Oil Market Report: 10 September 2008

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Highlights

  • August global oil supply fell by 1.0 mb/d to 86.8 mb/d on North Sea maintenance, the BTC pipeline outage and lower OPEC supply.  Non-OPEC output is revised by -180 kb/d for 2008 and by -85 kb/d for 2009, with hurricane outages impeding 2H08 supply.  Non-OPEC growth including OPEC NGL is now 580 kb/d in 2008 and 1.56 mb/d in 2009.
  • OPEC crude supply in August fell by 195 kb/d to 32.5 mb/d on field and pipeline outages in Iraq, Angola, Libya and Nigeria, while effective spare capacity rose from 1.5 mb/d to 1.9 mb/d.  The 'call' on OPEC is revised up to 32.2 mb/d for 3Q08 and 31.7 mb/d for 4Q08.  This report went to press ahead of the OPEC 9 September meeting in Vienna.
  • Hurricane activity in the US Gulf of Mexico results in a 1.4 mb/d downward revision to US refinery crude throughput in September, to an average of 13.9 mb/d.  Global September crude runs could decline by 1.3 mb/d from August.  OECD crude runs are forecast to average 37.4 mb/d in September, their lowest level since October 2002.
  • OECD stocks rose by 47 mb in July to 2,646 mb.  A large, unseasonal crude build from a revised June base and weaker demand leave end-July OECD cover at 54.5 days.  Higher OECD end-June stocks now imply a 380 kb/d OECD stockbuild in 2Q08 versus last month's estimate of flat second-quarter stocks, and a seasonal 2Q average build of 0.9 mb/d.
  • Forecast global oil demand has been lowered for both 2008 and 2009, following weaker deliveries in the OECD.  World demand averages 86.8 mb/d in 2008 (+0.8% or +0.7 mb/d versus 2007 and 100 kb/d lower than previously estimated) and 87.6 mb/d in 2009 (+1.0% or +0.9 mb/d year-on-year and 140 kb/d lower than in our last report).
  • Benchmark crude futures continued their downward slide in August, approaching $100/bbl in early September, as fundamentals eased.  Weaker OECD demand and higher stocks dominated sentiment, while markets have so far shrugged off Hurricanes Gustav and Ike, though the latter could yet defer post-Gustav supply recovery.

Foreword from the first OMR editor

25th Anniversary of the IEA Oil Market Report

This month marks the 25th anniversary of the IEA Oil Market Report (OMR).  I had the privilege to edit the report from its first public issue in September 1983 until August 1985.  I would like to acknowledge my predecessor, James Bretherton, who worked tirelessly to prepare the groundwork to take the OMR public.  The report's growth and contribution to understanding the complex world oil market is impressive as each succeeding editor has contributed their special talents.  The OMR provides readers with a consistent, accurate and timely picture of key oil developments and first-rate objective analysis of market trends.  A large and growing number of subscribers from consuming and producing countries including governments, oil industry executives and oil market watchers around the world regularly read the OMR.  The report provides valuable data and objective analysis on world oil consumption, production, capacity, trade, prices, refinery activity and OECD inventories.  Over the years, the report has broadened and deepened its coverage to include more countries and new topics.  The next 25 years will be equally challenging as changing market developments and new issues emerge.

The First 25 Years

The oil market has experienced many swings in oil prices over the past 25 years, driven by geopolitical issues including wars and supply disruptions, changes in OPEC production behaviour and economic business cycles which influenced the world oil balance and price trends.  As shown in the graph below, oil prices exhibited wide swings over this period, falling in 1986 in response to the Saudi decision to abandon its role as swing supplier, rising in 1990 following Iraq's invasion of Kuwait and falling again in late 1997 and 1998 following the Asian financial crisis that depressed oil demand.  From 1983 to 2001 annual oil prices rose in seven years and fell in 11 years with prices averaging a low of $14 per barrel in 1998 and a high of $30 per barrel in 1983 and 2000.



The last seven years have been characterised by an unprecedented, sharp and steady rise in oil prices.  Prices have risen for a record-setting seven consecutive years from $26 per barrel in 2001 to over $140 per barrel in July 2008.  The reality of fundamentally tight market conditions, combined with market uncertainties about demand, supply and political developments, is putting steady upward pressure on prices.  World oil consumption rose by 9 million b/d over the period.  China, India, and the Middle East are major contributors to this growth.  Non-OPEC supply, excluding Angola, climbed by almost 4 million b/d with OPEC countries supplying the remaining increase in demand.  Over the period, available surplus production capacity dropped from 4 million b/d in 2001 to under 2 million b/d currently.  Surplus capacity has fallen well below historical levels, which creates uncertainty in the market and amplifies any actual or perceived geopolitical concerns.

The Next 25 Years

The current high oil prices and concern about the global economy and the environment promises to make oil market conditions a priority issue for both consuming and producing countries in the years ahead.  The OMR will remain a critical tool to help understand oil market trends.  The future challenges for the report, however, are substantial as market watchers are eager to know the answers to tough questions such as why are prices so high, will the recent downturn in prices continue, when and by how much will prices fall?  The current debate over the cause of high oil prices between those believing fundamental factors are the primary driver and others arguing that speculators are the culprit, reinforces the view that well-functioning markets need transparency.  A clearer understanding of current and forward supply and demand fundamentals, as well as a better understanding of non-traditional fundamental factors, such as the influence of financial markets, is needed.  More accurate information about future available production capacity levels in both OPEC and non-OPEC countries would add to market transparency.  Collecting consumption and inventory data on non-OECD countries is also important given they will represent a growing share of the world market.  The joint statement from the recent Jeddah Energy Meeting in June 2008 noted the need for enhanced oil-data collection to further improve market transparency and stability.  The IEA certainly will play an important role in meeting that challenge.

Acknowledgements

I would like to acknowledge the hundreds of dedicated individuals that worked tirelessly to meet tight deadlines amid fast-changing developments that required last-minute adjustments to put out the monthly report over the past 25 years.  I also want to challenge the individuals that will work on the report in the future to make it better and more useful and more transparent to oil market watchers.

Guy Caruso



Twenty-five years and counting: data, demand destruction and supply downtime

This issue coincides with the 25th anniversary of the very first Oil Market Report.  We are celebrating the occasion with a new look for the report, with an introductory article from our very first editor, Guy Caruso  and, by coincidence, with a new Editor, as Lawrence Eagles moves on to new challenges after ably steering the Oil Industry and Markets Division at the IEA for three years.

It would be nice to reflect that, 25 years on, analysis had somehow filled in most of the gaps in our understanding of how the oil market functions and where it may be headed in future.  In reality, the challenges are as great as ever, and the proliferation of information and technologies these past two and a half decades, while helping us dig deeper beneath the workings of the industry, throw up many of their own surprises.

Data availability and quality remain crucial.  Huge progress has been made by governments and international bodies, through valuable initiatives such as JODI.  Yet this report frequently calls for more data on reserves and field-specific output from producers, and for more granular demand and inventory data from the developing countries that now drive global consumption growth.  We will continue to do so.  This month's report also sees notable revisions to preliminary data from the US, Japan, Canada and Belgium among others.  Data revisions are a fact of life, although the scale of some of the recent adjustments is larger than usual.  Our own member countries recognise gaps in their data-reporting systems, highlighting the need for adequate resources if analysts are to be able to keep up with ever-more complex, globalised, and yet at times more differentiated, markets.

This month's report touches on the debate over OECD demand suppression versus destruction.  It is too early to come down overwhelmingly on one side or the other, though there are clear signs that weakening economic prospects plus high prices are causing behavioural shifts and purchasing choices in the OECD countries.  Whether these would be sustained if prices were to weaken further remains open to debate, but it is something we will continue to try to assess.  We also have to bear in mind potential two-way substitution impacts, into and away from oil.   Significantly, we are yet to see clear signs that economic slow-down or demand weakness are becoming entrenched in the non-OECD economies.  Quite the reverse, as higher demand estimates for China, India and Iran this month partly counter downward revisions for the OECD economies.  There are even signs that some earlier reductions in price subsidies in Asia are being reversed, so it looks premature to write off global demand growth yet.

OPEC Ministers will have already met in Vienna to decide on production policy by the release date of this report.  Market fundamentals look likely to ease in coming months, in part a response to the high prices seen over the past 12-18 months.  Inventories look slightly more comfortable, but maybe they need to be, given the market risks and tight spare capacity that persist.  New upstream capacity in Saudi Arabia and Angola is welcome, but is being temporarily eclipsed by stoppages elsewhere.  The recent BTC pipeline outage, shuttered Georgian ports and Hurricanes Gustav, and now Ike, show how easily and quickly crude and products can be knocked out of the supply/demand balance if weather, technical and political risks materialise.  In this environment, Guy Caruso's call for a better, more useful and transparent OMR in future represents a stiff challenge, one we grasp with enthusiasm, but also one which will require the help of producer and consumer governments alike.

Demand

Summary

  • Forecast global oil demand has been lowered in both 2008 and 2009, following weaker-than-expected deliveries in the OECD.  World demand is expected to average 86.8 mb/d in 2008 (+0.8% or +0.7 mb/d versus 2007 and 100 kb/d lower than previously estimated) and 87.6 mb/d in 2009 (+1.0% or +0.9 mb/d compared with the previous year and 140 kb/d lower than in our last report).
  • Oil demand in the OECD is seen averaging 48.4 mb/d in 2008 (-1.6% or -0.8 mb/d versus 2007) and 47.9 mb/d in 2009 (-1.1% or -0.5 mb/d on a yearly basis).  These prognoses are roughly 160 kb/d lower than previously estimated for both years, as a result of significant revisions in both North America and the Pacific.  The data suggest that the demand impact of weaker economic conditions and high prices during the summer - when oil prices reached an all-time peak - was more marked than expected, notably in the United States.  Furthermore, the effects of the ongoing hurricane season on US demand are subject to considerable uncertainty.


  • Non-OECD oil demand is forecast at 38.3 mb/d in 2008 (+4.0% or +1.5 mb/d versus 2007 and 50 kb/d higher than previously estimated) and 39.8 mb/d in 2009 (+3.7% or +1.4 mb/d compared with the previous year and 20 kb/d higher than in our last report).  These upward revisions are mostly related to a reassessment of China's 3Q08 demand, gasoil use in India and fuel oil consumption in Iran.  Non-OECD demand thus continues to offset the contraction seen in the OECD.  Moreover, even though the outlook for post-Olympics Chinese demand remains uncertain, claims that growth will plummet during the forthcoming months are open to question.
  • Demand in the US may be poised for a more permanent, rather than transient, downward trend.  Sustained high prices and sluggish economic activity are arguably likely to reinforce the current wave of structural adjustments, which could further reduce US consumption per capita in the medium to long term.  Anecdotal evidence of this transformation includes the marked shift to more efficient vehicles, changing mobility and driving habits, signs that suburban living is gradually losing its appeal, and ongoing modifications in business practices.  Nevertheless, we have kept our US demand forecast for 2009 largely unchanged until more tangible proof of these trends becomes available.

OECD

OECD inland deliveries (oil products supplied by refineries, pipelines and terminals) contracted by 1.5% year-on-year in July, according to preliminary data, with losses in North America and Europe largely offsetting gains in the Pacific.  In OECD North America (which includes US Territories), oil product demand shrank further (-2.9%) as a result of less driving by US motorists amid record-high oil prices.  In OECD Europe, demand was also affected by high prices, but fell by a more modest 0.1%.  In OECD Pacific, demand rose by only 0.1%, despite strong Japanese electricity needs and vigorous demand in Australia.







June revisions, however, were significant.  Finalised figures indicate that OECD demand contracted by 4.1% during that month - almost three times more than previously estimated and implying a downward adjustment of 1.3 mb/d for the month and 0.5 mb/d for 2Q08.  These revisions came essentially from the US and Japan.  Consequently, OECD demand is now forecast at 48.4 mb/d in 2008 (-1.6% or -0.8 mb/d versus 2007).  In 2009, demand is seen contracting by 1.1% on a yearly basis (roughly -0.5 mb/d) to 47.9 mb/d.  For both years, these estimates are about 160 kb/d lower when compared with our last report.



Demand 'Destruction' versus Demand 'Suppression'

As oil demand continues to shrink in the OECD as a result of adverse fundamentals - the economic slowdown and the high oil price - there is ongoing debate on whether this loss will be permanent or temporary - i.e., whether demand has been 'destroyed' or merely 'suppressed', notably in the US, the largest OECD (and global) oil consuming country.  Although, at first glance, historical evidence would lend some credence to the 'suppression' view, the 'destruction' case may be more persuasive and points to profound long-term consequences.

Proponents of the 'suppression' view argue that US oil demand will rebound to previous levels as oil prices fall.  According to this thinking, the oil market is cyclical: strong demand prompts the oil price to rise, which then eventually curbs demand; the weaker demand, in turn, depresses the price, fostering a new round of demand growth.

The sharp price rise that began in the late 1970s, which slammed US oil demand, is thus often presented as incontrovertible evidence of this dynamic.  The oil price doubled in real terms between 1978 and 1980, leading to a 9.9% oil demand contraction over that period.  By 1983, US demand had fallen to 15.7 mb/d.  Over the following 20 years, however, the oil price gradually fell to its pre-1979 level (in real terms) and, by 1998, oil demand had more than recovered (averaging 19.2 mb/d in that year).  By extrapolation, the current price slide should therefore result in a similar outcome, with US oil demand eventually rebounding to its 2005 peak of 21.2 mb/d.

Such reasoning, however, ignores the fact that, even though a price decline may play an important role, the rebound in oil demand will be primarily driven by strong economic growth; the correlation between economic activity and oil demand is very strong.  Between 1983 and 2007, US GDP grew by 3.2% per year on average, while demand expanded by 1.1% per year on average over the same period.  The current contraction in oil demand, and particularly of gasoline, is mainly related to worsening economic conditions (an endogenous factor), which have coincided with skyrocketing prices (an exogenous factor).

The 'suppression' argument also overlooks efficiency improvements (notably regarding vehicle fuel efficiency), interfuel substitution (particularly away from heavy fuel oil) and demographic patterns: as such, US oil demand per capita fell from 32 barrels in 1978 to almost 26 barrels in 2007 - a 19% drop, despite the increase in overall oil demand.  Thus, both the income and price effects are asymmetric: their rise has greater impact upon demand than their decline, a conclusion supported by much academic literature.

As such, rather than pondering whether demand will be 'destroyed' or 'suppressed', a more pertinent question is arguably whether the ongoing structural shift towards greater energy efficiency will be more pronounced than in the past.  Even though the current price slide from its July all-time record high is largely related to fundamentals (the severe contraction in OECD demand, most notably in the US), the oil market will likely remain tight given the continued strength of demand growth outside the OECD and supply-side constraints.  From that perspective, sustained high prices and sluggish economic activity (the economic rebound in the OECD is not expected to occur before late 2009 at best) will continue to support the current wave of structural adjustments, which will further reduce US consumption per capita in the medium to long term.  The available evidence so far, albeit admittedly anecdotal, suggests that US consumers are both expecting the oil price to stay high and the economy to remain subdued.  Nevertheless, we have kept our US 2009 forecast largely unchanged until more tangible proof of these trends becomes available.

  • The shift from gas-guzzling SUVs and light trucks to smaller, more efficient vehicles is becoming a stampede (the share of gas-guzzling units with respect to total vehicle sales is now below 50% for the first time since the early 2000s).  This change in sales patterns is likely to have significant consequences upon the efficiency of the overall US 250-million vehicle fleet (in addition to tougher fuel-efficiency standards), of which 90% runs on gasoline.  Although it would probably take almost two decades to turn over the entire fleet, assuming that sales remained at about 13 million new vehicles per year on average, the potential effect could be dramatic: a 30% efficiency improvement - to levels seen in Europe and Japan - could translate into a fall of some 3 mb/d in US gasoline demand (which currently accounts for close to 45% of total domestic oil demand).  This figure may seem far-fetched, but the current trend may well be seen in retrospective as the inflexion point - i.e., the peak - of US gasoline demand.
  • US motorists are driving much less and using other means of transportation.  The number of vehicle-miles driven (VMT) has fallen for the eighth month in a row in June (the latest available figure), notably in rural areas.  More symbolically still, most observers expect a sharp VMT drop during the Labor Day weekend in early September, when the so far lacklustre summer driving season comes to an end.  The same can be observed in air travel, which is also contracting and unlikely to pick up as fares rise and previously complimentary services such as checked baggage become subject to a fee.  More travellers are expected instead to opt for trains, buses, motorcycles and cruise ships during the Labor Day holiday.  Admittedly, these patterns may be transient and revert once the economy improves; however, it is unclear whether old habits will return, as behavioural changes could by then be well entrenched.
  • The suburban sprawl may be gradually losing its appeal.  House prices seem to be falling slightly more outside city centres or in areas where economic activity is concentrated - that is, in the suburbs and most particularly in the 'exurbs' (which are further away).  This could suggest that more Americans are considering living closer to their place of work, given often-limited public transportation alternatives - another structural trend that would eventually entail even less driving.
  • Finally, there is increasing evidence that businesses, ranging from manufacturing to airlines, are fundamentally changing the way they operate - since many business practices were designed for an era of cheap energy.  Many US companies are seemingly reviewing how they handle stocks or manufacture, package and ship goods.  This trend could also signal a momentous structural change in the making.

North America

Oil product demand in North America (including US Territories) shrank, for the seventh month in a row, by 2.9% year-on-year in July, according to preliminary data.  Demand weakness in the US and to a certain extent in Canada continued to drag down regional consumption by largely offsetting sturdy Mexican growth.  Moreover, revisions to June preliminary data, as noted earlier, were particularly large (almost -0.7 mb/d): demand in OECD North America actually contracted by 5.3% year-on-year during that month, over twice as much as previously estimated.  Regional oil demand is now expected to average 24.8 mb/d in 2008 (-2.9% or -750 kb/d on a yearly basis) and 24.4 mb/d in 2009 (-1.5% or -380 kb/d).  Compared with our last report, these estimates are about 100 kb/d lower in both years.





Adjusted preliminary data in the continental United States corroborate the demand weakness that has been documented since August 2007.  Inland deliveries - a proxy of oil product demand - contracted by 4.0% year-on-year in July and by as much as 4.5% in August, with all product categories bar naphtha and gasoil registering significant contractions.  More dramatically, monthly data for June were sharply revised down (-600 kb/d), with the bulk of the adjustment related to gasoil deliveries.



This confirms the assertion that the oil price rise, combined with the economic downturn, has been devastating for beleaguered US consumers - after all, retail prices have almost tripled in less than two years, while most indicators suggest that many economic sectors are rapidly weakening (with the possible exception of exports, which underpinned the relatively strong 2Q08 GDP growth).  US oil demand is thus on track to contract by as much as 3.6% year-on-year in 2008 to 19.9 mb/d, and by 1.9% in 2009 (to 19.5 mb/d), roughly 100 kb/d less for both years when compared with our previous report.

The June revisions also bring back to the fore the issue of reliability of the weekly data released by the US Energy Information Administration (EIA).  Our adjustment was lower than the EIA's (which totalled almost -800 kb/d), but simply because we attempt to anticipate such changes.  We nevertheless base our estimates of the current month (in this case, August) on EIA weekly figures - yet, by its own admission, the agency is having increasing difficulties in estimating weekly deliveries.  EIA officials have recently pointed out that this is related to missing ethanol and trade data (notably exports), which results in inflated estimates of gasoline and diesel deliveries - and in subsequently large downward revisions.

Europe

Oil product demand in Europe fell by a modest 0.1% year-on-year in July, according to preliminary inland delivery data.  Gains in naphtha and gasoil almost entirely offset losses on other product categories, notably gasoline (-4.8%) and residual fuel oil (-3.9%).  Revisions to June annual submissions, meanwhile, stood at -110 kb/d, largely driven by the Netherlands (lower-than-expected fuel oil deliveries) and Turkey (minor downward revisions across the board).  In addition, Belgium made further upward adjustments to its naphtha figures back to January (roughly +30 kb/d).  Looking forward, demand in OECD Europe is foreseen to average 15.3 mb/d in 2008 and 15.2 mb/d in 2009, implying a year-on-year decline of 0.3% and 0.4%, respectively, only marginally lower than our previous forecast.





Inland deliveries in Germany rebounded by 3.9% year-on-year in July.  Higher-than-expected heating oil deliveries (+46.1%) were largely behind the rise, as the relative weakness of gasoline (-3.7%) and residual fuel oil demand (-8.7%) observed in recent months prevailed.  Heating oil consumer stocks averaged 48% of capacity by end-July, markedly higher than a month earlier (45%) but well below the readings of July 2007 (56%).  The German heating oil market has thus shown some signs of life over the past two months, but demand could nevertheless remain quite subdued when compared with last year.  For 2009, though, we continue to base our forecast on expectations of more normal patterns of refilling.



Demand in France rose by 3.0% year-on-year in July, pulled up by strong deliveries of heating oil (+14.9%) and residual fuel oil (+20.0%), which offset the pronounced weakness in gasoline demand (-5.9%).  The heating oil rebound is akin to the one observed in Germany, probably indicating that consumer stocks were low (although there are no figures for inventories).  The spike in fuel oil, meanwhile, was probably prompted by stockbuilding, since the weather was not particularly hot.



Demand for road transport fuels remains subdued in the main European countries.  The relative weakness of diesel deliveries is quite instructive in this regard and provides further evidence of the deterrent effects of high oil prices.  (Gasoline, which is structurally declining across most of Europe, is a less reliable indicator of the vigour of transportation fuel demand.)  In July, diesel demand rose by a paltry 0.2% in Germany, and by 0.4% in France and Italy.  By contrast, it plummeted in both Spain (-10.6%) and the United Kingdom (-2.5%) in June (the last month for which official data are available).

It should be noted, though, that the overall demand picture is much weaker in Italy, Spain and the UK than in France and Germany, since all three have been facing a sharp economic slowdown for some time (although the outlook for the latter two has also worsened recently).  This has contributed to amplify the negative effects of high oil prices.  Italian demand, in particular, has contracted during most of this year across all product categories.

Pacific

According to preliminary data, oil product demand in OECD Pacific rose by just 0.1% year-on-year in July.  Gains in Japanese demand for both residual fuel oil and direct crude use for power generation resulting from the ongoing nuclear outages, and in Australian diesel demand following June's natural gas temporary disruption, barely offset losses in other product categories, notably in transportation fuels.  This provides further evidence of the shattering effects of record-high oil prices.



Meanwhile, revisions to June preliminary data, as noted earlier, were significant (-0.5 mb/d): demand in OECD Pacific plummeted by 4.4% year-on-year during that month, instead of growing by 2.7% as previously estimated.  As a result, oil demand in the Pacific is expected to average 8.4 mb/d in 2008 (+0.2% or +20 kb/d on a yearly basis) and 8.3 mb/d in 2009 (-1.2% or -100 kb/d) - down in both years by about 70 kb/d when compared with our last report.  The contraction in 2009 is poised to be driven by falling Japanese demand, notably for gasoline, as discussed below.



The June revisions were mostly linked to Japan, where all product categories bar naphtha were adjusted down.  In addition, the 'other products' category was also revised down from March to May 2008, as naphtha backflows (which are subtracted) had been underreported in official submissions.  As such, Japanese demand, which represents two-thirds of regional demand, actually fell by 5.6% in June (instead of rising by 4.6%) and further declined in July (-0.9%).  It is worth noting that high oil prices have amplified the structural decline of gasoline demand.  This trend is set to accelerate next year: electric vehicles will reportedly be commercialised next year on a massive scale.  The government is indeed actively encouraging the construction of recharging facilities and other infrastructure across the country.



Korea is featuring a similar story.  Overall demand (-1.3% year-on-year in July) has been dragged down mostly by a marked weakness in transportation fuels demand following the sharp rise in international oil prices.  For example, gasoline deliveries declined by almost 5.0% year-on-year in both June and July, instead of rising seasonally.  More striking still was the fall in diesel demand: -27.6% in June and -13.5% in July.  Nevertheless, it should be noted that weaker deliveries of fuel oil (-15.6% on average from January to July), which is being increasingly substituted by LNG, have also contributed to the country's subdued demand picture.

Non-OECD

China

Preliminary data indicate that China's apparent demand (refinery output plus net oil product imports, adjusted for fuel oil, direct crude burning and stock changes) rocketed up by an estimated 9.4% year-on-year in July.  As in recent months, the rise was supported by strong deliveries of transportation fuels (gasoline, gasoil and jet fuel/kerosene rose by 21.3%, 21.5% and 8.1% year-on-year, respectively) ahead of the August Olympic Games.  Meanwhile, the weakness in residual fuel oil demand - the feedstock of choice for 'teapot' refineries - persisted for the twelfth month in a row, with deliveries contracting by 38.2% as a result of continuing poor refining economics.  Although we revised up slightly our 3Q08 forecast of China's oil demand to account for somewhat higher-than expected growth in July, our prognosis for the year remains essentially unchanged compared with our last report, at 8.0 mb/d (+5.9% versus 2007) and 8.4 mb/d in 2009 (+5.3%).  As we have noted, however, this forecast may be revised again as the post-Olympics picture becomes clearer.



The jury is still out on whether the strong oil product imports - notably of gasoil - and higher refinery runs seen in the build-up to the Olympics will abruptly fall from September (or even August, but data for last month are not yet available).  The state-owned majors, PetroChina and Sinopec have indeed strongly hinted that this will be case, arguing that stocks are plentiful.  Other observers argue that a possible rise in retail prices and a slowing economy will further curb oil demand.  These assertions, however, need to be qualified.

First, gasoline and gasoil stocks from PetroChina and Sinopec have reportedly surged by 66% year-on-year to a combined 58.4 mb in July, according to data compiled by China OGP.  However, even though the composition of this limited sample of data is open to question (only three years have been documented, while secondary stocks are seemingly not included), inventories are not particularly high in terms of forward demand cover.  At roughly 18 days for gasoline and 12 days for gasoil, the cover is about half of OECD levels - where demand growth is much lower.  From this perspective, the decision to curb imports is most likely dictated by the losses incurred by the majors given the prevailing caps on retail prices, rather than by a sober assessment regarding supply security.  If anything, China probably needs to continue building up its product inventories, which means maintaining a minimum level of imports until new refining capacity becomes operational.



Second, the rise in end-user prices is far from certain, despite recurring rumours and given recent policy moves ostensibly aimed at improving energy efficiency and curbing demand growth.  In mid-August, the government increased the sales tax on some gas-guzzling new vehicles, while reducing it for small cars.  Although the move was largely symbolic - the tax for car engines between 1.0 and 2.5 litres, which account for roughly 80% of the country's fleet, was left untouched - the government will probably wait before making another move.  (The sales tax increase, in fact, was arguably aimed at supporting domestic car manufacturers, which tend to specialise in mid-sized engines, whereas imported vehicles have generally bigger engines.)  Moreover, a key motivation for adjusting retail prices - the gap between international and domestic prices - has become less pressing given the recent slide in international oil prices, which is reportedly contributing to restore a modicum of profitability to refining activities and, if sustained, could help bring back some production from teapot refineries.

Third, China's often-cited, impending economic slowdown remains elusive.  June's relatively low export growth (18% year-on-year) prompted many pundits to declare that China had finally been hit by the economic slowdown in OECD economies - but then July figures came in, showing a rebound of almost 27%.  In addition, subdued construction and real estate activity in the Beijing/Tianjin area, which accounts for less than 6% of Chinese GDP, hardly portends a nationwide slowdown.  Moreover, some economists contend that real GDP growth is actually higher than reported (perhaps as high as 14-15%), simply because it does not match with nominal GDP growth and inflation figures - unless inflation is actually higher.  Meanwhile, the yuan's appreciation has significantly slowed down - suggesting that Chinese policymakers are prepared to use the exchange rate as a tool of trade competitiveness if their main foreign markets slowdown - and bank lending quotas have been relaxed.  That being said, though, there is one element that could eventually dampen growth: the recurrent power shortages in several key regions.  Therefore, if over the next few months China's economic growth shows more tangible evidence of a weaker outlook, we may adjust our demand prognosis accordingly.



Other Non-OECD

According to Indian preliminary data, oil product sales - a proxy of demand - rebounded by 7.2% year-on-year in July, following June's weak growth (1.2%), when retail prices for several products were raised.  As we had predicted, the modest price hike merely slowed down the pace of growth, rather than inducing a contraction in absolute levels: in July, sales of LPG, gasoline and gasoil - the products subject to the increase - rose by 2.1%, 5.8% and 10.3%, respectively.  It should be noted that hitherto-subdued naphtha demand (mostly used for petrochemical production) was stronger than expected, increasing by 19.8% versus July 2007.  Nevertheless, our forecast remains basically unchanged compared with our last report, with Indian demand expected to average 3.1 mb/d in 2008 (+4.9% on a yearly basis) and 3.2 mb/d in 2009 (+4.4%).



The increase in gasoil sales, which account for over a third of total oil product sales, was particularly strong.  As noted in past reports, the spike in gasoil demand has been largely prompted by consumers switching to cheaper unbranded gasoil.  Truckers seeking to reduce their costs after the June price rise are unwilling to purchase more expensive premium grades, relying instead on unbranded gasoil, which does not contain performance-enhancing additives; utilities are switching away from much more expensive fuel oil (which is not subsidised and currently costs some 10% more than gasoil); and many motorists are mixing gasoil with subsidised kerosene (adulteration is a common practice in India).  In addition, the unusually weak start of the monsoon season in July, in western and southern India (with strong rains normally falling from July until late September), forced farmers to irrigate their fields with gasoil-fuelled pumps.  It also curbed hydroelectric generation, obliging urban and rural dwellers to rely on back-up gasoil generators.

The gasoil surge has resulted in localised shortages across the country, notably in the states of Maharashtra, Gujarat, Bihar, Jharkhand, and Madhya Pradesh, despite efforts by state-owned oil companies to meet demand.  Gasoil demand from utilities may ease somewhat if fuel oil becomes competitive given the fall in international oil prices; in addition, August's monsoon rains were reportedly abundant, which could reduce the usage of back-up generators.  By contrast, gasoil demand from truckers and motorists is unlikely to recede - unless the government decides to increase gasoil prices sharply, an implausible proposition given the forthcoming national elections.  A government-mandated high-level panel recently advocated a gradual, monthly increase in gasoline and gasoil retail prices over the coming months, but some voices arguing in favour of a price cut are getting louder, following July's massive strike by truckers calling for more supplies of unbranded gasoil.

Preliminary data indicate that oil demand in Russia grew by 0.9% year-on-year in July.  As in other large emerging countries, demand is driven by transportation needs, with gasoline, gasoil and jet fuel/kerosene soaring by 7.0%, 4.0% and 14.2%, respectively, in July.  As such, total Russian demand is expected to average 2.9 mb/d in 2008 (+2.8% versus 2007) and 3.0 mb/d in 2009 (+3.3%).

Even though oil product prices are nominally market driven, the Russian government has pressured refiners to reduce wholesale prices on jet fuel and diesel.  In mid-July, following two months of complaints about excessively high jet fuel prices by several domestic airlines  - and also probably due to concerns regarding mounting inflation (which reached 15.1% in June) - Prime Minister Vladimir Putin threatened to fire key officials of the Federal Antimonopoly Service (FAS) if they failed to take measures aimed at reducing jet fuel prices.  The FAS obliged by launching an investigation into eight companies supplying jet fuel to airports across Russia, as well as into the country's five majors - Lukoil, Gazprom Neft, TNK-BP, Rosneft and Surgutneftegas.  The charges include setting unacceptably high prices for jet fuel and diesel, and charging differentiated prices.



In mid-August, arguably seeking to avoid a costly confrontation with the authorities, Lukoil, Gazprom Neft and Surgutneftegas announced month-on-month wholesale price cuts, with further reductions to follow over the next few months.  Interestingly, the cuts - ranging from 4% to 15% -- have not only been applied to jet fuel and diesel, but also to gasoline and fuel oil.  As a result, motorists in Moscow, for example, currently pay 25 roubles ($1.03) per litre of gasoline, some 30% less than in Europe or Japan.



According to preliminary data, oil demand in Iran jumped by 7.7% year-on-year in June.  Demand was not only driven by transportation fuels (+8.6%), but also by buoyant residual fuel consumption (+44.5%).  Gasoline use, which rose by 2.2%, has virtually returned to its 2007 pre-rationing levels of about 500 kb/d, although demand could slip a bit in the months ahead following adjustments to the quota system (in late June, quotas for taxis, trucks and some dual-fuel private vehicles were reduced).  Total Iranian oil demand is foreseen to reach 1.8 mb/d in 2008 (+4.9% on a yearly basis) and 1.9 mb/d in 2009 (+5.1%).

The soaring demand for fuel oil, meanwhile, has been driven by power needs, as Iran has suffered recurrent and widespread power shortages during most of the summer.  A severe drought has left dams virtually empty, thus crippling hydroelectric plants (some 5,000 MW out of the country's installed 6,500-MW hydro capacity has reportedly been shut in since the 2007 summer).  Nevertheless, thermal power generation (about 34,000 MW or 85% of total capacity) has also proved insufficient, largely because of the slow pace of generating capacity additions amid frozen end-user prices.  Under the current administration, supply has indeed failed to match the country's rapidly growing electricity consumption (about +10% per year).



A Reversal of Asian Retail Price Increases?

In the past few months a number of non-OECD countries, notably in Asia, surrendered to ever-rising international oil prices by revising their end-user price regimes.  The cost of subsidies had become untenable, threatening the fiscal position of many governments in the region.  Given their highly contentious nature, these adjustments were far from homogenous - ranging from a 10% increase in India to a 63% hike in Malaysia.  Although in many cases these increases were not sufficient to offset the growing subsidy burden, they were nonetheless commended by many observers as a positive step in the right direction - that is, the beginning of market pricing in a region accustomed to very cheap energy and runaway oil demand growth.  The only exception has been Thailand, which had de facto reintroduced subsidies in March, by imposing set prices in its theoretically unregulated market.

Over the past few weeks, however, several governments have backtracked, following the recent slide in international oil prices.  The trigger has been widespread discontent from populations already struggling with high inflation, which is running at or close to double-digit levels in several countries.  The first country to reverse previous price increases was Taiwan, which in early August cut end-user prices of gasoline (-5.6%) and diesel (-6.6%).  From now on, retail prices will be adjusted every Friday (instead of every month) in order to better reflect changing market conditions. Thailand's state-owned company PTT followed suit, cutting gasoline prices by 1.6% and diesel prices by about 2.3%.  In the Philippines (nominally a deregulated market), oil companies have shaved retail prices twice since late July.  Finally, in late August the Malaysian government decreed a 5.6% reduction in gasoline prices and 3.1% in diesel prices.  Starting in September, prices will be adjusted in the first day of every month.

Do these moves augur a domino effect of price cuts across the region?  Probably not, considering that the largest Asian oil consuming countries - China, India and Indonesia, in that order - are expected to hold off on cutting prices, which remain well below international levels despite the recent hikes.  Cutting prices would increase the subsidy burden; China could arguably afford it, but India and Indonesia less so.  More importantly, perhaps, it would probably create fresh supply disruptions, as refiners (such as 'teapot' refineries in China) would again see their losses mount, or even go bankrupt (which could happen to state-owned refiners in India).  Nevertheless, price cuts cannot be entirely ruled out given electoral considerations.  India and Indonesia, which face parliamentary and presidential elections next year, could follow the example of Malaysia - which had pledged to fully liberalise prices before backtracking following the government's recent popularity plunge.

Supply

Summary

  • Global oil supply fell by around 1.0 mb/d to 86.8 mb/d in August.  The bulk of the month-on-month decline came from non-OPEC countries.  European summer oil field maintenance and the now-resolved outage on the BTC pipeline from Azerbaijan underpinned the drop. However, on a year-to-year basis, global supplies looked healthier, gaining in excess of 2 mb/d for a third month running.
  • Non-OPEC production estimates have been revised down by 180 kb/d for 2008 and by 85 kb/d for 2009, to 49.9 mb/d and 50.7 mb/d respectively.  Output is now 470 kb/d lower than previously expected in 3Q08 and 270 kb/d lower for 4Q08.  Third-quarter production is affected by an assumption of substantially heavier September hurricane outages for the USA.  Downward adjustments for Russian supply, and assumed ongoing October US hurricane outages cut the forecast for 4Q08.  Weaker Russian, Norwegian, Australian and Chinese projections are employed for 2009.
  • Growth in non-OPEC output averages 270 kb/d for 2008 and 760 kb/d for 2009, after an increase of   425 kb/d in 2007.  The US, Brazil, Azerbaijan, China and global biofuels are key components of this year's increases.  Canada, Australia and Kazakhstan will potentially join that list for 2009.
  • OPEC condensates and gas liquids growth, which has averaged around 0.2 mb/d each year so far this decade, accelerates to 0.3 mb/d in 2008 and potentially 0.8 mb/d in 2009, taking total OPEC NGL supply next year to 5.9 mb/d. Saudi Arabia, Qatar, the UAE, Nigeria and Iran underpin the rise.
  • OPEC crude supply in August fell by 195 kb/d to 32.5 mb/d on oil field and pipeline outages in Iraq, Angola, Libya and Nigeria.  Effective OPEC spare capacity increased from July's 1.5 mb/d to 1.9 mb/d.   Lower production and higher installed capacity for Saudi Arabia, Angola and Iran drove the rise.  This report went to press ahead of OPEC's 9 September Vienna meeting.  Pre-meeting, lower prices and potentially easing fundamentals appeared to foster debate within OPEC over a trimming of supplies, either officially via lower target output or unofficially via closer adherence to previous targets.


The 'call on OPEC crude and stock change' for 3Q08 is revised up by 0.5 mb/d to 32.2 mb/d and by 0.3 mb/d to 31.7 mb/d for 4Q08 after downward adjustments to non-OPEC supply.  Lower OECD demand reduces the 2Q09 'call' to 30.1 mb/d, but overall the 2009 'call' is unchanged from last month's 31.1 mb/d.  The potential for a weaker 2009 'call' on lower OECD demand is likely offset by downside risks for non-OPEC supply and upside non-OECD demand growth.

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 a nationally allocated (but not field-specific) reliability adjustment has also been applied for the non-OPEC forecast to reflect a historical tendency for unexpected events to reduce actual supply compared with the initial forecast.  This totals ?410 kb/d for non-OPEC as a whole, with downward adjustments focused in the OECD.

OPEC

OPEC crude supply in August fell by 195 kb/d to 32.5 mb/d.  The August reduction was based largely on involuntary cuts by Iraq, Angola, Libya and Nigeria, where oil field and pipeline shut-ins were instrumental in reducing monthly supply.  September supplies are difficult to assess, particularly with uncertainty surrounding the timing and extent of some of the facility outages.  OPEC's 9 September Vienna meeting, the outcome of which was unknown at the time of writing, could change the production dynamic further, albeit any official production changes are unlikely to take effect before October.  In addition, a series of recent field start-ups in Nigeria, Angola and Saudi Arabia further cloud the issue, as do preliminary tanker tracking data, which in part underpin the reduction we estimate for August, but which appear to show a modest increase for the first three weeks of September.



Effective OPEC spare capacity increased from the 1.5 mb/d estimated for July, reaching around 1.9 mb/d in August (2.7 mb/d on a notional basis including Iraq, Indonesia, Nigeria and Venezuela).  The increase comes partly from lower monthly production in August, but also from increased estimates for capacity for three producers after new field start-ups.  Saudi Arabia reportedly saw initial volumes produced from the AFK (Khursaniyah) project after long delays associated with gas processing facilities.  Production of crude is seen building to an initial 250 kb/d in the next few months and 500 kb/d in early 2009.  Our capacity estimates for Saudi Arabia are likely to nudge 11 mb/d by end-year accordingly.  Khursaniyah, along with much of the impending 2009 increase in Saudi capacity, is likely to comprise predominantly Arab Light grade or lighter.  August saw a relative shift in Saudi price discounts, suggesting that supplies of heavier/sourer grades may be reined in to make way for incremental lighter barrels.

August also saw start-up at the Saxi-Batuque fields offshore Angola, part of the Kizomba C project which will ultimately produce 200 kb/d.  Angolan crude capacity now stands at 2.0 mb/d.  Finally, we have boosted Iranian capacity to 4.1 mb/d after higher supply levels in recent months, albeit exports have oscillated due to crude marketing issues.   Total OPEC crude capacity is seen increasing by almost 500 kb/d, to just shy of 36 mb/d, between now and the end of the year as these projects ramp up.  Increments also derive from deepwater Nigeria, and from Iraq, although serious question marks now hang over the short-term service agreements which underpin any increase in Iraqi capacity.



At the time of writing, OPEC Ministers were meeting in Vienna to discuss production policy and indeed readers of this report will likely be aware of their decision.  The downward shift in prices from July peaks has seen more hawkish members of the producer group call for reduced output levels, with suggestions that Iran, Venezuela, Algeria and Libya are eyeing defence of a $100/bbl price floor.  However, market reports suggest that Saudi Arabia and others may see a lower floor of perhaps $80/bbl as being more realistic.  The latter group, so the argument goes, mindful of the adverse impact of $100/bbl-plus oil on OECD consumption levels, is thought happier to allow prices to go slightly lower, not only to shore-up medium-term crude demand, but also to avoid the political difficulty of being seen to cut official production ahead of the winter heating season.

While the Organisation may find actually cutting official targets difficult in the present environment, closer adherence to the individual production targets published briefly last September might be an option.  On our reckoning this option, if pursued, would cut OPEC supply by around 570 kb/d compared with August levels, to around 29.7 mb/d for the OPEC-12 and perhaps 32 mb/d for the Organisation as a whole.   Although it has largely been the core Gulf Arab producers who have been producing above target (partly to make up for shortfalls elsewhere), Iran also appears to have done so in recent months. 

Brazilian officials were quoted during August as having turned down an invitation from Iran to join OPEC, with indications that Brazil sees its longer-term future more as a refined product exporter than a crude exporter if plans for new refining capacity are realised.

August Iraqi crude supply is assessed down by 155 kb/d compared with July, averaging 2.3 mb/d.  On our estimation, this is the lowest level since January.  Power outages affected southern crude exports, which fell from 1.51 mb/d to 1.43 mb/d, while interrupted northbound pipeline deliveries to Ceyhan also had an impact on tanker liftings from the Turkish port.  These were 305 kb/d in August compared with 380 kb/d in July.  Domestic crude use is estimated at 565 kb/d, including around 80 kb/d for power generation.

There were further reports in late August of political delays for the six Technical Support Agreements (TSAs) designed to add 500 kb/d to Iraqi crude capacity via existing fields over the next one to two years.  In contrast, 28 August saw Iraq reach agreement with China's CNPC to develop the 1.2 billion barrel al-Ahdab field.  A new technical service agreement replaces a production sharing contract signed by CNPC a decade ago for development of the same field.  The project is costed at $3 billion and could see start-up in three years for ultimate capacity of 100-120 kb/d.

Nigerian output is estimated to have fallen by 15 kb/d in August to 1.95 mb/d, as outages on the Bonny pipeline system and elsewhere persisted, and offsets expected from new field start-ups proved disappointing.  Force majeure announced in July for exports of Bonny Light will remain in place through September.  Meanwhile, technical/documentation problems have prevented initial exports from Chevron's recently started Agbami field and have limited initial production levels to only some 15 kb/d.  Field capacity is 200 kb/d, although this is unlikely to be reached until some time in 2009.  A supply vessel for the Agbami field was also attacked during August.

In Libya, production outages have also multiplied in recent weeks.  We estimate that production is running some 150 kb/d below capacity of 1.8 mb/d.  The offshore, 45 kb/d al-Jurf field which was shut for repairs in late April, is now expected to remain offline through September and October. Although pipeline maintenance also shuttered around 100 kb/d of Waha crude in August, this is due to be back online in September.  However, as much as 70-100 kb/d of supply was also cut by a tank fire at the Ras Lunuf export terminal on 19 August.

Angola meanwhile has seen field outages overshadow otherwise rising supply from new field start-ups. Production of crude oil for August is estimated at 1.85 mb/d compared with 1.90 mb/d in July.  BP was forced to stop production on the Greater Plutonia FPSO on 16 August after a blockage of gas flow to a flare.  It is believed that repairs might keep Greater Plutonia output of some 200 kb/d off stream until late September.  This has overshadowed the mid-August start of production from the Saxi-Batuque fields, which will eventually double existing production at the Kizomba C project.  The first phase of Kizomba C, the Mondo field, began production of around 100 kb/d from January.

Non-OPEC Overview

Estimates for 2008 and 2009 non-OPEC supply have been cut by 180 kb/d and 85 kb/d respectively.  Autumn storms, pipeline outages and project deferrals underpin the changes this month, with North America being the focus of reductions for 2008 and a weaker Russian profile now envisaged for 2009.  US production in September 2008 could be reduced by as much as 1.5 mb/d by the passage of Hurricanes Gustav and Ike.  After the yearly contraction seen for much of the period since November 2007, non-OPEC Growth could surge potentially in excess of 1.0 mb/d for 4Q08.  New project starts are part of the expansion late in the year, but so too is an assumed seasonal reduction in autumn maintenance and storm-related shut-ins. All told, 2008 non-OPEC supply now averages, 49.9 mb/d, rising to 50.7 mb/d in 2009.  Non-OPEC growth averages 270 kb/d in 2008 and is centred upon Brazil, China, the Caspian Republics, the USA and global biofuels.  In 2009, growth reaches 760 kb/d, with Canada and Malaysia augmenting the list of expansions seen in 2008.



Having rebounded by 410 kb/d in July from maintenance-affected June lows, non-OPEC production dipped 0.8 mb/d below July, to an estimated 49.1 mb/d in August, US production came in lower, with outages in Alaska, prior to significant Gulf of Mexico hurricane outages at the end of the month.  Summer maintenance schedules saw a 500 kb/d fall in August North Sea supplies, and a sharp drop from Azerbaijan due to the near-three-week outage on the BTC pipeline. September is likely to see recovering North Sea production and near-normal operations in Azerbaijan, but this is offset now by markedly higher assumed hurricane outages for the US Gulf in September after passage of Hurricane Gustav and the approach of Hurricane Ike.  As a result, September non-OPEC production actually falls from August levels of 49.1 mb/d to 48.4 mb/d. Sharp growth to 50.5 mb/d is possible in October, based on recovering supplies from North America and Europe, with this growth reflecting a combination of new project start-ups and a seasonal run-up in supply after autumn maintenance and weather-related downtime.

Over and above non-OPEC production growth, the forecast continues to assume sharp growth for 2008 and 2009 in OPEC condensates and gas liquids.  These volumes effectively augment the non-OPEC portion of our forecast since, unlike crude oil, gas developments in OPEC countries tend not to be subject to voluntary production quotas or targets.  Indeed, OPEC NGL expansion matches or exceeds the entire growth expected from other non-OPEC producers in both years.

Total OPEC gas liquids output averages 5.1 mb/d in 2008 (up from 4.8 mb/d in 2007) and 5.9 mb/d in 2009:

  • Saudi Arabian NGL production (including ethane) is seen hitting 1.8 mb/d in 2009 from 1.5 mb/d this year after the recent start-up of the Khursaniyah project and with further non-associated gas treatment expected from the Hawiyah plant;
  • Qatari gas liquids are seen adding a combined 300 kb/d for 2008 and 2009 to reach 760 kb/d next year based on North Field liquefaction plant expansion;
  • Iranian condensate and gas liquids output gains 100 kb/d over 2007 and 2008 to reach 485 kb/d in 2009, growth coming from expected completion of phases 6-10 of the South Pars project;


Nigerian gas liquids gain 100 kb/d in 2009 to reach 315 kb/d following recent start-up at facilities at the EA and Agabmi fields and next year at the Akpo field.

Bearing in mind the bottlenecks evident in raw materials, drilling and installation capacity, we are wary of such a significant increase concentrated in 2009.  However, latest information suggests that these projects are on schedule for completion as modelled in our forecast, although clearly there are risks on the downside if project delays materialise late in the day.  It is also worth noting that associated petrochemical capacity expansions appear to back up the likelihood of these expanded NGL supplies.

OECD

North America

US - August Alaska actual, others estimated:  Forecast US oil production for 2008 has been cut by 105 kb/d, largely as the result of now sharply higher assumed September hurricane outages in the Gulf of Mexico (see below).  In addition, Alaskan August crude production came in well below expectation at only around 555 kb/d.  This followed maintenance work on the Trans Alaska Pipeline system and other outages affecting the Alpine and Lisburne production systems, although Alaskan output is expected to recover over the remainder of 2008.

Total US oil production in 2008 is now forecast at 7.55 mb/d, of which 5.0 mb/d is crude oil.  Annualised growth amounts to 100 kb/d, with increases in NGL production and ethanol offsetting declines for crude oil.  Earlier expected annual growth deriving from new fields in the GOM has been wiped out by the now-higher expectation of autumn hurricane outages. The US forecast for 2009 has been left largely unchanged however, at 7.87 mb/d for total oil and 5.1 mb/d for crude. Ethanol and GOM crude oil growth underpin next year's rise.



The Impact of Hurricanes Gustav and Ike on US Crude and NGL Production

At the time of writing in early September around 1.03 mb/d of Federal Offshore US Gulf crude production remained shut after the passage of Hurricane Gustav (down from an earlier 1.3 mb/d), plus an estimated additional 300 kb/d of US Gulf Coast NGL capacity and Louisiana state crude production.  Although Gustav is not believed to have caused substantial damage to production infrastructure, platform and pipeline inspections were continuing before extra volumes of production could be reactivated.  Those inspections now look likely to be impeded by the approach of Hurricane Ike.  Latest projections from the National Hurricane Centre see this storm reaching producing areas of the GOM around 10-11 September and making landfall sometime the following weekend.

We have therefore decided to revise up prevailing hurricane outage assumptions for 2008 (normally a rolling, five-year average of GOM production stoppages).  Our new working assumption is that offshore facility evacuations and production shut-ins begin anew on 9 September and result in the bulk of GOM, Louisiana and regional NGL production remaining completely offline for one week after Ike's assumed landfall on 14 September.  For now, we assume no lasting damage to production facilities.  Production then progressively recovers during the two weeks through 6 October.  After that date, Louisiana state production and Gulf Coast NGL output return to normal levels.  The forecast for Federal offshore GOM production then reverts to October's five-year rolling average assumption of 266 kb/d shut-in.

In total, this scenario implies average September shut-ins totalling 1.5 mb/d, with 1.1 mb/d in the Federal waters of the GOM.  This is a massive 1.2 mb/d higher than our previous September assumption, but close to our related assumption for September that regional refinery crude runs are cut by an average 1.4 mb/d due to the storms.  October average crude outages fall back to around 325 kb/d in total, within 55 kb/d of the previously assumed average.  These assumptions will naturally change as the actual track and impact of Hurricane Ike and any subsequent Atlantic storms hitting the GOM becomes apparent.  Until final assessments of 2008 production outages are available, we have not changed our lower storm assumptions for the 2009 forecast.

Canada - Newfoundland July actual, others June actual:  Total forecast Canadian oil production has been trimmed by 30 kb/d for 2008 but is boosted by 15 kb/d for 2009.  The 2008 adjustment follows news that start-up at CNRL's Horizon oilsands project is delayed from 3Q to 4Q.  Mined syncrude supply has been reduced by 30 kb/d for 3Q and by 70 kb/d for 4Q as a result.  However, we have re-evaluated our projection for Canadian in-situ bitumen output, with new project announcements suggesting this could rise by a net 65 kb/d in 2009 versus 2008.  A 40 kb/d upward adjustment for our 2009 bitumen number offsets a net 25 kb/d downward revision for other components of Canadian oil production, leaving the 2009 forecasts for Canada a total 15 kb/d higher than last month.



Our OMR and MTOMR forecasts for Canadian supply growth are underpinned largely by growth in Alberta's oil sands production.  However, August saw an agreement reached for development of the offshore Newfoundland/Labrador Hebron project.  Project operator Chevron now expects the $7 billion project to enter service around 2016 and attain 150 kb/d plateau production two years later.  The project had been delayed over the past few years by uncertainties over provincial government equity stakes and royalty rates.  Settlement of these issues for Hebron will likely open the way for further offshore developments such as Hibernia South.

Mexico - July actual:  Mexican crude production fell by 57 kb/d in July versus June, to 2.78 mb/d.  NGL production was stable at 374 kb/d.  Production at the baseload Cantarell field has fallen for ten straight months, and averaged 970 kb/d in July compared with over 1.5 mb/d a year ago.  Our forecast envisages Mexican crude output continuing to slide, averaging 2.8 mb/d in 2008 and 2.6 mb/d in 2009, with gas liquids production expected to average 375 kb/d both years.

North Sea



Norway - June actual, July provisional:  Total Norwegian liquids production in 2008 and 2009 is likely to continue to show the annual decline of some 150-200 kb/d seen during recent years.  Output averages 1.8 mb/d of crude in 2008 and 1.6 mb/d in 2009.  These volumes are augmented by around 570 kb/d of gas liquids, resulting in total oil production of 2.4 mb/d and 2.2 mb/d for 2008 and 2009 respectively.  That said, June and July data came in stronger than our forecast, suggesting that our maintenance assumptions may have been too high.  Upward adjustments are not immediately extended through the forecast however, as export loading schedules for key Norwegian grades suggest lower output month-on-month in August and September, before a seasonal rebound in production in October of up to 200 kb/d.  The 2009 forecast is in fact reduced by 25 kb/d, largely on recent evidence that Grane field output has been running below our original 220 kb/d plateau assumption.

UK - June actual:  Stronger than expected June production, and indications of higher export loadings from the key crude streams through September, boost our forecast for 2Q08 and 3Q08 UK production by around 25 kb/d.  A 10 kb/d upward adjustment accrues to the 2009 forecast on evidence of marginally higher Forties system production. However, these alterations do not change the underlying trend in UK production, seen falling by 115 kb/d in 2008 and by 165 kb/d in 2009 to average 1.55 mb/d and 1.38 mb/d respectively. Output from mature fields has fallen sharply since 1999, when UK output averaged 2.9 mb/d.  New field start-ups expected for the UK in 2008 and 2009 are generally small, with only the Ettrick and Brodgar/Callanish projects exceeding 20 kb/d. 

Former Soviet Union (FSU)

Russia - July actual, August provisional:  July and August Russian crude production made modest month-on-month gains of 50 kb/d and 20 kb/d respectively, reaching 9.57 mb/d in August.  Condensates and gas plant liquids production amounted to around 445 kb/d in July and 475 kb/d in August, giving a total August production level of just over 10.0 mb/d.  Forecast production now stands at 10.0 mb/d in 2008 and 9.9 mb/d in 2009, following 10.1 mb/d in 2007. Our now-weaker forecast for Russia follows news that the country's largest producer, state-sponsored Rosneft, is curbing its production outlook after delays for its 3.8 billion barrel Vankor field in Eastern Siberia.  The company has pushed back Vankor start from late 2008 until 2H09, although plateau capacity is reportedly doubled to 500 kb/d.



ExxonMobil has also raised its production forecast for the Sakhalin 1 project for 2008 to the equivalent of 189 kb/d for 2008 and 169 kb/d for 2009 after discovering a new productive layer at the field earlier in the year.  Since this is close to prevailing OMR forecast output levels for Sakhalin 1, there is no impact to our existing projections. There have also been renewed reports that year-round exports of Vityaz crude from the Sakhalin 2 project will begin this year, again confirming our earlier assumption. This follows the completion of an onshore pipeline to the southern Sakhalin export terminal at Prigorodnoye.

Azerbaijan - June actual:  Forecast 2008 production for Azerbaijan is revised up by around 25 kb/d after a faster recovery in production from the offshore Azeri-Chirag-Guneshli (ACG) fields than had been assumed in last month's report.  In the aftermath of the 6 August explosion on the BTC pipeline, which ships ACG crude to the Turkish Mediterranean port of Ceyhan, we had previously assumed that production would remain constrained until mid-September.  However, in the event pumping resumed on BTC in the fourth week of August, with tanker loadings beginning again from Ceyhan on 25-26 August.  Azeri crude exports were reported back at levels close to 1.0 mb/d on 3 September.  That said, the ACG consortium and state company Socar have been forced to juggle export schedules as shipments on the Baku-Supsa pipeline and by rail to Georgian ports were disrupted by the now-ended hostilities between Russian and Georgian forces in August.  The BTC pipeline outage itself may have 'cost' nearly 0.5 mb/d in lost August ACG production as the producers were forced to reduce output substantially.

FSU net oil exports fell by 220 kb/d in July, to 8.62 mb/d, according to preliminary data.  Crude exports were almost flat, rising by just 35 kb/d on the month.  A 140 kb/d rise in BTC exports, plus 60 kb/d extra through the Druzhba pipeline (notably heading for Poland and Slovakia), overshadowed drops in other seaborne exports.  FSU product exports decreased by 250 kb/d, led by a drop of 150 kb/d in gasoil.  Representing partly a correction from unusually high June volumes, this reduction in July may also have been prompted by stronger domestic demand.



August data are likely to reflect the sharp decrease in Azeri crude exports resulting from shutting of the BTC pipeline for almost three weeks in August, following an explosion on the line in Turkey.  Our production estimate from last month's report, which assumed a cut of around 500 kb/d for August as a whole, has not been changed.  Furthermore, the military intervention of Russia in regions of Georgia in August resulted in the closure of several Black sea ports (Supsa, Poti and Batumi) while the Baku-Supsa pipeline and parallel rail links were also out of operation for some time.  An increase in Russian export duty from 1 August may have reduced exports of Russian crude as well. However, the reopening of certain trade routes through Georgia, not least the BTC pipeline in late August, could prompt a September recovery in FSU exports from low August volumes.

Other Non-OPEC

Brazil - June actual:  Crude production reached 1.83 mb/d in June and an estimated 1.87 mb/d in July, the latter based on preliminary Petrobras data.  A strike by Petrobras workers previously expected for early August was averted.

All told, Brazilian crude production is seen averaging 1.88 mb/d in 2008 and 2.1 mb/d in 2009, annualised growth of 135 kb/d and 215 kb/d for the two years respectively.  New field developments expected before the end of 2008 include the Marlim Sul and Marlim Leste projects in the Santos Basin, to be followed by the Jabuti project in the Campos Basin from 2Q09.  However, official expectations for dominant state producer Petrobras have been revised down recently due to field underperformance and delays in new project start-ups.



Mitsui Ocean Development and Engineering was reported to have won a contract to convert an existing FPSO vessel for use at the giant deepwater Tupi field in the Santos Basin.  The 100 kb/d vessel is scheduled to begin production in 4Q10.  Petrobras intends to install up to ten such vessels at the Tupi field by 2015, after initial production tests.

India - June actual:  Indian oil production is seen levelling off at close to 815 kb/d in 2008 and rising modestly to 820 kb/d in 2009 (with NGL production accounting for 110 kb/d in both years).  An offshore explosion at the Panna-Mukta fields in June has been overcome, and production recommenced at partial levels in July.  Meanwhile, Reliance Industries is expected to begin offshore east coast output from its MA field before end-September, with peak output of 40 kb/d expected within several months.  Onshore, Cairn Energy has reported that development work has begun on its three Rajasthan fields, Mangala, Bhagyam and Aishwariya, together with the long-delayed export pipeline.  Initial production is expected in 2H09, rising eventually to 175 kb/d.

OECD stocks

Summary

  • OECD stocks built by 46.9 mb in July to 2,646 mb.  A large and unseasonal crude build accounted for 20.3 mb of this increase, the result of higher OPEC exports since May and weak OECD refinery runs.  European and Pacific crude stocks rose by 14.6 mb and 8.1 mb respectively.
  • OECD product inventories saw a typical July increase of 24.4 mb, as a weakening of consumer demand ran in parallel with lower OECD refinery runs.  A fall in OECD fuel oil stocks was the only unseasonal stock change, notably dropping 4.0 mb in OECD North America, with OECD inventories of motor gasoline seeing a characteristic July decrease of 3.9 mb.  However, preliminary data suggest that usual August product stockbuilds may not fully materialise in the West, while September US product stocks could face substantial draws given the disruption to US Gulf oil infrastructure caused by this year's hurricanes.
  • A healthy July build from an upwardly revised June base leaves end-July OECD stock cover at 54.5 days, compared with the five-year average of 53.6 days.  Absolute OECD inventory levels are also above the 2003-07 average, including a greatly improved OECD Pacific crude position.  Distillates remain the tightest of all the product categories in terms of forward demand cover, at 29.9 days for the OECD as a whole, lagging the five-year average by 0.5 days.  Preliminary data show a hefty 15.8 mb decrease in European crude stocks in August reducing total oil cover by 0.5 days.
  • A net upward revision of 19.2 mb for OECD end-June closing stocks now implies a 380 kb/d OECD stockbuild for 2Q08, versus last month's estimates of flat second quarter stocks and a 2Q average build of 890 kb/d.  End-June European product and Pacific crude inventories were adjusted higher by 12.5 mb and 12.8 mb respectively, while Canadian crude stocks underwent large downward revisions extending back over a year, including reductions of 10-20 mb for the last seven months.


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

The latest OECD stock data show a rise of 46.9 mb in July on top of an upward revision to end-June inventories of 19.2 mb.  Coupled with a downgrading of the OECD demand outlook, this means that OECD total inventories represented 54.5 days of forward demand cover at the end of July.  This was an improvement of 0.6 days on June, and took forward cover to the top of the 2003-07 range.  In all product categories bar distillates, forward cover was above the five-year average at end-July.

A counterseasonal increase of 20.3 mb in crude stocks was instrumental in the July OECD stockbuild.  A significant boost in OPEC crude output since May, coupled with weak OECD refinery throughputs (in a poor margin environment) were the twin drivers of higher crude inventory.  By end-July, absolute OECD crude stocks in North America had stabilised around the five-year average after three months of unseasonal decline, while in Europe they had jumped to the top or above the five-year range.  In the Pacific, July saw crude stocks return within seasonal norms after five months well adrift.  Still, preliminary August data suggest a hefty 15.8 mb European crude draw overshadowing a 7.2 mb increase in US crude stocks.  This would drive an August drop in forward demand cover of 0.5 days for total oil.

Broadly speaking, OECD product stocks built seasonally in July, suggesting that weakness in consumer demand matched the aforementioned weakness in OECD refinery throughputs.  Only distillates remain below the five-year average in terms of forward demand cover, and preliminary August data for Japan as well as ARA and Singaporean independent stockholdings reflect healthy distillate builds in the Pacific.  However, initial indications show European and US product stockbuilds well behind August norms, while also subject to any losses incurred as the US hurricane season intensifies in September.



Substantial revisions to OECD stocks affected May and June data most significantly, culminating in net revisions of -11.8 mb and +19.2 mb respectively for those months.  European distillate stocks were revised up by 9.0 mb for June, including 4.3 mb in the Netherlands and 3.3 mb in the UK.  There was also a large upward adjustment to Japanese crude stocks of 10.9 mb, due to an underestimation of volumes in ocean vessels waiting to unload (a recurrent grey area which has been discussed at length in previous reports).  Otherwise, for June, the adjustment-prone 'Other Oils' category in OECD North America was subject to a correction of +8.6 mb, as were European crude stocks, to the tune of +5.7 mb.



Perhaps of more long-term significance was the downward revision of Canadian crude inventories extending back over a year, including reductions of 10-20 mb for the last seven months.  This meant that OECD North American crude stocks fell below the five-year average (in May and June) for the first time since September 2004.  Even so, incorporating all revisions, the second quarter OECD stockbuild now stands at +380 kb/d (34.2 mb), having been reported as almost flat in last month's report.  This still substantially lags the five-year average second quarter build of 890 kb/d.

OECD Industry Stock Changes in July 2008

OECD North America

Although OECD North America stocks saw a seasonal build of 9.9 mb in July, this included a shallow crude draw of 2.3 mb while the product build of 9.9 mb was less than July norms ('Other oils' made up the balance, rising by 2.3 mb).  On the crude side, Mexican stocks dropped by 2.8 mb in July led by a dip in production of 60 kb/d.  US stocks were essentially flat in July, stemming the declines seen since end-April, despite a drop in US refinery crude throughputs (at least in part economic) and a slight increase in crude imports.

Canadian crude stock levels were significantly downgraded for the last year or so, with reductions of 10-20 mb affecting the last seven months.  This meant that OECD North American crude inventories fell below the five-year absolute average in May and June.  Questions raised at the time over inflated Canadian crude inventories and their artificially supportive effect on regional aggregates now seem to have been justified.  In any case, the shallow July draw took regional crude inventories back in line with seasonal averages.  Preliminary weekly data suggest that US crude stocks could see a rebound of 7.2 mb in August.



North American product inventories increased by 9.9 mb in July on aggregate.  A sharp drop of 4.0 mb in fuel oil, shared between US and Mexico, reflected the broad tightening of the fuel oil sector in recent months.  It also partially offset a healthy 13.8 mb July rise in US distillate stocks.  A shallower-than-usual ebb in OECD North American motor gasoline stocks of 1.3 mb, possibly resulting from weak mid-summer demand, left them near the five-year average.  However, September US product stocks are likely to face substantial draws given the disruption to US Gulf oil infrastructure caused by this year's hurricanes.

OECD Europe

A 15.8 mb build in OECD European stocks in July was well ahead of seasonal norms and almost entirely driven by a jump of 14.6 mb in crude stocks.  Product stocks rose by only 2.1 mb, including a mild increase of 1.1 mb in distillates.  Aided by upward revisions to end-June closing inventories for crude (+5.7 mb) and products (+12.5 mb), July stock changes pushed regional levels back above the five-year range in absolute terms.

Norway and France led the July crude stockbuild in Europe.  Norwegian crude inventories increased by 7.2 mb as crude production firmed by 240 kb/d while exports apparently slowed (according to tanker data).  French crude stocks built by 5.0 mb, with higher imports being the likely cause given that refinery runs were flat.  Lower refinery runs contributed to an Italian crude build of 3.0 mb.  Coming after an upward revision of 5.7 mb to end-June OECD Europe crude stocks, the build left regional crude inventory near the top of the five-year range, having appeared near the bottom based on last month's preliminary figures for the end of the second quarter.



The upward revision of 9.0 mb to end-June European distillate stocks indicates that regional tightness in the product unwound by even more than was reported last month.  A significant proportion of the bumper US exports of distillates reported for June (of 745 kb/d) is likely to have headed for Europe.  However, a shallow rise of 1.1 mb in July, limited notably by a 1.5 mb monthly draw in Germany where consumers appear to be finally rebuilding domestic heating oil stocks, left distillate demand cover below the five-year range once again.  The European draw of 2.3 mb in gasoline in July was bigger than the five-year average July decrease of 0.4 mb, possibly a result of the lower gasoline yields observed in the region or just lower throughputs.  Data for independently held stocks in the ARA region show a 2.4 mb increase in August distillate stocks and a very marginal 0.1 mb draw in motor gasoline.

OECD Pacific

A large upward revision of 14.4 mb was observed for June's closing stocks in the OECD Pacific, of which 10.9 mb was Japanese crude.  From this higher base, a July stockbuild of 21.2 mb, well ahead of seasonal norms, brought regional oil inventories back within the five-year range in forward demand cover terms for the first time since February.



OECD Pacific commercial crude stocks were revised up by 12.8 mb for end-June and were observed to rise by a further 8.1 mb in July.  This marked a significant recovery in regional crude stocks with a clear boost coming from higher imports from OPEC countries.  June revisions for Japanese crude stocks amounted to +10.9 mb and were prompted by an underestimation of volumes held in vessels in Japanese waters not yet unloaded, a recurring and significant grey area when assimilating preliminary Japanese crude stock data.  Japanese crude stocks are now seen to have risen by 6.3 mb and 4.8 mb in June and July respectively.  METI data shows that imports from the Middle East rose by almost 1 mb/d in July, with notable extra volumes from UAE (up 250 kb/d) and Iran (up 230 kb/d).  This outpaced a 410 kb/d rise in refinery crude throughputs.  Korean crude inventories built by 3.3 mb in July despite an apparent increase of 140 kb/d in refinery runs and imports only rising by 50 kb/d.

Total OECD Pacific product stocks built by 12.4 mb in July, including 6.4 mb increases in both the middle distillates and 'other products' categories.  Japanese stocks of distillates rose by 5.7 mb in July, while those of 'other products' by 5.1 mb, a recovery from a very low end-June level. Regional product inventories were boosted by a 570 kb/d monthly increase in refinery crude runs.  However, OECD Pacific fuel oil stocks remained close to the bottom of the five-year absolute range as a Korean build of 0.5 mb offset a corresponding Japanese draw.

Recent Developments in Singapore Stocks

Independent stocks of light and middle distillates continued to rise in Singapore in August, by 0.7 mb and 1.0 mb respectively.  Reports that China has reduced its gasoil imports since the Olympics may have reduced the distillate tightness in the region, allowing stocks to build (note:  some recent Chinese stock data are discussed in this month's demand section).  By contrast, independent fuel oil stocks in the same location fell by 3.0 mb as demand for the product rose (essentially for power generation), helping to drive a narrowing of the HSFO (Singapore) discount to Dubai from -$12/bbl to -$2/bbl.



Prices

Summary

  • Benchmark crude futures continued their downward slide in August and early September, approaching $100/bbl, as fundamentals eased and Hurricane Gustav proved less devastating than feared.  Demand in the OECD weakened further, dominating market sentiment, and prices shrugged off crude shortfalls resulting from Gustav and the BTC pipeline shut-in.  However, when going to press, Hurricane Ike was approaching the US Gulf and is expected to defer post-Gustav supply recovery.
  • Spot crude prices weakened, as the BTC pipeline shutdown and the prospect of a prolonged shut-in of US Gulf production were offset by below-average refinery throughputs.  Stronger fuel oil cracks have narrowed light/heavy spreads, while gasoline's recovery is increasing premia for light sweet grades.
  • Refining margins improved in the US and Europe in August, on stronger gasoline and fuel oil crack spreads.  The recovery was particularly visible on the US Gulf Coast, where cracking margins had previously been negative.  In Singapore, margins declined, as previous distillate strength unravelled and, unlike in the other regions, gasoline cracks fell month-on-month.  Several refiners reported economic run cuts.
  • Gasoline crack spreads saw continued recovery, especially in the US, where levels are now back in line with their seasonal five-year average and are contributing towards stronger refining margins.  The acute distillate tightness noted in past reports has loosened, though distillate cracks remain unusually high in all regions.  Fuel oil discounts to crude narrowed further on tight fundamentals.
  • August saw dirty tanker rates continue to decline to the usual subdued levels expected in advance of autumn refinery maintenance, after a dramatic late-July plunge from historical highs.  Conversely, clean tanker rates to Asia rocketed on tight vessel fundamentals and increased long-haul trading.


Overview

Oil prices continued their downward slide, as fundamentals eased further, with clear signs of demand weakness and a somewhat rosier stocks picture outweighing downward-revised supply.  Moreover - as far as could be ascertained at the time of writing - there was considerably less damage than feared from the impact of Hurricane Gustav on the US Gulf Coast.  However, the approach of Hurricane Ike could significantly impede recovery of both crude and refined products supply until late September or early October.  Previously, the military flare-up in Georgia briefly halted a slide that has now taken prices from their early-July high around $147/bbl to around $105 at the time of writing - a similarly dramatic plunge of over $40 in just two months as the preceding rise in prices.  Prices are now at their lowest since early April.

In what increasingly appears to be a shift in sentiment, weaker supply/demand fundamentals are asserting themselves.  As soon as it was apparent that Hurricane Gustav was not going to be nearly as devastating as Hurricanes Katrina and Rita in the summer of 2005, prices began retreating sharply, with spot crudes in some cases falling by as much as $10/bbl in one day.  This followed a rapid restart of the Baku-Tblisi-Ceyhan (BTC) pipeline through Turkey and an end to hostilities in Georgia.

It would appear that both Georgia and Gustav came at a time when short-term crude supplies were inflated by lower-than-average OECD crude throughputs and higher OPEC output - the widening of WTI's near-month contango would also hint at a loosening of near-term fundamentals.  In addition, it appears that statements both by the US authorities and the IEA to the effect that strategic stocks would be released in the event of long-lasting outages, helped to reassure markets (at the time of writing, the SPR was set to lend a small volume of crude to some Gulf Coast refineries).  Having said that, the hurricane season is not yet over, with several more major storms forecast to form.  Ahead of going to press, Hurricane Ike was approaching oil and gas facilities in the US Gulf, while in August, Edouard and Fay had caused some precautionary shut-ins and evacuations in what is proving to be a stormier-than-average season.  Forecasters expect 14-18 tropical storms in the US Gulf this season, which is considerably higher than the historical average of ten.



As with Katrina/Rita, the greatest potential impact looks likely to come from the shut-in refining capacity (compared with crude production capacity).  However, even this, and the prospect of much of it potentially remaining offline for some weeks, has failed to rally prices.  This is largely due to even weaker-than-expected OECD demand, as incoming data consistently show a decline due to the economic downturn and prevailing high prices.  In the OECD, continued economic slowdown or even recession are likely to continue to hamper demand further, as reflected in this report's substantial downward revisions for 2008 and 2009.

At the same time, as highlighted in last month's report, demand from some additional, temporary non-OECD sources has abated.  This is especially true for distillates, which as a result have seen a marked downturn in crack spreads compared with their previous and unseasonal premium to gasoline.  Indeed, in the US, the world's largest consumer, gasoline cracks have caught up with distillates again, also supporting a rise in refining margins, and are back in line with their average.  Unusually, this comes at a time when the summer driving season is traditionally considered over.  On the product front, fuel oil discounts to crude have narrowed even further, again boosting simple refining margins.  At the same time, various refiners have announced economic run cuts, even in China, though this may be due to a post-Olympic easing, at least of product imports.

Spot Crude Oil Prices

Spot crude prices in some cases fell even more steeply than futures as markets appear amply supplied.  Global refinery crude throughput in August was in line with that of last year and is set to dip below year-on-year's level in September, in large part due to refinery outages on the US Gulf Coast related to Hurricanes Gustav and Ike, but also on below-average runs in the OECD as a whole.  A sharp recovery of refining margins in August, at least in the US and Europe, has improved the profitability of hydroskimming and thus widened the choice of crudes for many plants.  This development - if sustained, which is not unlikely, given the potential for a short-term product shortfall stemming from refinery shutdowns on the US Gulf Coast - may yet boost refining margins and hence demand for crude.



Overall, as mentioned above, the Georgia and Gustav crude outages came at a time when alternative crude supplies were higher and prices reacted with a sharp fall.  In the North Sea, crudes fell relative to Dated Brent, despite a sharp dip in August supply.  North Sea crudes were also likely to benefit from a widening discount to WTI, LLS and other US crudes, as refining dynamics change and dirty transatlantic freight rates are now much lower.  In the Mediterranean, the Azeri Light outage was not immediately visible in prices, but eventually showed up in a strengthening of rival grade Es Sider versus Dated Brent - though Libyan crude production itself was also curbed slightly in August.  Urals meanwhile saw its discount to Brent narrow further, taking some strength from the Azeri shortfall, but also from a reduced export schedule and a further narrowing of fuel oil's discount to crude.



In the US, the improvement in refining margins supported crudes, especially LLS and related grades for cracking, but also Mars for coking.  WTI and other grades' relative strength to Atlantic Basin crudes such as Brent and Bonny Light should, especially if refining margins improve, be sufficient to draw in more crude from outside the region, should this prove necessary.  Total US crude stocks increased slightly in August and remain just below their five-year average.  In Asia, Dubai crude, which has recently been supported by fuel oil's recovery, saw one of the single greatest daily falls on 2 September, when it first became apparent that Gustav was not going to cause as much devastation as Katrina and Rita three years ago, dropping by more than $10/bbl.  The Asian market is suffering more than the US and Europe from an easing of distillate tightness, seeing refinery margins fall in August as a consequence.



Refining Margins

August refining margins improved in the US and Europe, but fell in Singapore.  Crucially, gasoline crack spreads are recovering, especially in the US.  This trend was already observable before Hurricane Gustav hit, but is likely to be exacerbated if outages are prolonged.  Fuel oil discounts narrowed too, while distillate spreads were generally down.  In any case, the margin improvement was quite marked after a weak patch, with all Gulf Coast and West Coast margins measured moving back into positive territory in August.  The improvements were more noticeable for domestic crudes such as LLS, Mars and Kern, where margins were higher.



In Europe, margins mostly improved.  The exception was Es Sider in the Mediterranean, which as a result of the Azeri Light outage and lower Libyan output, had risen sharply vis-à-vis other regional crudes.  In Northwest Europe, diesel cracks improved, unlike elsewhere.  Gasoline too was up, though not as strongly as in the US, and fuel oil cracks improved too.  While in August, on average, hydroskimming margins were still negative, the latest weekly calculation showed a shift into modestly positive territory, improving the chances of some marginal capacity being reactivated.



In Asia, Singapore margins were mostly down on the month, as unlike the other two regions, gasoline and distillate cracks fell month-on-month, as the regional market eased.   Even though latest weekly data showed an improvement, Singapore cracking margins are only just profitable, while Tapis hydroskimming margins remain deeply negative (Dubai hydroskimming crept into positive territory in early September).  As a result, several regional refineries have announced economic run cuts.



Spot Product Prices

Gasoline crack spreads showed the greatest improvement in August and early September as, despite weak demand, supply has tightened after refiners hiked distillate yields.  This was particularly pronounced in US markets, where gasoline prices had been unseasonably depressed on weak or declining demand due to the economic downturn and high retail prices.  Compared with other regions, gasoline cracks in the US Gulf, New York Harbor and the West Coast are all significantly higher.  But US cracks have in reality only just returned to their five-year average, highlighting their previous weakness.  Stocks fell 14.4 mb in August - an unusually steep decline at this time of year, even though overall levels remain only below their five-year average.  Gains in the US have also improved the economics of sending gasoline transatlantic.  In Asia, markets have eased, with China expected to return to gasoline net-exporter status in September.  Independent light distillate stocks held in Singapore have risen to well above their five-year average range for this time of year.



Diesel, jet fuel and gasoil crack spreads have continued their slide from end-May peaks but saw a slight uptick in late August/early September, when Gustav hit, and remain high.  The acute tightness noted in the past several reports appears to have slackened, as pockets of temporary demand have eased.  China is expected not to import any gasoil at all in September after stock requirements were apparently relaxed following the end of the Olympic Games.  Indonesia is expected to import only 170 kb/d in September, down from 225 kb/d in August.  Europe meanwhile has been receiving volumes from the US, but also from Asia, and the new 10 ppm ultra-low-sulphur diesel (ULSD) export stream from the Russian port of Primorsk is contributing to greater availability.  The European Union will be switching to mandatory 10 ppm diesel from end-2008 and most refineries appear to be prepared.



Fuel oil discounts have in most cases continued to narrow vis-à-vis crude, as demand for power generation in the Middle East soars, curbing exports.  Lower volumes are emanating especially from Iran, which is hit by a drought-related hydroelectric power shortage.  Arab Gulf countries too are seeing a combination of strong population growth and soaring energy needs for ambitious construction projects, not least in the energy sector.  On the other side of the world, Japan's power utility TEPCO reportedly burned around double the amount of fuel oil (and crude) in July year-on-year, with little prospect of imminent recovery of nuclear power output.





End-User Product Prices in August

End-user product prices on average decreased by 10.0% in August, in US dollars, ex-tax.  Following August drops in international crude and product prices, gasoline prices at the pump on average fell by 9.6% and diesel prices by 10.5% in all surveyed IEA countries except Japan.  There, gasoline, diesel and heating oil prices rose by 1.4%, 2.1% and 2.3%, respectively, and started to fall only in the last week of August.  At the pump, US drivers on average paid $1/litre for gasoline (¢377.9/gallon), while Japanese paid $1.69/litre (¥185/litre).  In Europe, retail gasoline prices varied from $1.77/litre (€1.18/litre) in Spain to $2.18/litre (€1.46/litre) in Germany.  Heating oil and low-sulphur fuel oil prices in IEA member countries (except Japan) on average dropped by 13.0% and 9.1%, respectively, in US dollars, ex-tax.  Compared with August 2007, retail product prices are on average 56% higher than a year ago.

Freight

After a dramatic late-July plunge from historical highs, dirty tanker rates continued to decline in August to the usual subdued levels expected in advance of autumn refinery maintenance.  Meanwhile, clean tanker rates to Asia rocketed to multi-year highs on tight vessel fundamentals and some increased long-haul trading.

Signs of an apparent easing in vessel fundamentals precipitated a dramatic downward correction in Middle East Gulf VLCC rates, which started in late July and carried on through much of August.  On the benchmark 260 kmt route from the Middle East Gulf to Japan, rates fell from a late-July peak of $41/tonne (almost $6/bbl) to a trough of $12/tonne (under $2/bbl) four weeks later, before firming to finish August at $18/tonne.  Vessel demand for crude loadings in September fell due to approaching (western and eastern) refinery maintenance.  This was probably exacerbated by economic run cuts.  Lower crude runs, evidence of an unseasonably high OECD crude build already occurring in July and compelling signs of a price effect on consumer demand were all disincentives for refiners to make extra crude purchases.  Meanwhile, Middle Eastern vessel supply was boosted as volumes of Iranian crude being stored in VLCCs in the Gulf were finally run down, ending three months of tight vessel fundamentals.  A late-month chartering rally allowed VLCC rates to stabilise as August ended, possibly the result of an improvement in US refinery margins.

Suezmax charter rates saw a similarly dramatic slide in late July and August, related principally to lower vessel demand.  One million barrel rates from West Africa to the US Atlantic Coast, at almost $50/tonne in late July, had collapsed to $20/tonne by mid-August, before a late-month firming to around $27/tonne.  In early August, reports emerged of US independent refiners such as Sunoco cutting third-quarter crude purchases from Nigeria due to poor margins, while forthcoming turnarounds also dented shorter-haul Suezmax demand for September.  BTC exports were interrupted for three weeks in August, adding downward pressure to spot charter rates in the Mediterranean.  Meanwhile, the prospect of lower Japanese crude runs undermined intra-Asian Aframax rates.



Clean tanker charter rates from the Middle East Gulf to Japan rocketed to near all-time highs in August as vessel fundamentals tightened further.  Anecdotal evidence of increased long-haul clean product exports, such as from South Korea to Europe or Mexico, added further strain to Asian vessel supply.  Clean rates for 75 kmt vessels rose from around $54/tonne at the start of August, to almost $62/tonne by month end.  In the Atlantic basin, a rising premium of gasoline sold in New York compared with Rotterdam encouraged mogas trade towards the US, as evidenced by higher import volumes reflected in EIA weekly data.

Refining

Summary

  • Hurricane activity in the US Gulf of Mexico results in a 1.0 mb/d downward revision to global crude throughput in September, to an average of 74.0 mb/d.  Consequently, September average global crude runs decline by 1.4 mb/d from August.  Stronger margins should boost crude runs in OECD regions and non-OECD Asia.  Nevertheless, OECD crude runs are forecast to average 37.4 mb/d in September, their lowest level since October 2002.
  •  The 3Q08 global crude throughput forecast is reduced by 0.5 mb/d to an average of 74.9 mb/d, due to the lower August and September crude throughput, offset by higher non-OECD July crude runs.  Year-on-year growth falls to 0.2 mb/d, driven by the 1.1 mb/d decline in the OECD, while non-OECD growth remains buoyant during the quarter at 1.3 mb/d.


  • Global crude runs in 4Q08 are forecast to average 75.7 mb/d, +0.7 mb/d quarter-on-quarter and +1.5 mb/d year-on-year.  Growth remains driven by the start-up of new refineries in India and China.  OECD Europe and Pacific crude throughput is revised up as a consequence of the stronger margin outlook as global product markets tighten in the wake of Hurricanes Gustav and Ike.
  • Refineries in all three OECD regions continue to raise middle distillate yields.  Data for June indicates that gasoil diesel yields were 30.7%, a year-on-year increase of 1.8 percentage points, or 6%.  Conversely, fuel oil yields decreased to a fresh five-year low of 10.1%.  The recent increase in gasoline yields following several months of weakness may herald a temporary halt to increases in middle distillate yields in future month's data.

Global Refinery Throughput

Preliminary data indicate that August global crude throughput averaged 75.3 mb/d, some 0.7 mb/d below last month's forecast of 76.0 mb/d.  OECD crude throughputs were 0.6 mb/d lower than forecast, largely on the back of US shutdowns in late August ahead of Hurricane Gustav.  Non-OECD crude throughput for August is estimated to have been 0.1 mb/d weaker than expected, partly on the back of run cuts in Singapore and maintenance work in Brazil.

September global crude runs are seen declining by 1.4 mb/d month-on-month, to an average of 74.0 mb/d, driven by weaker US crude runs and downward revisions to crude runs in Singapore, Thailand and China.  Consequently, September's forecast global refinery throughput is 1.0 mb/d lower than last month's report.  OECD crude runs are 0.9 mb/d lower, driven mainly by a 1.4 mb/d reduction to the US forecast as a result of the refinery shutdowns in advance of, and because of Hurricanes Gustav and Ike.

The consequentially stronger margin environment should raise crude runs in other regions (notably OECD Europe and Asia) by between 0.5 and 0.8 mb/d, despite the start of autumn maintenance.  This reflects the prevailing degree of available spare capacity, following the weaker margins in recent months.  Overall, 3Q08 global crude throughput estimates are now 74.9 mb/d, 0.4 mb/d below last month's estimates.

We have extended our forecasts to include 4Q08, and expect global crude runs to increase by 0.7 mb/d quarter-on-quarter to an average of 75.7 mb/d.  The start-up in 4Q08 of Reliance's 580 kb/d Jamnagar refinery expansion and CNOOC's 240 kb/d Huizhou refinery, which we assume to be operational from December, underpin much of the growth.  Elsewhere, growth comes from the FSU, the Middle East and Latin America as capacity expansions, fiscal incentives and lower maintenance contribute to higher crude runs.



Forecast OECD 3Q08 crude throughput averages 38.1 mb/d, 0.5 mb/d lower than last month's report.  At the time of writing, the impact of Hurricane Gustav, plus the likely impact of Hurricane Ike, are forecast to reduce US crude runs by 1.4 mb/d over the course of September (see Atlantic Hurricane Season Moves Into Full Swing).  Some offset is forecast from higher OECD Pacific and Europe runs as margins increase in response to the prospective loss of 46 mb of product supply.  Consequently, we have raised our September and October estimates by 0.5 mb/d for the two regions as a whole.  OECD average 3Q08 crude throughput is now expected to be 1.3 mb/d below the five-year average and 1.1 mb/d below 3Q07 average levels.

OECD crude throughput in 4Q08 is assumed to recover quickly from disruptions seen in September (assuming no further hurricane-related interruptions).  Crude runs increase by 0.6 mb/d in October to 38.0 mb/d and by 1.0 mb/d in November, to 39.0 mb/d.  A quicker recovery in US throughputs may dampen the increase seen elsewhere in the OECD (and non-OECD) regions, if margins again come under pressure from an easing of any potential product market tightness.

OECD North America crude throughput is forecast to decline to 16.7 mb/d in September, from 17.8 mb/d in August due to the hurricane-related drop in refinery activity on the US Gulf Coast.  Little response is expected from other refineries in Canada and Mexico, as seasonal maintenance is thought likely to constrain crude runs during September and October.  Elsewhere in the US, some increase is possible on the US East Coast and Midwest.



US refinery crude throughput averaged 14.9 mb/d in August, according to provisional weekly data, some 0.3 mb/d below July's level and 0.8 mb/d lower year-on-year.  This August level of throughput is the lowest since 1996.  The shortfall of 0.3 mb/d below our expectations is partly driven by precautionary shut-ins of Gulf Coast capacity, ahead of Tropical Storm Edouard in early August and Hurricane Gustav at the end of the month.



OECD Pacific crude runs jumped 0.6 mb/d in July, due to higher Japanese throughput and Korean crude runs which were ahead of expectations.  Offsetting this increase is Japan's lower-than-forecast (-0.1 mb/d) August crude throughput, according to preliminary weekly data.  Nevertheless, in light of the upwardly revised September forecast, 3Q08 average throughput is revised up by 0.1 mb/d to 6.9 mb/d.  Crude throughput in 4Q08 is forecast to average 7.0 mb/d, 0.2 mb/d lower than 4Q07.  The assumed resumption of weak Japanese and Korean crude throughputs during November and December underpin this forecast.  However, stronger margins and/or stronger demand driven by colder weather, could lead to upward revisions.

Atlantic Hurricane Season Moves Into Full Swing

The initial assessment of product supply from US Gulf Coast refiners following disruption from Hurricane Gustav suggests that approximately 27 mb of refined products is likely to have been lost.  At the time of writing Hurricane Ike seems poised to result in a further loss of around 19 mb, if landfall is near Corpus Christi as assumed.  However, US government forecasts note that the average error in their four-day forward path assessments is 225 miles.  Therefore, it remains possible that Hurricane Ike could yet result in greater disruption were it to approach more closely the Houston, Texas City and Port Arthur refining clusters.  Unlike 2005, we expect this level of disruption to be manageable given the depressed level of refining activity elsewhere in the OECD and non-OECD Asia and the relatively short duration of assumed outages.

In assessing the potential impact of Ike, however, we have made numerous assumptions that may prove to be inaccurate.  At the time of writing the impact from Gustav appears to be receding, with many of the refineries that shut down ahead of landfall on 1 September in the process of restarting.  While the availability of third-party power supplies has been a key issue, the latest publicly available information indicates that most, if not all, refiners are now reconnected.

Using an abridged version of the product supply model we have assessed the impact for the loss of refined product supply, but this analysis does not attempt to factor in issues such as availability of pipelines, although industry comments suggests this is becoming less of a constraint.  While much of the US GoM production is assumed not to return to service before the end of the month, Louisiana Offshore Oil Port and the Colonial pipeline are operating, albeit possibly at reduced rates.

The central scenario considered assumes that Hurricane Ike makes landfall on the Texas Coast, just North of Corpus Christi, as opposed to earlier projections that it would hit just south of Houston, on or about 14 September.  As noted above, a significant degree of uncertainty remains over the eventual track of the storm.  A more northerly track would imply a higher offline figure than we present here (doubling lost product supply to around 36 mb), as refinery operations around Houston and to the west of New Orleans would be more severely disrupted.  Similarly, a more southerly track implies a lower loss of product supply.

Our assumptions are as follows:

  • Refineries in and around Corpus Christi, Texas, are shut-down on a precautionary basis, but none suffer severe damage.  On average, operators require five days to assess and repair the damage and then a further five days to reach full throughputs.
  • Refineries around Houston, Texas City and Port Arthur, temporarily reduce runs ahead of the landfall, but can quickly resume full production.  Refineries in New Orleans and Lake Charles are unaffected by Ike.
  • As refiners have improved their preparedness for a possible hurricane strike, no refinery suffers a long-term outage as witnessed in 2005.


Peak hurricane-related offline capacity is around 3.4 mb/d due to Gustav and 2.2 mb/d for Ike.  On aggregate, lost crude throughput is forecast to average 1.4 mb/d over the course of September, but assume the impact does not spill over into October.  This level of lost refinery throughput suggests that product supply will drop by around 46 mb, after taking account of other refinery feedstocks.  Gasoline will represent the majority of the loss in production, with a 22 mb reduction, followed by middle distillates down by 11 mb.  The balance consists of jet/kerosene (3 mb) and other products (including LPG, refinery gas, fuel oil, petroleum coke and speciality products) of 10 mb.



The potential peak level of disruption to product supply is comparable with that seen in September 2005.  Crucially however, we do not assume a protracted outage at this stage.  Furthermore, there are several key differences in the market for refined products between the two occurrences:

  • US gasoline markets have at times displayed signs of chronic oversupply in recent months; USGC gasoline cracks to LLS were negative in July, although they have subsequently recovered and US imports of finished gasoline have, on a rolling four-week average basis, fallen in August to their lowest level since 2000.
  • Refined product exports from US refiners have reached 1.4 mb/d over the summer months, up 20% year-on-year, as US demand falters, in the face of slowing economic growth and high oil prices.
  • Significant idle refining capacity exists in the US, Europe, and Asia, thanks to the presence of economic run-cuts and the poor margin environment, which can be brought into service if margins strengthen sufficiently.


Higher levels of disruption to Gulf Coast refining than those discussed here remain eminently possible.  Should a heavier-than-assumed disruption occur, or indeed further hurricanes strike the US Gulf Coast in October, then a reassessment of the situation will be required, but the scenario described above would appear, at least for the moment, to be within the ability of the market to cope.



OECD Europe crude throughput was essentially flat in July.  Higher crude throughput in Germany was offset by declines in the UK and the Netherlands.  Crude runs averaged 13.5 mb/d and are now below the five-year range for the first time since February.  Italian crude runs remain particularly weak on the basis of the preliminary data, down 0.2 mb/d year-on-year.  More generally, reports in August continue to point to economic run-cuts at some hydroskimming refineries in Northwest Europe and the Mediterranean.  European crude runs are expected to increase over 3Q08, with upward revisions to September's forecast following the disruption to US crude runs.



Chinese July crude runs of 7.1 mb/d, according to National Bureau of Statistics data, were in line with our forecast.  However, crude throughput after the Olympics now looks to be weaker than previously thought, as higher domestic product inventories remove much of the pressure on refiners to maximise runs.  Reports suggest that planned diesel import levels will drop sharply this month, with PetroChina and possibly Sinopec halting diesel imports, although much uncertainty surrounds the issue.  Preliminary data on planned crude runs in September does show both lower crude throughputs at the largest refineries.  Forecast September crude throughput is trimmed to 6.9 mb/d.  Fourth-quarter crude runs are expected to average 7.1 mb/d as the start-up of CNOOC's Huizhou refinery in December boosts overall activity levels.

Russian July crude throughputs of 4.8 mb/d were flat month-on-month, despite reports of increased maintenance activity.  The increase in crude export duties to $67.65/bbl in August from $54.31/bbl in July is likely to put further upward pressure on refiners to increase crude throughput where possible.  We have therefore increased Russian (and hence FSU) throughput forecasts for 3Q08, despite reports of planned maintenance, although a dip during September still seems likely.  FSU 4Q08 crude throughput is expected to increase to 6.2 mb/d from 6.1 mb/d in 3Q08 as the weaker crude price will maintain pressure on oil companies to sell refined products domestically and for export, in preference to exporting crude oil.

OECD Refinery Yields

OECD refinery middle distillate (jet/kerosene and gasoil/diesel) yields continued their counterseasonal increase in June, in response to very strong middle distillate cracks.  Overall OECD gasoil/diesel yields reached 30.7%, an increase of 1.8 percentage points (or 6%) year-on-year.  Concurrently, OECD jet/kerosene yields increased above the five-year range for June, similarly reflecting the strength in middle distillate cracks.



The gains in middle distillates continue to be made at the expense of gasoline and fuel oil, which continue to trail beneath the bottom end of their respective five-year ranges, according to data for June.



North American refiners continue to push ahead with increased middle distillate yields, during June, in the face of weakening gasoline demand in the US and the lowest middle distillate yield of the three OECD regions.  The increase in OECD Pacific middle distillate yields is more biased towards jet/kerosene, compared with the gasoil/diesel bias in OECD North America and Europe, thus reflecting regional refinery configurations and crude selection patterns.