Oil Market Report: 16 January 2009

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Highlights

  • Forecast global oil demand in 2009 is revised down by 1.0 mb/d, following a halving of assumed GDP growth to 1.2%, given the worsening outlook.  Global oil demand is now projected at 85.3 mb/d in 2009 (-0.6% or -0.5 mb/d year-on-year).  The 2008 estimate is revised down 70 kb/d to 85.8 mb/d (-0.3% or -0.3 mb/d versus 2007).  The expected two-year contraction in oil demand would be the first since 1982 and 1983.
  • Global oil supply was flat in December at 86.2 mb/d, with curbed OPEC output offset by gains elsewhere.  Non-OPEC supply for 2008 and 2009 is forecast at 49.5 mb/d and 50.0 mb/d, lowered by 60 kb/d and 30 kb/d versus last month's report.  2008 output declined by 150 kb/d, partly due to the first fall in Russian supply since 1996.  2009 growth is forecast at 0.5 mb/d, in addition to a 0.6 mb/d increment in OPEC NGLs.
  • December OPEC crude supply was 30.9 mb/d, down 330 kb/d versus November. This was 1 mb/d below September 2008 levels, and nearly 2 mb/d below mid-2008 highs.  OPEC agreed a new target of 24.8 mb/d from January, equivalent to OPEC-13 output of 28.2 mb/d versus a reduced 2009 'call' of 29.5-30.0 mb/d.
  • 1Q09 global refinery throughput is forecast at 72.3 mb/d, 1.2 mb/d lower than last month's report.  Weaker global demand and poor economics continue to hamper crude runs.  Evidence of more structural changes to the refining industry is emerging in addition to reduced plant operation rates.
  • OECD industry stocks fell by 2.0 mb to 2,658 mb in November, as a US build was offset by lower European crude and Pacific distillates.  Despite a downward revision to October data, end-November forward demand cover remains high at 56.4 days on lower OECD demand.  Preliminary December data indicate an OECD draw of 8.0 mb.
  • Crude oil prices rose to nearly $50/bbl in early January, supported by cold weather, the Russian/Ukrainian gas crisis and fighting in Gaza.  Subsequently, weak global refinery demand and an increasing crude overhang have pressured Brent futures to currently around $45/bbl, while WTI was at $35/bbl, distorted by record-high Cushing stocks.

A moving target

One problem analysts currently face is that as the economic outlook worsens, so the shelf life of prevailing forecasts for GDP and oil demand shortens.  Exceptionally this month, we try to pre-empt widely flagged, but as yet unspecified, downward revisions to global GDP growth forecasts from the major international institutions.  We normally rely on projections from the IMF, the OECD and Consensus Economics in trying to construct a balanced GDP view and consciously avoid dabbling in macroeconomic crystal ball gazing ourselves.  This month we are forced to anticipate upcoming institutional revisions on the likelihood that the IMF and others will shortly cut their forecasts.  Our GDP changes try to reflect the worsening trends evident since mid-December when we published our last Oil Market Report (OMR).  Crucially, the IMF's managing director has gone on record saying its next forecast will incorporate sharply lower global growth, with China in particular prone to a steep slowdown.



We now assume 2009 global real GDP growth of 1.2%, versus the IMF's November estimate of 2.1% we employed last month.  Much of our interim revision rests on the recent Consensus Economics survey.  The non-OECD GDP projection is cut by nearly a quarter, to 4.1% for 2009, while OECD contraction is pushed to 0.9%, from an earlier decline of 0.2%.  Many forecasters go lower still, and although our assumptions are provisional and prone to adjustment, we await the IMF update before going further.  For China, a recent spate of lower GDP forecasts range from 5% (mainly commercial banks) to 7.5% (World Bank).  We have gone mid-range at 6.5%, acknowledging that uncertainty for China is high.

Combined with a lower 4Q08 demand baseline, this has dramatic implications for our 2009 oil demand forecast, which now stands at 85.3 mb/d, down by 1.0 mb/d from last month, and a contraction of 0.5 mb/d from 2008 (itself some 0.3 mb/d lower than 2007).  OECD 2009 demand is cut by 0.5 mb/d (declining by 1.2 mb/d vs 2008), and the Chinese outlook is cut by 0.3 mb/d, suggesting 2009 growth of less than 0.1 mb/d.

Not only demand has been cut since the last OMR however.  Non-OPEC supply and OPEC NGL have been trimmed by a combined 0.1 mb/d for 2008 and 2009.   The IEA has previously flagged the need for sustained investment when economic slowdown occurs, in order to avoid a renewed supply squeeze when demand growth recovers. While government stimulus packages can help sustain investment in clean energy forms, private sector, conventional upstream oil and gas investment is already being hit.  That said, modest non-OPEC growth should resume this year, reinforcing OPEC's desire to cut output in the face of weak demand, even if questions persist over compliance.  In fact, OPEC's production target looks to us to be below the underlying 'call' for 2009.  Commercial inventory could therefore tighten, even while spare capacity increases, albeit 4Q08 stocks are starting from a high base at 56 days plus of forward cover.  Lower winter temperatures and interrupted Russian gas supplies via Ukraine have supported heating oil, but have also put a floor under crude prices in Europe at least.

However, it would be wrong to suggest that minor adjustments to non-OPEC supply and commercial stocks come close to offsetting a weaker global economic and oil demand trend that has yet to bottom out.  Highlighting the weak state of demand, both for oil and for seaborne transport, floating storage is estimated to have risen recently to between 50-80 mb.  This will eventually find its way into onshore storage, possibly offsetting some of OPEC's attempts to deflate what it sees as an OECD commercial stock overhang.  Meanwhile, consuming nations like China and the US are taking advantage of prevailing prices to build strategic stocks. Demand will eventually rebound to absorb this oil currently struggling to find a market, but predicting the timing and extent of the rebound remains as elusive a target as ever.

Demand

Summary

  • Forecast global oil demand has been sharply revised down for 2009, following a reassessment of global economic prospects partly based on the latest survey by Consensus Economics (the forthcoming IMF economic assumptions, to be released by the end of January, will be incorporated in next month's report).  Global GDP growth has been roughly halved to 1.2%, given the worsening outlook in OECD and non-OECD countries alike, notably in Asia and Latin America.  Global oil demand is now projected at 85.3 mb/d in 2009 (-0.6% or -0.5 mb/d year-on-year and 1.0 m/d lower than our last report).  The estimate for 2008 remains broadly unchanged, at 85.8 mb/d (-0.3% or -0.3 mb/d versus 2007 and 70 kb/d lower than previously estimated).  The expected two-year contraction in oil demand will be the first since the early 1980s.
  • Forecast oil demand in the OECD remains virtually unchanged at 47.5 mb/d in 2008 (-3.3% or -1.6 mb/d versus 2007).  In 2009, oil demand is forecast at 46.3 mb/d (-2.5% or -1.2 mb/d on a yearly basis), about 530 kb/d lower than previously estimated.  This revision is in line with the downward adjustments to GDP assumptions.  The forecast still assumes that OECD demand destruction will bottom out next year and that demand will begin to gradually recover in 2H09, on the basis that a repeat of the near financial meltdown of 2H08 is unlikely.


  • Forecast non-OECD oil demand is revised down by 65 kb/d to 38.2 mb/d in 2008 (+3.7% or +1.4 mb/d) and, more significantly, by 480 kb/d to 38.9 mb/d in 2009 (+1.8% or +0.7 mb/d compared with the previous year).  As with the OECD, these revisions are related to much lower economic assumptions, notably for Asia and Latin America.  China's economy, in particular, appears to have sharply slowed down as its main export markets tumble.  Therefore, non-OECD demand growth in both 2008 and 2009 is now seeing failing to offset the severe demand contraction expected in the OECD.
  • A new oil product price regime has been implemented in China.  Although the new regime comes a step closer to aligning domestic prices with international benchmarks, it remains far from more conventional, market-based mechanisms.  A gap remains between domestic retail prices (currently at roughly US$60/bbl) and international crude prices (which hover around US$40/bbl).  The price cuts will arguably ease costs for drivers, airlines and manufacturers - and help defuse social tensions over high fuel prices - but they could arguably contribute less than required under the present circumstances to cushion the economic downturn.

Global Overview

This month's report includes a significant downward adjustment to our 2009 GDP assumptions.  The November and December 2008 editions of this report were based on economic forecasts published by the IMF in early November (which in turn were significantly lower than its October predictions).  However, the relentless worsening of global economic conditions has once again made these prognoses outdated.  On the one hand, the IMF itself has strongly hinted that it will release new - and much lower - economic projections in the forthcoming weeks.  On the other hand, the latest survey of private sector economists by Consensus Economics (Consensus Forecasts, December 2008) depicts a much gloomier picture for the global economy, not only in OECD countries - where the current turmoil began - but also in most emerging countries, notably in Asia and Latin America, which are increasingly affected by developments in mature economies.



As such, we have adjusted our global GDP assumption on the basis of the latest Consensus Forecasts, which as noted see marked downward adjustments across all regions.  The global economy is now posited to expand by only 1.2% year-on-year in 2009 - at almost half the pace previously expected - with OECD countries firmly in recession (shrinking collectively by about 0.9%) and non-OECD economies growing by only 4.1% (1.25 percentage points lower).  Regarding China, we have not used Consensus Forecasts as a source, given the precipitous deterioration of the country's economy, notably in the second half of December (after the survey was taken).  Instead, we have settled for a mid-point (6.5%) between the most recent institutional forecast (the World Bank's 7.5% in early December) and gloomier private-sector prognoses (currently at around 5.0-5.5%).

From a seasonal perspective, the global economy should see a moderate recovery in 2H09, since a repeat of the sharp 2H08 slump, when the financial system came close to collapsing, is unlikely.  In addition, we have lowered our oil price hypothesis to $60/bbl for 2009, versus the $80/bbl assumption that we have kept over the past two months (however, given the severity of the global economic contraction, a lower price will only have a limited offsetting effect upon oil demand).

Needless to say, these economic assumptions are temporary and likely to be revised in the light of new IMF prognoses.  Yet the revisions to the 2009 global oil demand forecast are significant (roughly 1.0 mb/d lower when compared with our previous report).  Thus, at 85.3 mb/d, world demand is seen contracting by 0.6% or 500 kb/d versus 2008 - a fall for a second consecutive year, something not seen since the early 1980s.

OECD

According to preliminary November data, OECD inland deliveries (oil products supplied by refineries, pipelines and terminals) plunged by 6.8% year-on-year.  As in the previous month, all three regions recorded losses, highlighting the worsening outlook for most advanced economies.  In OECD North America (which includes US Territories), oil product demand contracted by 6.9% on prevailing weakness across all product categories bar diesel.  Demand in OECD Europe shrank by 4.4%, as heating oil deliveries lost steam despite remaining in positive territory.  In OECD Pacific, demand plummeted by 10.7%, dragged down by very feeble Japanese and Korean deliveries in virtually all product categories, notably for key products such as naphtha and diesel.







Revisions to preliminary figures were again significant, mostly driven by changes in North America.  However, by contrast to previous months, the October adjustments were positive (+1.5 mb/d).  According to revised data, OECD demand fell by only 3.4% during that month, versus an earlier estimate of -6.0%.  Coupled with preliminary data for November (and December for the US), this results in a revision of +30 kb/d in 3Q08 and -70 kb/d in 4Q08.  Overall, OECD demand is expected to have averaged 47.5 mb/d in 2008 (-3.3% or -1.6 mb/d versus 2007, virtually unchanged versus our last report).  In 2009, given weaker economic assumptions, OECD demand is seen contracting by 2.5% on a yearly basis (roughly -1.2 mb/d) to 46.3 mb/d (530 kb/d lower when compared with our previous assessment). This forecast still posits that OECD demand destruction will bottom out this year and that OECD economies will begin to gradually recover in 2H09 - or at least stop declining when compared with 2H08, when they came close to the brink of financial meltdown.



North America

According to preliminary data, oil product demand in North America (including US Territories) plummeted by 6.9% year-on-year in November, falling for the eleventh month in a row.  Demand weakness in the United States (-7.1% year-on-year) dragged down the whole region.  Canada and Mexico, however, are also now clearly showing the effects of the US recession, with demand in both countries declining by 2.6% and 9.4%, respectively.



Revisions to October preliminary data, largely driven by the US, were very large, but contrary to previous months, positive (+1.5 mb/d), suggesting that earlier weekly estimates had been too bearish.  Despite these revisions, however, demand in OECD North America still contracted by 2.6% year-on-year during that month.  Regional oil demand is now estimated at 24.3 mb/d in 2008 (-4.7% or -1.2 mb/d on a yearly basis and 140 kb/d higher when compared with our last assessment).  In 2009, demand is expected to reach 23.7 mb/d (-2.6% or -0.6 mb/d, 160 kb/d lower than previously estimated) on the back of lower GDP assumptions.



Adjusted preliminary data for the continental United States continue to reflect the ongoing economic recession.  Inland deliveries - a proxy of oil product demand - contracted by 6.3% year-on-year in December.  Virtually all product categories registered significant contractions, most notably jet fuel/kerosene (-13.0%), gasoline (-4.0%) and gasoil (-11.4%).  By contrast, residual fuel oil deliveries, which had declined since December 2007 (excepting a brief interruption in July 2008), grew by 8.3% year-on-year.  Given the fall in international oil prices and subdued natural gas prices due to higher production and relatively mild weather (heating-degree days in December were only slightly higher than the 10-year average and the same month of the previous year), residual fuel oil is indeed once again competitive vis-à-vis natural gas as a fuel of choice for power generation.  Both fuels are now (mid-January) practically at par, at about $6.44/mm Btu on average.



The demand picture would have been gloomier had preliminary weekly data not been corrected up in October.  The revisions (across all product categories bar naphtha and jet fuel/kerosene) totalled 1.2 mb/d, implying an annual decline of -3.7%, instead of -9.6% as previously estimated.  Although this positive adjustment bucked the trend of the past several months (of large downward revisions), it is premature to conclude that demand is rebounding - previous revisions had largely stemmed from the fact that gasoline and distillate volumes had been counted as 'product supplied' (a proxy of demand) rather than as exports.  Indeed, the weakness in gasoline demand has if anything intensified: despite much lower gasoline prices (retail prices, at about $1.60/gallon, are about 50% lower year-on-year), weekly gasoline demand is still contracting by some 3-4% on a yearly basis.  Meanwhile, new car sales continue to plummet (-35.7% year-on-year in December), hitting both domestic and foreign manufacturers.



On the basis of October's revisions, preliminary November and December data, and a new GDP assumption of -1.3% for 2009, and assuming that demand destruction will bottom out this year, US oil demand is now expected to contract by 5.6% year-on-year in 2008 to 19.5 mb/d (some 140 kb/d higher than in our previous report).  In 2009, demand should fall by 2.8% to 19.0 mb/d (about 140 kb/d less than previously anticipated).

Preliminary data show that the free fall of Mexico's oil product demand accelerated sharply in November (-9.4% year-on-year).  The plunge has a structural component - the substitution of residual fuel oil (-37.2% year-on-year) by natural gas - but also reflects the economic slowdown triggered by the US recession.  Indeed, the Mexican economy is set to contract by 0.1% in 2009.  For the first time since July 2005, gasoline demand fell on a yearly basis (-1.4%); meanwhile, jet fuel/kerosene demand shrank for the seventh consecutive month (-19.7%), providing further evidence that air travel is weakening significantly.  Total oil demand is thus now expected to fall in both 2008 (-1.0% year-on-year to 2.10 mb/d) and 2009 (-2.2% to 2.05 mb/d).



Seeking to temper the economic slowdown, in early January the Mexican government decided to freeze retail energy prices, most notably of transportation fuels, which had started to rise on a monthly basis in 2H08 amid concerns that fuel subsidies (some $20 billion in 2008) would become unsustainable.  The sharp fall in international oil prices had made the monthly price increase politically untenable, with protests erupting amid several constituencies (ranging from truck drivers to fishermen), while stoking inflation as well.  In addition, the fiscal stimulus plan also mandates a 10% cut in LPG prices, which should benefit poor urban households (LPG is the main cooking fuel).

Europe

Oil product demand in Europe shrank by 4.4% year-on-year in November, according to preliminary inland data.  All product categories bar heating oil registered losses, notably gasoline (-6.8%), jet fuel/kerosene (-5.4%), diesel (-4.7%) and residual fuel oil (-7.9%).  Although heating oil deliveries remained positive (+1.1%), they lost momentum, partly because of mild temperatures (the number of heating-degree days in November was well below both the 10-year average and the same month of the previous year).  Revisions to annual submissions for October, meanwhile, stood at -200 kb/d.  However, given weaker-than-expected preliminary figures and lower economic growth expectations, forecast demand in OECD Europe has been revised to 15.2 mb/d in 2008 (-0.8% or -130 kb/d, some 60 kb/d lower than previously estimated) and to 14.9 mb/d in 2009 (-2.0% or -300 kb/d, 160 kb/d below last month's projection).

It should be noted that this forecast has not yet taken into account the potential effects of the ongoing Russian disruption to European natural gas supplies.  A similar situation in early 2006 led to a spike in residual fuel oil demand in countries such as Italy.  This time, however, gasoil demand may have increased, judging by an uptick in prices (residual prices, by contrast, have barely moved).  Moreover, the unfolding economic contraction is arguably depressing electricity use, although the cold spell of early January most likely led to strong demand for power-generated heating.  As such, we will wait for more precise data before making further adjustments to our prognosis.





Inland deliveries in Germany rose by 2.3% year-on-year in November, according to preliminary estimates, given the sustained firmness of both heating oil (+33.3%) and, to a lesser extent, fuel oil deliveries (+1.5%), which offset losses in all other product categories.  Heating oil consumer stocks averaged 64% of capacity by end-November, higher when compared with both the previous month (62%) and the previous year (59% in November 2007).  This suggests that German households continued to take advantage of falling prices to replenish their inventories.  Nonetheless, the unfolding economic recession is bound to hit oil demand: assuming heating oil demand follows refilling patterns and weather conditions in line with the historical 10-year average, overall oil demand may contract by as much as 2.0% in 2009.



In France, by contrast, total oil demand plunged by 10.9% year-on-year in November.  As the economic slowdown bites, key products such as diesel are bearing the brunt.  Indeed, diesel deliveries fell by 11.2%, in line with the continued declined in new vehicle sales (-5.0% year-on-year in November and -15.8% in December).  Meanwhile, gasoline demand (which faces a structural decline) contracted by 16.2%, over twice as much as the January-October average (although this could be partly due to two working days less in November 2008 relative to the previous year).



A similar situation prevails in Italy, where total oil product deliveries plummeted by 10.6% year-on-year in November, with diesel demand - about a third of the total - shrinking by 7.2%.  In addition, jet fuel/kerosene deliveries faced yet another sharp contraction (-14.5%) as the saga involving near-bankrupt state-owned carrier Alitalia unfolded (the airline, which has cancelled many flights over the past months, has now found new partners; its situation and thus jet fuel demand could improve in the months ahead).  Finally, it is worth noting that residual fuel oil demand plummeted by 18.3%, due to both higher hydro power supplies and lower electricity demand given mild weather and lower industrial activity.

In Spain, whose economy is facing a severe economic recession, the demand picture mirrors that of France and Italy.  Oil demand plummeted by 7.3% year-on-year in November, according to preliminary figures, with all product categories bar naphtha posting sharp losses, particularly gasoline (-7.9%), jet fuel/kerosene (-10.6%) and diesel (-8.8%).  Contrary to other large European countries, however, Spain's slump in new vehicle sales has been particularly marked (-49.6% year-on-year in November).

Pacific

According to preliminary data, oil product demand in the Pacific plummeted by 10.7% year-on-year in November, dragged down by persistent demand weakness in both Japan and Korea.  All product categories registered losses, notably naphtha (-12.6%), jet fuel/kerosene (-8.4%), diesel (-7.0%) and heating oil (-17.0%).  The shrinking deliveries of kerosene and fuel oil are arguably related to mild weather (the number of heating-degree days in November was inferior to both the 10-year average and the same month of the previous year), but the overall fall is largely related to the sharper-than-expected economic slowdown in Japan and Korea, which is sharply curbing industrial production and power consumption.

Revisions to October preliminary data totalled 60 kb/d, split roughly evenly between Japan and Korea.  Coupled with the reassessment of the region's economic outlook, oil demand in the Pacific is now seen averaging 8.0 mb/d in 2008 (-3.7% on a yearly basis or -300 kb/d, 80 kb/d down versus last month's report) and 7.8 mb/d in 2009 (-3.1% or -250 kb/d, -210 kb/d versus earlier projections).





Oil demand in Japan tumbled in November (-12.3% year-on-year), for the third consecutive month, as the economic recession compounds the country's structural oil demand decline.  As such, demand for products directly associated to economic activity continues to plummet (naphtha and diesel, for example, fell by 15.1% and 10.1%, respectively).  In addition, diminishing power use - as a result of reduced industrial operations - has led to lower deliveries of 'other products' (which include crude for direct burning) and residual fuel oil, which contracted by 42.5% and 2.1%, respectively.  The country's largest power utility, Tokyo Electric Power Company (TEPCO), is now expecting to use 14% less crude and fuel oil over the October 2008-March 2009 period than earlier anticipated - despite the fact that its huge Kashiwazaki-Kariwa nuclear power plant is likely to remain shut.  Indeed, electricity consumption from TEPCO's main industrial customers is drying up (notably from car manufacturers, which are drastically curbing production).



A similar situation prevails in Korea, where oil demand contracted by 12.6% year-on-year in November, according to preliminary data, as the economy's main engines - exports and domestic consumption - stall.  Deliveries of all product categories bar gasoline thus continued to post sharp losses.  Naphtha demand, which accounts for roughly 40% of the total and is the main feedstock of the petrochemical industry, dived by 10.2% year-on-year despite lower prices.  Diesel deliveries, meanwhile, fell by 9.7%.

Non-OECD

China

According to preliminary November data, China's apparent demand (refinery output plus net oil product imports, adjusted for fuel oil, direct crude burning and stock changes) fell by an estimated 1.9% year-on-year, for the first time since June 2005.  All product categories bar gasoil posted losses, leading to a downward revision of about 450 kb/d for the month compared with our previous estimate.



Three factors may explain this abrupt fall.  First, the Chinese economy is clearly losing momentum as its export markets, notably in OECD countries, dry up.  The slump is more sudden than anticipated, thus prompting the sharp revision to the country's 2009 GDP outlook discussed earlier.  For example, freight indicators, which had risen almost continuously over the past several years, show a dramatic slowdown.  Freight-tonnes per kilometre plunged by 8.0% in November after falling by 10.0% in October, thus likely weighing on gasoil demand, which expanded by only 1.1% year-on-year - the lowest pace since May 2003.  Similarly, power generation - largely driven by industrial production - fell by an unprecedented 9.6% year-on-year in November for the second month in a row, following October's -4.0%.  Although this decline may be partly due to relatively mild weather, electricity output had risen almost uninterruptedly over the previous decade and a half.

Second, the fall in oil demand could also be related to some destocking, which would exaggerate the weakness of China's apparent demand (this, however, is impossible to ascertain, since Chinese stock data is virtually non-existent).  Both net crude imports and refinery output fell sharply month-on-month in November (by 14.3% and 5.1%, respectively), arguably in anticipation of changes to the country's price system (see China's Price Regime Reform: Elegant but Partial).  Moreover, even though net oil product imports jumped by 29.5% month-on-month, this resulted essentially from a 89.7% increase in net fuel oil imports (which accounted for almost 93% of the month's total).  Imported residual fuel oil (generally Russian M-100, used as a feedstock by many 'teapot' refineries) became reportedly more competitive relative to domestic wholesale prices.  More significantly, net gasoline exports rose by 62.2% month-on-month, underlying the new-found weakness of gasoline demand, which contracted by 0.7% year-on-year in November after rising uninterruptedly since May 2007.  In the same vein, after seven consecutive months of net imports, the country became again a net exporter of jet fuel, as domestic demand plummeted (-18.5%).

Third, the smuggling of so-called 'red diesel' from Hong Kong (normally used in industry and shipping), prompted by the growing price differential between the island and mainland China as international prices retrenched, likely continued.  Such contraband - anecdotally reported but by definition impossible to measure - contributes to depress our estimate of mainland distillate demand.

China's Price Regime Reform:  Elegant but Partial

As anticipated in last month's report, a new oil product price regime was finally approved on 19 December by China's National Development and Reform Commission (NDRC), ostensibly to match recent developments in international oil markets.  The main features of the new system include the following:

  • The immediate cut of ex-refinery and retail prices for transportation fuels.  Ex-refinery gasoline prices were reduced by 13.9% to 5,580 yuan/tonne (roughly $92/bbl), diesel prices were cut by 18.1% to 4,970 yuan/tonne ($98/bbl), and jet fuel/kerosene prices were slashed by 32.2% to 5,050 yuan/tonne.  Meanwhile, gasoline and gasoil retail prices fell by roughly $21/bbl and $25/bbl, respectively.
  • The 'indirect' linkage of domestic prices to international benchmarks.  Domestic ex-refinery prices will be based on international crude oil benchmarks, to which 'average' processing costs and a 'reasonable' profit margin will be added (thus setting the 'guidance' retail price).  How this will be precisely done, however, remains unclear.  Unconfirmed reports suggests that if crude oil trades below $80/bbl, domestic ex-refinery prices will fluctuate freely; between $80/bbl and $130/bbl, refining margins will be curbed to minimise the impact on retail prices; above $130/bbl, the government will set retail prices.
  • The reduction of the tolerance band around guidance retail prices.  The allowed fluctuation around 'guidance' retail prices (ex-refinery prices + costs + profit margin) falls from +/-8% to +/-4%.
  • The increase of consumption taxes, to be applied from 1 January 2009 and to be absorbed by refiners.  Gasoline and diesel consumption taxes were raised by 400% to 1 yuan/litre ($23/bbl) and by 700% to 0.8 yuan ($19/bbl), respectively.
  • The abolition of road and waterway maintenance charges and tolls on second class roads.  Tolls on highways and first class roads will remain, but several constituencies (such as farmers) will be subsidised.  It should be noted that the increase of fuel consumption taxes and the removal of road taxes roughly cancelled each other out.
  • The reduction of the fuel oil import tax.  The tax was slashed from 3% to 1% on 1 January 2009.

Although the new regime comes a step closer to aligning domestic prices with international benchmarks, it remains well away from more conventional, market-based mechanisms.  The government has been reluctant to further reduce prices, although in mid-January it announced another - marginal - cut (-2.5% for gasoline and -3.2% for diesel, effective on 15 January).  As such, a gap remains between domestic retail prices (currently at roughly US$60/bbl) and international crude prices (which hover around US$40/bbl).  The price cuts will arguably ease costs for drivers, airlines and manufacturers - and help defuse social tensions over high fuel prices - but they will probably contribute less than required under the present circumstances to cushion the economic downturn.

Moreover, the country's refiners, which will absorb the increased consumption fuel taxes, will once again bear the brunt of the reform.  However, China's refining sector remains financially fragile.  The slide in international oil prices since the summer helped refiners to only partially recoup the losses incurred when prices skyrocketed (the price reform was allegedly delayed until December precisely for that reason).  State-owned giants PetroChina and Sinopec are arguably better equipped to face the burden, but many smaller 'teapot' refineries will probably continue to operate below capacity (and in the case of the less sophisticated ones, notably in Guangdong, cease operations altogether).  Indeed, the increase in fuel consumption taxes is likely to more than offset the fuel oil import tax cut.  As such, the recent revival of fuel oil imports could well vanish in the months ahead.

On the basis of the revisions discussed above, a lower GDP assumption and much lower expectations of naphtha, gasoline and gasoil consumption (which together account for almost two-thirds of total oil product use), Chinese oil demand is now expected to rise by only 1.1% to 7.95 mb/d in 2009 (270 kb/d less than previously anticipated), well below the 4.2% growth rate expected in 2008 (to 7.86 mb/d, almost 80 kb/d below versus our previous forecast).  The 2009 year-on-year growth (+90 kb/d) would thus be the lowest since 2001.  As shown in the table below, growth is expected to be marginal for most product categories bar residual fuel oil (which is seen expanding on the admittedly strong assumption of sustained competitive import prices).  As such, this forecast is bound evolve as the current state of the Chinese economy becomes clearer.  In addition, the effectiveness of the new price regime - in terms of its impact upon demand patterns - will be tested in the months ahead.



Other Non-OECD

According to preliminary data, India's oil product sales - a proxy of demand - rose by 2.0% year-on-year in November, resuming the growth trend that had been briefly interrupted in October (-0.8%, after accounting for data revisions).  The increase was largely driven by strong gasoline (+5.8%) and gasoil (+8.8%) demand, which are subsidised (demand for both fuels probably rose further in December following the retail price cuts).  Fuel oil sales also rose markedly (+9.7%), possibly due to both higher power needs and less availability of both natural gas (LNG) and naphtha, which are mainly used by the petrochemical industry.  The government, however, is seeking to provide cheaper naphtha as an alternative to more expensive LNG; in early December it waived (until 31 March 2009) the 5% naphtha import duty.  The move should help utilities and other industries that are able to switch fuels (such as steel producers and, to a lesser extent, fertiliser producers).



The relative strength of India's oil demand does not mean that the country is insulated from the global economic downturn.  Given the country's subsidy regime, the burden will mostly be borne by the government or, more precisely, by state-owned oil companies, which are expected to collectively lose some $21 billion in the current fiscal year ending 31 March.  Assuming the Indian economy slows down slightly - albeit less markedly than other Asian countries - oil demand, estimated at 3.1 mb/d in 2008 (+4.3% on a yearly basis and unchanged versus our last report), is expected to expand by 3.0% to 3.2 mb/d in 2009 (25 kb/d less than previously expected).

Yet the subsidies appear to be insufficient - that is, prices are still perceived to be too high by some constituencies.  In early January, tens of thousands of Indian truck drivers, notably in Gujarat, went on strike demanding additional reductions in diesel retail prices.   The truckers' reaction is partly related to the fact that the government had not further revised diesel prices down since the cut in early December - but had continued to slash jet fuel prices in a bid to help domestic airlines.  As a result, jet fuel is now cheaper than diesel - India is possibly the only country in the world where this occurs.  Still, the truckers' strike lost steam and was called off a few days later.  It should be noted that, at the time of writing, the government was reportedly envisaging further price cuts to gasoline, diesel and LPG.

More significantly, some 50,000 employees from several state-owned oil companies and utilities (IOC, ONGC, BPCL, OIL and GAIL) went also on strike on 7 January, demanding higher pay.   This strike was called off three days later after the government issued stern warnings to strikers to return to work or face harsh consequences, but it nonetheless severely disrupted oil refining operations and product deliveries, notably to retail outlets and airports.  For example, most service stations in large cities such as Mumbai, Delhi, Bangalore and Kolkata had reportedly run out of stocks.  As such, oil demand data for January are likely to register unseasonal weakness, but at this point it is difficult to estimate the strikes' impact.

Supply

Summary

  • Global oil supply was unchanged in December at 86.2 mb/d, with reduced OPEC output offset by gains in OECD North America, Brazil and China.  Year-on-year, monthly average production is down around 200 kb/d , largely due to recent OPEC production curbs having taken output well below December 2007 levels.
  • Non-OPEC forecasts for 4Q08 and 1Q09 are revised down by 140 kb/d and 90 kb/d, respectively, following several oil field-related incidents and some project slippage in Brazil, China and Russia, though this is partly offset by a higher 4Q08 number for Norway.
  • Total non-OPEC output is now forecast at 49.5 mb/d and 50.0 mb/d for 2008 and 2009, following downward revisions of 60 kb/d and 30 kb/d, respectively.  This implies a year-on-year drop of nearly 150 kb/d for 2008, the first decline since 2005. Disrupted US and Azeri supply in 2008 was compounded by the first decline in Russian output since 1996. Renewed 2009 non-OPEC growth of around 0.5 mb/d derives from the Caspian, US ethanol, offshore GOM, Brazil and OECD and non-OECD Asia.  Moreover, OPEC NGLs are forecast to add a further 0.6 mb/d to total supply in 2009.


December OPEC crude supply averaged 30.9 mb/d, down 330 kb/d versus November. This was 1 mb/d below levels of both a year ago and those of September 2008, and almost 2 mb/d below mid-2008 highs. Supply curbs were widespread, most notably from Saudi Arabia and Kuwait, albeit partly offset by increases from Iran, the UAE and Iraq. OPEC Ministers agreed a new collective target of 24.8 mb/d effective from January. Leaving aside for now Indonesia's OPEC membership suspension, this equates to OPEC-13 output of around 28.2 mb/d, versus a now-reduced 2009 'call' of between 29.5-30.0 mb/d.

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

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

OPEC Crude

OPEC crude supply in December averaged 30.9 mb/d, down 330 kb/d versus November.  The December total was 1 mb/d below both levels of a year ago and our own estimate for September 2008, the apparent reference point for recent adjustments in OPEC target. It was, however, a more fulsome 2 mb/d below the recent high point in production attained in June 2008.  December curbs in supply were widespread, and volumetrically most significant from Saudi Arabia and Kuwait.  However, these cuts were partly offset by increases from Iran, the UAE and Iraq, with the latter two seeing, respectively, field recovery after maintenance and higher supplies for export in December.

This month's installed OPEC capacity estimates remain unchanged from last month, totalling 35.8 mb/d.  Nonetheless, as producers cut supply to keep pace with weakening demand, so spare capacity is inevitably freed up, potentially undermining OPEC's efforts to support prices. While notional spare capacity is approaching 5 mb/d, we think that readily available, effective spare capacity may be closer to 3.8 mb/d based on December production levels. This latter level excludes notional spare capacity held by producers who have, for some time, experienced problems boosting supply, namely Indonesia, Iraq, Nigeria and Venezuela (Indonesia's OPEC membership is suspended from January 2009, and remains in our estimates here, but will be removed from OPEC calculations in next month's report).

Regardless of the ambiguities of spare capacity, it is clear that if OPEC continues to reduce supply in early 2009, as looks likely, one side effect could be a wider margin of spare capacity, something that has tended in the past to eventually undermine OPEC attempts at production discipline. While lower prompt volumes appear to be placing a floor under prices currently, ironically the emergence of a wider capacity margin, if it begins to unravel production discipline, could dilute this support for prices.  A Saudi Arabia-driven increase in OPEC installed capacity of nearly 1.0 mb/d is expected during 2009, potentially exacerbating the gap between early-year market demand and supply potential.  That said, the immediate fact is that OPEC's target, if realised, lies below our underlying 'call on OPEC crude and stock change' for 2009 of 29.5-30.0 mb/d, so tighter stocks will accompany any rise in spare capacity.



We have trimmed our November estimate for Saudi Arabia's production from 9.05 mb/d to 8.9 mb/d, but struggle to corroborate lower third party November estimates of 8.5-8.8 mb/d with tanker tracking data.  However, sharply lower supply does look more likely for December, and this is provisionally estimated at 8.45 mb/d.  Term export allocations for January and February to Asian and North American destinations have also been cut sharply, with some suggestions in the market that output may have been curbed to 8.0 mb/d this month, and potentially as low as 7.7 mb/d for February. US buyers have seen the sharpest cuts for February.  Already in December the Kingdom was producing within 5% of its January target, and concerns over global demand slowdown may already have pushed supply close to the Kingdom's 8.0 mb/d quota.

More Credible Than It First Seemed?

A flurry of cuts to OPEC production targets for 4Q08 matched frequent GDP revisions from economic forecasters. OPEC Ministers on 17 December agreed a new collective production target of 24.8 mb/d, excluding Iraq and Indonesia, and effective from 1 January. Leaving aside for now Indonesia's departure from the OPEC fold, this is equivalent to total OPEC-13 output of around 28.2 mb/d, compared with our own, now markedly lower, 2009 'call on OPEC crude and stock change' of just under 30 mb/d.  However, December supply stood 1 mb/d above expected demand for next year, with forward stock cover also above normal, in excess of 56 days' supply, something that OPEC has in its sights to reduce.

The OPEC meeting in Oran, Algeria on 17 December had been widely expected to agree further cuts in supply of up to 2.0 mb/d.  In the event cuts totalling 4.2 mb/d were announced, although the reference point was OPEC's Monthly Oil Market Report assessment of September supply, specifically 29.05 mb/d for the OPEC-11 (excluding Iraq and Indonesia).  Thus, new cuts over and above those supposedly in place from 1 November were closer to 2.2 mb/d.  New individual production targets were not itemised.  The decision to dress up a 2.2 mb/d cut as a 4.2 mb/d cut, however, appeared to backfire, with marker crude prices falling in the meeting's aftermath (albeit high US stocks also played a role).  Continued weak economic indicators and further weekly builds in US inventories have continued to weigh on prices, although some renewed market support did come from the outbreak of conflict in Gaza, colder European weather, curbed Russian gas supplies and signs that OPEC cuts themselves were beginning to bite in late December/early January.

While individual production targets remain hazy, and it is too early to gauge compliance with the latest production accord (which only came into force on 1 January), the agreement to curb by 2.2 mb/d was nonetheless a record in terms of previous announced reductions.  Evidence from December suggests that key members of OPEC are beginning to curb supply by significant amounts.  Our estimate of December OPEC-11 production of 27.7 mb/d was within 2% of the 1 November target, something emphasised in a mid-January statement from the OPEC Secretary General which suggested that "… there has been an almost  100% compliance with the first two cuts...".  Our calculations suggest, moreover, that December output was itself within 11% of the new January target of 24.8 mb/d.



As usual however, there is variation in the degree of compliance among OPEC members, with Saudi Arabia and the UAE facing a requirement to cut by only a further 5-10% to attain target output (which they appear already to have done since December).  Others such as Iran, Angola and Libya are facing more substantial cuts of 15-20% if target is to be attained.  That said, most producers have announced further cuts in supplies for January and February.  OPEC Ministers plan to meet again formally on 15 March in Vienna.

Demand uncertainty and cost issues have reportedly caused the cancellation of bids for the 75 kb/d upstream Dammam project and have forced a review also of the 900 kb/d Manifa field development.  However, Saudi sources have been keen to reiterate that short-term plans for 12-12.5 mb/d capacity to be attained during 2009 remain in place.  This report estimates current installed Saudi Arabian crude capacity (excluding condensates and Bahrain's 150 kb/d share of output from the Abu Safah field) at 11.0 mb/d.

The hijacking of a 2 mb cargo of Saudi crude aboard Vela's Sirius Star tanker reportedly ended on 9 January, after a near-two month standoff.  The vessel was freed off the Somalia coast amid reports that a $3 million ransom had been paid. A surge in hijacking around the Horn of Africa and the Gulf of Aden has seen the formation of an international task force of vessels from 20 nations to combat piracy in the area.

Kuwait is thought to have cut supply by some 80 kb/d in December to 2.5 mb/d.  The emirate's approach to curbing supplies has initially involved the removal of 5% upside tolerance from term export liftings.  Full-term volumes were offered for January in early December, again with tolerance removed, but reportedly liftings from the third week of January onwards will be curbed by a further 5%.

Angolan crude production is now estimated at 1.83 mb/d for November and 1.8 mb/d for December.  While last month saw production fall into line with the country's November target, it still remained above the new implied January target of 1.51 mb/d.  International operators were reportedly instructed by state company Sonangol to curb production from 1 January, although preliminary data showing revised February export schedules around 1.6 mb/d suggest Angola still has some way to go to get down to its January OPEC allocation.

In contrast, December UAE crude supply is estimated up by 130 kb/d from November to 2.43 mb/d, amid signs of higher tanker sailings and the expected return of the Umm Shaif and Lower Zakum fields from October/November maintenance.  These indicators likely countered lower output of onshore Murban crude to push December output higher. Here too though, January and February availability looks likely to be scaled back, following December's reduction of the Emirates' OPEC quota to around 2.2 mb/d.

Iranian December supply is also assessed up by 120 kb/d from November at 3.88 mb/d based on preliminary indications for both exports and domestic refinery activity. This suggests Iran would need to cut supply by a sizeable 560 kb/d starting in January to match its target output level of 3.33 mb/d.  Although no curbs on December export loadings were made public, Iran does appear to have been scaling back liftings on both a spot and term basis for both January and February, and has itself cited cuts in supply of around 550 kb/d that it intends to make from January.

Iraqi supply in December is estimated up by 20 kb/d compared with November, at 2.39 mb/d, comprising 1.84 mb/d of exports and 550 kb/d of local use. Our November supply estimate was revised up 40 kb/d to 2.37 mb/d, largely on the basis of higher Ceyhan exports than preliminary data had suggested.  In the event, 10.1 mb of Kirkuk crude left Ceyhan by tanker in November plus around 625 kb of pipeline crude destined for Turkey's Kirikkale refinery.  Tanker liftings from Ceyhan rose to 10.9 mb in December, although no crude moved to Kirikkale. Crude exports from southern ports averaged 1.48 mb/d in December compared with 1.45 mb/d in November.  Around 20 kb/d is estimated to have moved cross-border to Jordan and Syria in both months.

Non-OPEC Overview

Forecast total non-OPEC production for 4Q08 and 1Q09 has been revised down by 140 kb/d and 90 kb/d respectively, with unscheduled outages and project slippage recorded across most regions, both OECD and non-OECD.  An historical downward revision to Sudan is carried through 2008 and into 2009.  Some key start-ups in Brazil, China and Russia (Sakhalin-2 year-round export capability) have been delayed, while we have nudged down growth in Russia, New Zealand and Kazakhstan for 2009.  Offsetting these changes is a substantially higher 4Q08 figure for Norway, which stems in part from higher actual data, but also from the deduction of our field reliability adjustment factor, now that the end of the year has passed without major incidents.



Total non-OPEC output is now set to come in at 49.5 mb/d and 50.0 mb/d for 2008 and 2009, following downward revisions of 62 kb/d and 34 kb/d respectively.  This in turn implies a year-on-year dip of almost 150 kb/d for 2008, the first decline since 2005.  Non-OPEC supply in 2009 is currently expected to grow by just over 500 kb/d on the back of large start-ups in the Caspian, US fuel ethanol, the US Gulf of Mexico and Brazil as well as both OECD and non-OECD Asia.  2008 is probably most notable as the first year in which Russian production has declined since 1996 (when it was down 130 kb/d), as economic and fiscal conditions for investment worsened, slowing the pace of new projects.  Our current outlook also forecasts a further decline in Russian 2009 production of 280 kb/d.

It is still too early to form a definitive view on the extent of cuts in capital expenditure or strategic project slippage due to the combined impact of the financial crisis, a contraction in oil demand and significantly lower oil prices.  Many companies have only just started to outline their capex plans for this year and beyond.

However, anecdotally the message is fairly stark, even if the impact may be felt more squarely on future, rather than 2009, production.  For example, Singapore rig builder Keppel has announced that two orders for new rigs have been cancelled as a result of the credit squeeze.  We note elsewhere Saudi Arabia's slipping of two of its next generation of capacity expansion projects, and more generally, analysts at Barclays Capital now expect 2009 upstream capex worldwide to contract by 12% after several years of double-digit growth.  Lower oil prices and the credit squeeze are likely to have played a greater role than a somewhat lagged reduction in project costs in driving this decrease.  We will continue to track these developments in the months ahead.



OECD

North America

US - December Alaska actual, others estimated:  December supply in the US came in 70 kb/d lower than expected, based on preliminary data.  A brief outage shut in the Trans-Alaska Pipeline (TAPS) at the end of December, forcing a slowing of production, but this was rapidly resolved.  Despite the outage, final Alaskan December numbers actually came in around 50 kb/d higher than anticipated, but still fell by nearly 30 kb/d on the month.  In the US Gulf of Mexico, we have now assumed a slightly earlier start-up of BP's huge Thunder Horse platform, which we assume to be currently running at around 100 kb/d liquids production.  We have also assumed the start-up of Eni's Pegasus field in the Green Canyon area, though this is running at only 1 kb/d of its expected eventual 5 kb/d capacity.  Adjustments elsewhere however partly offset the impact of these revisions, resulting in 4Q08 and 1Q09 revisions of -30 kb/d and 30 kb/d respectively, but almost no net change for the two years as a whole.

According to the US Minerals Management Service (MMS), nearly 200 kb/d of US Gulf of Mexico production was still shut-in in December due to hurricane damage.  Our working assumption is that this daily volume will stay shut in until the end of March, by which time repairs to infrastructure should have been completed.



Canada - Newfoundland November actual, others October actual:  Newest data for October and November brought slight downward revisions of 34 kb/d and 15 kb/d respectively, though this is marginal for yearly production.  Looking forward, producer group the Canadian Association of Petroleum Producers (CAPP) has trimmed its forecast for Albertan oil sands to 1.22 mb/d for 2008 and 1.44 mb/d in 2009 - each revised down by 90 kb/d.  Our corresponding numbers currently stand at 1.22 mb/d and 1.34 mb/d respectively.

North Sea

Norway - November actual:  Total October Norwegian output was trimmed by 20 kb/d, while November production was raised by 170 kb/d, leading to a higher 4Q08 total figure of 2.56 mb/d.  The latter adjustment however once again stems from the removal of our assumed field reliability factor, which we currently hold at -160 kb/d.  Thus, the upward-revised November figure is not carried forward further than December, which also sees a higher figure (+200 kb/d).  Year-on-year, we now see 2008 and 2009 each around 30 kb/d higher than in the last report at 2.47 mb/d and 2.23 mb/d respectively, thus implying a downturn next year of 240 kb/d.



Former Soviet Union (FSU)

Russia - November actual, December provisional:  Russian November and December data were revised down sharply, largely on the assumption that Sakhalin-2 year-round exports, due to start in late November, are running at far lower daily volumes than previously assumed.  We have carried this forward into early 2009, after which new infrastructure should see production ramp up to a total of 150 kb/d by year end.  Preliminary December figures for total Russian oil also indicate a downward revision of around 200 kb/d, some of which may be related to lower exports due to prohibitively high export duties (though this has been reformed subsequently).

Overall, end-year figures, albeit provisional, now clearly indicate a year-on-year decline for Russian oil production, its first since 1996.  We now see total Russian supply at 10 mb/d in 2008.  Looking ahead, we have also nudged down 2009 production on the basis of less optimistic company forecasts as well as the slower-than-anticipated Sakhalin-2 ramp-up.  Thus our 2009 total Russian supply figure now stands at 9.7 mb/d, implying a yearly fall of 280 kb/d.  However, declining Russian output would appear to be due more to a punitive fiscal and regulatory regime, which is impeding investment, rather than to voluntary output curbs in support of OPEC.



Azerbaijan - October actual:  Azeri production numbers for October and the rest of the year are raised due to upward-revised SOCAR output data and an assumed faster restart of the Central Azeri offshore platform.  The latter is part of the ACG complex which suffered outages due to a gas leak in the autumn.  Thus 4Q08 production is upped by nearly 70 kb/d, followed by an additional 20 kb/d spread over next year.  With an assumed 370 kb/d increment expected in 2009, Azerbaijan is one of the key growth areas for non-OPEC production, with total output rising to 1.26 mb/d, from 0.9 mb/d in 2008.

November FSU net exports fell to 8.11 mb/d as a 110 kb/d rise in product exports was not enough to offset a 290 kb/d drop in crude oil exports to 5.64 mb/d.  Prohibitively high Russian crude export duties, which lagged the fall in oil prices, were the main factor behind the decrease.  In order to avoid losses, exporting companies shifted cargoes scheduled to be loaded in the second half of November to the beginning of December, which resulted in the lowest crude oil export levels from Russia in almost five years.  Black Sea ports were hit hardest by this decision as exports from Novorossiysk and Pivdenne decreased by 22% and 72%, respectively from October, which is more than the seasonal dip.  Shipments to Baltic ports and via the BTC, however, increased compared with October, though part of this was due to resolution of previous production problems at Azeri oilfields and maintenance on the pipeline leading to Primorsk.

Product exports rose to 2.53 mb/d in November led by a 9% increase in deliveries of gasoil, notably deliveries of 10 ppm diesel to Europe.  Fuel oil and other product exports rose by 2% and 3%, respectively.

According to preliminary numbers, December FSU crude oil exports increased sharply as the Russian crude export duty was cut to $26/bbl from 1 December and cargoes originally scheduled for November finally left ports.  Transneft reported a 17.8% increase in Russian crude oil exports in December.  Exports of Caspian crude via the BTC pipeline also rose sharply in December, close to 800 kb/d levels seen ahead of pipeline and field outages from August onwards.  The export duty has been cut further in January to $16/bbl, though Transneft's pipeline tariffs increased.  Nonetheless, January loading schedules show exports contracting by 8% as compared with December loading schedules.



For the longer term, the Caspian Pipeline Consortium's shareholders have signed an agreement on the expansion of the CPC pipeline after BP, who was opposing the scheme, agreed to sell its stake.  The project should raise the capacity of the pipeline, which runs from the Tengiz oil field in Kazakhstan across Russia to Novorossiysk on the Black Sea, from around 750 kb/d to over 1.30 mb/d by 2013.

Other Non-OPEC

Brazil - October actual:  Brazilian production data for October came in some 36 kb/d higher than anticipated, though on a quarterly basis this was more than offset by the later-than-anticipated start-up of Petrobras's new Marlim Leste P-53 platform offshore in the Campos Basin in early December.  The platform had delayed first production several times from an original start-up estimate of 2007 and we most recently had included initial volumes from October 2008.  Meanwhile, a failed valve at the Jubarte field's P-34 platform briefly halted production in early January, though news reports indicate this was not long lasting and we have not carried through the outage further than January.  We now see total Brazilian oil production at 2.27 mb/d in 2008, rising by around 250 kb/d to just over 2.5 mb/d in 2009.



Non-OECD Asia:  China saw the start-up of its first commercial coal-to-liquids (CTL) plant in December, but at a negligible volume and only gradually ramping up by end-2009.  Shenhua's plant in Inner Mongolia has a capacity of 20 kb/d.  This is one of two CTL projects to go ahead in China, after more ambitious plans for a higher number of plants was scaled down last year. Elsewhere in China, we have noted the delay in the start-up of the offshore Penglai 2 increment, which also commenced ramp-up around end-year rather than the previously assumed September.  A new FPSO should add around 50 kb/d by end-2009.  Vietnam meanwhile saw the start-up of the offshore Song Doc field in December, again delayed several times over the course of 2008.  We are assuming a gradual ramp-up to maximum production of 25 kb/d by mid-2009.  In the Philippines, the recently inaugurated Galoc field was shut-in in late December, when its FPSO was disconnected due to bad weather.  It is due to come online again by end-January.  Lastly, actual production figures for India in November came in around 20 kb/d, slightly higher than expected at 830 kb/d in November.  Total non-OECD Asian production (including China) in 2008 is forecast at 6.45 mb/d, set to rise to 6.66 mb/d in 2009.

Sudan:  A reassessment of Sudanese production on the basis of new statements by the Oil Ministry led us to revise down 2008 numbers by an average of 40 kb/d.  Carrying this through to around mid-year implies a downward revision for 2009 of a further 15 kb/d.  Ongoing violence, project slippage, a lack of investment and a partial sanctions regime would appear to be curbing previously announced expansion plans. Overall, output is now seen averaging 480 kb/d in 2008 and 500 kb/d in 2009.

OPEC NGLs

Around 30 kb/d is trimmed from estimated OPEC NGL and condensate production for the second half of 2008, spread across the UAE, Indonesia and Angola.  The same countries see a collective 65 kb/d cut from forecast 2009 NGL production.  These adjustments follow downward revisions made last month for Nigeria, Qatar and Saudi Arabia and reflect the likelihood of lower associated gas production and some slippage for LNG expansions.  That said, OPEC gas liquids still increase from 5.0 mb/d in 2008 to nearly 5.6 mb/d in 2009 as expanding non-associated gas output and burgeoning domestic gas requirements to some extent insulate OPEC gas expansion from the more sluggish market affecting crude in 2009.

OECD stocks

Summary

  • Total OECD industry stocks fell slightly, by 2.0 mb in November, to 2,658 mb, as higher North American inventories were more than offset by lower stocks in Europe and the Pacific.  Both crude and product stocks moved slightly higher for the OECD, while a draw in 'Other Oils' stocks (a broad category including NGLs, feedstocks and other hydrocarbons) dragged down the total.
  • Stocks in days of forward demand were 56.4 days at the end of November, 0.4 days lower than the previous month and 4.4 days above November 2007.  Forward demand cover is near or above the top of the five-year range across all three regions.  On an absolute level, however, Pacific stocks continue trending in the bottom half of the five-year range following recent middle distillate draws, while European and North American stocks remain at the top end of their historical range.
  • Preliminary December data indicate total OECD industry oil inventories fell by 8.0 mb in that month.  Japanese stocks were 7.2 mb lower, mostly in products, and US stocks were slightly higher.  European stocks fell 2.5 mb according to Euroilstock, led by middle distillates which fell 6.2 mb in December.
  • Floating storage continues to increase.  Industry and shipping sources report as many as 25 VLCCs hired for floating storage as of early January, representing up to 50 mb. Mid-January estimates put floating storage even higher, at 80 mb, with enquiries for more vessels continuing.


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

Total OECD inventories fell by 2.0 mb in November, closing the month at 2,658 mb, 82.0 mb above the same month last year.  A rise in total stocks in North America, where both crude and products increased, was not enough to offset inventory falls in Europe and the Pacific.



North American crude stocks led the inventory gains and helped OECD crude levels to rise 1.2 mb in total on the month amid continued low refinery utilisation.  OECD product stocks as a whole also showed an uptick of 3.2 mb, mostly due to rising US gasoline and 'Other Products' stocks.  A 6.4 mb fall in the volatile 'Other Oils' category for OECD, however, pushed the total stocks change into negative territory.



November's total oil forward demand cover showed a dip to 56.4 days from October's 56.8 but the figure remained well above both the five-year range and last year's end-November reading of 52.0 days.  Regionally, forward cover in November came to 54.5 days for North America, 63.7 days for Europe and 49.1 days for the Pacific, compared with levels of a year ago of 49.9, 59.6 and 45.0 days, respectively.  In North America, all categories are at or above the five-year range in forward demand cover except for gasoline, which is trending along the five-year average.  In Europe, only middle distillates lie slightly below the top of the five-year range.  The story is similar in Asia, where middle distillate days of cover are trending along the five-year average.

Total OECD inventories for October were revised down by 37.4 mb since last month's report as official data for both crude and products came in lower.  The main changes were in North America, where US stocks were 28.7 mb below preliminary weekly data.  The US revision came mainly from product stocks, with other products and gasoline making up the bulk of the change.  European stocks were also revised down (-9.7 mb) as higher product stocks failed to offset sharply lower crude oil inventories (-17.1 mb).  European distillates were also lower (-6.0 mb). Pacific stocks were largely unchanged in comparison.

OECD Industry Stock Changes in November 2008

OECD North America

North American industry stocks increased by 13.3 mb in November to 1,294 mb as both US crude and product inventories moved higher.  EIA weekly data show total US stocks were relatively unchanged in December, but with higher gasoline and diesel stocks offset by drops in the more volatile 'Other Oils' and unfinished products categories.  North American crude stocks increased by 6.1 mb in November with an 8.7 mb gain in US crude stocks outweighing a fall in Mexican inventories.  Though US refinery runs increased on the month by 100 kb/d and crude imports fell, low overall refinery utilisation rates and increased domestic production produced a stock build for the month.

Weekly data show US crude stocks continuing to build in December, by about 3 mb, but the most dramatic story in storage has been the ascent of stocks at Cushing, Oklahoma - the delivery point for NYMEX light, sweet crude - to record highs.  Data from the week ending 9 January show Cushing inventory levels at 33 mb, a gain of 10.1 mb since the end of November, helping to deepen the contango in WTI and prompting market participants increasingly to store oil for future sale.  At what point might this practice bump up against storage constraints?  Most industry sources put maximum Cushing storage levels between 42-47 mb. However, operational limits reportedly put effective maximum storage levels more in the 34-38 mb range, suggesting mid-continent barrels may undergo further discounts to find another storage home or US crude imports may wane until the impact of OPEC production cuts more fully takes hold. Moreover, the combination of storage constraints and WTI's physical contract expiry on 20 January may particularly exacerbate the near-term contango structure.



US product stocks added 10 mb in November as product demand weakness persisted.  Total product inventories climbed back to less than 5 mb below the five-year average and were on par with 2007 levels.  Gasoline and distillate stocks built by 4.1 mb and 1.7 mb, respectively.  Weekly figures show stronger builds in December with gasoline and distillate gaining 10.5 mb and 10.7 mb, respectively.  Increases in diesel stocks, however, accounted for almost all of December's distillate build.  Heating oil stocks in PADD 1 and the US Northeast, the main heating oil-consuming region, still remain near the bottom of the five-year range.



US and China To Take Advantage of Lower Oil Prices To Fill Strategic Reserves

Both the US and China have recently made announcements that they will resume filling their strategic petroleum reserves (SPRs) in 2009 following the recent drop in oil prices.  The US Department of Energy (DOE) said in a statement released 2 January that it intends to fill the SPR to its 727 mb capacity, indicating a 25 mb fill over 2009.  Receipts from the 2005 sales of crude following Hurricanes Katrina and Rita will go to purchase 12 mb (135 kb/d) in the February-April period. Another 5.5 mb (35 kb/d) will be added in the January-May period as refiners return oil lent to them during Hurricanes Gustav and Ike in September 2008.  The SPR will receive royalty­in­kind (RIK) deliveries of 2.2 mb (24 kb/d), which were deferred from last year, from March to May.  Finally, the DOE plans to restart a 25 kb/d RIK oil fill program in May. Work towards increasing SPR capacity to 1 bn barrels, as mandated in the Energy Policy Act of 2005 continues to proceed.

In China, the National Energy Administration head, Zhang Guobao, told state-run 'People's Daily' at the end of December that phase 1 strategic storage construction, holding 100 mb, has been completed and phase 2, which will hold 170 mb more, is moving forward.  He announced that China will take advantage of the lower prices to resume filling of the first phase tanks, though the fill rate and current fill level remain unclear.

OECD Europe

European industry oil inventories fell 5.5 mb in November to 942.1 mb, 31.4 mb higher than at the same time last year.  The decline was led by a 4.3 mb drop in crude oil stocks, despite higher regional supplies.  Norwegian crude stocks fell by 5.8 mb in the month, in spite of North Sea production being some 150 kb/d higher than a month earlier.  French crude oil stocks were 1.7 mb lower, though slightly higher German and Dutch inventories dampened the overall decline.  Regional refinery throughputs were largely unchanged compared to October.  Looking into December and January, crude stocks could gain a boost as Brent's premium over WTI and dwindling US mid-continent storage capacity could retain higher Atlantic Basin supplies within Europe.



Regional product stocks were largely unchanged from a month earlier despite overall weak demand.  Preliminary data for main consuming countries show inland deliveries for the region as a whole contracting by some 700 kb/d, or -4.4% from a year earlier.  Only heating oil deliveries posted year-on-year gains, supported by high German purchases.  For the first time since at least 1995 (when our data series began), German consumer heating oil stocks built counter seasonally in November.  Mild temperatures and lower prices led households to add further volumes to tanks.  At the end of November, German household tanks stood at 64% of capacity, 2% higher than the previous month and 5% higher than at the same time last year.  Although household storage fell to 63% of capacity in December, the 65 kb/d decline falls short of the 225 kb/d five-year average draw for the month.

Preliminary data from Euroilstock indicate product inventories were only slightly higher (0.2 mb) in December, however masking a 6.2 mb draw in middle distillate stocks.  By contrast, stocks held in independent storage in the Amsterdam, Rotterdam, Antwerp area (ARA) moved higher in December, with increases in all product categories and most notably in gasoil stocks.  Gasoil stocks rose by 3.1 mb over the month to 15.97 mb and the highest level since August 2006.  A steep contango in the ICE gas oil futures market has encouraged refiners to put gas oil in storage to await higher prices before selling.  Heating oil stocks will likely come down sharply in January, however, as a cold snap in the first half of the month and disrupted gas supplies following the Russia-Ukraine pricing dispute likely increased European demand.  Jet fuel stocks built by 0.8 mb over the month and reached 5.4 mb, their highest level ever, due to weak airline demand.  Naphtha and gasoline stocks were also slightly higher while fuel oil stocks were unchanged for the month.

OECD Pacific

Total industry stocks in the Pacific declined by 9.9 mb in November given lower product and 'other oils' stocks.  Japanese product stocks fell by 5.8 mb in the month, as seasonally increasing demand for heating fuels offset increased refinery production.  Regional demand, although posting a massive 10.7% annual decline, was some 300 kb/d higher than a month earlier as kerosene and fuel oil used for heating picked up seasonally.  Pacific middle distillate stocks consequently fell 4.0 mb on the month, with the bulk of the decline coming from Japanese kerosene.  According to the Petroleum Association of Japan (PAJ), Japanese kerosene stocks continued to fall in December, shedding 3.4 mb for the month as a whole.



OECD Pacific crude oil stocks on the other hand changed little in November, as higher Korean inventories mostly offset a 2.7 mb decline in Japanese stocks.  Japanese crude runs were 220 kb/d higher in November than a month earlier, although still sharply below levels of a year ago.  Total regional crude oil stocks have moved back in line with last year's levels and into their five-year range, totalling 162 mb at end-month.

Recent Developments in Singapore Stocks

Falling residual inventories left independent stocks held in Singapore, as measured by International Enterprise, almost 10 mb lower in December.  Light and middle distillates retained their healthy inventory levels and changed little on the month, whereas declining fuel oil stocks accounted for almost all of the total product change.  Strong fuel oil buying by Chinese independent refiners in the first half of December helped to draw down stocks.  Such refiners were looking to increase their residual fuel oil purchases ahead of 1 January tax increases.





IEA Stockholding Obligation - Days of Net Imports Feature Added to the IEA Website

A key attribute of the IEA is the collective ability of its member countries to release oil stocks into the market when normal supplies are severely disrupted. One of the main elements of the IEA's founding treaty formulated nearly 35 years ago was the establishment of a basic oil stockholding obligation.  Each IEA member country is required to maintain total oil stock levels equivalent to at least 90 days of their respective net imports in the previous calendar year.

Countries may meet this obligation with a combination of crude and refined product stocks held exclusively for emergency purposes (either by governments, stock agencies or industry), and stocks held by industry for commercial or operations use. By definition, net exporting countries do not have an IEA stockholding obligation.

Each month the OMR includes volumetric information on stockholding in individual IEA member countries. This covers primary stock levels within the national territory of each country, including industry stocks and government-controlled stocks.  However, this does not always correspond to how a country meets its IEA stockholding obligation.

For example, under a bilateral agreement some countries may count stocks held in the territory of another country in order to meet their minimum 90 day level.  Thus to evaluate how a country is meeting its stockholding obligation, stocks held within its territory for the benefit of another country need to be deducted. And stocks being held for its benefit in other countries need to be added. Also, the primary stocks shown in the OMR do not include utility stocks, while countries can count these stocks, provided they are subject to government control, to meet the 90 day requirement. Finally, the OMR publishes the volumes of stocks, in barrels. The conversion into days of net imports is a complex, not always well understood, calculation that includes for example a 10% operational deduction and excludes naphtha.

In order to help readers better understand the IEA's stockholding obligation and the various stockholding systems in place to meet this requirement, we have added information to our web site (www.iea.org/netimports.asp), with detailed information on stock levels and explanation on stockholding practices in each of the member countries.  The stock levels of each country, measured in days of net imports, will be updated monthly in conjunction with the OMR.

Prices

Summary

  • Crude oil prices recovered from December lows in early January, supported by cold weather, the Russian/Ukrainian gas crisis and fighting in the Gaza Strip.  Signs that OPEC is making good on its pledge to curb global oil supplies further, as agreed at their 17 December meeting, were also becoming evident in early January.  However, at the same time, weak global refinery demand and an increasing crude overhang, as shown in record Cushing stocks and floating storage, continued to lend a bearish tone.
  • The US spot crude market is currently characterised by WTI's relative weakness, distorted by record-high inland Cushing stocks, and the grade is trading at a discount to not only Dated Brent, but also to other US domestic light sweet grades such as LLS, while standing at near parity with sour Mars.
  • Refining margins were mixed in December but remain weak overall, despite a slight uptick in depressed gasoline cracks.  While margins fell on the US Gulf Coast, West Coast margins rose sharply on a spate of outages constraining regional supplies.  December European margins fell on narrowing distillate cracks, though remain positive in most cases.  Singapore margins rose as distillate cracks held up.
  • After an early-December surge in benchmark crude freight rates, dirty rates fell throughout the month.  Declining OPEC export volumes more than offset increased charters for floating storage, pressuring rates lower.  Clean rates continue to suffer from falling product demand and were steady or down for all routes in December.

Overview

Crude futures prices continued their downward slide in December, briefly trading in the low $30s on weak fundamentals and - at that time - little indication that OPEC was making good on its intent to curb oil supplies.  However, in early January, the Russian/Ukrainian gas crisis, fighting in the Gaza Strip and cold weather supported a brief return to around $50/bbl before prices started falling again.  At the time of writing, WTI futures were hovering around $35/bbl, though Brent was around $45/bbl.



OPEC's 17 December meeting in Algeria effectively resulted in a pledge to reduce output targets by a further 2.2 mb/d, adding to previous cuts made in September and October.  Markets were initially unimpressed, but the early-January rise could in part be attributed to signs that the group is increasingly tightening output - with the usual time lag until lower exports actually are felt in the market.

However, currently, all market signals indicate a large crude overhang, with stocks at WTI's delivery point in Cushing, Oklahoma, at an all-time high around 33 mb in early January.  Preliminary indicators suggest a growing volume of crude held in floating storage, with estimates ranging as high as 50-80 mb.  Anecdotal reports point to crude being held offshore Iran, Venezuela and also the US Gulf Coast, West Africa and the North Sea.  In part, this is the result of a steady, wide contango in crude futures, with first/second month WTI currently showing a difference of around $7/bbl.  Indeed, the Cushing overhang in particular is also keeping near-month WTI below Brent futures in a pattern observed frequently in recent years, making Brent for now arguably more reflective of global market sentiment.



But the crude overhang is also symptomatic of weaker refinery demand, with OECD utilisation rates below average amid increasingly frequent reports of economic run cuts in nearly all markets, including China.  In addition, new capacity is coming online - notably the huge Jamnagar expansion in India as well as capacity in Vietnam and China to follow soon.  In general, on the product demand side, all signals point at a further weakening and indeed, we have revised down our forecasts substantially in this report on the back of lower GDP assumptions and lower deliveries data.  Negative economic data emerging especially from the US continues to jolt markets on a near-daily basis.  The exception is perhaps heating fuels in Europe, which is experiencing a colder-than-average January.

Part of the early-January price gain may also be related to the halt in Russian natural gas supplies pumped through Ukraine to Europe, related to a price dispute between the two countries.  Southeastern European countries in particular quickly faced gas shortages, due to a high degree of dependency on Russian pipeline imports and low storage volumes.  As a result, heating oil/gasoil crack spreads rose in early January.  Countries further west were less affected, but the uncertainty supported prices.  Against the background of colder temperatures, heating oil and fuel oil demand is likely to have risen, though this is not yet evident in reported data.  Israel's incursion into Gaza from late December also raises the spectre of a spread of violence to the wider Middle East, boosting supply concerns.

The US and, according to news reports, China are taking advantage of the low-price environment to restart building strategic crude stocks.  The US Department of Energy announced that it would seek to purchase 12 mb of crude, which is in addition to 7.6 mb already secured - resulting in about 20 mb to be filled by end-May.  China is reportedly also engaged in building its strategic inventory, though there is no published stocks data available to confirm this.

Spot Crude Oil Prices

Spot crude markets were pressured by the global crude overhang due to lower refinery demand.  However, OPEC's gradual curb of exports is supporting sour grades.  Hence, in the Asian market, Dubai was trading at a premium to Dated Brent since mid-December, also taking support from higher fuel oil.  Despite lower freight rates, the unusual differential was insufficient to tempt Asian refiners into buying more West African crudes, given lower refinery throughputs and still-weak light distillate cracks.  Asian purchases of Nigerian, Angolan and other West African crudes were set to be around 830 kb/d in January, relatively steady from December, but lower than volumes seen earlier last year.  Meanwhile, regional sweet marker grade Tapis was further depressed by weak naphtha, briefly falling to near parity with Dubai in early January, an unusual occurrence.  However, this is part of a trend of generally narrowing sweet-sour spreads.



The US market is currently characterised by WTI's relative weakness, distorted by record-high, inland Cushing stocks (making WTI for now less reflective of global fundamental trends).  Consequently, the marker grade is trading at a discount to not only Dated Brent, its  fellow international benchmark, but also to other US domestic light sweet grades such as LLS, while standing at near parity with sour Mars.  As a result, some traders are apparently doing deals based on alternatives to WTI.  In Europe meanwhile, Urals is currently at parity to Dated Brent, supported by the prospect of lower OPEC sour crude volumes, possibly strengthening heating oil and fuel oil demand in Europe on colder temperatures in January and lower export volumes due to prohibitively high Russian export duties in the last months of 2008.



Refining Margins

Refining margins on average made small gains in December, but many key ones fell despite a slight uptick in depressed gasoline cracks, and overall remain weak.  US Gulf Coast light sweet crude cracking margins all fell further and remained in negative territory, with only coking margins consistently profitable.  The slight improvement in gasoline differentials was more than offset by narrowing distillate cracks.  The US West Coast however saw a sharp rise in margins due to a spate of refinery outages, which kept the regional product market tight.  European margins mostly fell and remain low, with Brent hydroskimming stubbornly managing to stay positive (and, notably, higher than USGC Mars coking).  Again, weaker distillate crack spreads dragged down margins.  Lastly, Singapore margins rose, as distillate cracks held up or only declined marginally - unlike the other regions surveyed.



NB:  In the process of our annual refining margins methodology overhaul, it is possible that some of the product price quotes will soon change due to tighter European sulphur specifications; equally, some of our fixed-cost assumptions may also be subject to change.  Over the longer term, we also aim to update the product yields used, on the basis of an observed and assumed continued shift to higher distillate output.



Spot Product Prices

Light distillate crack spreads improved marginally in the latter half of December and early January.  Puzzlingly, and barring the fact that many refineries have minimised their gasoline yield due to recent months' unfavourable prices, markets by all accounts remain well supplied and stocks high.  Recent days have seen the NYMEX RBOB/WTI differential rise to its highest since early September, though this was rather a function of depressed crude futures than signs of fundamental strength in gasoline.  More impressively, naphtha discounts to crude have narrowed substantially in December and early January as fundamentals improve gradually.  Due to its recent low price, India for one has reportedly stepped up domestic use of naphtha in power generation and fertiliser production, avoiding natural gas, and is hence reducing exports.  In South Korea meanwhile, naphtha crackers are allegedly ramping up utilisation rates to currently around 85%, from November's lower 70-75%, though elsewhere, demand remains weak.



Heating oil crack spreads fell in December, but rose sharply in early January as temperatures fell below average in Europe, coupled with the cutting off of Russian gas supply due to its price disagreement with Ukraine, the main conduit for shipments to Central and Western Europe.   The US Northeast has seen cold spells too, although in Northeast Asia, temperatures remain above average.  Nonetheless, in Japan heating kerosene stocks are well below their five-year range, despite weak demand.  On the other hand, China looks set to maintain its gasoil net-exporter status in January.  Meanwhile, diesel and jet fuel crack spreads were broadly flat over the past month.

Low-sulphur fuel oil discounts to crude in Europe (and elsewhere) remained steady or widened slightly in December and January, despite the Russian gas shortfall and some potential for utilities switching to burning fuel oil.  High-sulphur discounts meanwhile narrowed in early January on tightening heavy/sour crude supplies.  In Singapore, fuel oil stocks fell in December, as fewer barrels arrived from the west and Chinese independent refiners increased purchases.  As already flagged in this report, first-quarter fuel oil supplies will be curtailed due to a halt to Saudi and Iranian spot sales, as both countries consume more barrels domestically.  In addition, South Korea is expected to nearly halve its fuel oil exports in January to around 200,000 tonnes, for the same reason.  On the other hand, Chinese buying in January is expected to be muted, as consumers reportedly stocked up ahead of a tax hike at the end of the year.





End-User Product Prices in December

Retail product prices fell by 18% month-on-month, in US dollars, ex-tax, in December.  Gasoline prices on average decreased by 21%, while diesel, heating oil and low-sulphur fuel oil prices were down by around 17%.  In December, US consumers on average paid $1.69/gallon for gasoline ($0.45/litre), Japanese consumers paid ¥118/litre ($1.27/litre), consumers in the UK £0.89/litre ($1.32/litre), and other European consumers paid between €0.86/litre in Spain ($1.09/litre) to €1.18/litre in Italy ($1.42/litre).  Retail prices in the surveyed IEA countries were 37% below December 2007 levels on average, in US dollars, ex-tax.

Freight

After an early-December surge in benchmark crude freight rates, dirty rates fell through the month while clean rates continued their steady descent since October.  Two opposing dynamics influenced crude rates, with declining OPEC export volumes more than offsetting increased charters for floating storage.  January floating storage hires to take advantage of a deepening contango in the crude forward curve may lend support to short-term rates until additional OPEC export cuts more fully take hold or the macro trading environment weakens further.

VLCC chartering costs from the Middle East Gulf to Japan were marginally lower at the end of December versus end-November.  The first week of December, however, saw rates jump from just below $11/tonne to over $17/tonne before gradually falling back to near $10/tonne by month end.  West Africa to US Atlantic Coast rates showed a similar pattern, jumping from $18/tonne at end-November to $26/tonne in early December before finishing the month just under $12/tonne.

The early-month strength for dirty freight rates stemmed from the chartering of VLCCs for floating storage to take advantage of the deepening contango in the benchmark crude forward curves.  Industry and shipping sources report as many as 25 VLCCs hired for floating storage as of early January, representing up to 50 mb.  Mid-January estimates put floating storage even higher, at 80 mb, with enquiries continuing.  Disruptive weather conditions in the Mediterranean and Caribbean and a strike at France's Fos-Lavera terminal also tied up tanker supply in December, supporting Atlantic Basin rates.

An easing of rates derived from lower activity during the Christmas holiday period, improving weather conditions and the end of the French strike.  In addition, OPEC sailings continued to fall in December, counteracting much of the new demand for floating storage.  With some Asian refiners reporting shipment cuts from Saudi Arabia of 5-10% in January and 10-15% in February, charter demand should remain under pressure.



The clean tanker market continues to suffer from falling product demand.  Middle East Gulf to Japan 75 kmt freight rates fell from $35/tonne at end-November to below $24/tonne by end-December.  Transatlantic UK-US Atlantic Coast rates held steady again around $20/tonne but healthy US gasoline and distillate stocks largely stifled any arbitrage opportunities.

With the end of the year comes a switch from Worldscale 2008 to 2009 rates.  Worldscale flat rates serve as voyage benchmarks; actual prices reflect a negotiated percentage of these rates.  Worldscale rates for long-haul voyages increased 35-40% with the New Year.  This rate hike includes a rise in average bunker fuel prices for the period October 2007-September 2008 to $554/tonne versus the $329/tonne used for 2008 Worldscale rates.  Still, the change is not expected to significantly affect actual freight costs.  Early-January quotes have generally expressed a lower percentage of Worldscale rates than end-2008.

Refining

Summary

  • Global 1Q09 crude throughput is forecast to average 72.3 mb/d, 1.2 mb/d below last month's report, as lower demand prognoses and the continued economic strain weigh on refinery activity.  The contraction in crude runs versus 1Q08 is now 1.7 mb/d, with roughly two-thirds of the decline in the OECD.  Non-OECD crude runs are now forecast to see an annual decline of 0.4 mb/d, driven largely by downward revisions to Chinese and Middle Eastern crude runs, totalling around 0.6 mb/d.
  • Global 4Q08 crude throughput averaged 72.8 mb/d, 0.2 mb/d higher than estimated in last month's report.  Stronger October official data for several European countries, and higher than estimated November data for OECD Europe and the Pacific underpin much of the upward revision.  However, December estimates have been reduced, following weaker than expected US weekly data and reports of further run cuts in China.


  • The refining industry has responded to the economic downturn and demand weakness by not only reducing operating rates but also cutting capital investment plans, idling distillation and upgrading capacity, and restructuring its operations to cope with poor gasoline cracks, volatile product prices and poorly functioning debt markets.
  • OECD refinery gasoil/diesel yields increased by 0.3 percentage points (1%) in October to a near-record level of 30.2% on strong demand and resilient crack spreads.  Strong month-on-month growth in both North America and Europe of around 0.7 percentage points (2-3%), underpin this move.  Equally significant shifts were witnessed in the yield of naphtha, which fell below the five-year range on record negative naphtha cracks and jet fuel/kerosene, which despite healthy cracks saw yields squeezed by stronger gasoil/diesel and gasoline yields.

Global Refinery Throughput

Global refining activity continues to undershoot levels of a year ago as weak demand and poor margins weigh on crude throughput levels.  Increasingly bearish assessments of demand, most notably in Asia, and reports of increased economic run cuts have reduced forecast 1Q09 crude runs by 1.2 mb/d from last month's report.  Elsewhere, US independent refiners continue to reduce utilisation, not only on overall crude processing levels, but also for upgrading capacity, most notably gasoline-focused catalytic cracking units, in light of sustained weakness in gasoline cracks on the US Gulf Coast.  Similarly, the increased run cuts in Japan continue to mute the typical seasonal peak in refinery activity for the start of the year.

Preliminary data for December indicate that global crude throughput averaged 72.7 mb/d - 0.8 mb/d below last month's forecast of 73.5 mb/d.  Lower-than-expected crude runs in the US, and China account for the vast majority of the downward revision.  US crude throughput was again weaker than expected, reflecting the increasing lengths that refiners are going to, in order to counter weak demand and rising product stocks.  US refinery utilisation rates fell to among the lowest levels since 1992 in late December, with particularly weak activity levels reported on the US Gulf and East Coasts.

Global 4Q08 crude throughput of 72.8 mb/d is 0.2 mb/d higher than last month's estimate.  Stronger October official data for a number of countries in OECD Europe and higher than estimated November data for OECD Europe and the Pacific, underpin much of the upward revision.  OECD Europe and Pacific preliminary data for November were both 0.3 mb/d ahead of our forecasts, as were Latin American crude runs.  Offsetting these upward revisions were lower-than-expected crude runs in the Middle East and China.  Chinese refiners are reportedly working to reduce product inventories in the face of weaker than expected demand.  We assume that this will continue to affect Chinese crude runs throughout December and 1Q09.



The most significant change to our 1Q09 forecast, both numerically and conceptually, comes from the reduction of non-OECD crude runs, which are now projected to average 35.3 mb/d, 0.7 mb/d lower than last month, and a decline of 0.5 mb/d compared to 1Q08.  Lower Chinese crude runs account for much of the reduction, reflecting this report's lower demand estimates and reports of continued high product stocks for gasoil, although further cuts to our Chinese forecast for crude runs are still possible.  Alternatively, the now weaker demand outlook could equally lead to higher product exports, but much will depend on domestic demand strength and the implications for refiners of China's new domestic pricing regime.  Nevertheless, there remains a possibility that the two state refiners will idle capacity rather than run at a loss.  Elsewhere, we have reduced our forecasts for the Middle East, due to additional planned maintenance work and recent crude runs falling short of expectations.

Consequently, 1Q09 global crude throughput is forecast to average 72.3 mb/d, 1.2 mb/d less than estimated in last month's report.  Overall, there is little seasonal variation expected during the quarter, with the typical seasonal peak at year-end 2008 much more muted than in previous years.  The balance of the quarter is expected to witness depressed refinery crude throughput levels, largely due to economic factors.  There is little reported planned maintenance in North America, so we have relied on seasonal averages to estimate the region's crude throughput levels over the quarter.  This may prove to be too aggressive an assumption, and would result in upward revisions to our forecast crude throughput during the coming months.  This month also sees a slight change in our methodology, with the switch to a rolling four-month forward forecast for throughputs.  Consequently, April throughputs are included in this month's report and are expected to see a small increase compared to the average for 1Q09, as US maintenance winds down while planned work in the OECD Pacific region increases.

OECD 1Q09 crude throughput is forecast to average 37.0 mb/d, 0.5 mb/d below last month's report and 1.2 mb/d below 1Q08 levels.  As already highlighted, the dominant factor determining crude throughput levels is currently economic viability, which far outweighs other considerations.  Unsurprisingly, continued weak gasoline cracks appear to be affecting those refiners with a structural bias toward gasoline production, i.e. US refiners, despite recent efforts to raise distillate yields.  This month's IEA margin calculations illustrate the fact that some hydroskimming refineries in Europe are earning higher margins than many cracking (and even coking) refineries on the US Gulf Coast.



OECD North America crude throughput continued to increase in November, as the tail end of the hurricane disruption that had dogged October crude throughput dissipated.  The higher-than-estimated November average of 17.5 mb/d is entirely attributable to Mexican crude runs, which were stronger than expected, despite reports of maintenance during the month.  December North American throughput is assessed at 17.5 mb/d, 0.2 mb/d below last month's report, following weaker than expected US weekly data.  1Q09 throughput is forecast to average 16.9 mb/d, 0.7 mb/d below previous year levels, reflecting the weaker demand environment and poor economics, as refiners seek to limit the rise in product inventories that is undermining margins.

OECD Pacific November crude runs were 0.3 mb/d ahead of forecast, with Korean crude intake substantially higher than our assumptions.  Korean crude runs have held up well, declining by only 5% year-on-year, compared to the 9% decline in Japan, despite the impact of heavily negative naphtha cracks.  Nevertheless, we retain our assumption of run cuts for the December forecast, providing the potential for another comparable upward revision next month.   1Q09 crude runs are forecast to average 6.8 mb/d, 0.5 mb/d below 1Q08 levels, with Japan shouldering the majority of the shortfall.  This level of throughput is 0.2 mb/d below last month's report, as further evidence of increasingly severe run cuts has emerged in recent weeks, driven by poor demand.



Refining Industry Responses to the Economic Downturn

The impact of the economic downturn on refiners is evolving.  The refining industry has for many months sought to offset weakening demand by cutting runs where economics dictate.  Recently however, there has been evidence that refiners are responding not just on an operational basis, but also strategically and financially.

Ever-increasing levels of run cuts have been visible in recent months, particularly among independent refiners in the US and Japan.  More evidence has recently emerged that refiners are not just trimming crude capacity utilisation rates, but increasingly turning their attention to upgrading units, particularly fluid catalytic cracking (FCC) units (with their relatively high gasoline yields) as a way to support overall margins and reduce their exposure to negative gasoline cracks.  For example, Valero, the largest US independent refiner, has indicated that average FCC utilisation was around 75% in December, well below historical levels.

Refiners have also sought to improve their cash flows by cutting planned capital expenditure levels in light of the weaker margin environment.  Typical reductions for 2009 plans are in the range of 12-20%, as the prospective returns potentially on offer must be balanced against continued problems for some refiners in accessing debt markets, and the overall level of profitability achievable under the current conditions.

So far two US refiners, Flying J and LyondellBasell, have sought protection from creditors by entering Chapter 11. This, in theory, protects the business while a restructuring of debts is agreed with creditors, but it is not yet clear that the weaker refining margin environment was directly responsible for either demise, i.e. other factors may have played a more dominant role.  Nevertheless, that is not to say that more refinery operators, be they independent or integrated operations, will not succumb to such steps, given the dysfunctional debt markets.  Lastly, it is worth noting that industry reports suggest that refiners may struggle to satisfactorily source crude in coming months as producers and suppliers seek better protection from refiners undergoing financial restructuring.

While bankruptcy may be seen as an involuntary restructuring of the business, some refiners have adopted a more aggressive path to improve their competitive position.  US refiner Sunoco, which is based largely on the East Coast, has flagged its intention to close its 85 kb/d refinery in Tulsa, Oklahoma if a buyer cannot be found by the end of 2010.  Similarly, Nippon Oil, the largest Japanese refiner, has agreed a merger with Nippon Mining Holdings, the sixth largest.  The combined entity would initially have approximately 1.9 mb/d of capacity, although the merger envisages closing some 400 kb/d within two years.  In the shorter term, Nippon Oil has accelerated plans to close is 60 kb/d Toyama refinery by the end of January, since it faces declining domestic demand and intensified international competition as China moves back towards being a net product exporter from its recent status as a net importer.

Elsewhere in the region, Australian refineries continue to be dogged by reliability issues, with Caltex's 126 kb/d Lytton refinery temporarily closed during December and Shell delaying the restart of its 85 kb/d Clyde refinery into 2009, from 2008.



OECD Europe crude throughput was broadly flat in November against October's upwardly revised estimate of 13.3 mb/d, and 0.3 mb/d ahead of expectations, according to preliminary data.   The bias towards higher distillate yields in the region, and relatively weak crude markets, have supported margins and therefore throughputs, vis-à-vis other OECD regions.  Nevertheless, there appears to be some disconnect between reported maintenance work and throughput levels, leaving the current throughputs subject to further revisions in future reports, most notably for Turkey, Greece and Italy.  December crude throughput is reduced marginally from last month, following a port strike in southern France, which forced varying degrees of run cuts at refineries with a total crude distillation capacity of 0.6 mb/d.  Crude supplies to refineries in Switzerland and Germany were also reported to have been affected, but the extent and validity of these reports remains to be seen in next month's preliminary data.



Forecast 1Q09 non-OECD crude throughput is revised down heavily this month (-0.7 mb/d), in light of changes to this report's demand forecast, continued weak refinery economics and reassessed Middle Eastern crude throughput levels.  Weaker crude runs are also assumed for December, following reports of heavier than anticipated run cuts in China.  Partially offsetting these changes are stronger than estimated crude runs in Brazil and India during November, which leaves the 4Q08 average 0.1 mb/d lower than last month's report.  India's Reliance Petroleum started-up the 580 kb/d expansion of its Jamnagar refinery at the end of December.  We have assumed a moderate ramp-up to full capacity over the course of the coming months, but initial reports suggest that this may be too pessimistic, with Reliance keen to reach full operating rates quickly.  However, on a regional basis Jamnagar product supplies will eventually displace supplies from other, less economically viable capacity, once the current excess crude availability is removed from the market.

Chinese crude runs fell precipitously in November, as the previously highlighted 4Q08 run cuts materialised.  Consequently, crude runs of 6.6 mb/d were 0.1 mb/d below our estimate.  This lower level of crude throughput appears more consistent with the evolution of Chinese demand.  Further restraint on the part of Chinese state refiners is now envisaged for December and 1Q09, which is likely to weigh on future refinery activity levels.  Therefore, we have reduced December and 1Q09 crude runs forecast by 0.4 mb, from last month's report, to an average of 6.5 mb/d.  Significant upside to this forecast is possible, given several new refineries that could be brought on stream during the quarter.  However, state oil companies appear to be slowing commissioning of planned projects and it is therefore unclear as to when these new plants will enter service.

The Middle East 1Q09 crude throughput forecast is reduced by 0.2 mb/d following a second month of lower-than-expected crude runs in November.  Saudi Arabian crude throughput forecasts bear the brunt of the reduction, but also reflect higher planned maintenance forecasts for February and March.  1Q09 FSU forecasts remain unchanged, following continued strong Russian crude runs in November, but the prospect for further increases above current levels appears dim, with some reports suggesting the spread of the global economic slowdown will be felt more heavily by Russian refineries in the coming months, which entails some downside risk to our current regional forecasts.

OECD Refinery Yields

We have revised our methodology this month to consider yields on a volumetric basis, instead of the weight-based yields used previously.  This brings our methodology for the analysis of yields into line with the other sections of the report, which are based on volumetric measures.

OECD refinery gasoil/diesel yields increased by 0.3 percentage points (1%) in October to a near-record level of 30.2%, on strong demand and resilient crack spreads.  Both North America and Europe showed a month-on-month growth of 0.7 percentage points, from 24.7% to 25.4% and from 36.9% to 37.6%, respectively.  OECD Pacific yields stayed around the previous month's level at 28.8%.  Year-on-year growth remains around 0.8 percentage points, driven by percentage point gains in Europe of 1.7, 0.2 in North America and 0.5 in the Pacific.

A continuous weakening of naphtha cracks appears to have resulted in yields for naphtha decreasing during October to 4.5%, well below the five-year range for the time of the year.  European yields decreased by 0.7 percentage points from September to 5.5%, offsetting an increase of 0.3 in the Pacific. The weakness of naphtha cracks in November suggests that OECD refiners will continue to exert downward pressure on naphtha yields during the remainder of the year.



OECD refinery gasoline yields have recovered to 33.6%, near the five-year average level, supported by an increase of 2.7 percentage points in North America yields since August to 46.5% in October.  The increase in North American gasoline yields reflects moves to offset the tight stock situation seen in September 2008, which exacerbated already low stocks seen in August in the US, and mirrors the uptick seen after the 2005 hurricanes.  Gasoline stocks in the US are now back in the five-year range, so it is possible that a reversion to lower level yields will be seen in data for the remainder of 2008.



A striking decrease in North American jet fuel/kerosene yields since August has reduced total OECD yield from above the five-year range to below the range at 8.3% in October, a reduction of 1.1 percentage points from the August level of 9.4%.  In part this move was necessary to accommodate the higher gasoline yields discussed above.  However, weaker demand has also far outstripped supply disruptions in the US following September's hurricanes, and has consequently pressured jet prices, resulting in a decrease of crack spreads.  European refiners similarly lowered jet fuel yields to 6.3%, in line with seasonal patterns, but the reduction of 1.3 percentage points from September level of 7.6% was far greater than the five-year average decline.  The Pacific jet/kerosene yields fell counter seasonally by 1.1 percentage points from 15.5% in September to 14.4% in October.  Weak heating-kerosene demand forced refiners to produce a higher percentage of jet fuel (leading to higher export volumes) relative to what the seasonal pattern would indicate ahead of the region's peak winter demand.



OECD fuel oil yields remain below the five-year range despite a monthly increase of 1.4 percentage points in European fuel oil yields from 11.2% in September to 12.6% in October.  OECD Pacific fuel oil yields are now well below the five-year range as a result of significantly lower yields in Korea (12.5% in October 2008 compared to 18.5% in October 2007), thanks to the start-up of new upgrading capacity in the middle of 2008.