Oil Market Report: 11 December 2008

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Highlights

  • Global oil demand is now expected to contract in 2008 for the first time since 1983, shrinking by 0.2 mb/d, with the total this year revised down by 350 kb/d to 85.8 mb/d.  2009 demand will grow again to a downward-adjusted 86.3 mb/d.  This forecast is based on the IMF assumption that the global economy will gradually recover from 2H09.
  • World oil supply growth slowed to 165 kb/d in November, averaging 86.5 mb/d, with OPEC crude supply curbed by 760 kb/d to 31.3 mb/d on weakening demand.  December supplies will likely be reduced further and OPEC Ministers meet on 17 December to mull further target cuts.  The 'call on OPEC crude and stock change' for 2009 averages 30.7 mb/d, around 0.8 mb/d below 2008.
  • Non-OPEC output now averages 49.6 mb/d for 2008 and 50.1 mb/d for 2009, representing annualised changes of -85 kb/d and +480 kb/d respectively.  But lower estimates are incorporated for 2009 Europe and the FSU (-0.2 mb/d), while the OPEC NGL forecast is also trimmed by 0.3 mb/d.
  • Crude oil prices dropped to nearly $40/bbl in early December, amid continued signs of economic slowdown and OECD demand decline.  Weak refining margins are causing economic run cuts and in turn a crude overhang, as seen in growing stocks and a widening contango.
  • Global 4Q08 refinery crude throughput should average 72.6 mb/d, 0.8 mb/d lower than in last month's report, due to weaker demand and the poor margin outlook, particularly on the US Gulf Coast.  Global 1Q09 crude runs are forecast to average 73.5 mb/d, a dip of 0.4 mb/d against 1Q08, driven by a 0.7 mb/d year-on-year decline in the OECD.
  • OECD industry stocks rose by 45.6 mb to 2,697 mb in October, on weak demand and post-hurricane recovery in the US.  Downward revisions to OECD demand increased end-October forward demand cover to 56.8 days, well above the five-year average.  Preliminary November data point to another OECD stock build of 10.3 mb.

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

  • Global oil demand has been revised down in both 2008 and 2009, given a much starker contraction in the OECD than expected, and early signs of weakness in non-OECD countries, notably in Asia.  World oil demand is forecast to average 85.8 mb/d in 2008 (-0.2% or -0.2 mb/d versus 2007 and roughly 350 kb/d lower than previously estimated) and 86.3 mb/d in 2009 (+0.5% or +0.4 mb/d versus 2008 and 260 kb/d lower when compared with our last report).  The global demand contraction expected in 2008 will be the first since 1983.
  • Oil demand in the OECD is seen averaging 47.5 mb/d in 2008 (-3.3% or -1.6 mb/d versus 2007) and 46.9 mb/d in 2009 (-1.4% or -0.7 mb/d on a yearly basis), about 290 kb/d and 210 kb/d lower, respectively, than previously estimated.  Once again, 3Q08 and 4Q08 revisions to preliminary demand data in both North America (United States) and the Pacific (Japan) were significant, reflecting much weaker economic performance, and were carried through to 2009.  It should be noted that this forecast assumes that OECD demand destruction will bottom out next year and that demand will begin to gradually recover in 2H09, in line with current IMF economic assumptions.


  • Non-OECD oil demand is now expected to average 38.3 mb/d in 2008 (+3.9% or +1.4 mb/d above 2007 and 60 kb/d lower than previously estimated) and 39.4 mb/d in 2009 (+2.9% or +1.1 mb/d compared with 2008 and 50 kb/d lower than in our last report).  These revisions are related to both the economic slowdown and data reappraisals in several Asian countries, notably Malaysia, Taiwan and Thailand.  Although demand in both China and India appears to be holding so far, non-OECD demand growth in 2008 will fail to offset the severe demand contraction in the OECD.
  • The fall in international oil prices has resulted in downward retail price adjustments in several Asian countries, which may help cushion the effects of the global financial turmoil upon their domestic economies.  Subsidies have not only become more affordable but are also politically expedient, as suggested by the recent end-user price cuts in India, Indonesia and Malaysia.  Only China is seemingly taking advantage of the current low oil price environment to move towards market-based end-user prices - although the price reform proposal unveiled in early December hints that domestic caps will prevail if international oil prices rebound above $80/bbl.

OECD

OECD inland deliveries (oil products supplied by refineries, pipelines and terminals) plunged by 6.0% year-on-year in October, according to preliminary data.  All three regions recorded losses, providing further evidence of the worsening economic situation.  In OECD North America (which includes US Territories), oil product demand contracted by 8.3% on an annual basis given a persistent weakness across all product categories, particularly transportation fuels.  Demand in OECD Europe shrank by 0.9%, despite the continued strength of heating oil deliveries, also on the back of declining transportation fuel deliveries.  In OECD Pacific, demand plummeted by 9.1%, dragged down by very feeble Japanese and Korean deliveries in virtually all product categories.



Once again, revisions to preliminary figures were huge, with September demand adjusted down by 1.1 mb/d, mostly on changes in North American figures.  According to revised data, OECD demand fell by 5.4% during that month, instead of shrinking by 3.1%.  This translates into a 380 kb/d downward adjustment for 3Q08, of which 370 kb/d came from OECD North America (mostly from the US).  Moreover, the much weaker-than-expected preliminary data for October, notably for the US, Japan and Korea, has resulted in a 760 kb/d downward revision in 4Q08 (of which -440 kb/d in North America and -310 kb/d in the Pacific).  This adjustment has been partially carried through to 2009 (not only in 4Q09 but in 1H09 as well, given the expected demand weakness by the end of 2008).



Overall, OECD demand is now expected to average 47.5 mb/d in 2008 (-3.3% or -1.6 mb/d versus 2007 and 290 kb/d lower than in our last report).  The OECD contraction will in fact offset non-OECD growth, and as such global demand should contract by about 0.2 mb/d in 2008, for the first time since 1983.  In 2009, OECD demand is seen contracting by only 1.4% on a yearly basis (roughly -0.7 mb/d) to 46.9 mb/d (210 kb/d lower on average when compared with our previous assessment), and global oil demand growth should thus shift back to positive territory (+0.4 mb/d) next year.  It is important to note that our 2009 forecast is based on two key assertions: 1) that OECD demand destruction will bottom out next year, and 2) that demand will begin to gradually recover in 2H09, on the basis of current IMF economic assumptions.  Therefore, should the recession prove to be more prolonged than expected, this prognosis could be further revised down.





North America

Oil product demand in North America (including US Territories) tumbled by 8.3% year-on-year in October, according to preliminary data, falling for the tenth month in a row.  Although this demand weakness continued to be mostly centred in the United States (-9.4% year-on-year), Canada and Mexico also posted losses (-2.7% and -4.3%, respectively).  Revisions to September preliminary data, also largely driven by the US, were significant (-1.1 mb/d): demand in OECD North America actually contracted by 10.0% year-on-year during that month, almost twice as much as previously estimated.  Regional oil demand is now projected at 24.2 mb/d in 2008 (-5.3% or -1.3 mb/d on a yearly basis and 200 kb/d lower when compared with our last assessment) and 23.8 mb/d in 2009 (-1.4% or -0.3 mb/d), 110 kb/d below our previous assessment.





Adjusted preliminary data in the continental United States continue to depict an extremely gloomy picture of oil demand, which since last year has suffered successive blows: a financial crisis, high oil prices, devastating hurricanes and, to cap it all, an officially recognised economic recession - since December 2007, according to the National Bureau of Economic Research (NBER) - as consumer spending continues to contract in order to pay off debts and rebuild private savings.  Inland deliveries- a proxy of oil product demand - fell by 8.6% year-on-year in November, with all product categories bar naphtha and diesel registering significant contractions.  For example, jet fuel/kerosene deliveries plummeted by an unprecedented 19.3% year-on-year, while gasoline demand shrank by 5.3%.  Residual fuel oil, meanwhile, plunged by 20.1% on an annual basis - this product, however, is once again becoming competitive vis-à-vis natural gas on a price basis and, as such, the month-on-month rebound reported in November could conceivably continue in the months ahead.



If that were not enough, preliminary weekly data were corrected down - for the twentieth month in a row - in September.  The adjustment totalled an unprecedented 1.1 mb/d, implying an annual decline of 12.6% or -2.6 mb/d, almost twice as much as previously estimated.  The revisions centred mostly on LPG, 'other products' and gasoline, in that order.  Arguably, the weekly assessments had failed to capture some of the negative effects of both Hurricanes Gustav and Ike, while counting some gasoline volumes as 'supply' (a proxy of demand) rather than as exports.  Moreover, the size of the weekly to monthly revisions to total US50 demand had tended to increase since mid-2007, despite this report's efforts to anticipate both monthly and annual EIA adjustments.  Our current estimate of future revisions going forward, based on a three-month average, stands at roughly -800 kb/d.

The weakness in gasoline demand was corroborated by low vehicle-miles travelled (VMT) readings.  VMT, which are strongly correlated to transportation fuels (gasoline and diesel), fell by 3.0% year-on-year in September, a drop not seen since May 1980.  Total average oil demand was the lowest since September 1996, while the year-on-year percentage decline was the largest since 1980.  On the basis of these revisions, and assuming that demand destruction will bottom out in 2009, US oil demand is now expected to contract by 6.3% year-on-year in 2008 to 19.4 mb/d (some 180 kb/d less than our previous report) and by 1.4% in 2009 to 19.1 mb/d (about 60 kb/d less than previously anticipated).



As noted earlier, Mexican oil product demand - which had so far proved more resilient than that of its North American peers - fell sharply (-4.3% year-on-year) in October, according to preliminary data.  The contraction is largely driven by the structural decline in residual fuel oil use (-31.8% year-on-year), which is increasingly being replaced by natural gas.  Nonetheless, there is some evidence that the economy has begun to slow down as a result of the woes in the US, thus denting consumer confidence.  Indeed, gasoline demand grew by a paltry 1.8% in October, well below the monthly average from January to September (+5.2%).  More significantly, perhaps, jet fuel/kerosene demand has fallen uninterruptedly since May, suggesting that air travel is weakening significantly.  On these trends, total oil demand is set to stagnate in 2008 (-0.1% year-on-year), and contract by 2.1% to 2.1 mb/d in 2009, as the structural decline in LPG and residual fuel oil use is compounded by weaker transportation fuel demand.



Looking further ahead, in mid December state-owned Pemex announced plans to introduce ethanol-blended gasoline in the country's three largest metropolitan areas - Guadalajara, Mexico City and Monterrey - over the next four years.  Ethanol, to be purchased from domestic sugar cane producers, is intended to replace MTBE as a gasoline oxygenate.  Pilot tests of the E6 fuel (containing 6% of ethanol) are set to begin in January 2009.  Nevertheless, the volumes will be relatively modest.  According to company estimates, ethanol demand in Mexico could average between 38 million and 180 million gallons/year by 2012 (roughly 2.5 kb/d and 11.7 kb/d, respectively).

Europe

Oil product demand in Europe fell by 0.9% year-on-year in October, according to preliminary inland delivery data.  Continuous buoyant deliveries of heating oil (+8.9%) failed to offset losses in other product categories, notably gasoline (-5.1%), diesel (-1.4%), jet fuel/kerosene (-3.0%) and residual fuel oil (-4.6%).  Revisions to September annual submissions, meanwhile, were negligible (-4 kb/d).  Forecast demand in OECD Europe is thus largely unchanged at 15.2 mb/d in 2008 and 15.0 mb/d in 2009, implying a year-on-year decline of 0.4% and 1.4%, respectively, as the continent's economic recession deepens.





Inland deliveries in Germany soared by 9.2% year-on-year in October, according to preliminary estimates, given the continued firmness of heating oil (+57.4%) and diesel (+1.9%) deliveries.  Heating oil consumer stocks averaged 62% of capacity by end-October, slightly higher when compared with both the previous month (60%) and the previous year (61% in October 2007).  The heating oil stock build began in July, possibly on the realisation that household inventories had dwindled to levels that could prove insufficient to withstand a cold winter.  More significantly, the trend accelerated sharply over the past three months, given the dramatic fall in German heating oil prices (about -35% from their July peak).  It should be noted, though, that Germany is already in recession (if defined as a GDP contraction over two successive quarters), and as such oil demand excluding heating oil is bound to stagnate or even weaken in the months ahead.



In France, by contrast, total oil demand fell by 4.2% year-on-year in October, weighed down by weaker deliveries of gasoline (-9.1%) and distillates (-3.6%).  In particular, the contraction in diesel demand (-1.6%) may be indicative of gradually slowing economic activity (even though in 3Q08 France technically escaped recession, contrary to Europe's other large economies).  In Italy, indeed, the economic contraction is well underway, with total oil product deliveries plummeting by 5.0% year-on-year in October.  Diesel demand, which accounts for roughly 35% of the total, shrank by 1.7%.  It is also worth noting that Italian jet fuel/kerosene deliveries dived by 13.2%, possibly reflecting the woes of state-owned carrier Alitalia, which is on the brink of bankruptcy.



In Spain, which is also already in recession, oil demand plummeted by 7.1% year-on-year in October.  All product categories declined sharply, most notably jet fuel/kerosene (-11.4%) and diesel (-8.6%).  In the United Kingdom the oil demand picture is broadly similar (i.e., falling amid a contracting economy).  However, deliveries only fell by 0.6% year-on-year in September, the last month for which data are available - after plunging by 10.2% in August.  As elsewhere, diesel demand deliveries - a barometer of economic activity - shrank by 7.8% in September, but remain slightly above the five-year average.



Europe's Car Industry:  Fewer Emissions … and Lower Sales?

In early December, the European Union's authorities reached an agreement on the new legislation governing the amount of allowed CO2 emissions from vehicles.  The new text - formally approved by the representatives of the 27 countries on 3 December and due to be passed by the Euro deputies on 17 December - aims at reducing European emissions to 130 grams/kilometre by 2012, from 158 g/km in 2007, and sets sliding penalties for those manufacturers that fail to meet their target.131



There are, however, several important caveats to the new legislation.  First, in order to make the collective effort more palatable, the 2012 targets will be applied to only 65% of new vehicle production; this share will gradually increase over the following three years (75% in 2013, 80% in 2014 and 100% in 2015).  Second, even though the targets for CO2 emission reductions seem particularly ambitious in the case of manufacturers of larger vehicles, the brunt of the adjustment will actually fall upon those specialised in smaller cars, which will be required to achieve further emission reductions in order to attain a European average of 130 g/km.356

Nevertheless, the overall European vehicle fleet is poised to gradually become more efficient, so growth in transportation fuels demand should further slow in the medium to long term, even as the region's economy recovers.  In addition, barring a major technological improvement, these efficiency gains will probably be met by diesel engines, which emit less CO2 than gasoline engines - i.e., the 'dieselisation' of the European vehicle fleet should continue, despite the saturation in some large markets, posing significant challenges to refiners.362

A most pressing question in the short term is whether European car manufacturers (as their US peers) can endure the current economic downturn.  Sales of new vehicles in key domestic markets have declined since 2Q08, aside from a brief rebound in July and September.  Being exposed to virtually every facet of the unfolding financial and economic crisis - from less access to credit to falling consumer confidence - all European carmakers have been forced to implement temporary plant closures, and some have even begun to cut jobs.  The downturn has become a serious political issue, since job losses could cascade down through the supply chain, from the manufacturing sites to parts suppliers and dealerships.  According to some estimates, the European car industry accounts for 27% of global vehicle production, with 2.3 million direct jobs and 10 million indirect jobs in related industries.  As such, several countries, such as France, are working on rescue packages for the industry.  In others, such as Belgium, dealers are attempting to dispose of costly stocks by offering two vehicles for the price of one.

Pacific

According to preliminary data, oil product demand in the OECD Pacific plunged by 9.1% year-on-year in October, given continued weakness in Japanese demand, compounded by a larger-than-expected contraction in Korea.  Contrary to previous months, downward revisions to September preliminary data were minimal (-30 kb/d).  Oil demand in the Pacific is now seen averaging 8.1 mb/d in 2008 (-2.7% or -220 kb/d on a yearly basis) and 8.0 mb/d in 2009 (-1.5% or -120 kb/d).  These prognoses are down in both years by about 90 kb/d on average when compared with our last report, given the worsening outlook for the regional economies, notably Japan.





For the second month in a row, oil demand in Japan tumbled by double-digit figures (-11.5% year-on-year in October, after -12.3% in September).  Demand has declined uninterruptedly since June, with deliveries falling across all product categories bar LPG in October, according to preliminary figures.  The woes of the Japanese economy are indeed compounding the country's structural oil demand decline.  Since the summer, demand for those products that are closely related to economic activity has been subdued, particularly naphtha (-8.8% year-on-year) and diesel (-8.0%).  Oil demand is thus expected to contract by 4.2% to 4.8 mb/d in 2008, and by 2.8% to 4.7 mb/d in 2009.



Preliminary data indicate that oil demand in Korea contracted by 9.0% year-on-year in October, with lower deliveries for all product categories bar naphtha.  As elsewhere in the OECD, the financial panic that gripped the markets that month took a toll on economic activity and consumer confidence.  Gasoline demand, for example, had been relatively buoyant during the previous two months, before diving in October (-9.0%).  Only demand for naphtha, roughly 40% of total demand, recorded strong growth (+9.0%), as the fall in international oil prices helped offset the effects of the won depreciation versus the dollar (which since early 2008 had rendered feedstock naphtha relatively expensive).  Nevertheless, Korea's solid fiscal position, abundant foreign reserves (sufficient to cover short-term liabilities, despite their recent fall) and relatively limited export exposure suggest that the country is better equipped to weather the financial turmoil than most of its OECD and Asian peers.  As such, oil demand should contract by only 1.0% in 2008, and remain flat in 2009 at 2.2 mb/d.



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 5.4% year-on-year in October.  Despite the often-repeated claims that Chinese oil product demand was inevitably bound to plunge after the Olympics, given the global economic deceleration and allegedly plentiful stocks, growth was notably higher than in September (+4.1%).  Moreover, even though net oil product imports have continued to fall (-34.4% month-on-month), both net crude imports and refinery output actually increased when compared with September (+6.1% and +1.7%, respectively).  Deliveries of two key products - gasoline and gasoil - also rose (+7.7% and +12.2%), suggesting that industrial activity, freight and road travel are holding despite concerns about the country's economic outlook.



Yet the Chinese economy is indeed slowing down, according to diverse indicators on manufacturing, power generation, retail sales and trade.  For example, growth in passenger car sales has virtually stalled since last summer, after rising at double-digit rates for several years in a row.  Jet fuel/kerosene deliveries, meanwhile, fell by 4.2% in October, despite a week-long holiday (when coastal migrant workers traditionally return home).  Moreover, the pace of growth of both gasoline and gasoil demand has slowed, although the relative weakness in domestic distillate demand could also be partially related to smuggling from Hong Kong.  Over the past two months, as international prices have fallen, the so-called 'red diesel' available to local industrial and shipping users in the island has become cheaper than in mainland China (where retail prices are currently about $0.77 per litre), thus reportedly triggering a wave of smuggling into southern China.

Aside from jet fuel/kerosene, only two other products showed year-on-year contractions in October: LPG (-8.6%), which is structurally declining as natural gas makes further inroads in urban areas with the development of pipeline networks, and residual fuel oil (-22.9%), partly because of lower electricity generation and limited use by 'teapot' refineries.  Power generation has fallen on a yearly basis for the second month in a row, suggesting that manufacturing and industrial activity is indeed slowing.  Moreover, the price of imported Russian M-100 fuel oil - the feedstock of choice for the teapots - was still too high in October relative to domestic wholesale prices. The slide in international oil prices over the past several weeks could thus augur a rebound in fuel oil use if the economics of teapot refineries becomes attractive again - provided, of course, that domestic retail prices remain high enough (see text box below) and that domestic demand does not plunge.  Most teapots are based in two provinces - Shandong and Guangdong - where industrial and export-oriented activities are reportedly slowing down.  However, Shandong teapots are arguably better equipped to respond to weaker oil product demand, having access to crude, featuring more sophisticated refining capacity and enjoying local government support.  By contrast, their peers in Guangdong typically have simple refining units, are heavily dependent on residue and are virtually ignored by the provincial authorities.



Overall, our Chinese oil demand prognoses are broadly unchanged versus the previous report (which featured significant downward revisions on the back of lower IMF assumptions).  Oil demand is expected to rise by 5.3% to 7.9 mb/d in 2008 and by 3.5% to 8.2 mb/d in 2009.  Nevertheless, we will continue to monitor China's economic and pricing policy developments.  If the country's slowdown is more pronounced than currently anticipated, this could eventually prompt further downward revisions to our oil demand forecast.

A Price Reform on the Cards?

China's policy of capping domestic gasoline and gasoil retail prices helped insulate domestic users as international oil prices skyrocketed over the first half of this year.  It also created supply shortages by rendering refining and marketing operations unprofitable, thus obliging the government to subsidise state-owned refiners in order to guarantee sufficient supplies, notably in the run-up to last summer's Olympics.  Given the recent fall in international oil prices, this situation has been reversed: average domestic retail prices are now much higher than international benchmarks (about $0.70/litre for gasoline and $0.73/litre for gasoil).  This helps explain the rise in both refining activity and in reported product smuggling into the country.

The fall in international oil prices also prompted a renewed wave of talk about an impending reform to China's administered price regime.  According to some observers, such rumours actually contributed to the fall in gasoline and gasoil imports over the past two months, as refiners increased crude runs and curbed product stocks in anticipation of a retail price cut of as much as 20%.  In the meantime, some consumers have loudly protested against the stickiness of domestic prices (for example, taxi drivers in Sichuan province's Chongqing, one the country's largest and most populous municipalities).

Although changes have often been anticipated in the past, this time around such expectations are arguably better grounded.  On 5 December, the government released a joint reform proposal that will serve as a basis for public hearings, to be conducted until 12 December; the finalised proposal is to be implemented on 1 January 2009.

The draft proposal is sketchy, but the reform should broadly maintain the state's oversight.  Price adjustments may become more frequent (the last one occurred in June), possibly monthly - especially if a 'refinery gate' price is established, based on a basket of crudes (Brent, Dubai and Minas) to which transportation costs and a 'reasonable' margin (around 4%) would be added.  This would replace the current mechanism for setting the so-called domestic 'guidance' retail prices, which are theoretically based on product prices prevailing in New York, Rotterdam and Singapore.  It is unclear, though, whether the retail tolerance band around guidance prices (currently +/-8%) may be broadened, or whether these may vary according to market conditions.  Indeed, if the basket were to exceed a certain level (reportedly $80/bbl), the government will exercise 'appropriate control' over domestic prices - i.e., reimpose a cap.

In addition, a much-touted fuel tax, which would be collected by the central government and replace the road tolls may finally be introduced.  The fuel tax, by definition, would be levied on all fuel users (not just road users).  However, it remains to be seen whether Chinese farmers and the military - two key constituencies currently exempted from paying road tolls - would accept the new tax (expected at roughly $0.13/litre on average).  Their objections could be overcome if they were to be subsidised, which seems likely (other sectors will also allegedly qualify for subsidies).  Furthermore, provincial governments, which collect the road tolls, would lose a sizable income stream, unless the central government were to share fuel tax revenues - a possibility that is reportedly being considered.

A reform based on international benchmarks would probably engineer an overall domestic price cut, even if a fuel tax is levied, given the extent to which international crude prices have fallen.  This could conceivably unleash pent-up demand, notably for transportation fuels.  Paradoxically, however, if the reform were to be delayed (and assuming that the government succeeded in stabilising GDP growth at around 8-8.5% in 2009 with the help of fiscal and monetary measures), the current price differential could also boost demand.  Expectations of sustained economic growth would arguably help relaunch vehicle sales, while high domestic prices would boost supplies.  Some answers to this Chinese riddle are likely to come over the next few weeks; we may then re-examine our outlook for the country's oil demand.

Other Non-OECD

According to preliminary data, India's oil product sales - a proxy of demand - contracted by 2.0% year-on-year in October, for the first time since December 2005.  Although it would be tempting to ascribe the fall to the global financial turmoil and to slowing industrial output, as some observers have claimed, a closer examination suggests that the picture is less clear cut.  The fall is largely related to a contraction in four product categories: 'other products', residual fuel, naphtha and LPG, in that order.  The first category is notoriously volatile, and is often significantly revised; the latter three, meanwhile, are certainly related to economic activity but also to interfuel substitution and seasonal factors.  Natural gas can replace fuel oil for power generation, as well as naphtha and LPG for fertiliser and petrochemical production.  In fact, naphtha has reportedly become less available despite falling prices, since refiners have been diverting it to the export market, obliging petrochemical companies to purchase more LNG.

By contrast, both gasoline and gasoil, which account for over half of Indian oil demand, continue to post significant gains (+10.6% and +6.3% year-on-year, respectively).  It should be noted that gasoil's relatively modest growth in October (compared with +17.2% in September) was largely due to a shift of the Diwali holidays (which fell in November last year).  Overall, the outlook for India's oil demand is marginally lowered compared with our last report.  Total demand is expected to average 3.1 mb/d in 2008 (+4.2% on a yearly basis) and 3.2 mb/d in 2009 (+4.0%).



The Indian government decided to lower domestic end-user prices on 5 December - with gasoline and gasoil prices falling by roughly 10% and 6%, respectively.  The measure was somewhat surprising, given the government's earlier reluctance to implement a cut despite falling oil prices - presumably to allow state-owned oil companies to recoup some of the substantial losses they had incurred up until 3Q08 as a result of domestic retail caps amid rising international oil prices.  Indeed, previous announcements that retail prices would be slashed if oil prices fell below a certain level had been ignored.  When oil reached $67/bbl (the initial threshold), the rupee's depreciation (about 25% since early 2008) was invoked to postpone a cut.  When oil fell below $61/bbl (the revised threshold), the government-cited regulations forbidding the introduction of policies that could influence voters after an election date has been set.  As such, any adjustment to domestic retail prices would not be implemented before 25 December (a series of state polls that began early this month will be completed the day before).

The government presented the cuts as part of a fiscal and monetary package aimed at stimulating the country's economy amid the ongoing global financial turmoil.  Moreover, India's Electoral Commission ruled in early December that the government had not violated campaign laws by announcing forthcoming price reductions, as the opposition Bharatiya Janata Party (BJP) had contented.  Therefore, the new retail prices will stand (fuel prices are a particularly sensitive issue in India, and as such can have a substantial influence upon electoral results).  In terms of oil demand, however, the retail price cuts are unlikely to have a substantial impact, since India's gasoline and gasoil demand is largely price-inelastic.

Another side-effect of the plunge of international oil prices has been the resumption of retailing operations by India's three private oil companies.  Reliance Industries, which had closed all of its 1,432 service stations in March 2008 as the combination of rising crude prices and capped domestic product prices led to huge losses, has reportedly sought government approval to reopen most of them.  Essar Oil, which had restricted operations to only 100 out of its 1,250 outlets, is also intent to reactivate its entire network by early 2009.  Finally, Shell India, which has abandoned its expansion plans, may seek to increase its retail network beyond the 50 stations it currently owns.

Renewed Signs of Life in Administered Price Regimes?

The upward retail price adjustments several Asian countries in the run-up of international oil prices during the first half of this year led many observers to conclude that administered price regimes were bound to become a relic of the past.  Subsidising end-user prices was not only inefficient - fuelling excessive oil demand and thus further feeding the price rise - but also extremely costly - the fiscal burden had indeed become untenable for most governments in the region earlier this year, forcing them to hike domestic end-user prices despite inflationary concerns.

However, the dramatic decline in oil prices over the past few months has not given way to fully market-based price movements, as many had hoped.  In fact, several governments in the region have taken advantage of lower oil prices to reintroduce some degree of price controls - as these have not only become more affordable but also present undeniable political advantages.  Malaysia and Indonesia, two of the region's largest consumers after China and India, are a case in point.  The retail price cuts will arguably help to temper the negative effects of the global financial turmoil upon their domestic economies, but will also entail a significant fiscal cost.

Malaysia has gradually cut the price of gasoline since last summer (-5.6% in August, -3.1% in September, -6.1% in October, -7.0% in November and -5.0% in early December).  This has partially reversed the massive June hike (+41%), which resulted in mass street protests and widespread calls for the government's resignation.  The country's gasoline price currently stands on the low side of the international spectrum, at about $0.52/litre.  Nevertheless, the government is actually collecting fuel sales taxes for the first time in many months, but these revenues will arguably be insufficient to recoup the massive subsidy cost incurred in 1H08 (estimated at about $15 billion, equivalent to over a third of the government's budget).

Indonesia, meanwhile, has gone a step further.  In early December, the government cut the retail price of gasoline to $0.44/litre (from $0.55/bbl in early November), finally bowing to political pressure - Indonesia is due to hold a presidential election in 2009.  With such a move, the government has partially reversed May's 28% hike, which had sparked street protests; Indonesia features once again the lowest gasoline price in Asia (the prices of subsidised diesel and kerosene remain unchanged, but they are likely to be lowered as well).  Furthermore, contrary to Malaysia, Indonesia is still footing a substantial subsidy cost despite lower international prices; the subsidy for this year, which covers gasoline, gasoil and cooking kerosene, is estimated to total some $14 billion.

Supply

Summary

  • Global monthly oil supply growth slowed to 165 kb/d in November, output averaging 86.5 mb/d amid OPEC curbs in the face of weakening demand.  OPEC's 760 kb/d reduction largely offset recovering non-OPEC output from the US GOM and from the Caspian.  Global oil supply had been running 1.6mb/d ahead of 2007 levels during January-August, but the past three months have seen supplies curbed close to parity with those of a year ago, as voluntary and involuntary shut-ins alike have taken effect.
  • Forecast non-OPEC production is trimmed by 290 kb/d for 4Q08 and 345 kb/d for 1Q09, then by around 150 kb/d for the remainder of 2009. Longer-than-expected outages affecting the GOM and Azerbaijan curb early 2009 supply, as do weaker expectations for the North Sea and Australasia.  Forecast 2009 production from Russia and Canada is trimmed on fiscal and investment barriers and field underperformance, while weaker expectations also now prevail for Malaysia and Vietnam.
  • Non-OPEC output now averages 49.6 mb/d for 2008 and 50.1 mb/d for 2009, representing annualised changes of -85 kb/d and +480 kb/d, respectively.  Azerbaijan, the US, Australasia, Brazil, China and biofuels represent the cornerstones of 2009 growth, offset in part by declines elsewhere, notably from the North Sea, Mexico and Russia.
  • Projected OPEC NGL and condensate production is cut sharply, by 105 kb/d for 2008 and by 255 kb/d for 2009 compared with last month's outlook, primarily due to reassessed Qatari and Saudi Arabian supplies.  Project slippage and likely lower associated gas output through early 2009 affect the outlook.  Nonetheless, total OPEC gas liquids grow by 205 kb/d in 2008 and 650 kb/d in 2009, averaging 5.0 mb/d and 5.6 mb/d, respectively.
  • November OPEC crude supply averaged 31.3 mb/d, down 760 kb/d compared with October, with Saudi Arabia, the UAE, Kuwait, Iran and Nigeria seeing lower output and only Iraq bucking the declining trend to increase supply, despite northern pipeline outages. Apparent compliance with target cuts agreed on 24 October was around 55%, although further reductions are likely for scheduled December supplies.  OPEC effective spare capacity has risen to 3.3 mb/d, its highest since late 2002, and OPEC Ministers meet in Algeria on 17 December amid widespread expectations of further output curbs.


  • The 'call on OPEC crude and stock change' is cut by 0.5 mb/d for 4Q08 to an average of 30.7 mb/d, largely the result of demand now around 1.0 mb/d below earlier expectations.  While 2009 demand is also curbed by 0.3 mb/d vs. the November report, supply revisions predominate next year, boosting the average call by 0.2 mb/d, to 30.7 mb/d, a level nonetheless 0.6-0.8 mb/d below the 2008 average.

OPEC Crude

November OPEC crude supply averaged 31.3 mb/d, a fall of 760 kb/d compared with October.  Saudi Arabia, Kuwait, Iran, the UAE and Nigeria all saw markedly lower output last month, with the UAE and Nigerian reductions being in part due to field maintenance and renewed facility outages, respectively. Only Iraq bucked the declining trend to increase November supply, as exports from southern ports increased compared with October, and despite renewed outages affecting the northern export pipeline to Ceyhan.

We have also trimmed Iranian October supplies by some 60 kb/d to 3.85 mb/d, on evidence of weaker domestic refinery crude throughput.  This, however, was offset by a 50 kb/d upward revision to Saudi Arabian supply to 9.4 mb/d, reflecting what we believe may have been a more gradual approach to curbing supply through November and December.



OPEC-11 production, excluding Iraq and Indonesia, fell by 825 kb/d in November, representing apparent compliance with the 1.5 mb/d cuts in target output agreed on 24 October of around 55%.  However, as noted above, further reductions are also scheduled for December supply.  OPEC Ministers gathered in Cairo on 29 November, ahead of their next scheduled meeting in Algeria on 17 December.  In the end, no further decision on output policy was taken, due apparently to uncertainties over upcoming winter weather and the fact that it was too early to judge the impact of production curbs only put in place from 1 November.  Despite clear indications ahead of the Cairo gathering that an output decision was likely to be deferred until December, the market took the lack of further immediate cuts as bearish. Our own market balances envisage a prevailing 'call' on OPEC crude of between 30.5-31.0 mb/d for much of 2009, albeit that would sustain inventory levels at close to recent levels.

OPEC effective spare capacity (net of producers who may struggle to raise short-term production) has risen to 3.3 mb/d, its highest since late 2002.  Installed OPEC capacity now stands at 35.8 mb/d compared with 34.8 mb/d on an equivalent basis (including Ecuador) one year ago.  Gains have come in recent months from Saudi Arabia (with start up of the Khursaniyah facilities within the AFK complex), Qatar (rising al-Shaheen field output), and with new field developments offshore Angola and Nigeria.  Potentially another 1.0 mb/d of new OPEC crude capacity could come on stream in the next 12 months, largely the result of Saudi Arabia's ongoing AFK ramp-up, and with additions late in 2009 from Shaybah and Khurais.  Smaller net additions in 2009 come from Angola, Nigeria, Iran, Kuwait, Qatar and the UAE.

How Much, Rather Than If?

Market sources now envisage OPEC will cut output targets when ministers meet in Oran, Algeria on 17 December.  Perceived wisdom focuses on how much the reduction will be rather than whether it will occur.  Saudi Arabia has indicated that reasonable compliance with the totality of existing planned cuts would be enough to trim forward OECD inventory cover, citing 52 days as a preferred target.  Iranian representatives have countered with claims that a further cut of up to 2.0 mb/d may need to be agreed in Oran, providing an 'envelope' of possible cuts for those wishing to indulge in anticipating outcomes for 17 December.  Official quota cuts so far in 2008 have comprised a collective cut of around 0.5 mb/d agreed on 9 September to regain long-dormant September 2007 targets, followed on 24 October by a cut of 1.5 mb/d, with individual reductions but no starting level specified.



The situation is complicated, however, by the fact that output levels before September, not least by Saudi Arabia, were running ahead of September 2007's indicated quotas.  Purely taking November output as an indicator, core gulf countries shouldered most of the burden of cuts in proportional terms.  Moreover, the Saudi King's statement that $75/bbl now represents a 'fair' price for oil may reflect a feeling within the Kingdom that prices have now fallen too far.  But that is not to say that GCC producers will necessarily be willing to curb supply unilaterally without corresponding compliance from other producers, Iran and Venezuela having been mentioned in this context.  Indeed, our own preliminary estimates show that reductions in supply from Ecuador, Venezuela, Libya and Iran were relatively limited in November.  Interestingly, however, to attain a notional absolute target of 25.8 mb/d, these four producers would need to trim by a further 0.7 mb/d, compared with a further 1.0 mb/d for Saudi Arabia.

In the past OPEC has at times struggled to rein-in production when crude capacity is rising, a phenomenon that is now re-emerging in the face of weaker demand.  There does not yet appear to be a clear internal consensus on the extent of any further cuts required in December, but that does not mean that OPEC will not find a compromise.  Actual supplies are likely to fall further in December in any case, although gauging the extent of these may not be possible before January. Signals on January term supplies so far from Gulf producers are mixed, although here too there may be leeway to impose further curbs by limiting spot sales or deferring cargoes into succeeding months. Interestingly, increased calls are being made to non-OPEC producers, notably Russia, to assist in dealing with what OPEC sees as a clear market over-hang.  For its part, Russia's will attend the Oran meeting and has reportedly submitted a draft accord for 'cooperation' with OPEC which will be discussed there.

OPEC NGLs

This month's report cuts anticipated OPEC condensate and gas liquids supplies for 2009 compared with our earlier forecast.  OPEC gas liquids appear as a quasi-non-OPEC component of supply in our global balance, since they lie outside the market management mechanism OPEC applies to crude oil.  They are however an important incremental source of supply, output of 'other liquids' from OPEC now exceeding 5.0 mb/d (including ethane, LPG, and condensate from gas fields and processing plants, but excluding output derived from crude refining).  Data for NGL supply remain sketchy however, with volumes often obscured within total oil, crude oil or 'other oils' categories, or simply not reported consistently on a monthly basis at all.  Our estimates derive from analysis of natural gas availability, and gas processing plant capacities.

Despite the uncertainties, rising global supplies of NGL, condensates and lighter crude at the expense of other feedstocks were identified in the MTOMR Refining Supplement earlier this month as a potential squeeze on global residue supplies.  This potentially arises because of a need for sustained crude throughputs to meet middle distillate demand, and at the same time ambitious refinery upgrading investment plans, despite slowing demand and a credit crunch in the short term.

Despite this month's revisions, OPEC NGL growth remains substantial, at +0.2 mb/d in 2008, and a further +0.6 mb/d in 2009, reaching a total next year of 5.6 mb/d.  However, 2009 growth has been scaled back from an earlier estimated +0.8 mb/d.  A re-evaluation of prevailing supply in 2H08 cuts levels by around 165 kb/d from previous estimates, with weaker output now seen from Qatar and Saudi Arabia.  Delays to the Qatargas phase II LNG project (trains 4&5) have pushed likely start up back to 2H09.  Meanwhile, slower ramp up in supply from new processing facilities associated with the Khursaniyah field in Saudi Arabia has also played a role.  For next year, around 130 kb/d is cut from the Saudi estimate, due again to slower Khursaniyah gas build up and a more general perception that crude oil output (as opposed to capacity) growth and, with it, associated gas supply could prove weaker in the first half of the year.  Qatari estimates for 2009 are curbed by 80 kb/d, on Qatargas II and also now-planned maintenance at the Dolphin gas project early in the year.  Iranian and Nigerian projected supply is also trimmed for 2009 (by around 20 kb/d each) on expectations of weaker early-year output. That said, OPEC producers still see strong gas and associated liquids growth in 2009, bearing in mind much of the increase in gas supplies is for domestic industry, power generation and oilfield reinjection purposes, that may prove more resilient to wider global economic slow-down.  Saudi Arabia should see incremental NGL and condensate of 0.2 mb/d in 2009, with nearly 0.1 mb/d each from Qatar, UAE, Nigeria and Iran.

Non-OPEC Overview

Forecast non-OPEC production is adjusted down by 290 kb/d for 4Q08 and 345 kb/d for 1Q09, followed by a downward adjustment of around 150 kb/d for the remainder of 2009. OECD and FSU production accounts for the bulk of the reductions.  Once more, longer than expected outages affecting the US GOM and Azerbaijan curb early 2009 supply, augmented by now-weaker expectations for the North Sea and for Australasia, the latter because of new project delays.  Weaker expectations also now prevail for Malaysia and Vietnam.  More generally, forecast 2009 production from Russia and Canada is trimmed (by 50 kb/d and 100 kb/d respectively) as companies begin to grapple with an unattractive fiscal regime (in the case of Russia) and curb spending plans in the face of weaker crude prices and the credit squeeze.  However, it will be some months before the full impact on medium-and-longer-term supply levels from the market's down-cycle can be assessed, which we hope to evaluate in the run-up to the 2009 MTOMR.



Non-OPEC output now averages 49.6 mb/d for 2008 and 50.1 mb/d for 2009, representing annualised changes of -85 kb/d and +480 kb/d, respectively.  Disappointing performance in 2008 mirrors that seen in 2005, when major hurricane outages last affected the US Gulf. As noted in previous reports, the combined loss to 2008 production from Hurricanes Gustav and Ike, plus stoppages affecting Azeri supply, have amounted to around 140 mb.  This is equivalent to 0.9 mb/d during the August-December period, or some 0.4 mb/d for 2008 as a whole.  Unscheduled outages have however again been accompanied by a litany of slippage in new project start-ups throughout the year.

Assuming no repeat of 2008's exceptional weather in the US Gulf (we already incorporate a five-year average hurricane adjustment) and the prolonged outages affecting pipelines and production facilities in Azerbaijan, non-OPEC growth is expected to recover next year to around 0.5 mb/d.

Azerbaijan, the US, Australasia, Brazil, China and global biofuels represent the cornerstones of 2009 growth, offset in part by declines elsewhere, notably from the North Sea, Mexico and Russia.



OECD

North America

US - November Alaska actual, others estimated:  US oil production is on track to grow by a modest 60 kb/d in 2008, although all of the increase comes from non-crude liquids (largely NGL and ethanol).  Outages in the US GOM have severely dented prospects for crude supply in 2008, and look likely to end up costing regional supply around 80 mb by end-December.  Put another way, 525 kb/d of GOM regional oil supply has been lost during August-December, compared with our working assumption prior to the autumn hurricane season of around 180 kb/d.  That said, November crude outages in the Federal waters offshore GOM did come in lower than we had assumed in last month's report, at 230 kb/d rather than 330 kb/d.  Our working assumption here remains that prevailing outages in early December - 190 kb/d (or some 15% of regional output) - continue through March 2009, the reported likely limit for when pipeline repairs should allow output recovery.  Clearly, upside potential for GOM supply exists if repairs are completed quicker than this.

While the Federal GOM crude outage assumption is lowered, we have cut expected NGL supply through March 2009.  This follows official September monthly supply data showing US NGL supplies dipped by 300 kb/d in the month, to 1.54 mb/d, rather than our assumed 200 kb/d reduction.  Given still-extensive outages affecting regional gas production (1.5 bcf/d or 21% of normal supply on 3 December) 100 kb/d has been trimmed from the 4Q08 NGL forecast, followed by an 80 kb/d reduction for 1Q09.  US NGL output only regains pre-hurricane levels of 1.8 mb/d again in April 2009 under the revised projection.

The final US Minerals Management Service Report on damage incurred by the 2008 hurricane season identified 60 oil and gas facilities as having been destroyed, amounting to some 14 kb/d of oil production and 96 million cf/d of gas supply (some 1% of regional output in both cases).  A further 124 damaged facilities face repairs of between one to six months, with 75% likely to be operating again by end-2008.

Alaskan November crude production rose to 745 kb/d, its highest level since December 2007.  BP's Prudhoe Bay field attained 400 kb/d at times during November, a level last seen in 2006 before extended pipeline and maintenance outages restricted supply. Despite prospects for increased supply from smaller offshore fields however, we expect Alaskan production to slip further to around 650 kb/d in 2009 from



690 kb/d in 2008, compared with near-1.0 mb/d output seen in the early part of the decade.

While Alaskan and onshore crude output is expected to continue to decline in 2009 (to the tune of a collective 150 kb/d), overall US crude supply is forecast to rise by 120 kb/d to 5.1 mb/d, driven by an assumed recovery in GOM supply. For 2009 we revert to lower assumed hurricane outages on a five-year average basis (cutting around 230 kb/d from output in the second half of 2009).  But offsets also derive from the ramp-up of production from new fields such as Thunder Horse, Blind Faith, Atlantis, Neptune and Genghis Khan, which collectively could add 300 kb/d of new supply in 2009 versus 2008 output.  Our estimates of output from both Thunder Horse and the recently started Blind Faith field have been revised up since last month.

Canada - Newfoundland October actual, others September actual:  Our forecast of Canadian total oil production has been cut by approximately 100 kb/d for the 4Q08-4Q09 period.  Production of oil is now expected to average 3.2 mb/d in both years, with earlier prospects of Canada as a significant short-term source of non-OPEC growth having diminished. Conventional crude production, net of NGL and synthetic crude production comes in at around 2.0 mb/d in both years.

Albertan bitumen and offshore East Coast light crude production are curbed by a combined average of 55 kb/d for the forecast, with a similar adjustment applied to Albertan syncrude production (not shown as conventional crude in the graph below). We have pushed back the advent of significant volumes of new oil from CNRL's 70 kb/d Horizon oil sands project into 1Q09, as start-up appears to have slipped to end-2008 at the earliest.  But over 100 kb/d of net growth in Albertan oil sands output is still expected for 2009, taking total production to 1.3 mb/d.  That said, persistent operating problems are impeding production in the short term.  Both Suncor and Shell's bitumen upgrading operations are affected by unscheduled stoppages for 4Q08.  Meanwhile, widespread reports of investment budgets being curbed for 2009 and beyond will likely affect available Canadian supplies for the period through 2015.  Again, this is something we aim to quantify in coming months ahead of the 2009 MTOMR.

Estimates of production from the Hibernia and White Rose fields offshore Canada's eastern Newfoundland coast have also been cut after recent performance came in below our previous estimates. The two fields are now seen averaging 130 kb/d and 115 kb/d of production in 2009, respectively.

North Sea

Norway - September actual, October preliminary:  Upward revisions to Norwegian oil output compared with our forecast amounted to 40 kb/d in September and 130 kb/d for October, but these are not carried through the forecast.  The October adjustment largely derives from the removal for that month of our assumed field reliability adjustment factor (currently 160 kb/d), which attempts to capture the tendency observed over several years for mature OECD producing infrastructure to underperform versus capacity. Further short-term, downside offsets result from a five-day shut-in at the Snorre and Vigdis fields in November due to a gas leak.  Statfjord North also began a maintenance shut down for pressure maintenance work in November and will likely be off for several months - here assumed until August 2009.  Finally, scheduled December loadings, notably for the Statfjord/Gullfaks streams came in lower than expected, so we have cut December output accordingly.



With late 2008 adjustments balancing out, the forecast for Norwegian oil production remains largely unchanged from last month at 2.4 mb/d in 2008 and 2.2 mb/d in 2009 (including 1.9 mb/d and 1.6 mb/d respectively of crude oil as measured by the OMR).  Annual declines in Norwegian oil output have averaged 185 kb/d since 2004.  Potentially reflecting this, recent estimates from the government envisage higher upstream investment than previously expected in 2009 at around $20.2 billion, the increase largely deriving from increases at fields already in production.

UK - September actual:  UK field-specific data for August and aggregate numbers for September paint a mixed picture for UK production.  September's preliminary total came in around 170 kb/d above expectation (with again our field adjustment factor having proved overly aggressive that month).  However, here too there are downside offsets to higher baseline production that keep forecast output on a downward trend:

  • liquids output from the Jura field is trimmed to 6 kb/d from a previous 30 kb/d;
  • the Janice field is to be shut for two to six months from October for safety improvements;
  • the previously included Affleck tie-in appears has been delayed to 2009 (Janice and Afflleck adjustments result in a cut of 10-15 kb/d from expected Fulmar system production) and;
  • Schiehallion field production is now assumed at below 50% of the FPSO's 120 kb/d capacity for 2008 and 2009 until a revamp is completed (30 kb/d cut from forecast West Shetland output).

UK offshore crude output averages 1.3 mb/d in 2008 and an expected 1.1 mb/d in 2009, with onshore crude output and NGL taking total oil production to 1.5 mb/d this year and 1.3 mb/d next year.

In an attempt to maximise recovery from maturing assets, the UK government in November unveiled a series of tax break proposals for marginal fields which it is hoped will be included in the April 2009 budget.  A value-based allowance will be suggested for new fields that fail to attract sufficient development funding, while change of use of North Sea infrastructure for gas or CO2 storage is to be exempt from petroleum revenue tax. Petroleum revenue tax more generally is to be simplified and measures are to be introduced to encourage the transfer of idled assets to new operators.382

Former Soviet Union (FSU)



Russia - October actual, November provisional:  Preliminary November data show Russian oil production running around 50 kb/d below our forecast (at 10.0 mb/d), with output from Lukoil, TNK-BP, Surgutneftegaz and from the Sakhalin 2 project lagging our expectation.  Amid growing anecdotal evidence of deteriorating upstream economics and stated plans by companies for lower upstream spending in 2009, and despite a proposed reduction in the mineral extraction tax from 1 January, we have extended the downward revision through the 2009 forecast.  Total Russian oil output is now seen falling by 200 kb/d in 2009 from this year's average 10.0 mb/d to 9.8 mb/d.  This follows a fall of 65 kb/d in 2008. Condensate and natural gas liquids are estimated to make up around 475 kb/d of total output in both years.

Azerbaijan - October preliminary:  In light of latest available production data covering the August- October period, we have revised up Azerbaijan's production for 3Q08 by 40 kb/d but revised down 4Q08 and 1Q09 by 80 kb/d.  August and September's outages on the BTC pipeline following first a pipeline explosion, and then the conflict in Georgia, thus look to have had less of an impact than we originally estimated. However, oilfield recovery offshore Azerbaijan at the Central Azeri field after a subsequent  and separate gas leak is now taking longer to resolve than previously estimated.  All told, pipeline outages, conflict and the later platform leak have reduced production from the ACG complex by some 60 mb during the August-December period, or nearly 400 kb/d on average.  Full output of 0.9 mb/d is not now expected to be reinstated until early 2009.

October FSU net exports on average increased by 0.11 mb/d to 8.30 mb/d from 8.19 mb/d in September.  Crude oil exports decreased by 0.7% month-on-month, reaching 5.93 mb/d in October.  The drop in crude oil exports was more than offset by a 7% rise in product shipments to 2.42 mb/d.  Residual fuel oil exports on average rose by 4% in October and gasoil exports grew by 12%.

BTC pipeline crude supplies fell by 320 kb/d (almost 46%) as the addition of Kazakhstan's Tengiz crude at the end of the month was not enough to offset production problems at the Central and West Azeri oilfields, which provide the baseload supply for the pipeline.  End-month maintenance of the Russian crude pipeline leading to Primorsk contributed to a 10% drop in Baltic October shipments.  The crude was diverted to Black Sea ports, which saw shipments rebound by 18% (+340 kb/d) to 2.22 mb/d.  Druzhba pipeline exports to the Czech Republic dropped by 30% month-on-month in October, but Russian companies signed agreements to switch to direct crude deliveries to Czech refiners to bypass a trading firm which Russia cites as reason for lower supplies since July.  Druzhba exports to Slovakia and Germany increased by 36% and 27% in October while Russian crude oil exports to China via Kazakhstan's Atasu-Alashankou pipeline rose by 45%.





While lower FSU crude exports can partly be attributed to force majeure on the BTC pipeline and elsewhere, tenuous export economics for Russian producers have also played a role in curbing supplies to international markets in recent months.  Incentives to preferentially export products ahead of crude have been rising, as falling crude prices combined with an inflexible crude export duty regime make crude exports uneconomic.  The previous export tax regime saw levels set in advance for two months, based on lagged Urals prices (e.g. June and July tax levels were determined by March and April crude prices).  By mid-October, prevailing Russian crude export duties of $66/bbl set for October and November were clearly making crude exports uneconomic. According to preliminary November data Russian crude exports via the Transneft system decreased by 440 kb/d (10%) and were the lowest in nearly five years.  Black Sea loadings fell by almost 20% while Baltic shipments and via Druzhba decreased more modestly.

The government reacted by making extraordinary cuts in export taxes for October and November, but the move reportedly did not stop companies from cancelling or decreasing loadings in the second half of both months to prevent losses.  New duty levels were set at $51/bbl for October, with a further cut to $39/bbl applicable from 1 November.  December duties will fall to around $26/bbl under a new regime, in which average daily Urals prices for mid-October through mid-November set the tax for that month.  Duties will also now reportedly be set monthly, instead of every two months.

OECD stocks

Summary

  • Total OECD industry stocks built by 45.6 mb in October, as US crude and product stocks recovered after hurricane disruptions and continued weak demand added to product stockpiles.  OECD European and Pacific crude stocks increased following higher crude production and relatively low refinery activity.  Total OECD crude stocks saw a 26.2 mb build while products added 17.6 mb, of which 11.1 mb in gasoline and 7.8 mb in 'other products'.  Inventories totalled 2,697 mb at end-month.
  • Further downward revisions to OECD demand added to growing stockpiles, increasing forward demand cover for end-October to 56.8 days, 4.1 days higher than a year earlier and the five-year average.  Regionally, stocks in terms of forward cover are high in North America and Europe, but close to their five-year average in the Pacific.  In terms of absolute levels, however, stocks are only trending marginally above their five-year range in Europe following recent sharp builds in crude stocks and high distillate inventories.
  • Preliminary November data point to another stock build of 10.3 mb in OECD industry stocks.  US inventories are expected to be 13.2 mb higher, with increases of 8.4 mb of crude oil and 4.8 mb in products.  Japanese product stocks on the other hand were falling seasonally (-6.1 mb), while European inventories were slightly higher (+3.3 mb).


OECD Inventory Position at End October and Revisions to Preliminary Data



Total OECD oil inventories built by 45.6 mb in October, closing the month at 2,697 mb, 78.4 mb above the same month last year.  Both crude oil and product stocks increased and builds were seen in all OECD regions.  The largest build was in North America, where US Gulf Coast refineries and port facilities resumed operations after hurricane-induced closures in September, while demand continued to lag levels of a year ago.  Increasing crude oil stocks were also registered in Europe and the Pacific, outpacing regional product draws.  Higher crude supplies from the North Sea and lower refinery operations due to maintenance, a slew of unscheduled outages as well as economic run cuts, underpinned stock movements.

The forward demand cover featured an even larger increase in October, as lower forecast OECD demand amplified the effect of higher inventories.  Total oil stocks were 56.8 days at end-month, compared with 52.7 days in October last year.  Regionally, forward demand cover came to 55.2 days for North America, 63.2 days in Europe and 49.7 days in the Pacific, compared with year-ago levels of 50.4, 59.1 and 48.1 days, respectively.  Perceptions of the level of forward stock cover can of course change rapidly in the event of demand fluctuations caused by weather or economic events.



September data are only marginally upgraded since last month's report, as an 18.4 mb upward revision to North American inventories largely offset lower-than-estimated stocks in Europe and the Pacific.  North American stocks were revised up for all categories bar crude oil.  A 10.6 mb revision to 'other products' and a 4.3 mb revision to 'other oils' make up the bulk of the changes.  Smaller changes to gasoline (+2.4 mb) and distillates (+3.1 mb) only slightly improve the US year-on-year deficit resulting from Hurricane Ike disruptions apparent in September data.  Downward revisions totalling 8.8 mb were recorded for European inventories for September as higher crude oil stocks in Germany, Italy and the Netherlands failed to offset lower product stocks across the continent.  Japanese crude oil stocks for end-September were also lower than indicated by preliminary data, reducing OECD Pacific crude oil stocks back below their five-year range.

Floating Storage Additions Further Augment Onshore Industry Stocks

Recent reports point to a significant increase in floating storage over the last few months.  As many as 16 tankers have reportedly been hired for offshore temporary storage.  The VLCCs, once filled, could add up to 26 mb according to industry and shipping sources, which would come in addition to onshore inventories reported in IEA statistics.  OMR balances capture quarterly changes to floating storage and oil in transit in our Table 1, 'World Oil Supply and Demand Balance', but these latest developments -- occurring after the end of the third quarter -- do not show up in current balances.

An equivalent major run-up in floating storage was last seen in spring 2008, when Iran reportedly held 20-30 mb offshore due to problems marketing heavy/sour crude.  In this instance, several tankers are currently storing oil in the Gulf of Mexico, but reports also show increased short-term storage rentals for the North Sea, India and Malaysia.

The increase in floating storage has developed as a result of abundant prompt supplies having a hard time finding customers, further supported by lower freight rates.  The forward price structure, in both paper and physical markets, shows a strong forward premium, i.e. a contango, driven by prompt price weakness.  This further encourages storage as the price premium covers the cost of storage.  The cost of storing oil on a super tanker is by some shipping sources estimated to 90 cents per barrel per month, plus at least a further 30 cents a barrel to cover the cost of capital in addition to insurance and other costs.

OECD Industry Stock Changes in October 2008

OECD North America

North American total oil stocks built by 37.0 mb in October as both crude and products moved higher.  After severe hurricane disruptions to the US oil supply chain in September, October builds brought total stock levels back above historical averages.



North American crude oil stocks increased by 9.1 mb in October, as higher US inventories offset lower Mexican stocks.  US crude stocks built by 11.6 mb in the month, as a return to normal operations by port facilities on the Gulf Coast led to a sharp increase in imports.  Crude oil imports into the Gulf averaged 6.2 mb/d in October, compared with 4.3 mb/d a month earlier and 5.5 mb/d last year.  At the same time, refinery runs had almost recovered, averaging 82% of capacity for the month, after hitting all-time lows in September.  Weekly data show US crude stocks continued to build in November, adding another 8.4 mb to tanks.  Crude oil stocks at Cushing, the delivery point for NYMEX Light Sweet Crude, rose sharply in October and November, according to weekly data.  From a low point of 14.4 mb reached in early October, stocks have risen to 22.9 mb.  The sharp increase in stocks is, as for increased floating storage, indicative of abundant prompt supplies, as is the strong contango in the front month spread, which has increased sharply in recent months.

US product stocks saw significant builds during October, adding 24.8 mb to inventories following increased product supplies and weak domestic demand.  Builds in US gasoline and distillate stocks of 11.6 mb and 5.3 mb respectively allowed product inventories to move back in line with five-year averages after falling to their lowest September level in eight years.  However, distillate stocks in the US North East (PADD1), the main heating oil consuming region, are trending at the lower end of their five-year average just as winter demand is starting to pick up.  US product inventories continued to build in November, adding 4.8 mb in total.  In contrast to October, however, only 'other oils' and gasoline stocks increased, while all other product categories fell.



OECD Europe

European crude oil stocks continued to build during October, adding 14.8 mb to already ample supplies.  The bulk of the increase came from Norway, where crude and condensate production picked up after maintenance and unscheduled outages seen in August and September.  Stocks also increased on the continent due mostly to lower refinery activity.  Outages and maintenance lowered refinery operations in the Netherlands, Italy and the UK, and a poor economic environment encouraged reduced runs elsewhere.



European total product inventories on the other hand were lower in October with draws in all product categories.  Distillate stocks fell by 3.9 mb in the month, though stocks are still trending well above historical averages, both on a volumetric basis and in terms of forward demand cover.  German distillates stocks were slightly higher (+0.8 mb) despite a sharp pick up in deliveries in October (+57.4% for heating oil and +1.9% diesel).  German consumers continued to take advantage of lower prices to refill depleted heating oil stocks.  During the July to October period, German consumers have added a total of 34 mb to household tanks, compared with only 12 mb last year and a 22 mb period average over the last five years.  But at 62% of capacity, household stocks were still 1.1 percentage points below the recent five-year average.  Elsewhere in Europe, demand continued to slide, leaving product available for storage.

Preliminary data from Euroilstock show that in November, EU16 inventories were 3.3 mb higher than the previous month.  Stocks held in independent storage in the Amsterdam-Rotterdam-Antwerp area were higher in all categories in November.  Fuel oil inventories in particular were higher, as rising FSU exports coincided with limited arbitrage opportunities to Asia following a slew of arrivals in Singapore over the October November period.  Gains in other products were more modest, as inflows only marginally exceeded inland deliveries and exports out of the region.

OECD Pacific

OECD Pacific crude oil stocks moved slightly higher in October as a build in Japanese inventories was partly offset by lower Korean stocks.  Korean crude oil stocks fell on reduced imports, to their lowest level since at least January 1997 (from which point a consistent time series is available).  Although crude prices have come down sharply since summer, the simultaneous depreciation of the Korean currency still makes crude very expensive for Korean refiners (the Won has depreciated by about 40% relative to the US dollar since the beginning of July).  Japanese crude oil stocks, meanwhile, built due to higher imports and lower refinery runs.



Product stocks were relatively unchanged in the region, as, again, higher Japanese inventories offset draws in Korea.  Korean product stocks fell by 2.5 mb, mostly due to lower fuel oil stocks.  Korean product stocks were down despite weak demand and higher year-on-year refinery runs, as product exports were higher.  Fuel oil exports to Singapore in particular were supported by strong bunker demand.  Japanese product stocks built by 1.7 mb, despite lower refinery throughputs.  Product demand continued to lag levels of a year ago, and increased global supply availabilities/decreased regional demand made it harder for Japanese refiners to find buyers for excess production.

Weekly data from the Petroleum Association of Japan (PAJ) point to declining Japanese product stocks in November.  Despite crude runs picking up quite sharply (from 73.1% utilisation in October to 81.7% in November), total throughputs were lower than last year.  Because of the lower-than-normal refinery activity, kerosene stocks in particular have fallen below their recent five-year range at the onset of winter.  Both gasoline and diesel/gasoil stocks, however, are still at comfortable levels as lower demand has more than offset the reduced refinery supplies.

Recent Developments in Singapore Stocks

Independent stocks held in Singapore, as measured by International Enterprise, were largely unchanged in November, as higher fuel oil stocks were offset by lower light and middle distillates.  Middle distillates came down from recent record highs as buying by Indonesia and Vietnam increased somewhat, while fuel oil stocks built on large volumes of arbitrage material coming from Europe, the US West Coast and Latin America.  It should be noted however that increasing storage capacity has been added in Singapore over the last year, in large part explaining higher recent stock levels.





Prices

Summary

  • Crude oil prices dropped to nearly $40/bbl by early December, amid continued signs of economic slowdown and OECD demand decline.  Weak refining margins are causing economic run cuts and in turn a crude overhang, as manifested in growing stocks (also in floating storage) and a widening contango.  Despite clear signs that any decision on output policy would be deferred to December, the absence of a new OPEC agreement to further curb output as the group met unofficially in Cairo in late November, was taken bearishly by the market.
  • Spot crude markets were hit by the widening contango, growing stocks and weakening refining margins.  The prevalent disparity between light/heavy products on the one hand and distillates on the other is narrowing crude quality differentials.  Urals and Dubai have both briefly risen to parity with Dated Brent.
  • Refining margins fell in November and remain negative in many cases.  Distillate crack spreads were broadly steady, just managing to hold up margins in the light of negative gasoline and naphtha, which remains at a greater discount to crude than fuel oil.  Compared with US and Singapore margins, European margins fared slightly better.  News reports indicate widespread economic run cuts in Japan, Korea and perhaps even China.
  • Freight rates dipped for all routes amid the generally weaker economic outlook and lower long-haul export volumes.  OPEC trimmed output in November and early tanker-tracking reports indicate a further curb in exports in early December, pressuring VLCC rates on the benchmark Middle East Gulf-Japan route.  Clean rates suffered too, with lower trade on the Atlantic and Far Eastern routes.  Surplus vessel availability is contributing to temporarily attractive floating storage.


Overview

Increased evidence of a severe global economic slowdown put further downward pressure on prices throughout November and early December.  Benchmark crude futures fell from around $55/bbl at the time of last month's report to currently just above $40/bbl, their lowest since early 2005.  We now see global demand contracting in 2008, as weakness in OECD countries outweighs lingering strength in emerging markets.  Mounting evidence of rising oil inventory, daily news about the extent of the economic malaise and shrinking refining margins all point towards weak product demand and an overhang of global crude.  Despite clear signs that any decision on output policy would be deferred to December, the lack of a new OPEC agreement to curb output further as the group met unofficially in Cairo in late November, was taken bearishly by the market.

Latest data show even greater-than-anticipated demand weakness or contraction in many OECD countries, most notably the US.  Our own analysis now shows a fall in global demand this year, as the world's economy slows down rapidly.  Prices have continued to show strong volatility, often rallying sharply on news of further economic stimulus initiatives or interest rate cuts, both of which have been plentiful.  But the rapid spread of economic contagion has blanketed out all other market signals, including even - so far - the fact that retail prices have also fallen sharply, e.g. gasoline in the US is back below $2/gallon at the pump, tumbling from a high around $4/gallon in the summer.

Statements by OPEC Ministers appear to make a further cut in quotas at the Algeria 17 December meeting likely.  Specifically, the mention of a preferred level of OECD stock forward demand cover around 52-53 days and a 'fair' crude oil price of $75/bbl would bear out OPEC's intention to stem the price decline.



As a result, oil stocks are rising, with gains in OECD inventory measured in October, while preliminary data show a further increase in November, including at WTI's delivery point in Cushing, Oklahoma.  Crude futures' contango has now widened to a point at which stockpiling is becoming economic, according to anecdotal reports, though credit and cash flow considerations may still weigh against this.  News stories indicate a flurry of VLCC bookings for offshore storage, as freight rates are also depressed due to lower long-haul, mostly OPEC, loadings.

Product markets also confirm the current weaker fundamentals.  Gasoline and naphtha crack spreads remained mostly negative in November and early December.  NYMEX RBOB futures dipped below $1/gallon for the first time since they were first quoted in late 2005.  Fuel oil discounts have narrowed again, but with a slight dip in distillate cracks, the latter's ability to prop up refining margins was strained and news reports indicate further planned economic run cuts at refineries.  Distillate cracks in coming months will be influenced by both winter temperatures and the imminent start-up of India's huge Jamnagar refinery expansion, which is reported to be heavily weighted towards exporting high-quality distillates.

Spot Crude Oil Prices

Spot crude markets were marked by a growing overhang of prompt cargoes and weakening refining margins on the back of the still-wide divide between strong distillates on the one hand, and the weaker extremes of the barrel on the other.  In Europe, Russian Urals once again rose to parity with Dated Brent on lower exports in November.  European refinery runs are down, with margins sliding, and regional crude stocks rising sharply by the end of October.  Furthermore, Russian crude export duties, which up until December have lagged crude price developments, were high to the point of making exports outright uneconomic.  The government has since altered its price calculation, but it remains to be seen how this affects December exports.

Dated Brent also fell to a discount to Middle Eastern benchmarks Dubai and Oman, potentially affecting the arbitrage to Asia.  Despite this, Asian imports from West Africa for December again fell and are now expected to total around 860 kb/d, down from November's 920 kb/d and far lower than last year's 1.2 mb/d.  Japanese, Korean and Chinese refiners were all hinting at economic run cuts amid unprofitable margins, though similar pronouncements made by Chinese refiners last month were not reflected in official statistics (indeed, until the Chinese government changes its administered wholesale prices, most analysts reckon Chinese refiners are enjoying a period of unusual profitability).  As for light sweet crudes, naphtha-rich Asian regional benchmark Tapis fell further compared with Dated Brent and Dubai, the latter development heralding a general narrowing of sweet-sour differentials.



In the US, where refining margins remain mostly depressed or negative due to weak gasoline, heavier, more sour crudes gained vis-à-vis light sweet WTI.  The latter is possibly also pressured by high and rising stocks at Cushing, Oklahoma, the delivery point for the NYMEX Light Sweet Crude contract, as the ever-widening contango makes storage worthwhile.  In addition, in theory, US domestic light sweet crudes benefit from the narrowing of the WTI-Brent spread.



Refining Margins

Refining margins mostly fell in November, as gasoline (and naphtha) weakness continued to weigh on spreads.  The most pronounced fall last month was on the US West Coast, which was particularly hard hit by falling gasoline prices.  As a result, margins there fell by around $10/bbl in November on average and, in the case of light/medium cracking, moved into negative territory.  US Gulf Coast margins also remain depressed, mostly falling on the month.  This was despite relatively pronounced gains in distillate cracks, in contrast with other regions.

European refining margins are still holding up, relatively speaking, with light sweet hydroskimming spreads increasing.  Europe, as outlined in previous reports, is benefiting from its higher distillate yields and, on average, higher crack spreads for diesel.  In Asia, Tapis margins rose on the grade's relative weakness, but overall, margins are mostly negative.  Fuel oil discounts to crude narrowed in November on average, though they picked up trend-wise towards the end of the month on increased Chinese buying, which could yet come to the aid of Singapore margins.  As mentioned above, news reports indicate widespread economic run cuts at Japanese, Korean and Chinese refineries.



Spot Product Prices

Gasoline prices remain unusually weak, with crack spreads largely negative throughout most of November and into early December in all markets.  Refiners are scrambling to adapt yields towards more distillate output where they can, but demand weakness emanating from the US above all is proving difficult to deal with.  Road transport and car sales statistics show a clear downward trend, though this may yet be affected by a sharp fall in gasoline pump prices since the summer.  Europe is shipping some excess gasoline to West Africa, while the US is taking in less than normal, but lower demand is prompting European run cuts too.  Meanwhile, naphtha's unprecedented discounts to crude have halved since our last report in early November, but remain in the $15/bbl range.  Petrochemical demand has picked up somewhat after margins improved.  Specifically, South Korean producers reportedly returned to the spot market for January cargoes after term deal renewal talks were delayed.



Distillate crack spreads trended slightly lower in November and early December, now on average hovering around the $20/bbl mark.  In Europe, heating oil sales were again robust, with lower retail prices encouraging consumer stock building and, in Germany, ahead of a sales tax increase due in January 2009.  Independent gasoil stocks held in the ARA region were down over the course of the month, but remain above average.  In contrast, jet fuel stocks are well above their five-year range, reflecting the downturn in global air travel.  At the time of writing, a strike by port workers at France's southern Fos-Lavera hub was hampering loading operations, but had not yet materially affected product flows or prices.  Meanwhile, in Asia, distillate cracks came under pressure due to China reverting to net-exporter status.  In December, China was expected to export 20-30 kb/d of gasoil, in sharp contrast to imports of over 200 kb/d seen during the summer.



Fuel oil discounts to crude narrowed over the course of the past month, with demand picking up slightly.  Colder weather and lower relative prices have encouraged some fuel switching in the US for low-sulphur fuel oil (LSFO).  In Asia, more attractive refining margins for so-called 'teapot' refineries in China have encouraged higher purchases of high-sulphur product.  However, this is partly offset by higher volumes of fuel oil moving into the region.  Some 2.5 million tonnes of fuel oil are expected to arrive in December, though less than November's record 3.6 million tonnes, after exports from Russia and the Caribbean were hiked.  Meanwhile, Saudi Aramco has confirmed it will no longer sell term fuel oil volumes from 1Q09 due to higher domestic requirements, thus tightening future supply.



End-User Product Prices in November

Retail product prices dropped by 23% month-on-month, in US dollars, ex-tax, in November, following plummeting benchmark oil prices.  Gasoline prices on average fell by 28%, while diesel and heating oil prices were down by almost 19%.  Low-sulphur fuel oil prices on average fell by 27%.  Retail prices in all surveyed IEA countries were 22% below November 2007 levels, in US dollars, ex-tax, except diesel and heating oil retail prices in Japan, which were 15% higher than a year ago.  Taking tax into consideration, last month US consumers on average paid $2.15/gallon for gasoline ($0.567/litre), Japanese consumers paid ¥136/litre ($1.398/litre), consumers in the UK £0.953/litre ($1.459/litre), and European consumers paid from €1.208/litre in Italy ($1.532/litre) to €0.94/litre in Spain ($1.192/litre).

Freight

Clean and dirty freight rates headed down in November, continuing to feel the impact of the weaker trading environment in the economy at large and for oil in particular.  Latest tanker-tracking data show a further curb in December OPEC export volumes, which is hitting long-haul rates.  Since last month's report, VLCC chartering costs on the benchmark Middle East Gulf-Japan route have slipped from around $12.50/tonne to near $10/tonne, also against many reports of Far Eastern refiners curbing runs on weak demand and a crude overhang.  A similar downturn was visible for Aframaxes, making the journey from West Africa across the Atlantic, with rates tumbling from near $23/tonne to $18/tonne over the past month.  However, low freight rates and an ever-widening contango in benchmark crude futures are beginning to attract the use of tankers for floating storage, despite persistent concerns over credit and cash flow.  News reports indicate the booking of several VLCCs to hold crude off the US Gulf Coast and in the North Sea, though volumes could not be confirmed.



Clean freight rates' downturn was also pronounced as falling or weak demand growth discourages trade.  Rates on the Middle East Gulf-Japan 75 kmt route slid from around $50/tonne one month ago to a current $35/tonne.  Meanwhile, UK-US Atlantic Coast rates were steadier, hovering around $20/tonne, but had previously fallen sharply in September/October as the usual bustling transatlantic gasoline trade began to dry up on weaker US demand.

The oil tanker trade hit the headlines when the VLCC Sirius Star, owned by Saudi Aramco's tanker arm Vela, was captured by pirates off East Africa in mid-November.  With around 2 mb of crude onboard, this is the largest ship ever held by pirates and brought the very real threat of piracy in some parts of the world home to oil and other markets.  The fact that the Sirius Star was boarded several hundred miles offshore East Africa was also a departure from previous hijackings, which are common off Somalia, but mostly take place in coastal waters.  In most cases, ships and crew are freed after the payment of a ransom, but this and other hijackings since could yet boost freight rates and insurance.  Despite a beefed-up international naval presence in the area of risk off the Horn of Africa and in the Gulf of Aden, news reports indicate that shipping companies are choosing to divert their ships around the Cape of Good Hope rather than go through the Suez Canal - which potentially adds as many as 10-20 days to a journey, as well as increasing fuel costs.

Refining

Summary

  • Global 4Q08 crude throughput is expected to average 72.6 mb/d, 0.8 mb/d lower than forecast in last month's report.  Factors contributing to this downward revision include the weaker demand now envisaged for the period and the poor margin outlook, particularly on the US Gulf Coast.  Lower Asian and OECD North American crude throughput forecasts account for the majority of the decline.
  • October global crude throughput of 72.0 mb/d was 0.1 mb/d below forecast according to provisional data.  Crude runs in the OECD and China were 0.8 mb/d ahead of our forecasts, but this was offset by lower than expected crude runs in Saudi Arabia and India.
  • Global 1Q09 crude throughput is forecast to average 73.5 mb/d, a decrease of 0.4 mb/d against 1Q08, driven by a 0.7 mb/d year-on-year decline in the OECD.  Year-on-year growth in crude throughput still looks likely in the non-OECD regions, notably in the Middle East, China and the FSU, while weaker crude throughput in Other Asia and Africa depresses the overall non-OECD increase.


  • OECD crude throughput averaged 36.9 mb/d in October as US refineries increased throughputs following the hurricane-related disruption in September.  Despite crudes runs rebounding by 1.3 mb/d on the month, they remain 0.9 mb/d below levels of a year ago.  Run cuts remain an issue for refineries in the US, particularly on the Gulf Coast, as well as in Japan and Korea.  European refineries continue to enjoy the healthiest regional margin environment, with Brent hydroskimming margins of around $3/bbl, some $4/bbl above levels of a year ago.
  • The repercussions of the credit crunch continue to constrain refiners' ability to optimise operations.  Unconfirmed reports suggest some refiners are being forced to prepay for crude purchases, having been unable to secure letters of credit.  Additionally, the inability for refineries to trade without credit constraints is likely to have distorted normal market practices and induced further run cuts as refiners balance operations against their contractual inland demand requirements, while shunning incremental export-related opportunities.  As noted in our MTOMR refining supplement earlier in December, investment impacts will also likely be felt from the current market slump.

Global Refinery Throughput

Continued reports of weak demand and rising stocks in the OECD, combined with weak margins in the US and Asia continue to weigh on refinery utilisation levels.  This report's estimate for global 4Q08 crude runs has been cut by 0.8 mb/d in line with the lower demand estimates, despite provisional October data for the OECD being slightly stronger than forecast.  Run cuts remain a necessity for refineries in the US, Japan and several Asian countries, as weak demand has translated into unwanted stocks.  Nevertheless, our forecast could be subject to upward revision if demand picks up, due to colder weather, resulting in stronger middle distillate cracks.

Recent announcements by independent refiners suggest that capital expenditure plans for 2009 continue to be cut as refiners reposition their businesses and their balance sheets to weather the weaker demand, margin and economic environment they currently face.  Furthermore, refiners are reported to be holding higher cash balances than previously to protect against the financial market turmoil.  In addition, the prospect of increased working capital, due to factors such as the inability to secure letters of credit, is also altering the structure of their balance sheet.  The lower oil price will however reduce working capital requirements, but does not offset the impact of having to pay for crude well in advance of previous arrangements.

The competition between European and US Gulf Coast refiners to move high quality gasoline to the US East Coast market in the face of slowing US demand, continues to depress Atlantic Basin and global gasoline cracks.  However, the higher yield of distillates enjoyed by European refiners is currently supporting their crude runs at the expense of US Gulf Coast refineries.  Recent comments highlight that an increasing number of Gulf Coast refiners have moved to cut throughput of fluid catalytic cracking units, (historically a major source of refining profitability), in addition to crude distillation units.  The recent strength in hydroskimming margins, driven by a narrowing of fuel oil discounts and high middle distillate cracks appears to be leading a reversal of this industry trend, at least temporarily.



Preliminary data for November indicate that global crude throughput averaged 72.4 mb/d, 1.1 mb/d below last month's forecast of 73.5 mb/d.  Lower-than-expected crude runs in the US, Mexico and India account for much of the downward revision.  Weaker US crude throughput reflects the continued weak state of gasoline cracks and the impact they are having on US Gulf and East Coast crude runs, as discussed above.  As highlighted last month, our forecast incorporates increasing volumes of crude throughput based upon the assumption that Reliance Petroleum's Jamnagar refinery expansion will start up during 4Q08.  However, the lack of confirmation of the completion of commissioning also results in a downgrade to our November estimate.

Estimated global 4Q08 crude throughput of 72.6 mb/d is 0.8 mb/d lower than last month's forecast, following further downward revisions to the demand estimates contained in this report.  Reductions to forecast North American and Asian crude runs total 0.7 mb/d, with an increased prevalence of run cuts in both regions now incorporated into our estimates.  A more muted seasonal increase in crude throughput is forecast for December, with global crude runs now expected to average 73.5 mb/d, a reduction of 1.3 mb/d to our previous forecast and 2.1 mb/d lower than the December 2007 level, as we largely discount the typical seasonal increase in crude throughput under the current market outlook.

We have rolled over our forecasts to cover 1Q09 and assume that the weak crude throughput patterns currently visible in several regions will continue next quarter.  As such, forecast global throughput is 73.5 mb/d, 0.4 mb/d below 1Q08.  Furthermore, the seasonal increase in maintenance work, particularly in the US, will further reduce crude runs for OECD North America to an average of 17.2 mb/d, down 0.3 mb/d quarter-on-quarter and 0.4 mb/d lower than in 1Q08.  Elsewhere, we have omitted the ramp-up in runs from new capacity starting in China, ahead of more clarity on new refinery start dates and have included only partial crude throughput volumes from Reliance's Jamnagar refinery expansion.  Lastly, we have maintained the assumption that run cuts continue throughout the quarter.

OECD 4Q08 crude throughput is forecast to average 37.2 mb/d, 0.3 mb/d below last month's report.  Many of the factors previously highlighted in this report as presenting a downside risk to our forecasts have materialised, and OECD crude throughput during the quarter, notably in the US are consequently lower.  This downward revision occurs in spite of a promising start to the quarter, with provisional October data suggesting that crude runs were 0.3 mb/d ahead of expectations.  Some European countries may be subject to further upward revisions next month when official data were submitted, if our assumptions about refinery maintenance are proved wrong.

OECD North America crude throughput bounced back in October, to an average of 17.4 mb/d, following the recovery from hurricane-related disruption to US Gulf Coast refining in September.  However, US crude throughput has struggled to move above 15 mb/d since the hurricanes disrupted operations, with industry reports citing weak margins rather than knock-on storm effects as being the root cause.  November regional throughput is 0.5 mb/d below last month's forecast, at 17.4 mb/d with unplanned outages on the US Gulf Coast and Mexico adding to the low throughput level.  North American December throughput is forecast to remain below seasonal norms at 17.7 mb/d with only the prospect of stronger gasoline or gasoil cracks likely to boost runs significantly.



OECD Pacific October crude runs were broadly unchanged when compared with September, despite the recovery of Japanese crude runs over the course of the month from the seasonal low seen at the end of September.  Nevertheless, OECD Pacific crude runs also remain subject to curtailment from voluntary run cuts.  A host of Japanese refiners, including, Nippon Oil, Showa Shell, Toyo Oil and Idemitsu Kosan have all announced cuts of as much as 20% for December.

Furthermore, some refiners reported that planned November run cuts were doubled during the month to offset weak demand.  We continue to assume that Japanese refinery utilisation rates will increasingly lag the five-year range through to the end of the year, but note that the lower Japanese crude throughput has resulted in kerosene stocks dropping below the five-year range.  This offers the potential for an increased supply requirement, were demand to spike on the back of colder weather.



Despite the announcement of additional run cuts by Japanese refineries, forecast 4Q08 OECD Pacific crude throughput is revised up by 0.1 mb/d as last month's reduction broadly captured these effects for the region.  In addition, provisional data for October crude runs were 0.1 mb/d ahead of expectations.  Nevertheless, we retain our cautious stance on the outlook for Japanese crude runs and would still see a move significantly above 4 mb/d, (excluding the processing of condensates by some Japanese refineries), as requiring significantly stronger refinery economics. 



OECD Europe crude throughput fell further in October, based on preliminary data.  Maintenance at refineries in Italy, Portugal and the Netherlands all contributed to the lower estimate of 12.9 mb/d.  November crude runs are expected to remain flat month-on-month, but the region's improved light sweet crude hydroskimming margins, particularly in the Mediterranean, may result in runs exceeding our expectations during the month.  That said, the restart of capacity following a heavy maintenance season in October and November (partly driven by the need to meet the tighter European Union product specifications for gasoline and diesel at the beginning of 2009) is likely to weigh on margins during December. However, the credit-constrained trading arrangements currently in place and the introduction of 10 ppm diesel at the beginning of next year could partially offset this impact.



Forecast 4Q08 non-OECD crude throughput has been revised down this month by 0.6 mb/d to 35.5 mb/d.  Weaker crude runs result from heavier assumed economic run cuts for Singapore, Chinese Taipei and Thailand, amongst others.  Lastly, we have extended our more cautious outlook for Nigerian crude runs through until the end of 4Q08, on reports that the Warri and Kaduna refineries remain effectively offline.

Chinese October crude runs were significantly ahead of our forecast at 7.0 mb/d, according to National Bureau of Statistics data.  Consequently, we have partially reversed last month's reduction to forecast crude throughput and increased November and December by nearly 0.2 mb/d.  Slowing demand growth, due to the global financial crisis, has been greater than originally anticipated, and is likely to weigh on future refinery activity levels, but the impact of this will be countered by the rapidly improving refinery economics, in light of the lower world oil prices.  However, the impact of a more liberalised product price has yet to be incorporated into our forecasts, pending clarification of exactly how it will work for independent and teapot refineries.  1Q09 crude throughput is assumed to average 6.9 mb/d, as we exclude the impact of new refining capacity additions, pending confirmation of start dates and ramp-up timeframes, following industry reports of delays to several projects.

Middle East 4Q08 crude throughput is lower this month following a very weak reported October level for Saudi Arabia of 1.6 mb/d, almost 0.4 mb/d below our forecast and September's level.  Similarly, Iranian crude throughputs were weaker than forecast during September and October, but we have not yet altered our forecasts for the balance of the quarter on the back of this data.

Forecasts 4Q08 Other Asia crude throughputs are 0.5 mb/d lower this month, on the back of much more aggressive run cut assumptions for the region and lower Indian forecast awaiting the start-up of Reliance's 580 kb/d Jamnagar expansion.  As highlighted last month, we see the merchant refineries such as those in Singapore as being exposed to the weaker economic outlook and margin environment.  However, lower crude throughputs is also likely elsewhere in the region if demand weakens and refiners choose to cut runs rather than export potentially unprofitable product cargoes, or if credit risks make such trade unattractive.