japan, associated with petrochemical processing expansions.  Conversely, North American and European refinery expansions by Valero, BP and others are aimed at improving the ability to process a heavier, sourer, and hence cheaper crude slate.

Product supply trends are forecast to diverge in 2009.  Continued easing of global gasoline and naphtha markets contrasts with a marginal easing of tightness in middle distillates, despite tighter diesel quality specifications in Europe from January 2009.  Fuel oil markets could start to tighten during 2009 (although this assumes that incremental supplies of heavy sour crude are not sold to hydroskimming refineries, which would result in additional fuel oil supplies).

Global gasoline supply potential increases significantly in 2009, thanks to the increase in refining capacity in Asia and North America, and increasing supplies of ethanol.  Against this, weak global demand growth is forecast in the major consuming regions. OECD demand declines on the back of a mixture of cyclical and structural factors, while non-OECD regions post below-trend demand growth on the back of high gasoline prices.  Concurrently, naphtha's supply potential will increase as rising supplies of gas condensates are processed in the Middle East and Asia, limiting refiners' ability to raise naphtha yields and minimise the gasoline overhang.

Middle distillate markets are expected to remain relatively tight in the face of robust demand growth next year.  The Chinese refinery expansions noted above are forecast to reduce Chinese distillate imports over the course of 2008 and restore China's net export status during 2009.  However, rising import requirements in OECD Europe and Latin America will keep the pressure on refineries to maximise middle distillate yields where possible.  The Middle East also looks set for tighter gasoil/diesel markets as strong demand growth outstrips local refinery supply capabilities, although the region will remain a net exporter of jet fuel/kerosene.  European diesel markets will move to 10 ppm sulphur limits at the start of 2009, from 50 ppm currently (apart from the UK and Germany, which have already adopted the 10 ppm rule), as part of the move to Euro-V standard fuels.  This change, which affects around 3mb/d of diesel supply, could support diesel cracks over the coming winter and into 2009, particularly if some European refineries are not ready to meet the tighter specifications.

Fuel oil markets should start to tighten as new upgrading capacity additions outpace falling demand.  Moreover, tightness in LNG and coal markets could support demand, particularly as spot LNG cargoes are trading well above price parity with fuel oil in Asia.  Overall, the scale of investment in upgrading suggests that fuel oil markets should see tighter conditions emerge over the course of 2009.