Oil Market Report: 13 November 2008

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Highlights

  • Oil prices continued their slide in October, with crude benchmarks falling around $25 since the last report to just under $60/bbl, as demand prospects weakened further.  But, crude futures stabilised in early November on a cut in OPEC output targets and further coordinated efforts to prop up the global economy.
  • Oil demand forecasts for 2008 and 2009 are cut by 330 kb/d and 670 kb/d respectively, after another large downward revision to global GDP prognoses by the IMF and continued signs of demand weakness in the OECD.  Global demand is now expected to grow by 0.12 mb/d in 2008, to 86.2 mb/d, and by 0.35 mb/d in 2009, to 86.5 mb/d.
  • OPEC October crude supply was flat from September at 32.1 mb/d, as recovery after outages in Iraq, Angola and Libya offset lower supplies elsewhere, including Saudi Arabia.  OPEC's emergency meeting on 24 October cut the OPEC-11 target by 1.5 mb/d from 1 November, implying a potential new collective output level near 30.5 mb/d.
  • Global oil supply increased by 1.8 mb/d in October to 86.9 mb/d, as both scheduled and unscheduled production outages eased.  Projected non-OPEC supply for 2008 and 2009 was revised down by 85 kb/d (to 49.7 mb/d) and 145 kb/d (to 50.3 mb/d) respectively, as Azeri and US Gulf outages proved more sustained and extensive.
  • OECD industry stocks fell by 16.9 mb in September, to 2,649 mb, including a hurricane-driven 24.3 mb US product draw.  However, upward revisions to August stocks plus lower demand prospects leave end-September cover high, at 55.0 days.  Preliminary October data show a steep rebound of 51.2 mb potentially raising cover to 56.0 days.
  • 4Q08 global refinery throughput is forecast to average 73.5 mb/d, around 1.4 mb/d lower than last month's report. Weaker global demand and negative margins in many regions underpin this reduction in forecasts.  Refinery investment is starting to suffer for 2009 and beyond, following the uncertain economic outlook and financial market turmoil.

Unchartable territory

Crude prices have fallen by a further $25/bbl since last month's report, OECD oil demand is in tailspin, naphtha cracks (arguably a more reliable measure of a weak economy than transport fuel) are touching historic lows and OPEC production may dip towards comparable levels last seen in spring 2004.  Charting oil market drivers requires an ability to constantly recalibrate axes in such a volatile market.



Economic recession raises its head in the IMF's most recent, exceptional revision, one month on from publication of its October World Economic Outlook.  Latest estimates slash 0.8 points from global GDP growth for 2009, taking the total to 2.1% and leaving OECD economies clearly in recession.  Incorporating this adjustment in our model, allied to substantial downward revisions to preliminary August and September OECD demand data, knocks a mind-boggling 1.0 mb/d off 4Q08 demand and 670 kb/d off next year's estimate.  Assumed 4Q08 refinery crude runs have been cut by 1.4 mb/d accordingly, as margins have weakened.

But there is scant consensus on the slowdown's scale and duration.  Some analysts see economic contagion from OECD countries worsening in 2009, dragging down China and the rest of the non-OECD, resulting in outright global contraction in both GDP and oil demand.  While we lack crystal ball certainty for our own, more optimistic forecast, China's recent announcement of a $590 billion stimulus package for the next two years, while vague on detail, nonetheless could help avert the first global demand contraction since 1983. If the Chinese government succeeds in setting a floor below which GDP growth is not allowed to fall, China's contribution to weaker global oil demand may be less than some imagine.

OPEC's 1.5 mb/d target cut from 1 November seeks to avert sharp stock builds due to slowing demand.  Some members also have an eye on the prices needed to finance higher spending requirements, though official OPEC statements shun the concept of an official price target.  Market fundamentals do look weak, but uncertainty remains over winter demand, new supply project timings and risks facing producers like Iraq and Nigeria.  Recent developments in Azerbaijan and the US GOM again cut non-OPEC supply for 4Q08 and 1Q09, albeit supply changes this month lag those for demand.  We also need to watch a rising 'miscellaneous to balance' for 2Q08 and 3Q08.  By definition, this component of the balance is not captured in official data.  It may comprise non-OECD stock build, unaccounted demand or over-stated supply.  So it may, in time, feed through to tighten otherwise sluggish 2009 fundamentals.

A recent pause for breath in prices around $60/bbl WTI, the far-end of the futures strip still around $85/bbl, and persistently strong distillate cracks collectively point to a possible eventual rebound.  As noted before, the current credit squeeze is not just a demand-side issue for oil.  Slowing oil sector investment in 2009 sows the seeds of a sharp tightening in market fundamentals if major projects are delayed, the impact being felt three to five years hence after economic recovery regains a foothold.  The release of the IEA's World Energy Outlook (WEO) this week throws these issues into sharper focus.  In the end, concerns over the adequacy of investment and re-emerging market tightness will come to eclipse the current focus on prompt market over-hang.  Oil markets remain cyclical, after all, even if the amplitude and frequency of the cycles remains as difficult to plot as ever.

Demand

Summary

  • Forecast global oil demand has been revised down in both 2008 and 2009, given continued weakness in the OECD and another marked downward revision to global GDP prognoses by the IMF.  At +2.1% in 2009, global GDP growth is 0.8 percentage points less than the IMF's October estimates.  Similarly, global economic activity was lowered by 0.2 percentage points to +3.7%.  World oil demand is thus now expected to average 86.2 mb/d in 2008 (+0.1% or +0.1 mb/d versus 2007 and 330 kb/d lower than previously estimated) and 86.5 mb/d in 2009 (+0.4% or +0.4 mb/d compared with the previous year and 670 kb/d lower on average compared with our last report).
  • Oil demand in the OECD is seen averaging 47.8 mb/d in 2008 (-2.7% or -1.3 mb/d versus 2007) and 47.1 mb/d in 2009 (-1.6% or -0.8 mb/d on a yearly basis), roughly 270 kb/d and 410 kb/d lower, respectively, than previously estimated.  Once again, revisions to both North America and Pacific data were significant, reflecting a more pronounced weakening of economic conditions as a result of the financial turmoil.  These revisions have been largely carried through to 4Q08.  In addition, the IMF now predicts that most OECD countries will face a sharp economic recession in 2009, for the first time since the Second World War, and has also reduced its prognosis for 2008.


  • Non-OECD oil demand is now expected to average 38.4 mb/d in 2008 (+4.0% or +1.5 mb/d and 60 kb/d lower than previously estimated) and 39.5 mb/d in 2009 (+2.9% or +1.1 mb/d compared with the previous year and 260 kb/d lower than in our last report).  These revisions are due to softening economic expectations in most emerging countries, as highlighted by the IMF, most notably in 2009, in addition to a reassessment of transportation fuel demand prospects in Asia.  So far, however, non-OECD demand growth is still seen offsetting the severe OECD demand contraction.
  • A potential uncertainty regarding these forecasts is the fate of China, which has been one of the main engines of global oil demand growth over the past several years.  The country indeed appears poised for a slowdown given the severity of the financial crisis affecting developed economies, which constitute important markets for Chinese exports.  Under the latest IMF assessment, the Chinese economy will expand by 8.5% in 2009, rather than 9.3% under the previous forecast.  This, coupled with a re-examination of gasoline and gasoil prospects in 2Q09 and 3Q09, translates into a prognosis of total oil demand growth of 290 kb/d in 2009, roughly 180 kb/d less than previously expected.  If the country's economy were to expand by only 7.0% in 2009 - an admittedly low figure, but currently touted by several observers - oil demand growth would be a further 70 kb/d lower (+220 kb/d), a level not seen since the late 1990s.  However, China's relatively low oil demand sensitivity suggests that the extent and duration of the recession in OECD countries are actually more relevant to the outlook of global oil demand growth.

Global Overview

This month's report features significant downward adjustments to our demand forecasts, both for 2008 and 2009.  This is very much related to the dramatic worsening of global economic conditions over the past few weeks, as a result of the ongoing financial crisis.  In an unprecedented move, the IMF revised its economic assumptions in early November, less than one month after releasing its latest World Economic Outlook and ahead of the G20 meeting scheduled on 15 November.

The Fund now sees advanced economies unable to escape recession:  collectively, these are bound to contract by at least 0.2% in 2009, for the first time since the Second World War, instead of growing by 0.5% as forecast in October.  In addition, their GDP growth outlook for 2008 has also been slightly adjusted down to 1.4% for the year, in anticipation of an even sharper contraction in both 3Q08 and 4Q08.

Emerging and developing economies will also suffer the consequences of the global slowdown.  Growth prospects for these countries as a whole have been revised down by a fifth of a percentage point in 2008 to 6.8% and slashed by almost a full percentage point to 5.3% in 2009.  Nevertheless, questions hang on the fate of the largest emerging countries, most notably China, and what slowing economic activity means in terms of oil demand (see What If?).



Overall, the global economy is poised to expand by roughly 3.7% and 2.1% in 2008 and 2009, respectively, sharply down from the IMF's October prognosis (3.8% and 2.9%).  This report - which uses IMF assumptions in its econometric model - has thus incorporated these changes.  In addition, we have lowered our oil price assumption to $80/bbl in 2009 (based on the forward curve at the time of writing), versus the $110/bbl hypothesis that we had kept over the past three months (however, given the economic contraction, a lower price will only have a very limited effect upon oil demand).  Consequently, we have revised down global demand by 0.3 mb/d in 2008 and by 0.7 mb/d in 2009, to 86.2 mb/d and 86.5 mb/d, respectively.  Demand growth this year is now expected to be a paltry 0.1 mb/d, rising to only 0.4 mb/d next year.  It should also be noted that global demand appears to have contracted in 3Q08, for the first time since 1Q02, a trend expected to continue in 4Q08.

OECD

OECD inland deliveries (oil products supplied by refineries, pipelines and terminals) contracted by 3.1% year-on-year in September, according to preliminary data, with gains in Europe unable to offset losses in North America and the Pacific.  Demand rebounded by 2.3% in OECD Europe, mostly on the back of strong heating oil deliveries ahead of the winter.  By contrast, in OECD North America (which includes US Territories), oil product demand contracted by 5.7% given persisting weakness across all product categories, most notably transportation fuels, in addition to hurricane disruptions.  In OECD Pacific, demand fell by 5.3%, dragged down by very weak Japanese deliveries.





August downward revisions to preliminary data, meanwhile, were massive (1.1 mb/d).  OECD demand actually contracted by 5.6% during that month, instead of -3.5% as previously estimated.  This translates into a 340 kb/d downward adjustment for 3Q08.  These changes came essentially from OECD North America (-240 kb/d, mostly from the US) and OECD Pacific (-210 kb/d, essentially Japan).  By contrast, revisions in OECD Europe were positive (+100 kb/d).  Most of these changes have been largely carried through to 4Q08.  Coupled with a weaker economic growth prognosis, OECD demand is now forecast at 47.8 mb/d in 2008 (-2.7% or -1.3 mb/d versus 2007 and 270 kb/d lower than our last report).  In 2009, demand is seen contracting by 1.6% on a yearly basis (roughly -0.8 mb/d) to 47.1 mb/d, 410 kb/d lower on average when compared with our previous estimate.



North America

Oil product demand in North America (including US Territories) shrank by 5.7% year-on-year in September, according to preliminary data, for the ninth month in a row.  Demand weakness is mostly centred in the US (-6.9% year-on-year) and Canada (-2.1%), more than offsetting Mexican growth (+2.5%).  Revisions to August preliminary data were large (almost -0.7 mb/d):  demand in OECD North America actually plummeted by 6.8% year-on-year during that month, almost twice as much as previously estimated.  Regional oil demand is now seen averaging 24.4 mb/d in 2008 (-4.5% or -1.1 mb/d on a yearly basis and 190 kb/d lower when compared with our last report) and 24.0 mb/d in 2009 (-1.8% or -430 kb/d), 270 kb/d lower than our last assessment.





Adjusted preliminary data in the continental United States for October provide new evidence on the sharp fall in oil demand, particularly since last summer.  Demand - battered successively by the financial crisis, high oil prices, devastating hurricanes and the gradual economic slowdown - has declined uninterruptedly since August 2007.  Inland deliveries - a proxy of oil product demand - contracted by 8.5% year-on-year in October, with all product categories bar LPG and naphtha registering significant contractions.  Although the plunge is also probably related to secondary and tertiary destocking, it has nonetheless been quite brutal, as illustrated in the following graphs:







Although oil prices have dropped quite markedly from their summer highs - with retail gasoline now sold below the psychological barrier of $3/gallon - it remains to be seen whether cheaper pump prices are enough to encourage increased demand in the coming months.  Indeed, as this report has repeatedly argued, US demand is far more responsive to economic activity than to prices.  With the economy headed towards recession - GDP contracted by 0.3% year-on-year in 3Q08, and the IMF is now predicting a 0.7% contraction for 2009 as a whole as private consumption drops - it is unlikely that, for example, US motorists will revert to driving and purchasing gas-guzzling SUVs.  If anything, the financial position of car manufacturers is getting worse by the day as SUV and light truck sales continue to plunge at annual rates surpassing 30% (-32% in October, the lowest level since February 1983).  One of the Big Three - General Motors, whose sales contracted by an unprecedented 45% in October - recently announced that it might go bankrupt by early next year unless the federal government bails it out.

On the basis of the latest IMF economic assumptions and observed revisions to current demand, US oil demand is poised to contract by 5.4% year-on-year in 2008 to 19.6 mb/d (some 170 kb/d less than our previous report) and by 2.0% in 2009 to 19.2 mb/d (about 230 kb/d less than previously anticipated).  Next year's fall is expected to be less abrupt than this year, for two reasons.  First, we assume that most of the potential demand destruction will have been largely completed by then - for example, the turnover of the vehicle fleet in favour of more efficient units is arguably much more limited during a sharp economic recession.  Second, oil prices next year will likely be lower on average.

Europe

Oil product demand in Europe rose by 2.3% year-on-year in September, according to preliminary inland delivery data, mostly buoyed by strong deliveries of heating oil (+11.8%) and diesel (+2.0%).  These offset losses in other product categories, notably gasoline (-2.1%) and residual fuel oil (-1.4%).  Revisions to August annual submissions, meanwhile, were relatively minor (-85 kb/d), given stronger-than-anticipated demand in France, Germany and Italy, which offset downward adjustments in the United Kingdom and elsewhere.



Demand in OECD Europe is thus expected to average 15.2 mb/d in 2008 and 15.0 mb/d in 2009, implying a year-on-year decline of 0.5% and 1.4%, respectively.  Compared with our previous forecast, this is about 25 kb/d higher in 2008 and 50 kb/d lower in 2009, on the back of bleak GDP growth prognoses - all key European countries are expected to be in recession next year.



Inland deliveries in Germany jumped by 12.6% year-on-year in September, according to preliminary estimates, given the strong rebound in diesel (+8.7%) and heating oil deliveries (+35.9%).  Heating oil consumer stocks averaged 55% of capacity by end-September, slightly higher than a month earlier (53%) but still below the level registered in September 2007 (60%), which suggests that average demand this year will be much weaker than in 2007.



In France, total oil demand also increased strongly (+7.3% year-on-year in September), on the back of buoyant deliveries of diesel (+5.1%) and heating oil (+24.8%).  However, the boost provided by the build-up of heating oil stocks ahead of the winter should not obscure the fact that oil demand is expected to contract markedly in 2009 in both Germany and France, since both countries are expected to face economic recession, according to the IMF.



In Italy, deliveries rose by a more modest 0.7% year-on-year in September, thanks in part to a rebound in diesel demand (+5.2%).  It is also worth noting an uptick in fuel oil demand (+3.0%), which was related to peak summer electricity demand (thus unlikely to last, as the country continues to shift towards natural gas).  In Spain, by contrast, demand plummeted by 8.0% year-on-year in August (the last month for which data are available), as all product categories registered sharp declines, reflecting the country's worsening economic prospects.  A similar situation prevails in the United Kingdom, with demand plunging by 7.7% in August.  In the latter two countries, diesel deliveries - which correlate strongly with economic activity - are declining markedly.  It should be noted, though, that the 2009 recession is expected to be far more pronounced in the UK, whose economy will contract by 1.3%, according to the IMF (more than any other European country).

Pacific

According to preliminary data, oil product demand in the Pacific plummeted by 5.3% year-on-year in September, given extremely feeble Japanese demand.  The weakness observed last month with respect to Japan's deliveries of gasoline, residual fuel oil and crude for direct burning in power generation persisted, dragging down regional demand despite strong gains in Australia, Korea and New Zealand.  Meanwhile, downward revisions to August preliminary data stood at 170 kb/d:  demand in OECD Pacific contracted by 6.6% year-on-year during that month, about a third more than previously estimated.  As a result, oil demand in the Pacific should average 8.2 mb/d in 2008 (-1.7% or -140 kb/d on a yearly basis) and 8.1 mb/d in 2009 (-1.3% or -110 kb/d).  These prognoses are down in both years by about 100 kb/d when compared with our last report, given the worsening outlook for the Japanese economy, which is also expected to be in recession next year.





Oil demand in Japan tumbled by 11.9% in September as deliveries fell across all product categories bar LPG, according to preliminary figures.  Moreover, the contraction in August was actually larger than previously estimated (-9.8% year-on-year instead of -6.9%), suggesting that naphtha backflows (listed in the 'other products' category) continue to be underreported in preliminary demand assessments.



Even though the country's demand decline is largely structural in nature, the steep year-on-year drop in deliveries - for the fourth consecutive month - is also indicative of the problems facing the Japanese economy.  For example, products such as naphtha (down by 11.8% year-on-year in September) tend to correlate with economic activity; given that Japan's economy is expected to contract by 0.2% in 2009, the outlook for demand growth remains bearish, with oil demand falling by 2.9% to 4.7 mb/d, a similar reduction as in 2008.

Non-OECD

China

Preliminary data indicate that China's apparent demand (refinery output plus net oil product imports, adjusted for fuel oil, direct crude burning and stock changes) rose by an estimated 3.9% year-on-year in September.  Compared with the summer months, this somewhat lower growth rate - more in line with levels seen in late 2007 and early 2008 - is indicative of reduced imports, notably of gasoline and gasoil, following the conclusion of the Olympic Games.  And yet deliveries of both products remain strong, rising by 11.2% and 12.5%, respectively.  By contrast, jet fuel/kerosene deliveries contracted by 9.9%, suggesting lower post-Olympics travel, while residual fuel oil demand - the feedstock of choice for 'teapot' refineries - fell for the fourteenth month in a row, with deliveries contracting by 15.2% year-on-year given persistently poor margins.



As noted earlier, the IMF cut its GDP growth forecasts for China (from 9.8% to 9.7% in 2008 and from 9.3% to 8.5% in 2009), since the country's main export markets (the US and Europe) are poised to contract sharply next year.  As such, oil demand is expected to be somewhat weaker.  Consequently, we have revised down our Chinese oil demand prognoses:  demand is now seen rising by 5.2% to 7.9 mb/d in 2008 (roughly +400 kb/d, some 60 b/d below our previous assessment) and by only 3.7% to 8.2 mb/d in 2009 (+290 kb/d, 180 kb/d less than previously anticipated).  However, as discussed below, some observers anticipate that the Chinese economy will grow at an even slower pace; should these projections materialise, this forecast would eventually be revised down further.



What If?

A key uncertainty impinging upon the oil market concerns the prospects of large emerging economies, most notably China, which has been one of the main engines of global oil demand growth over the past several years.  At this point, given the severity of the financial crisis affecting developed economies, which constitute important markets for Chinese exports, it has become clear that the country will not escape unscathed - the much cited 'decoupling' will be much less pronounced in such a gloomy international environment, which even a generous boost in domestic demand will struggle to offset.  Under the latest IMF assessment, the Chinese economy will expand by 8.5% in 2009 (rather than by 9.3%, as forecast only last month).  Coupled with a re-examination of gasoline and gasoil prospects, this implies that 2009 oil demand (+290 kb/d) should grow by about a third less than anticipated in our previous report.

What would happen to Chinese oil demand if economic growth were to be lower?  A sensitivity analysis - taking a lower GDP growth figure, which some analysts have advanced - is illustrative.  Assuming that the country's economy were to expand by 9.2% in 2008 (rather than 9.7%) and by 7.0% in 2009 (instead of 8.5%), and that the oil price averaged $100/bbl this year and $80/bbl next, oil demand growth would be some 70 kb/d lower (+220 kb/d).  Admittedly, this would be a level not seen since the late 1990s.  However, although this hypothetical drop in oil demand growth versus the current base scenario (-25%) may seem high in Chinese terms, it is relatively marginal in a global scale, suggesting that the extent and duration of the recession in OECD countries is actually much more pertinent to global oil demand than developments in China.

Moreover, this scenario may appear to be too pessimistic - although some observers have advanced even lower figures for economic expansion in 2009 (of around 6.0%).  The risks faced by the Chinese economy are all too real - not only contracting export markets but, perhaps more importantly, a much lower pace of investment growth and rising unemployment, notably in the export and construction sectors, and cooling domestic demand, as evidenced by weaker real estate markets and falling car sales, for example.  However, this does not mean that a sharp slowdown is inescapable, since Beijing has powerful stimulus tools at its disposal.

Indeed, aggressive fiscal and monetary policies - including public infrastructure investment (particularly in railway transportation and low-cost housing), social spending and subsidies (notably in rural areas), tax and VAT cuts, lower interest and mortgage rates, export rebates and a depreciating currency - could well help sustain domestic consumption and hence growth at around 8.0% in 2009.  This figure is actually considered by many analysts to be the lowest acceptable to ensure economic and social stability.  Nevertheless, for domestic consumption to become the economy's principal growth driver, China's high savings rate will need to fall - but this will only occur if the structural reasons that prompt Chinese citizens to save in the first place (mainly the lack of social security, retirement concerns, poor health care and urban migration) are properly addressed.

The $590 billion fiscal package recently unveiled by the government will presumably aim to tackle these issues.  At the time of writing, however, several uncertainties remained regarding the stimulus plan, particularly its actual size (i.e., new versus previously budgeted spending), timeframe (the funds are to be invested gradually over the next two years, rather than immediately), sources of funds (central government, local governments and private actors) and details on proposed spending measures (notably regarding social priorities, such as health and housing).

Other Non-OECD

According to Indian preliminary data, oil product sales - a proxy of demand - surged by 7.0% year-on-year in September, essentially supported by booming gasoil demand (+17.3%).  As noted in previous reports, gasoil sales have been boosted by distorting pricing policies.  The fuel is now used to power both vehicles (trucks and taxis, with the latter using an adulterated mixture of gasoil and kerosene) and electricity generators.  It should also be noted that naphtha demand (+8.8%) remains quite strong since last summer; the fuel has become cheaper than natural gas (LNG), and many fertiliser companies are reportedly stepping up their naphtha purchases.



The government is still mulling whether to cut end-user prices on gasoline and gasoil.  By contrast, jet fuel prices have steadily fallen since September (by about 25%).  Yet Indian prices remain among the highest in the world because of steep sales taxes imposed by the country's local governments, which average around 25% in the states hosting the busiest airports (Chennai, Bangalore, Mumbai and New Delhi) and are as high as 33% in other regions.  As a result, Indian airline companies have become heavily indebted - collectively, they reportedly owe state-owned oil companies (Indian Oil Corporation, Bharat Petroleum Corporation Limited and Hindustan Petroleum Corporation Limited) over $500 million, and their combined losses are expected to reach $1.5 billion this year.  By lowering prices (which are now to be revised every 15 days instead of the current monthly cycle) and extending the credit period (from the current 60 days to 90 days), the oil companies are throwing a lifeline to the struggling carriers.  Nevertheless, unless local taxes are lowered - an unlikely occurrence at this point - airline companies will probably continue to face serious financial woes, despite lower international oil prices.

Looking ahead, our oil demand forecast is marginally changed compared with our last report, with Indian demand expected to average 3.1 mb/d in 2008 (+5.0% on a yearly basis) and 3.2 mb/d in 2009 (+4.0%).  Even though the IMF revised its 2009 economic growth prognosis for India (from 6.9% to 6.3%), the growth in transportation fuels - and hence oil demand - is prone to continue.  This month, the Indian car manufacturer Tata is expected to launch its $2,500 Nano car, which should replace rickshaws and three-wheelers.  The company hopes to sell some 150,000 units per year, and is likely to be followed in this market segment by other firms such as Maruti and Bajaj.

According to preliminary data, oil demand in Russia expanded by 7.2% year-on-year in September, on the back of strong deliveries of transportation fuels (gasoline, jet fuel/kerosene and diesel rose by 8.5%, 11.7% and 17.9% year-on-year, respectively).  Overall, total oil product demand is expected to grow by 3.1% to 2.9 mb/d in 2008.  The pace should be slower in 2009 (+2.9% to slightly above 3.0 mb/d) because of the global financial turmoil, on the one hand, and lower oil revenues, on the other.  The IMF almost halved its Russian economic growth prediction for 2009 (from 5.5% to 3.5%); such a moderation in economic activity will likely curb growth rates among all product categories with the exception of fuel oil, which is anticipated to account for an increasing share of power generation.

The legal battle between Russia's antimonopoly agency (FAS) and the country's main oil companies (Gazprom Neft, Lukoil, Rosneft, Surgutneftegaz and TNK-BP), which erupted in July, is seemingly coming to a close.  In two rulings (in September and October), the FAS stated that four out of the country's five biggest companies - Gazprom Neft, Lukoil, Rosneft and TNK-BP - were guilty of violating antimonopoly legislation.  The companies are accused of abusing their dominant position, allegedly by colluding to set up and maintain high prices for gasoline, gasoil, jet fuel and fuel oil (the investigation against Surgutneftegaz was dropped because of lack of evidence).  Although at this point the ensuing penalties or redressing actions are unclear, the companies could be fined by anything between 0.01% and 0.15% of their sales revenues on the incriminated products.



In the end, the companies' legal problems stem from the fact that Russian pricing is not transparent.  Jet fuel prices are usually linked to Kortes - a weekly Russian assessment of regional refinery prices, which is considered by some players to be highly inaccurate - rather than to international standards.  Moreover, competition is limited, with most Russian airports supplied by one company - usually the airport itself or a third party affiliated with it.  As such, refuelling fees tend to be three to four times higher than in Europe, particularly in small Russian airports.



Supply

Summary

  • Global oil supply increased by 1.8 mb/d in October to 86.9 mb/d, as both scheduled and unscheduled production outages eased, notably in North America and Europe.  OPEC crude supply was largely unchanged from the previous month, although condensate and gas liquids supplies increased.  Despite recovering from weak September levels, a year-on-year comparison shows October global supply growth having slowed markedly from the average 1.8 mb/d evident during January-August.
  • Forecast non-OPEC production is revised down by 85 kb/d for 2008 and by 145 kb/d for 2009.  It now totals 49.7 mb/d and 50.3 mb/d in the two years respectively.  Adjustments are concentrated in 4Q08 and 1Q09, with recent production stoppages in Azerbaijan and the US Gulf of Mexico (GOM) proving to be more extensive and longer lasting than previously assumed.  Canada, Mexico, Australia and India also see significant downward revisions for forecast output.  Egypt, Colombia and Malaysia are subject to upward adjustment after production in recent months came in higher than expected.
  • Net growth in non-OPEC output now stands at 35 kb/d in 2008 and 595 kb/d in 2009.  OPEC gas liquids increase by an additional 310 kb/d and 800 kb/d respectively.  Year-on year non-OPEC growth is strongest in 1Q09 and 3Q09, partly reflecting recovery from production outages and partly new field start-ups. Brazil, US other liquids, China, and global biofuels underpin 2008 supply, albeit offset by declines elsewhere. In 2009, growth centres on Brazil, Canada, the USA, Azerbaijan, China, Australia and biofuels.  Significant declines are likely from Mexico, the North Sea and Russia next year.
  • October OPEC crude supply was unchanged from September at 32.1 mb/d.  Saudi Arabia, Qatar, UAE, Nigeria, Venezuela and Indonesia saw lower supply, but recovery after oilfield/pipeline outages in Iraq, Angola and Libya offset voluntary cuts. OPEC's emergency meeting on 24 October reduced target output for OPEC-11 (excluding Iraq and Indonesia) by 1.5 mb/d from 1 November.  The new implied target is 27.3 mb/d, suggesting total OPEC supply around 30.5 mb/d if cuts are fully realised. OPEC effective spare capacity is 2.3 mb/d, and installed capacity is due to rise 0.3 mb/d in 4Q, to 35.8 mb/d.
  • The 'call on OPEC crude and stock change' is curbed by fully 0.6 mb/d for 4Q08, and by 0.5 mb/d for 2009.  Demand-side adjustments, largely on the back of sharply lower IMF economic growth expectations, are the key reason. Non-OPEC supply adjustments this month relate to production outages rather than sharper systematic decline, are focused in 4Q08 and 1Q09, and so fail to provide an offset for weaker demand for 2009 as a whole. The call averages close to 31.1 mb/d in 4Q08, before falling close to 30 mb/d for much of 2009, until 4Q09, when it recovers towards 31 mb/d.


Note:  Random events present downside risk to the non-OPEC production forecast contained in this report.  These events can include accidents, unplanned or unannounced maintenance, technical problems, labour strikes, political unrest, guerrilla activity, wars and weather-related supply losses.  Specific allowance has been made in the forecast for scheduled maintenance in all regions and for typical seasonal supply outages (including hurricane-related stoppages) in North America.  In addition, from July 2007, a nationally allocated (but not field-specific) reliability adjustment has also been applied for the non-OPEC forecast to reflect a historical tendency for unexpected events to reduce actual supply compared with the initial forecast.  This totals ?430 kb/d for non-OPEC as a whole, with downward adjustments focused in the OECD.

OPEC



October OPEC crude supply was largely unchanged from September at 32.1 mb/d.  This is around 0.7 mb/d below what we estimate to have been peak June levels close to 32.8 mb/d.  Saudi Arabia, Qatar, UAE, Nigeria, Venezuela and Indonesia all saw lower supply.  Saudi Arabia and the UAE are estimated to have cut output by around 100 kb/d each, the latter as offshore field maintenance, that will run into November, began.  Nigerian supply suffered from crude pipeline outages, which also sharply reduced domestic refinery crude runs at the Warri and Kaduna plants. However, partial recovery after earlier oilfield, pipeline and export outages in Iraq (+135 kb/d), Angola (+75 kb/d) and Libya (+25 kb/d) offset both discretionary and involuntary supply cuts by other producers. Nonetheless, a renewed northern pipeline outage in early November may again cut supply from Iraq this month.

OPEC's Emergency Meeting on 24 October reduced target output for OPEC-11 (excluding Iraq and Indonesia) by 1.5 mb/d from 1 November (see OPEC Agrees on 24 October to Curb Supplies).  The new implied target is 27.3 mb/d, suggesting total OPEC supply around 30.5 mb/d if cuts are fully realised and Iraq and Indonesia continue to produce at October levels. OPEC effective spare capacity is 2.3 mb/d. With installed capacity due to rise by 0.3 mb/d in 4Q08 to 35.8 mb/d, ceteris paribus, spare capacity is also likely to rise by end-year. Saudi Arabia and, to a lesser extent, Angola and Nigeria account for the bulk of the increase in absolute capacity by end-year as recent field starts ramp up.

OPEC Agrees on 24 October to Curb Supplies

An emergency meeting of OPEC Ministers on 24 October in Vienna was convened to discuss the impact of the global economic/financial crisis on the oil market and particularly the rapid deterioration in prospects for global oil demand. An agreement was reached to cut production targets by a collective 1.5 mb/d from 1 November.  Individual production cuts were itemised in the post-meeting communiqué rather than new country-specific output levels, although 27.3 mb/d was cited as the new collective target for the OPEC-11 (excluding Iraq and Indonesia).  The implied new target production levels for each of the OPEC-11 are illustrated below, taking recently re-instated target levels dating back to September 2007 as a starting point.  Iraq faces no official OPEC production limits, and Indonesia has also been excluded as it will suspend its membership of OPEC at end-2008.



With the meeting coming in late October, after many producers had already informed customers of November contract volumes, it may be a couple of months before the impact and durability of actual production cuts becomes apparent.  However, statements from most member countries have stressed that compliance will be strong, and export nominations so far released for December do suggest some cuts are being implemented. Moreover, current scheduled and unscheduled production shut-ins from Angola, Nigeria, Venezuela and the UAE provide those producers with some extra leeway to curb supply, although whether volumes remain off-line for a prolonged period is less certain. It is unlikely that a producer such as Nigeria, for example, whose production and revenues have been impeded for years by Niger Delta unrest, will forestall reinstating production should the opportunity arise.  That said, operator Shell has been forced to invoke force majeure again on November and December exports, after state NNPC ordered 5% cuts in export volumes.

Volumetrically, Saudi Arabia, Iran and Kuwait potentially face the largest cuts.  The planned reduction in targets likely came too late to materially affect Saudi November term supplies, although spot volumes may have been curtailed.  Early indications of term prices for December suggest some throttling back in supplies to western destinations, while Asian buyers will reportedly see shipments curbed by 5%, or perhaps 200-250 kb/d.  Kuwait meanwhile has informed Korean and Japanese buyers of 5% cuts for November, likely to amount to some 50-70 kb/d.

Iran was a vociferous proponent of cuts in the run up to 24 October. In light of the muted price response since then, Iran together with Venezuela has been suggesting a further 1.0 mb/d supply cut, either at the Organisation's next scheduled meeting in Algeria on 17 December, or at a previous emergency meeting in November.  But Iran itself is under pressure to sustain supplies of associated gas for domestic power generation and oilfield re-injection purposes, obscuring the prospects of sustained crude production cuts.  GCC OPEC members may also be wary of a further cut in target until adherence to the 1 November cuts can be better assessed.  Reducing supply too steeply may be a concern, if it risks a price surge with adverse consequences for a sick global economy and already-sluggish oil demand growth.

Non-OPEC Overview



Forecast non-OPEC production has been revised down by 85 kb/d for 2008 and by 145 kb/d for 2009 in this month's report.  Output now totals 49.7 mb/d and 50.3 mb/d for 2008 and 2009 respectively.  Adjustments are concentrated in 4Q08 (-367 kb/d) and 1Q09 (-314 kb/d), with recent production stoppages in Azerbaijan and the US Gulf of Mexico (GOM) proving to be more extensive and longer lasting than previously assumed.  Indeed, those areas account for a combined 75% of the late-08/early-09 adjustments.  Thereafter, an average 90 kb/d downward revision for 2Q09-4Q09 non-OPEC production is largely due to weaker expectations for Canadian oil sands output. Mexico, Australia and India also see downward revisions for forecast output.  In contrast, Egypt, Colombia and Malaysia are subject to modest upward adjustment after recent production exceeded expectations.

Net growth in non-OPEC output now stands at only 35 kb/d in 2008, recovering to 595 kb/d in 2009.  Year-on year non-OPEC growth is likely to be strongest in 1Q09 and 3Q09, partly reflecting recovery from weak, previous year output, and from long-running production outages, together with the impact of expected new field start-ups.  Brazil, China and output of US non-crude liquids and global biofuels help to shore up 2008 supply in the face of ongoing decline at mature fields, chronic project delays and more recently, extended production outages. In 2009, growth centres on Brazil, Canada, the USA, Azerbaijan, China, Australia and biofuels.  Significant declines are likely from Mexico (-245 kb/d), the North Sea (-415 kb/d) and Russia (-160 kb/d) next year.  As noted above, the 2009 forecast assumes 'normal conditions' without accounting for exceptional events.  Renewed, above-trend field outages or the emergence of extended new field start-up delays could correspondingly diminish non-OPEC supply.

OPEC gas liquids supplies (considered alongside non-OPEC output, since they tend not to be subject to OPEC output restrictions) increase by an additional 310 kb/d in 2008 and 800 kb/d in 2009.  This potentially boosts total OPEC condensate and NGL output to 5.1 mb/d and 5.9 mb/d respectively.  The NGL forecast remains largely unchanged from previous months, with Saudi Arabia, Qatar, the UAE, Nigeria and Iran generating the bulk of the increase.  Significant new sources of gas liquids supply have recently started up in Saudi Arabia (Khursaniyah), Nigeria (Agbami) and Iran (South Pars phase 6), contributing to the sharp expected 2009 increase.  The Middle East region's imperative to boost natural gas supply for domestic power generation and oilfield re-injection purposes could ensure projections of strong gas liquids growth remain robust, even in the face of global economic slow-down, weaker OECD gas import demand and lower oil prices.



Oil Price/Credit Slump Hits Long-Term Supply More than 2009/2010

Upstream operators may revisit spending plans under the impact of crude prices' slide towards $60/bbl and tightening credit markets.  But larger companies Chevron, ExxonMobil, StatoilHydro and Total all stress that existing projects will be unaffected, as indeed does Saudi Aramco.  Total and other companies have also reportedly identified sustained prices of $50/bbl as a threshold below which progress on the next generation of yet-to-be sanctioned projects might be delayed.  So the impact is more likely to be felt on production five years out than on OPEC and non-OPEC supply in 2009/2010. 

Operating costs vary hugely between regions and different production environments, but prices here too can probably fall to $50/bbl or lower before a significant impact on existing supply occurs. And despite statements to the contrary, OPEC Middle East Gulf producers, with large accumulated revenues from five years of rising prices and conservative, near-$50/bbl, budget price assumptions, seem unlikely to curb ongoing investment projects even at current price levels.

However, two regions that are already suffering, albeit in different ways, are Russia and Canada. Major Russian companies are highly dependent on debt for growth and until recently reductions in export tax that have lagged lower crude prices were beginning to threaten existing production.  However, as our prevailing forecast for Russia was already well below that of most local companies and government agencies for 2009, the modest trimming of Russian supply expectations this month is more due to lower forecast Sakhalin 2 output and a weaker October base, than to lower crude price or credit issues.

In Canada, Suncor has said it will cut 2009 capital spending by 30-40% compared with previous estimates, but expects no impact on production volumes until 2010/2011.  PetroCanada has suggested the Fort Hills upgrader investment decision will be delayed, while Shell is to delay final investment decision (FID) on phase-two expansion of the Athabasca oil sands project (a 100 kb/d phase-one expansion is proceeding).

But there may be flecks of silver lining on an otherwise darkening cloud for medium-term supply. Weakening demand growth, commodity prices and liquidity could ultimately prompt new thinking among some host governments.  If production and prices fall in tandem, then those governments struggling with maturing production and hitherto wedded to punitive fiscal terms or prohibitive access restrictions may be forced to re-consider.  However, political impediments to genuine reform can be substantial and slow to change.  Industry cost inflation could also ultimately recede, although total costs are unlikely to fall imminently, with some suggesting it could be 12-18 months before costs overall begin to ease.  Nonetheless, Saudi Aramco has said it will renegotiate engineering, procurement and construction (EPC) terms already agreed for its next phase expansion programme for post-2010 from Manifa and Shaybah (oil) and Karan (gas).  Of course, renegotiation itself could result in further delays for the longer term.

OECD

North America

US - October Alaska actual, others estimated:  US oil production has been revised down by around 35 kb/d for both 2008 and 2009 in this month's report.  It now averages 7.5 mb/d in 2008 and 7.8 mb/d in 2009, with crude oil comprising respectively 4.9 mb/d and 5.0 mb/d of the total. Supply growth in 2008 amounts to 100 kb/d, similar to 2007 performance.  All of this year's growth derives from non-crude liquids (predominantly NGL - in part due to a natural gas supply surge - and ethanol).  Next year however also sees stronger performance from GOM crude potentially offsetting mature field decline, and contributing 0.1 mb/d to total oil growth of 0.3 mb/d.



Major downward adjustments accrue to our 4Q08 and 1Q09 federal offshore GOM production assumptions, respectively -155 kb/d and -245 kb/d compared with last month.  This follows reports from the Minerals Management Service (MMS) suggesting that offshore pipeline outages resulting from Hurricanes Gustav and Ike in September could keep a substantial portion of currently off-line production (245 kb/d on 5 November) shuttered until March.  In as much as pipeline repairs are seen taking between three and six months to complete, supply could recover more quickly than our new assumption suggests.  However, that upside risk in our forecast may be partly offset if substantial amounts of production turn out to have been lost altogether due to facility damage.

Canada - Newfoundland September actual, others August actual:  Lower-than-expected output of NGL, and synthetic crude from Alberta in recent months feed through to curb our forecast of Canadian oil production by 30 kb/d in 2008 and 120 kb/d for 2009. Total oil now averages 3.27 mb/d for 2008 and 3.33 mb/d in 2009.  Projected conventional crude production is left largely unchanged.  Bitumen and syncrude continue to generate combined growth of 150 kb/d in 2009, partly offset by weaker supplies elsewhere.  That said, the past two months have seen a spate of announcements of project deferrals affecting Alberta's oil sands expansion (see Oil Price/Credit Slump Hits Long-Term Supply More Than 2009/2010).



Mexico - September actual:  Weakening performance from the ageing Cantarell field, reported Mexican production shut-ins in September/October due to a lack of US Gulf refiner demand and weather-derived port closures have cut 50 kb/d from 4Q08 forecast crude production.  A similar downward adjustment has been applied to 2009 production, so crude production averages 2.8 mb/d in 2008 and 2.6 mb/d in 2009.

Energy reform proposals approved by Mexico's Congress include greater cash incentives, but no equity stakes for private companies drilling in Mexican waters.  State company Pemex is also seen obtaining more budgetary and planning autonomy, while monitoring of energy efficiency and hydrocarbon recovery optimisation are to be strengthened. However, analysts suggest the reform package lacks provisions allowing Pemex to form joint ventures, widely seen as essential if deepwater reserves are to be tapped.

North Sea



Norway - August actual; UK - August actual:  Norwegian oil production is expected to average 2.4 mb/d in 2008 and 2.2 mb/d in 2009, compared with 2.6 mb/d in 2007.  Growth in gas liquids supply masks still-steeper crude decline.  However, as for several OECD producing countries, we include an adjustment factor in the Norwegian forecast to reflect a historical tendency for mature fields to suffer down-time due to mechanical outages and equipment failures.  For Norway, this amounts to a sizeable 160 kb/d, and this in turn depresses 2009 average crude supply to 1.62 mb/d.  While this may seem an aggressive downward adjustment, evidence of problems with mature fields surfaced anew in early November, when StatoilHydro announced it will shut the Statfjord Nord field for a year.  Work to enhance reservoir pressure maintenance will take the 15 kb/d field out of action until 3Q09.

Around 30 kb/d has been cut from estimated UK production for 3Q08 and 4Q08, partly on indications that summer maintenance was higher than anticipated, albeit this is difficult to verify as field-specific data are restricted to July 2008.  Aggregate production data for August, and loading schedules for the main production grades through November also support lower assumed production.  The trend in UK production is largely unchanged however, with output declining by 130 kb/d in 2008 to 1.5 mb/d and by 160 kb/d in 2009 to 1.3 mb/d.  Here too the forecast is influenced by a similar field reliability adjustment to Norway's, at -160 kb/d.  That aside, some incremental production accrues in 2009 from the start-up of the Ettrick, Jura, Tweedsmuir, Saxon and Perth fields, each of which adds 10-20 kb/d to 2009 production.  

Pacific

The Australian production forecast is trimmed by some 20 kb/d this month.  Since July 2007, we have carried an upward adjustment for Australian supply of similar magnitude, reflecting a historical tendency to understate actual production over several years.  As our capture of new Australian project start-ups has improved, this adjustment has become inappropriate and is now removed.

Former Soviet Union (FSU)

Russia - September actual, October provisional:  Forecast total Russian oil production is largely unchanged from last month, at 10.0 mb/d for 2008 and 9.85 mb/d for 2009.  However, stronger performance in the past couple of months from Rosneft, Gazprom and some smaller companies is offset by a weaker trend from Lukoil, Gazpromneft and the Sakhalin 2 project. Crude exports from the latter project face a hiatus as offshore tanker loadings cease while a new onshore pipeline is filled, allowing year-round production to commence from the end of 2008.  We have however trimmed total forecast Sakhalin 2 production for end-2009 from an earlier 175 kb/d to 150 kb/d.

Major state-backed producers Lukoil, Rosneft and Gazprom have all said that investment budgets for 2009 will be scaled back in the absence of deeper tax reform than the government has so far proposed. However, most companies have reiterated that the bulk of the impact from reduced 2009 spending will likely be felt in post-2009 production. Reports that some marginal production shut-ins had already occurred, and threats of sharply lower crude exports on poor economics, encouraged the government to enact an exceptional cut in crude export tax from October's $51/bbl to $39/bbl for November. Export taxes are normally set for two months at a time, but the Finance Ministry has suggested this may change to a monthly basis from December.



Just prior to OPEC's 24 October meeting, the Russian Energy Ministry raised the prospect of setting up strategic oil storage at ports, aimed at regulating supply to influence prices.  Russia does not appear to be planning direct cooperation with OPEC in terms of production quotas.  However, the proposal for strategic inventory comes against a backdrop of an OPEC call ahead of 24 October for non-OPEC producers to help to curb supplies, a request that has had limited success in the past.

Azerbaijan - September estimated:  The offshore Azeri-Chirag-Guneshli (ACG) complex is not now expected to have all units operating again until end-November.  Up to 650 kb/d of capacity at the Central and West Azeri fields was shut in mid-September after a gas leak.  This followed sharply lower exports of Azeri Light crude in August after a blast on the Turkish section of the BTC pipeline.  The West Azeri field was brought back into operation in October, but Central Azeri will not be back until late November.  This report assumes that full output from ACG of around 1.0 mb/d will be regained by January 2009.  Azerbaijan, which had previously been seen as a major source of potential non-OPEC growth in 2008, will now likely see total oil production largely flat in 2008 at 895 kb/d, but potentially rising in excess of 1.2 mb/d for 2009, assuming major outages are not repeated next year. 



FSU net exports rebounded by 0.39 mb/d to 8.16 mb/d on average in September.  Crude oil exports rose by 0.45 mb/d to almost 6 mb/d, mainly due to 340 kb/d of incremental shipments through the BTC pipeline and 160 kb/d higher exports from the Baltic port of Primorsk.  The rebound was partially offset by a 120 kb/d decrease in Black Sea shipments.  Product exports from the FSU fell by 80 kb/d month-on-month to 2.23 mb/d, driven by a drop in fuel oil exports and influenced by high export duties.

In October, Caspian exports likely dipped once again after production problems at the Central and West Azeri fields, although the month did see the entry of Kazakhstani Tengiz crude into the BTC pipeline for the first time. There are also reports that October exports from the Baltic port of Primorsk were hit by bad weather.  The Russian government cut crude oil export duty by 25% to $50.78/bbl from 1 October before implementing a further extraordinary cut to $39.15/bbl from 1 November in an attempt to shore up export economics.  Moreover, the Russian Energy Ministry is reportedly preparing a new formula for calculating export duties to better reflect recent price changes.  Despite these moves, pipeline operator Transneft reported that November export shipments by major producers were likely to be sharply cut. The re-start of the Baku-Supsa pipeline in November, after outages due to conflict in Georgia, will be offset by continued shortfalls from BTC, which is likely to run once again at 50% capacity this month.

Other Non-OPEC

Revisions to Other Non-OPEC Estimates

Chinese production is trimmed by 15 kb/d for 2008 and 2009 with offshore output coming in lower than expected.  Estimates for Other Asia remain largely unchanged, with downward adjustment for India and Vietnam countered by higher than expected production in recent months from Brunei and Malaysia.  This month's report sees Latin American production revised up by some 30 kb/d for 2009, with Argentina, Colombia and Peru seeing stronger performance than previously envisaged during 3Q08.

African production sees a substantial 75 kb/d upward revision for 2008 and 95 kb/d for 2009, based on a re-examination of Egyptian data.  2008 now looks likely to see the first annual rise in production in over a decade, and production of crude, condensate and NGL could stabilise at close to 700 kb/d this year and next.  Our forecast for Chad has been cut by 10 kb/d for 2008 (to 130 kb/d, in line with reported 1H08 output), and by 20 kb/d to 115 kb/d for 2009.  Declining reservoir pressure, sand clogging and a fragmented field structure are reportedly behind the disappointing performance for Doba blend output.  Our assumption of flat production in 2009 at around 515 kb/d from Sudan is retained for now but may prove optimistic if recent kidnappings and murder of Chinese and Sudanese oil workers in the disputed Kordofan region between north and south Sudan degenerate into a renewed outbreak of civil war.

OECD stocks

Summary

  • An unseasonal September draw of 16.9 mb reduced OECD industry stocks to 2,649 mb, driven by hurricane disruptions in the US.  However, a 21.4 mb upward revision to end-August OECD stocks combined with a further reduction to OECD demand prospects mean that end-September forward cover is still high, at 55.0 days.  The 3Q08 stock change stands at +0.50 mb/d (+46.4 mb), slightly above the five-year average third-quarter build of 0.44 mb/d.
  • Hurricane-related refinery closures led a US product stockdraw of 24.3 mb in September.  Of this, 13 mb were distillates and 6.9 mb were gasoline, with stocks of the latter already recovering by the end of the month.  US crude stocks fell by only 1.1 mb as refinery outages offset the impact of production losses and lower imports.
  • Crude stockbuilds in OECD Europe and the Pacific were observed in September, totalling 7.6 mb and 1.3 mb respectively.  European cover rose as a result, despite notable draws of 10.6 mb in distillates, as domestic heating demand ran ahead of expectations, and 1.9 mb in gasoline, as extra cargoes sailed to the US.  However, in the Pacific the crude build was matched by a product draw, leaving regional cover trending down seasonally.
  • Preliminary October data indicate a very sharp recovery of 51.2 mb in OECD stocks, including 41.5 mb in the US.  Combining preliminary US, Japanese and EU-16 data, this would suggest a firming of OECD cover to 56.0 days by end-October.


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

OECD industry stocks fell by 16.9 mb in September, to close at 2,649 mb.  US refinery shut-ins related to hurricanes Gustav and Ike created a dent in US product stocks of 24.3 mb over the month.  European gasoline stocks dipped as extra cargoes headed across the Atlantic to mitigate product supply losses in the US.  At the same time, stronger domestic demand eroded European distillate stocks by 10.6 mb.



Nevertheless, end-September OECD stocks represented 55.0 days of forward demand cover.  In other words, even the passage of two extremely disruptive hurricanes was unable to reduce OECD stock cover below seasonal averages.  In fact, end-September cover was 1.7 days above levels of a year ago, 2.2 days above the corresponding 2003-07 average and 2.6 days above hurricane-ravaged September 2005.  Furthermore, preliminary October data already point to a 41.5 mb stock build in the US (of which 28.7 mb in products) and a 51.2 mb increase in total OECD inventory.  This would raise OECD cover to 56.0 days of forward demand.

There are two main reasons why OECD stock cover remains high despite such a heavy US hurricane impact.  Firstly, end-August stocks were revised up by 21.4 mb, providing a higher pre-hurricane base than previously thought.  Secondly, the projection of OECD daily demand for 4Q08 was reduced by 0.7 mb/d from last month's forecast; a smaller denominator for the cover calculation thereby inflating the number of days of demand that stocks represent.

The customary caveat to add to this is that, of course, ample inventory is not uniform across all regions, countries or products.  Hurricanes reduced US distillate stock cover by 2.7 days in a single month, instantly eroding its surplus versus the five-year average.  Although preliminary October weekly data suggest a rebuilding of distillates, levels still look tight in PADD 1 - a key region for heating oil demand - as winter approaches.  In the Pacific, where Korean stockdraws offset Japanese builds in September, stock cover is still on the low side for distillates and 'other products'.

There is currently a steep contango in paper markets for crude and products (beyond seasonality), providing a theoretical economic incentive to build stocks.  However, this contango appears to be the result of a weak prompt market and it would seem that lines of credit to buy extra inventory and take advantage of storage economics, are severely curtailed.  In fact, there are widespread reports of an ongoing destocking in OECD and non-OECD countries to release capital.  With OPEC announcing reductions to production targets from 1 November, it is indeed conceivable that 4Q08 stockbuilds will not match seasonal norms in absolute terms.



There were large revisions to end-August OECD stocks, totalling 21.4 mb.  These included an upward adjustment of 14.5 mb to European distillate stocks, resulting from previously unavailable data revealing distillate builds (for example, in Greece) or accounting shifts (e.g., Belgium) or simply contradicting the indications we had from preliminary data last month (Spain, Italy).  There were also significant upward changes to US products as well, including 6.8 mb and 4.5 mb in gasoline and distillates respectively, which substantially improved the pre-hurricane position.  In partial offset, Italian and German crude stocks were adjusted downwards by 4.0 mb and 2.2 mb, respectively, for August.  Meanwhile, after suspicions that reported Canadian crude stocks were too high for July, there was indeed a downward end-July correction of 2.0 mb.

OECD Industry Stock Changes in September 2008

OECD North America

After disruption to the oil supply chain caused by hurricanes Gustav and Ike, September draws in OECD North American oil stocks, at 10.7 mb, were not quite as steep as expected.  Regional crude stocks actually rose by 9.3 mb in September.  In the US, lower crude runs neutralised the negative stock impact of production outages and disrupted imports.  At the same time, there was a colossal spike of 10.4 mb (over 50%) in Mexican crude stocks, in line with lower crude exports to the US.

OECD North American product stocks were hit harder by the hurricanes, falling by 21.4 mb in September for the region, including a drop of 24.3 mb in the US.  The latter included dips of 6.9 mb in gasoline to 190.6 mb (shallower than expected due to a steep late-month rebound from a mid-month low of 178.7 mb), 13 mb in distillates and 4.7 mb in 'other products'.  US product draws were the result of lower refinery throughput both in the Gulf, as a direct result of hurricane disruption, and inland (PADDs 1 and 2), due to closures of crude pipelines originating in the affected area around Houston.  Equally, product pipelines (e.g., the Colonial) that also start near Houston faced temporary closures, contributing further to inland product draws.  Weekly data show that US refinery runs had recovered to pre-hurricane levels (relative to seasonality) by early October and that, by mid-October, gasoline stocks had rebounded to over 196 mb.  Distillate stocks also appear to have recovered in October according to EIA weekly data, although tightness is still evident in PADD 1, the region consuming by far the most heating oil.



Mexican product stocks built sharply in September, by 2.9 mb, countering the gentle declines usually seen at this time of the year.  This build included 1.0 mb in gasoline and 0.8 mb in distillates and took Mexican product stock cover back close to the five-year average, having been below range for the whole of the year to date.  With Mexican refinery activity only down slightly on the month, the product build suggests a fall in product exports (the majority of which are naphtha or jet kerosene cargoes heading to the US).

OECD Europe

A seasonal September draw of 6.1 mb in OECD European total oil inventory disguised the product-specific detail, namely that regional crude stocks built atypically, by 7.6 mb, while product stocks dropped sharply, by 12.8 mb.  In terms of forward demand cover, the counter-seasonal crude build was more influential than the product draw, causing total regional stock cover to rise by 0.8 days to 61.8 days.

The September build in European crude stocks was led by increases of 4.4 mb and 3.3 mb in the Netherlands and France.  With only minor changes in refinery runs in both of these countries, higher imports were necessarily responsible.  Preliminary tanker data confirm increased arrivals into both countries of Saudi Arabian and North and West African grades.



OECD Europe product stocks drew by 12.8 mb, led by a distillate draw of 10.6 mb.  Decreases of 2.6 mb and 1.9 mb were observed in French and German distillate stocks respectively on higher domestic demand (the fill level of German consumer tanks of heating oil apparently increased from 55% to 60% in September).  However, an upwardly revised August base kept regional distillate cover healthy.  European gasoline inventory took an unseasonal hit of 1.9 mb, as extra cargoes moved across the Atlantic to a hurricane-ravaged US market.  For this reason, gasoline stocks in Germany and the Netherlands, two of the main transatlantic 'mogas' suppliers to the US, both fell by 0.8 mb.  ARA independent stock data show an October recovery in gasoline stocks at the margin, with US data confirming an easing in imports, overshadowing the impact of extra cargoes heading to West Africa to mitigate refinery outages in Nigeria.  ARA data reflect a notable tightening in October independent gasoil stocks, although Euroilstock data imply that distillate stocks in EU-16 countries may in fact resist the seasonal decline.

OECD Pacific

OECD Pacific oil stocks were flat in September, consistent with seasonal expectations.  This masked a slight improvement in crude inventory, vis-à-vis the five-year average, boosting forward throughput cover, and a mild dip in products.



Pacific crude stocks rose by 1.3 mb in September.  In Japan, an upward revision of 4.6 mb to end-August crude stocks plus a 7.1 mb provisional build in September has improved forward cover (in terms of throughputs) considerably.  Weekly data show that Japanese throughputs fell to an autumn low of 3.4 mb/d by the early October, down from 3.9 mb/d at the end of August.  Although directionally anticipated, this trough was very low in absolute terms and below the five-year average.  With imports only off by 0.1 mb/d (with a notable drop in Iranian arrivals), crude inventory was allowed to build.  This offset a sharp, atypical draw of 5.8 mb in Korean crude stocks in September, caused by a hike in refinery runs of 140 kb/d, with imports only marginally firmer (up 36 kb/d, to 2.30 mb/d).

OECD Pacific product inventories dipped by 2.3 mb in September with a notable draw of 2.5 mb in Korean distillate stocks.  Despite higher refinery activity, Korean gasoline stocks also failed to rise in line with seasonality, while fuel oil stocks dropped by 0.5 mb amid reports of higher spot export allocations to profit from a tight Asian residual market.  Korean product stock cover is now at its lowest level since December 2005.  In Japan, a 2.4 mb hike in 'other product' stocks (related to slack naphtha demand) offset smaller draws in gasoline and fuel oil.  An observed September rise of 1.2 mb in distillate stocks, in the face of seasonally low crude runs, suggest that Japanese distillate exports took a hit, which would tally with lower imports by China, Japan's key distillate export customer.  Despite dropping in September, Japanese product stock cover remains above the five-year average after large builds in July and August.

Australian stock data for August showed a very slight counter-seasonal build, led by a 0.5 mb rise in gas liquids inventory.  It is worth noting that while Australia product stock cover is below the five-year average, crude cover in terms of forward throughputs has rocketed through the top of the five-year range aided by the 2.25 mb jump seen in June.  The fourth-quarter temporary closure of both BP's Kwinana and Shell's Clyde refineries has had a significant amplifying effect.

Recent Developments in Singapore Stocks

Lower Chinese imports have contributed to the recent easing in Asian product markets that has prompted October builds in product stocks held independently in Singapore.  Fuel oil stocks saw the largest rise, of 4.0 mb over the month, as Korean refiners increased spot export allocations and Middle East domestic demand eased seasonally.  High premia of Singapore fuel oil prices to Rotterdam in August and September probably encouraged some long-haul eastbound exports that are now arriving in Asia.  Slackening bunker demand, in light of the broad drop in shipping volumes demonstrated by the collapse of the Baltic Dry Index, has also contributed to build in residual stocks.  Middle distillate inventory rose by 0.7 mb on the month, while light distillate stocks saw a 1.4 mb build.



Prices

Summary

  • Oil prices continued their slide from early-July highs throughout October and early November, falling some $25 since last month's report, to just under $60/bbl at the time of writing.  Lower actual demand, as well as the prospect of further weakening ahead amid global economic woes, appeared to offset the impact of OPEC's 24 October decision to cut output quotas and news that a substantial volume of US Gulf of Mexico crude could remain shut in until March 2009.
  • Crude prices fell on reduced refiner interest, with negative gasoline and naphtha cracks weighing on refining margins.  In the US, domestic sweet crudes such as LLS suffered as a consequence, and an overhang of heavier grades saw regular imports from Latin America diverted elsewhere.  Russian Urals remains strong vis-à-vis Dated Brent on anticipated lower export volumes, despite a decision to cut previously prohibitive export duties from 1 November.
  • Refining margins fell across the board in October, as lower (but still strong) distillate cracks failed to fully offset pronounced weakness for all other products.  US Gulf Coast margins fell the most steeply (albeit from exceptionally high September levels), with cracking spreads turning negative over the course of October.  Singapore refining margins are also depressed, but margins in Europe are more robust, thanks to higher distillate yields.
  • Refined product crack spreads all weakened amid a general downturn in demand.  This is especially true for gasoline, which is suffering due to lower consumption in the US, and naphtha, which is at an unprecedented discount to crude on depressed global petrochemical markets.  Fuel oil has seen discounts to crude widen again, while only distillate cracks remained steady and relatively high.
  • Benchmark crude freight rates fell in October, undermined by prospects of broadly lower demand and reduced supply, especially from the Middle East.  Clean rates also eased on slackening naphtha demand and lower Chinese imports.


Overview

Oil prices have continued their steep downward slide in October and early November, with crude benchmarks down around $25/bbl since the last report.  At the time of writing, WTI and Brent futures were near $59 and $56/bbl respectively - or around 60% lower than their early-July highs - and on a par with levels last seen in early 2007.

Weak observed demand is having a strongly bearish effect on oil prices, with this report again making a downward revision to demand estimates.  The US is showing a contraction in demand, but this is also spreading across the globe and we have also revised down our China estimates, for this year and the next.  Generally speaking, as we observed last month, the actual and anticipated effects of the global economic crisis are outweighing the potentially supportive effects of still-constrained US Gulf crude output and OPEC's 24 October decision to curb crude allocations.

Arguably, something of a temporary price floor may have been reached in late October, when crude prices touched $60/bbl for the first time.  Not only did this coincide with OPEC's meeting (though some would argue an anticipated cut had already been factored into prices), but also with broad and concerted efforts by central banks and governments to shore up the global economy.  Indeed, that was the first instance of some positive market sentiment for some time, with a pick-up in stock markets and similar news.  Having said this, markets remain hugely volatile, with daily price swings on average around $5/bbl for crude futures over the past month, and hindsight may prove this episode of price support to have been transient.  Furthermore, WTI's November contract expiry on 21 October was unspectacular compared with the previous month, when prices briefly spiked by around $25/bbl, likely on intense short-covering.



Near-term market weakness is increasingly apparent in the WTI forward curve.  The near end of the curve has moved to a deep discount to future months, reflecting weak demand for prompt crude, but also pointing towards anticipated tightness ahead.  Prices reach $80/bbl in July 2011 and even around $85/bbl in the longer term (all NYMEX Light Sweet Crude).  Somewhat unusually, the current contango is not seemingly encouraging stock building, with anecdotal reports that refiners are finding financing difficult in the current tight credit environment.

OPEC's announcement, at its Extraordinary Meeting on 24 October, of its intent to reduce output quotas by 1.5 mb/d, will likely take time to materialise in actual market supply, even though the lower allocations were to come into force from 1 November.  But in any case, individual member pledges to reduce volumes to the market - mainly by curbing term contract volumes - appear to have influenced market sentiment.  Potentially tighter supplies are also suggested by the fact that over 250 kb/d of US Gulf of Mexico production could remain offline, on average, until March next year due to pipeline repairs, and potentially lower Russian crude exports despite moves to cut export duties

Product markets meanwhile are increasingly divergent, with still-strong distillate crack spreads not quite offsetting weakness in all other products and correspondingly lower refining margins.  Naphtha cracks have plummeted to unprecedented discounts to crude (see Is Naphtha the New Fuel Oil?), while gasoline cracks also languish in negative territory.  Fuel oil discounts to crude have widened in the meantime.  Distillates' continued strength will to some extent depend upon winter temperatures, though the European Union and Australia's switch to 10 ppm maximum sulphur content diesel from 1 January 2009 may lend some additional support.

OPEC Members' Budgetary Requirements

Given OPEC's 24 October decision to reduce output allocations, much has been written recently about the average oil price members need in order to balance their budget and whether this influenced some members' positions.  For this year, given previous high levels, most budgets should be safe - the average price of Brent futures in 2008 has been $107/bbl so far - but were prices to remain at their current level throughout next year - ceteris paribus - arguably some countries might fail to meet all their financial commitments.

Taking a range of external estimates for individual countries' needs, the average oil price for the group of OPEC producing countries selected here (on the basis of available data) is around $54/bbl - a threshold recently approached around the time of the group's meeting.  Prices have subsequently stabilised at a slightly higher level, not least due to the market's assumption that OPEC will indeed curb output. 

But what this average number hides is the starkly different price needed by different members, leading many commentators to resurrect the view of a hawk/dove divide within the group, one which admittedly does partly fit with statements surrounding the meeting.  Estimates of average price 'requirements' range from $32/bbl for Qatar, around $42/bbl for the larger Arab Gulf producers and, most significantly, a price around $91/bbl for Venezuela and Iran.

These numbers quoted here are themselves an average of a range of assumptions and should be taken with a degree of caution.  Beyond assuming that all other conditions remain constant, i.e. crude production volumes, budgetary and fiscal conditions, GDP assumptions, debt repayment and exchange rates etc, there are also off-balance-sheet funds and income from non-oil sectors to consider.  Most importantly perhaps, many OPEC countries have amassed large rainy-day funds, which could be and - in some cases, are already - being tapped.  To illustrate to what degree price assumptions vary, calculations for Qatar range from $10-60/bbl and $18-55/bbl for Saudi Arabia.  Countries such as Qatar, Kuwait and most of all the UAE benefit from large sovereign wealth funds and overseas investments - in other words they are not so susceptible to short-term fluctuations in oil-related income.

While some countries should fare reasonably well given conservative budgeting and a degree of fiscal flexibility - such as kingpin Saudi Arabia - others could, in theory, make economic concessions, raise efficiency or tighten belts.  The recent rise in the dollar with respect to many currencies could also cushion the impact of lower prices on some OPEC country budgets.  But a key group of members is arguably already losing out with prices at current levels - notably Venezuela, Iran and Nigeria.  Though in Venezuela's case, President Chavez has reportedly made claims stating that his country's budget would balance even with prices around $55/bbl, many doubt these assumptions (he had previously stated prices more in the range of $80-90/bbl).  The Nigerian oil minister recently was reported to have said his country would be 'comfortable' with $80/bbl.

Does this mean that OPEC will collectively agree upon a price floor?  This is far from certain, especially as members' needs diverge so starkly.  Nor do public pronouncements necessarily coincide with apparent budgetary needs.  Nigeria, with a price around $75/bbl needed to balance its budget, might be assumed to act more hawkishly to defend prices than Algeria with a lower $55/bbl or so required to balance its books this year.  Yet Algeria has been the more forceful in suggesting that production needs to be reduced.  Of course long-standing production outages partly underpin Nigeria's position.  In the end however, OPEC's policy motivations are manifold and cannot simply be reduced to a formula - political, economic and other considerations surely all play a role.

Spot Crude Oil Prices

Falling cracks, especially for light distillates, as well as the weakening demand picture and difficulties in obtaining credit, are curbing refiners' appetite for prompt cargoes.  This is evident in the widening near-term contango in crude futures, even while crude stock levels do not appear to be rising much beyond seasonality and post-hurricane refill.  In the US, weak or even negative gasoline cracks are causing an overhang of light sweet grades, pressuring domestic LLS's spread to WTI into negative territory (and reducing its premium to sour grade Mars).  Reduced refinery throughputs in the US Gulf have also caused the diversion of Latin American heavy grades such as Mexican Maya and Ecuadorean Oriente to Europe and Asia-Pacific.

In Asia, regional Tapis has been pressured due to its high naphtha yield, seeing its premium to Dated Brent reduced.  Asian refiners too are in many cases reducing throughputs and purchases of West African grades for November delivery were down, largely due to less interest from India, which was reportedly receiving only around 350 kb/d in November, down from October's 580 kb/d.  China's November imports look to remain steady at around 540 kb/d.  Nigerian premia to Dated Brent have remained relatively steady in October and early November around $4-5/bbl.  Meanwhile, medium sour Dubai and Oman are trading at parity to Brent, despite weakening fuel oil, as light distillate cracks plummeted.



Europe has seen Russian Urals again narrow its discount to Dated Brent to near-parity, especially in the Mediterranean.  The prospect of lower export volumes in November is underpinning the crude's relative value.  Until a recent decision to slash the export duty from 1 November, expectations had been that tariffs would be prohibitive, given its time-lagged calculation, and some exporters had threatened to curb volumes.  After the reduction in duties from around $51 to around $39/bbl at the beginning of this month, some of those cargoes may be reinstated, though at the time of writing, pipeline operator Transneft had hinted that total volumes might be down by 25%.  As for sweet grades, Mediterranean Azeri Light and Saharan Blend have seen premia to Brent narrow on gradually reinstated Azeri supplies and lower gasoline demand and reduced interest from US buyers.



Refining Margins

Refining margins fell across the board in October as crack spreads for all products except some European distillates and some US and European fuel oils fell.  In fact, were it not for distillates' relative strength, refining margins would be far weaker, with naphtha and gasoline now both negative and fuel oil seeing discounts to crude widening again.  As a consequence, there have been reports of planned reductions in throughputs in the US, Europe, Japan and Asia.

The strongest falls were seen on the US Gulf Coast, though this was also distorted due to brief price spikes in September after Hurricane Ike hit the region's refining industry, forcing widespread shut-ins.  Cracking margins in particular are now all negative again, as gasoline cracks plummeted and, in early November, in most instances turned negative.  West Coast margins remain firmer, despite falling, as gasoline cracks remained stronger.



In Europe, margins fell too, but had some support from 50 ppm diesel prices, despite its imminent phase-out at the end of the year (Euro-5 specifications will require a maximum sulphur content of 10 ppm in road diesel).  In October as an average, Brent hydroskimming margins remained positive, but the trend was a falling one throughout the month and into early November, and news reports indicate some economic shut-ins at marginal refineries.  Urals hydroskimming margins meanwhile are now quite clearly negative on that crude's relative strength.  In Asia, margins remain lowest, largely on a weaker distillate market, though in contrast to Europe, gasoline cracks remain higher.

Spot Product Prices

Light distillate cracks have fallen further in October and early November, dragging down refining margins and encouraging refinery run cuts.  Relative to crude, gasoline went negative in late October in most regional markets on falling demand, especially in the US.  This is having the usual carry-over effect in Europe, which has seen itself forced to divert some cargoes to West Africa and the Middle East.  Naphtha cracks are even more dramatic, having fallen to around a $25/bbl discount to crude in early November on a depressed petrochemical market and stronger competition from alternative feedstocks (see below).

Is Naphtha the New Fuel Oil?

Naphtha crack spreads have been negative since the beginning of the year, but have declined sharply since September and, in early November, averaged nearly a $25/bbl discount to benchmark crudes - easily their lowest in over 20 years.  Amid the global economic downturn, naphtha appears to be particularly badly hit, not least because it is seen as more sensitive to a GDP slowdown than more demand-inelastic transport fuels.

The development of naphtha as a petrochemical feedstock stems from the historical need to find alternative uses for structural surpluses in OECD Europe and Pacific.  Although commonly referred to as a single product, in reality naphtha refers to a range of different hydrocarbons, which have varying properties.  For gasoline production, those fractions containing a higher proportion of aromatic compounds are preferred, due to their higher octane rating, with catalytic reforming or isomerisation used to boost octane values further.  Petrochemical use of naphtha requires higher paraffinic content, to ensure satisfactory yields of ethylene and minimise unwanted by-products.  Alternative sources of feedstock more commonly used in North America and the Middle East include NGLs associated with gas production.



Naphtha is being hit predominantly by weak demand from the petrochemical industry, which in turn is affected by low ethylene prices as a result of the global economic malaise and lower demand for plastics and other petrochemical derivatives.  Reports indicate that many naphtha crackers (which transform the feedstock into ethylene) are slowing output, bringing forward maintenance or even shutting in output temporarily as ethylene prices tumble by nearly 70% from their recent early-August high.  As a petrochemical feedstock, naphtha is also seeing strong competition from natural gas liquids (NGLs), output volumes of which are growing in line with large new gas fields coming onstream.

On the demand side, an alternative outlet for naphtha is generally speaking the gasoline pool.  But with US and other demand for the motor fuel plunging in response to higher prices and the general economic malaise, this destination is also increasingly unattractive.  With few other outlets, prices may well remain weak until the petrochemical industry picks up, leaving naphtha as the new laggard of the product slate.

Distillate crack spreads in contrast remained relatively strong in October and early November, with demand holding up and supplies structurally more constrained.  In Europe, heating oil sales were robust in September as consumers chose to restock after retail prices fell.  The region will also see diesel sulphur specifications tighten further - to 10 ppm - from 1 January 2009, though the cleaner product has narrowed its premium to 50 ppm diesel in the last six months.  In Asia, latest reported figures show that China did indeed import less gasoil in September - around 80 kb/d - and after reportedly no influx in October, is expected to forego imports in November on weaker demand.  It is also expected to buy only around 80 kb/d of jet fuel in December, down from an earlier-expected October/November average of 100 kb/d.  The Asian distillate market is the weakest, regionally speaking, also suffering from sharply above-average independent inventory volumes held in Singapore.



In contrast to September, fuel oil has seen its discounts to crude widen again, especially for high-sulphur product.  Rather than a substantial change in supply volumes, demand has weakened, with the Singapore bunker market for example reporting sales down by 10% in September.  China's independent, 'teapot' refineries are also showing little buying interest on unfavourable economics, while the Asian market continues to see an inflow of barrels from the west.  Reportedly, 3.4 million tonnes of residue are expected to arrive in November and regional stocks remain high.



End-User Product Prices in October

In October, end-user product prices on average fell by 16.4%, in US dollars, ex-tax.  A sluggish decrease of only 2.4% in Japan was in strong contrast to an 18% drop of retail product prices in other surveyed IEA countries.  Gasoline prices dropped by 18.2% month on month, and they were even below October 2007 prices in Germany, Italy, Spain and Canada.  For the entire product range, end-user prices were only 14% above October 2007 levels.  Last month, consumers on average paid $3.05/gallon for gasoline ($0.837/litre) in the US, ¥163/litre ($1.629/litre) in Japan, £1.056/litre ($1.781/litre) in the UK, and in Europe from €1.348/litre in Germany ($1.789/litre) to €1.082/litre in Spain ($1.436/litre).  Diesel prices on average fell by 13.3%, heating oil prices by 14.5% and fuel oil prices by 19.8%, in US dollars, ex-tax.



Freight

In spite of the looming winter uptick in crude runs, benchmark crude freight rates weakened throughout October, undermined by the prospect of broadly lower demand and reduced supply.  Clean rates also eased on slackening naphtha demand and lower Chinese imports.

In the Middle East Gulf, VLCCs to Japan were chartering at $12.64/tonne by the end of October, down by a significant $13/tonne on the month.  Prospective regional supplies (and, by extension, more immediate tanker chartering demand) were dented by field maintenance in the UAE, which started in October, and the implementation of reductions to OPEC production targets of 1.5 mb/d, effective 1 November.  Tanker movement reports suggest that regional export volumes have indeed begun to decline through mid-November.  Furthermore, as with the whole oil complex, bunker prices have fallen considerably in the last few months.  This has also had a downward effect on freight rates as spot charter rates incorporate the cost of fuel.

After falling to a mid-month trough, Suezmax rates recovered strongly in the latter part of October.  Accordingly, West Africa to US Atlantic coast rates (130 kmt) fell by $8.50/tonne in the first two weeks of October to a low of $17.15/tonne, before rebounding to $27/tonne by the end of the month.  Flows were bolstered by a recovery in Angolan output after maintenance.  Some incremental Suezmax liftings from Venezuela and Mexico may have also tightened the Atlantic vessel supply picture.  A resumption of flows through the Baku-Supsa pipeline to the Black Sea may have lent support to tanker demand in the Mediterranean.  Aframax rates in and around European waters firmed in October, as refinery throughputs rose seasonally.



Reports of extremely weak naphtha demand in Asia (and a drop in naphtha prices, which has turned cracks negative) as well as an ongoing reformer outage in Saudi Arabia, weighed on eastbound trade flows in large clean vessels from the Middle East Gulf.  However, reports of naphtha arbitrages to Europe opening up may have provided some offsetting long haul vessel demand.  Korean product exports apparently rose in October, supporting intra-Asian clean tanker rates, although weaker Chinese import demand could have proved more influential, given that Singapore to Japan rates (30 kmt) eased from over $30/tonne early in October to under $27/tonne by end-month.

Refining

Summary

  • Global 4Q08 crude throughput is forecast to average 73.5 mb/d during 4Q08, 1.4 mb/d lower than last month's report.  Weaker demand and the deteriorating margin outlook underpin this month's large downward revision.  Lower Chinese, Russian and OECD Pacific and Europe crude throughput forecasts account for the majority of the adjustment.  4Q08 annual growth moves firmly negative, driven by the heavy decline in OECD throughput (-1.3 mb/d) and the collapse in growth in Chinese crude runs.  A partial offset to these reductions comes from Saudi Arabia, where crude runs have significantly exceeded forecasts for two months running, leading to increased 4Q08 estimates.
  • The 3Q08 global crude throughput estimate is broadly unchanged, at 74.1 mb/d, despite downward adjustments to reported Canadian and Japanese August crude throughput, and lower-than-expected throughputs in Iran, Russia, Thailand and Taiwan.  Partially offsetting these declines were upward revisions to provisional reported August crude runs in Italy, Belgium and Spain, and above-forecast crude throughput in Egypt, Brazil and Saudi Arabia.


  • OECD crude throughput averaged 35.6 mb/d in September, a capacity utilisation rate of just 78.9%.  This represents the lowest monthly average level since October 1995.  Lasting damage to US Gulf Coast refineries from Hurricanes Gustav and Ike appears minimal, with the last refineries restarting by mid-to-late October.  The US DOE has lent just over 5 mb of crude from the SPR to assist refiners in supplying US demand for products.  Elsewhere in the OECD regions, the temporary strength in refining margins appeared to offer little support to crude throughput levels.

Global Refinery Throughput

The deteriorating margin outlook, rising product stocks and weakening demand have all contributed to this month's large reduction to forecast 4Q08 crude throughput.  Weaker-than-expected preliminary October data from the US, Japan and Russia have contributed to the 1.4 mb/d reduction in our crude throughput estimate.  Furthermore, the announcement of economic run cuts from Japanese and Chinese refiners, among others, and the prospect of further cuts by refineries in Korea, Europe and the US reduce our November and December forecasts by 1.5 and 1.2 mb/d, respectively.

Financial market turmoil, falling profitability and slowing demand growth has led several refinery operators to reduce capital expenditure plans for 2009.  US independent refiner Valero has reduced planned 2009 capex to $3.5 bn from the previously planned level of $4.0 bn, by deferring some 2009 projects into 2010 and 2011.  In the longer term, the two planned joint-venture refineries in Saudi Arabia, with ConocoPhillips and Total, have both been postponed by at least six months, to allow time for likely construction costs to ease and for project sponsors to evaluate the changing economic outlook.

Preliminary data for October indicate that global crude throughput averaged 72.1 mb/d, 1.4 mb/d below last month's forecast of 73.5 mb/d.  Lower-than-expected crude runs in Japan, the US and Russia account for much of the downward revision.  In addition to the weaker margin environment, maintenance in several European countries, plus Brazil was heavier-than-anticipated, and reports of accelerated run cuts in China also contribute to this month's lower estimate. 

The balance of 4Q08 is forecast to see global crude runs recover from current low levels, in line with the seasonal trend, as refiners return from maintenance in Europe, Russia and Brazil.  Crude throughput is forecast to increase month-on-month by 1.5 mb/d in November and 1.3 mb/d in December, to an average of 73.5 mb/d and 74.8 mb/d, respectively.  This level of crude throughput nevertheless represents downward revisions of 1.5 mb/d and 1.2 mb/d, respectively to our previous forecast.



OECD 4Q08 crude throughput is forecast to average 37.4 mb/d.  As highlighted in last month's report, we remain concerned about the downside risks to our 4Q08 crude throughput forecast.  This month's 0.9 mb/d reduction to our estimate is a direct consequence of these negative factors, namely weakening demand and deteriorating profitability, becoming a reality.  Lower-than-anticipated October crude runs in Japan, and a slow recovery by US refineries in late October, suggest the weak margin environment is restricting activity levels in these two OECD countries.  Furthermore, Nippon Oil, the largest Japanese refiner, has confirmed further run cuts in November and December, and reports suggest that other refiners in Japan have followed suit.  Unless there is a significant pick-up in demand for kerosene, Japan is likely to see utilisation rates lag the five-year range through to the end of the year, as has been the case recently.

OECD North America crude throughput collapsed in September to an average of 15.7 mb/d, following the hurricane-related disruption to US Gulf Coast refining.  Crude runs bounced back in October as refineries progressively restored operations to normal.  ExxonMobil's Beaumont refinery, one of the most seriously affected by Hurricane Ike, was the last to complete its restart in late October.

Forecast December throughput remains broadly unchanged for now.  However, November crude throughput has been trimmed by 0.3 mb/d, following the inability of US crude runs to move above 15 mb/d in the most recent EIA weekly data.  This suggests that a further increase in crude throughput from the current level may require a stronger margin environment, essentially driven by stronger gasoline or heating oil cracks, which is difficult to envisage given the current economic uncertainties.



OECD Pacific crude runs dropped in September, as the start of autumn maintenance at Japanese refineries, increased offline capacity by an average of 0.4 mb/d.  Conversely, Korean refiners reported higher runs during the month, as the return to service of distillation capacity at SK and GS Caltex refineries more than offset the impact of economic run cuts.



Forecast 4Q08 crude throughput for the region has been reduced following reports of heavy voluntary run cuts by Japanese refineries, including Tonen General, Nippon Oil and Cosmo Oil.  Recent weekly Japanese data point to some refineries completing scheduled maintenance, but the weak margin environment continues to weigh on activity levels and it now appears unlikely that crude runs will move significantly above 4 mb/d, barring a recovery in refinery economics.  Crude throughput in Korean refineries could also fall short of our previous expectations, based on their significant exposure to the heavily negative naphtha crack. Korean refiners have average naphtha yields of 17%, twice that of Japan and four times the OECD average.  Consequently, we have lowered our forecast Korean crude throughput level by around 200 kb/d, about 8% lower than our previous forecast for 4Q08.

Furthermore, the planned shutdowns at BP Kwinana and Shell Clyde in Australia in November and December also reduce this month's 4Q08 forecast.  The closure of the two Australian refineries for maintenance is partly due to the tighter sulphur specifications that will come into force in January 2009, although Shell's Clyde refinery has reportedly been suffering from reliability issues that may need up to three months work to rectify.



OECD Europe September crude throughput dipped as autumn refinery maintenance more than offset the impact of stronger margins.  August crude throughput was revised upward by 0.3 mb/d to 13.8 mb/d with Italy, Belgium and Spain accounting for the majority of the increase.  4Q08 crude throughput is revised down by 0.4 mb/d, in light of the weaker margin environment, and heavier-than-forecast maintenance.  Notably, Italian, UK and Turkish average crude throughput are each forecast to be 0.1 mb/d below last month's report.



Voluntary run cuts at the Petroplus Teesside refinery in the UK have been reported and similar moves are likely elsewhere in Northwest Europe, e.g. in Belgium, Germany, and the Mediterranean.  Current forecasts envisage a seasonal trough in European crude runs in October with a gradual recovery through to the end of the year.  A stronger margin outlook would enable us to raise forecasts in coming months, but the heavy turnaround work ahead of tighter sulphur limits in diesel and gasoline next January will likely cap overall activity levels.

The introduction of these tighter EU-wide 'Euro-V' diesel specifications has been well flagged and it would appear that very few European refineries are unprepared to meet them.  Perhaps of greater concern is the ability of export refiners, who supply significant volumes of diesel to Europe, to meet the tighter specifications.  However, forward price spreads for 10 ppm diesel in the OTC derivatives market do not appear to currently price in any shortfall in import volumes during 1Q09, although this may more generally reflect concerns about future European demand strength for diesel.  It would therefore appear that refiners currently supplying 50 ppm diesel to Europe will be able to meet the tighter specification.

Refiners have several options available to them to meet the tighter specifications, depending on the timeframe considered.  Refiners can invest in increased hydrotreating capacity over the longer term or perhaps in improved hydrotreating catalysts, which deliver ultra- low sulphur levels (as low as six ppm) in diesel from existing units.  In the short term, operational changes include running sweeter crudes, or possibly running hydrotreaters more intensively.  This last option comes at a cost, as refiners face a trade-off between minimising the yield reduction from meeting the tighter specification and the resultant shorter periods between maintenance and catalyst changes.

Forecast 4Q08 Non-OECD crude throughput has been revised down this month by 0.5 mb/d.  Weaker Chinese, Russian, Brazilian and Nigerian estimates account for the majority of the change.  Year-on-year growth is now 0.6 mb/d in 4Q08, just over half the estimate in last month's report as slowing demand and weaker margins affect our forecasts.  Nigerian crude runs for 4Q08 are reduced following the attack on crude pipelines feeding supplies to the Kaduna and Warri refineries.  Uncertainty, over the exact timing of the restart of these supplies leads us to cut forecast crude runs by 0.1 mb/d for the quarter. 

Chinese September crude runs were marginally ahead of our forecast at 6.9 mb/d, according to National Bureau of Statistics data.  Subsequent reports of product de-stocking on slowing demand growth and planned run cuts by Sinopec and Petrochina result in a 0.3 mb/d downward revision to this month's 4Q08 forecast.  Despite the return to profitability of processing imported crudes, this move by the state oil companies appears to reflect concern over future demand for products, rather than a response to weaker margins.  Arguably, margins are currently looking healthier than has been the case for much of the year, although Sinopec has requested continued state subsidises for the next several months.  Consequently, forecast 4Q08 crude throughput is now expected to average around 6.6 mb/d.

FSU 4Q08 crude throughputs are reduced by 0.2 mb/d, on heavier maintenance in Russia, lower expectations for Ukrainian throughputs, and reports of tighter credit markets forcing some refineries to cut crude runs.  This despite Russian crude runs in September being marginally ahead of our forecasts, at 4.8 mb/d.  However, during 4Q08, TNK-BP's 300 kb/d Ryazan refinery now appears to have been undergoing maintenance during October, and follows closely on work at Yaroslavl refinery in September.  Furthermore, reports of the imminent restart of the 137 kb/d Kherson refinery in Ukraine appear premature, and we have removed this increase in crude runs from our November and December forecasts.  Lastly, the combination of rapidly changing product export duties and the tougher credit market conditions seem to indicate that our previous forecast for continued strong Russian throughput is unlikely to materialise before the end of the year, and we have trimmed estimates accordingly

Middle East 4Q08 forecasts have been increased following the continued strong performance of Saudi Arabian refineries, despite some offset from operational issues in Kuwait during October.  Saudi crude throughput has averaged 2.0 mb/d during August and September, well above previous highs and our forecasts and we have accordingly raised our forecasts for 4Q08 by an average of 0.1 mb/d.  Kuwait's refineries suffered a total loss of power during part of the month of October and this is likely to have reduced crude runs by an average of almost 0.1 mb/d for the month, equivalent to about 10% of capacity.

Other Asian 4Q08 forecasts are unchanged this month however, a lack of news concerning the operational status of Reliance's 580 kb/d Jamnagar expansion suggests that we may see downward revisions in the coming months to our 4Q08 forecasts, having included progressively higher volumes for this project over the course of the quarter.  Furthermore, export orientated merchant refiners in Singapore and Thailand may also be particularly exposed to the weaker economic outlook and margin environment.