Oil Market Report: 11 February 2009

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Highlights

  • Benchmark spot crude oil prices were steady in a $40-45/bbl range after an early-January surge.  Lower OPEC output offset falling demand.  Gasoline and naphtha have recovered significantly as refiners trim output to stem losses, thus improving refining margins.
  • Forecast global oil demand is revised down by 570 kb/d to 84.7 mb/d in 2009 (-1.1% or -1.0 mb/d year-on-year) after the IMF again slashed its GDP growth prognosis to 0.5%.  Our 2008 estimate remains largely unchanged at 85.7 mb/d (-0.4% or -0.4 mb/d versus 2007).  Two consecutive years of demand decline have not occurred since 1982/83.
  • Global January oil supply fell by 520 kb/d to 85.2 mb/d, largely on lower OPEC output.  2008 and 2009 non-OPEC supply is revised down by 20 kb/d and 110 kb/d respectively, resulting in 2009 growth of 0.4 mb/d to 50.9 mb/d.  OPEC NGL output in 2009 is trimmed by 0.4 mb/d to 5 mb/d on lower gas output and project delays, implying +0.3 mb/d growth year-on-year.
  • OPEC crude supply in January fell by an estimated 950 kb/d to 29 mb/d (now excluding Indonesia) as output curbs deepened.  Effective OPEC spare capacity is 4.4 mb/d.  The 'call on OPEC crude and stock change' for 2009 now stands at 28.8 mb/d, at least 1.7 mb/d below 2008, but potentially 1.5 mb/d above OPEC-12 output implied by the current target.
  • OECD industry stocks fell by 20.1 mb to 2,673 mb in December, but 4Q08 still saw a counter-seasonal build of +170 kb/d on low refinery runs.  Forward cover was steady at 57 days, 4.5 days higher on the year.  Preliminary January data indicate a further 8 mb stockbuild, while short-term floating storage reportedly rose as high as 50-80 mb.
  • Global 1Q09 refinery crude throughput is revised down 0.3 mb/d to 71.9 mb/d, 2.0 mb/d lower year-on-year, on the back of weaker demand, run cuts by US and Japanese refiners and heavier US maintenance.  Non-OECD weakness is concentrated in China and Other Asia, whose collective throughput is 0.8 mb/d below last year.

Weaknesses abound

This month's report highlights a number of dislocations affecting both the broader global economy and the oil market.  Bottlenecks, affecting physical flows of oil or constraining trade, economic activity and the flow of investment capital, tend to distort market pricing trends and increase volatility.  The smooth functioning of the market requires international flows to take place, even though national, regional or international market dislocations will ultimately be resolved through the mechanism of price.

The most obvious weakness lies on the demand side.  Trend oil demand growth above 1% has evaporated, firstly after the price surge, and more recently amid worsening financial and economic crisis.  In retrospect, last summer's $140/bbl triggered demand destruction in the face of inelastic supply, but widespread financial and economic collapse are now the key brakes on global demand.  The IMF's end-January estimate for 2009 GDP growth came in lower than anticipated, at 0.5%.  We have therefore again cut forecast 2009 global demand, this time by 570 kb/d. The resultant 2008 and 2009 fall in world oil use of 1.4 mb/d is the first such decline since the early 1980s. The economy and oil demand will ultimately recover, so long as another distortion - economic protectionism - doesn't intervene.

Weak demand is also having a severe impact upon international trade, leaving substantial tanker tonnage idle and rendering floating storage an economically attractive 'sink' for oil that is struggling to find a market. While current OPEC supply curbs will eventually begin to clear the onshore stock over-hang, significant volumes of 'floating' oil could dampen any upward price momentum in the short term.

Meanwhile, low US crude runs and rising inventory bumping against limited storage and mono-directional pipelines around Cushing, Oklahoma have distorted WTI prices, providing another bottleneck, both literally and in terms of arbitrage flows.  Cushing is the delivery point for the NYMEX crude futures contract and logistical constraints here have recently caused exceptional discounts, both for prompt versus forward WTI, and for WTI versus other grades.  The only long-term solution to this logjam will be investment in diversified pipeline capacity.

Curtailed investment will also undermine future oil supply growth.  Slashing budgets and deferring projects until cost reductions materialise makes commercial sense if credit is scarce and oil prices are falling.  However, it risks leaving the global supply sector stretched once demand growth re-emerges.  This year's MTOMR will focus on medium-term implications of lower capital spending, notably project slippage.  But even short-term, reduced spending is having an impact.  Our 2009 capacity forecast has been curbed by a net 1 mb/d since prices began to tumble last summer.  Non-OPEC contributes 0.3 mb/d of that, with a sharp reduction in Russian and Canadian spending underpinning the downgrade. Although prices would likely have to fall further before a significant slug of current output were to be shut-in, sustained $40/bbl oil will likely accelerate prevailing decline rates, and thus curb 2009 supply.

OPEC crude and NGL/condensate capacity for 2009 has been even harder-hit, revised by a net -0.7 mb/d since mid-2008.  OPEC crude production policy underpins this, as associated gas and NGL supplies are also affected.  Some of this year's expected increase in OPEC crude capacity may also slip - something OPEC Ministers have themselves begun to flag.  Ultimately, low prices sow the seeds of their own destruction, and only clear signs of a recovering global economy will spur investment in new oil supply.  The danger is that if too much investment slips now, the scale of the price response to resurgent demand could again destabilise the global economy.

Demand

Summary

  • Forecast global oil demand has been revised down for 2009, following a reassessment of economic assumptions by the International Monetary Fund.  Expected global GDP growth, at 0.5%, has been more than halved for a second month in a row, given the worsening outlook across all regions, particularly in Europe, the FSU and Asia.  Global oil demand is now projected at 84.7 mb/d in 2009 (-1.1% or -1.0 mb/d when compared with the previous year and 570 kb/d lower versus our last report).  The demand estimate for 2008 remains largely unchanged at 85.7 mb/d (-0.4% or -0.4 mb/d versus 2007 and roughly 90 kb/d lower than previously estimated).  Not only will the two-year contraction in oil demand be the first since the early 1980s, but 2009's decline will also be the largest since 1982.
  • Oil demand in the OECD for 2008 has remained virtually unchanged from last month's estimate at 47.5 mb/d (-3.4% or -1.7 mb/d versus 2007).  For 2009, given lower GDP assumptions and assuming that OECD demand destruction begins to ease by mid-year, oil demand is now forecast at 46.0 mb/d (-3.2% or -1.5 mb/d on a yearly basis), some 340 kb/d lower than previously estimated.  The outlook has significantly worsened in Europe and the Pacific, highlighting a lagged response to economic developments in North America.


  • Non-OECD oil demand has been revised down by almost 70 kb/d to 38.2 mb/d in 2008 (+3.5% or +1.3 mb/d versus 2007) and, more markedly, by 230 kb/d to 38.7 mb/d in 2009 (+1.4% or +0.5 mb/d versus the previous year), reflecting the IMF's lower economic assumptions.  The outlook for Asia and the FSU is particularly grim.  Oil demand growth in China is thus expected to be less than a fifth of what was recorded in recent years, while in the rest of Asia and the FSU growth will probably be nil.  Only Latin America and the Middle East, partly insulated by price subsidies and, in the case of the Middle East, a strong fiscal position, will be able to sustain relatively strong growth - but at about half the pace of previous years.
  • These changes to economic assumptions - the third since October - and concomitant revisions to our demand forecasts illustrate the extreme frailty of the global economy.  As available monetary policy tools are exhausted, efforts to prop up stricken economies have moved to the political arena, as evidenced by the announcement of multiple, competing fiscal stimulus packages.  Herein lies the greatest source of uncertainty ahead: a lack of effective international policy coordination could potentially fuel protectionism and curb global trade.  This would aggravate the current downturn, postpone recovery well beyond 2010 and further depress global oil demand.

Global Overview

For the third time since last October, this report has slashed the economic assumptions that underpin its oil demand forecasts.  The first revision, in November, was based on the first update of the IMF's World Economic Outlook (originally released in October 2008).  The second amendment, in January, was an attempt to foreshadow further, widely flagged forthcoming IMF changes, in the light of the sharp deterioration of the world's economy by late 2008.  The third - and current - change incorporates the IMF's second update, published in end-January.  The Fund now sees global GDP growth barely reaching +0.5% year-on-year in 2009 - compared with a projection of +3.0% in October.

The continued - and dramatic - revisions of the past few months underscore the extreme weakness of the global economy; the slowdown in industrial activity and consumption is the unavoidable sequel to the financial meltdown.  All countries will be affected, with the OECD firmly in recession (-1.7%) and non-OECD countries posting collectively one of the lowest rates of growth of the recent past (+3.4%).

While the Fund also assumes global GDP rebounding by 3.0% in 2010, it notes that this is contingent upon the successful implementation of coordinated, expansionary fiscal and monetary policies.  Any temptation by individual governments to erect protectionist barriers or to engage in competitive currency devaluations would risk curbing global trade, thus aggravating the current downturn, postponing recovery well beyond 2010 and further depressing global oil demand.

Naturally, the latest lowering of economic assumptions weighs on this month's global oil demand prognoses.  As such, this month's report includes yet another significant downward revision to the 2009 global demand forecast (roughly 0.6 mb/d compared with last month's report).  In line with both the changes to GDP projections and the latest preliminary data, oil demand revisions are concentrated in Europe, the FSU and Asia (our assessment last month of other areas turned out to be broadly in line with the latest IMF prognoses).



Although the cold spell in the northern hemisphere will somewhat temper the GDP-induced downward adjustment in 1Q09, world demand is now poised to average 84.7 mb/d in 2009, down by 1.1% or 1.0 mb/d versus 2008, when demand averaged 85.7 mb/d according to the latest preliminary data (about 100 kb/d lower than previously estimated).



As noted in the previous report, two consecutive yearly contractions (demand in 2008 was also down by 0.4% or 0.4 mb/d compared with 2007) represent an unprecedented occurrence since the early 1980s.  Moreover, a fall of the magnitude expected in 2009 has not been recorded since 1982, and would be almost equivalent to that of the first oil shock in the early 1970s.

OECD

Preliminary data suggest that OECD inland deliveries (oil products supplied by refineries, pipelines and terminals) contracted by 4.5% year-on-year in December.  In what is becoming a familiar pattern, all three regions recorded losses for the eighth month in a row, highlighting once again the extreme frailty of most advanced economies.  In OECD North America (which includes US Territories), oil product demand fell by 5.4% year-on-year, with all product categories posting losses.  In OECD Europe, distillates deliveries helped contain the fall to 0.8%.  In OECD Pacific, demand plunged by 7.9%, despite relatively buoyant growth in gasoline and jet fuel.



Revisions to preliminary data, albeit large, were less pronounced than in previous months, with the largest changes brought about by European data.  November's demand estimates were adjusted down by 0.4 mb/d, indicating that OECD demand fell by 7.6% during that month, rather than by 6.8%.  Coupled with preliminary data for December, this results in a downward revision of 90 kb/d in 4Q08.



OECD demand is thus estimated at 47.5 mb/d in 2008 (-3.4% or -1.7 mb/d versus 2007, virtually unchanged versus our last report).  In 2009, following the inclusion of newer economic assumptions and assuming that OECD demand destruction will have been largely played out by mid-year, OECD demand is seen contracting by 3.2% on a yearly basis (-1.5 mb/d) to 46.0 mb/d (340 kb/d lower when compared with our previous assessment).  It should be noted that the outlook has significantly worsened, mostly in Europe and the Pacific, highlighting a lagged response to economic developments in North America.



North America

According to preliminary data, oil product demand in North America plummeted by 5.4% year-on-year in December, falling for the twelfth month in a row.  Persistent demand weakness in the United States (-6.0% year-on-year) was compounded by losses in both Canada (-2.3%) and Mexico (-2.4%), as both countries followed their neighbour into recession.

Revisions to November preliminary data were relatively minor (-90 kb/d), driven essentially by the US and Canada.  Still, demand in OECD North America plummeted by 7.2% year-on-year during that month.  Regional oil demand averaged some 24.3 mb/d in 2008 (-4.8% or -1.2 mb/d on a yearly basis and virtually unchanged when compared with our last assessment).  In 2009, demand is expected to reach 23.7 mb/d (-2.7% or -0.6 mb/d).  The forecast for this year has been essentially untouched, since the newer IMF GDP assumptions are largely in line with what we had anticipated last month.





Adjusted preliminary inland deliveries - a proxy of oil product demand - in the continental United States were predictably weak in January (-5.5% year-on-year or -1.1 mb/d).  All product categories continue to post significant contractions, most notably gasoline (-3.3%), jet fuel/kerosene (-10.5%), distillates (-2.6%) and residual fuel oil (-8.6%).  Moreover, markedly colder temperatures failed to provide much support (the number of heating-degree days in January was much higher than the 10-year average but only slightly higher than in the same month of the previous year).  This is possibly related to the fact that natural gas prices fell further in the past month; this fuel has again become more competitive than heating oil and residual fuel oil.





Interestingly, revisions to preliminary weekly data (-60 kb/d) in November were minimal - the lowest in over a year - implying an annual decline of 7.5%, instead of 7.2% as previously estimated.  This could suggest that either US weekly estimates have improved or that our own pre-emptive adjustment is becoming more precise - the months ahead, however, will provide better insights into these alternative explanations.  In the meantime, based on November's revisions, coupled with preliminary December and January data, and a slight change to our GDP assumption for 2009, US oil demand is estimated to have contracted by 5.6% year-on-year in 2008 to 19.5 mb/d.  In 2009, demand is expected to fall by 2.9% to 19.0 mb/d.  Both estimates are essentially unchanged versus our previous report.

As noted, the decline in oil demand was to be expected, given the extent of the US economic downturn.  The country's economy contracted by 3.8% year-on-year in real terms during 4Q08, and the prospects for this year are little better, as uncertainty prevails (the fall in air traffic and hence of jet fuel/kerosene demand is one telling example among many).  The IMF predicts that GDP will shrink by 1.6% on average in 2009, assuming that the much-touted fiscal stimulus package (expected to total some $800 billion) is rapidly adopted and implemented.  As such, a modest rebound later in the year would help partly offset what promises to be a very difficult 1H09 (some economists, for example, foresee GDP contracting by as much as 6% in 1Q09).  And even though the rebound should gain momentum in 2010 (+1.6%), according to the IMF, it will probably take two years for the economy to return to its growth trend (around 2-3%).

However, assuming that oil demand destruction in the US will bottom out this year is different from saying that demand will quickly rebound to pre-2006 levels (when it started to contract).  Several products face structural decline, either because of competition from cheaper sources (for example, LPG/naphtha could be displaced as imports of cheaper petrochemical products from the Middle East and Asia rise) or interfuel substitution (with natural gas replacing heating oil/residual and ethanol eating into the gasoline pool).  Yet the key issue is arguably the outlook for gasoline demand.  This report has long argued that the income effect is far more significant than the price effect.  Indeed, despite the fall in gasoline prices, vehicle sales (particularly gas-guzzling SUVs) continue to contract each month by some 30% year-on-year on average.

We have also suggested that gasoline demand may well remain subdued even if the economy improves.  The reason is simply that the US vehicle fleet has much scope for efficiency improvements.  Admittedly, the previous administration toughened fuel efficiency targets in 2007, but somewhat lukewarmly (from the current 27.5 to 35 mpg by 2020).  More significantly, perhaps, it refused to allow California and other states to set their own, more stringent standards.  However, the US Environmental Protection Agency (EPA) has been instructed by President Obama to reconsider that decision; if revoked, California and thirteen other states, which account for about 60% of the US vehicle market, could impose emissions mandates as much as 30% lower than current levels.  In addition, the Department of Transportation is expected next month to also tighten further the current federal fuel efficiency targets.  And unlike previous attempts to raise standards, domestic car manufacturers, which have so far staved off bankruptcy thanks to a federal emergency bailout, are ill equipped to oppose these moves; further financial aid will be contingent upon their commitment to produce much more efficient vehicles.

The oil demand picture north and south of the US is only slightly less gloomy.  In Canada, demand is poised to contract by about 1.7% in 2009 to 2.3 mb/d as a result of US economic contagion, after falling by an estimated 1.6% in 2008.  Last year's decline was relatively limited, given the resilience of diesel consumption, particularly in western provinces that until recently featured buoyant mining and energy industries.  Alberta, Manitoba and Saskatchewan actually imposed diesel rationing measures in October, as strong demand for transportation, mining and agriculture combined with turnarounds and unscheduled outages at several refineries (notably in Alberta, with Imperial Oil, Petro-Canada and Suncor facing some problems to supply enough product).  November's preliminary data (the latest available) show a spike in diesel deliveries, probably as a result of stockbuilds.

In Mexico, meanwhile, the 2008 demand fall was limited by a December, holiday-induced rebound in transportation fuels.  As such, oil product demand shrank by only 0.7% to 2.1 mb/d.  However, as the country follows its main economic partner - the US - into recession, oil demand is poised to contract further in 2009 - by as much as 2.6%, in line with the previous downturn in the early 2000s.

Europe

According to preliminary inland data, oil product demand in Europe fell by 0.8% year-on-year in December.  Although the number of heating-degree days in December was barely above the 10-year average (and below the same month of the previous year), the anticipation of lower temperatures helped offset the effects of the continent's worsening economic outlook.  Indeed, strong deliveries of heating oil (+10.9%) and to a lesser extent diesel (+1.7%) cushioned the sharp contraction in naphtha (-19.2%), jet fuel/kerosene (-3.2%) and residual fuel oil (-8.5%) demand.  Furthermore, November data were revised down by 270 kb/d, mostly with respect to products that are quite sensitive to economic conditions (such as naphtha, jet fuel/kerosene and diesel).

These revisions, coupled with lower GDP prognoses by the IMF, naturally impinge upon this report's assessment of OECD Europe demand.  The Fund is noticeably pessimistic about the Eurozone, given the brutal slowdown experienced by its largest countries in late 2008.  Thus, although the estimate for 2008 oil demand remains broadly unchanged at 15.2 mb/d in 2008 (-0.8% or -120 kb/d versus 2007), the forecast for 2009 is some 170 kb/d down at 14.7 mb/d (-3.2% or -480 kb/d compared with the previous year).  However, the outlook for this year could conceivably be revised up.  Next month's preliminary data (for January) will likely disclose whether the cold spell that struck Europe late in December and in January tempered again the fall in oil demand, and should also reveal the effects of the Russian disruption to European natural gas supplies, so far excluded from our forecast given the lack of more precise indicators.





According to preliminary estimates, inland deliveries in Germany rose by 2.6% year-on-year in December, as gains in demand for heating oil (+48.7% year-on-year) and road transport fuel (gasoline was up by 4.7% and diesel by 9.8%, possibly because the month had two more working days than a year earlier) contributed to offset losses in other product categories.  Heating oil consumer stocks averaged 63% of capacity by end-December, slightly below the previous month (64%) but well above the previous year (55% in December 2007).

However, German heating oil refilling patterns - which are now higher than the five-year average - obscure the fact that oil demand in the industrial sector is virtually collapsing.  Indeed, demand for naphtha - a key component for the production of plastics, polymers and synthetic fibres - plummeted by an astonishing 40.4% year-on-year in December, after falling by roughly 15.0% in both October and November, as both domestic demand and, more crucially, exports of manufactured goods stall.  Similarly, LPG demand contracted for the fifth month in a row in December, by 22.9%, while residual fuel oil demand shrank by 14.8%, suggesting lower electricity consumption by big industrial concerns.  Assuming that these trends continue, total oil demand could contract by as much as 5.2% in 2009 - over twice as much as previously expected.



In France, the picture is quite similar, with distillate deliveries (heating oil, up by 22.4% year-on-year in December, and diesel, up by 4.5%) offsetting losses elsewhere.  Thus, total oil demand managed to rise by 5.2% in December, partially reversing the sharp plunge observed in the previous two months.  Interestingly, diesel demand declined slightly in 2008 (-0.4%), for the first time in over two decades.  According to a poll, over a third of French motorists drove less and more slowly last year because of high prices, growing environmental awareness and economic concerns, opting instead for public transportation, car sharing, bicycle riding and walking.  However, whether this heralds a durable behavioural change and hence an era of falling diesel demand in France remains to be seen; arguably, a key factor keeping diesel demand subdued is the current economic downturn.



In Italy, total oil product deliveries sank for the third month in a row, by 4.9% year-on-year in December, as the country anchors itself in recession.  Italy's economic structure is much closer to Germany's than to France's, with a relatively large industrial sector, mostly geared towards exporting.  Depressed export markets have further compounded Italy's long-dated structural problems - high unit labour costs and falling productivity.  The resulting, continuous fall in industrial production since last summer can be seen in naphtha deliveries, down by over a third on a yearly basis in 4Q08.  The depth of the country's economic downturn portends another sharp contraction of total oil demand in 2009 - possibly as much as -4.7% versus the previous year.

Pacific

According to preliminary data, oil product demand in the Pacific plunged by 7.9% year-on-year in December.  Falling consumption in both Japan and Korea, where economic activity has sharply slowed down, and mild weather (heating-degree days in December were well below the 10-year average and lower than the same month of the previous year) continued to weigh on the region's demand for the seventh month in a row.  All product categories bar gasoline and jet fuel/kerosene registered losses, notably naphtha and residual fuel oil deliveries, which shrank by an astonishing 14.3% and 17.9%, respectively.





The outlook for Japan is particularly dismal.  The country's industrial production, exports and domestic demand tumbled strikingly in December (-9.6%, -35.0% and -4.6% year-on-year, respectively).  With the economic downturn compounding the country's structural decline in oil use, oil demand plummeted by double-digit figures in December (-10.9% year-on-year), for the fourth consecutive month.  Naphtha deliveries, in particular, appear to be in free fall, 21.1% down on a yearly basis as many industries, ranging from electronics firms to car manufacturers, curb production.  Moreover, diminishing industrial power demand and relatively mild weather have sharply curtailed deliveries of 'other products' (which include crude for direct burning) and residual fuel oil, which contracted by 51.0% and 21.1%, respectively.  Overall, total Japanese demand declined by an estimated 5.3% in 2008, a contraction not seen since the mid-1970s.



In 2009, demand could fall further if Tokyo Electric Power Company (TEPCO), the country's largest power utility, manages to restart at least one of the seven reactors of its giant Kashiwazaki-Kariwa nuclear power plant in northwest Japan.  The plant was shut in mid-2007 following a major earthquake, and had been expected to remain offline until early 2010 at the earliest.  In early February, however, the city of Kashiwazaki lifted an operation-suspension order on Unit 7, a 1.4 GW reactor.  Should the city of Kariwa and the Niigata Prefecture follow suit, TEPCO could begin restarting tests in a few months and perhaps bring the reactor back online later this year.  Our forecast of Japanese oil demand, however, assumes that Kashiwazaki-Kariwa will remain shut in for all of 2009.

Non-OECD

China

According to preliminary data, China's apparent demand fell by an estimated 4.0% year-on-year in December, contracting for the second month in a row.  Several key product categories registered losses (notably naphtha, gasoline and gasoil), providing further evidence of the country's ongoing economic slowdown.  Given weakening exports (which fell by 2.8% year-on-year in December, after declining by 2.2% in November), the Chinese economy posted quarterly year-on-year growth of only 6.8% in 4Q08, dragging down the pace of economic activity for 2008 to 9.0%, the lowest since 2001.  For the year as a whole, however, China's apparent oil demand - which implicitly includes crude and products stockbuilds, arguably significant in the run up to the Olympics - posted strong growth in 2008 (4.3%), only slightly below the pace of 2007 (+4.6%).



The IMF expects GPP to expand by 6.7% in 2009 (in line with what we had anticipated), presumably under the assumption that the huge fiscal stimulus package announced last November (some 14% of GDP) as well as the ongoing monetary easing will rapidly succeed in boosting domestic demand amid falling external consumption.  Bank credit and the money supply duly increased in both November and December.  The effects of the fiscal stimulus, however, are less obvious (some observers contend that numerous construction and infrastructure projects have already started, but it is unclear whether these are truly new).  On the one hand, the real size of the package is subject to debate; on the other, there are doubts that local governments, which will ultimately be in charge of spending, will be up to the task given the considerable amounts involved.  On the external front, it remains uncertain whether the country will devalue the yuan gradually to boost exports, although the Chinese prime minister has recently insisted that exchange rate stability is paramount for an orderly global recovery.  Moreover, the continued closure of thousands of coastal factories and construction sites (which has so far resulted in a wave of layoffs, with some 20 million workers, mostly coming from inland China, having reportedly lost their jobs) could potentially nurture social unrest.

Evolving economic conditions mean that China's oil demand forecast for 2009 is likely to be revised often over the next months.  Based on the current GDP projection, and assuming that demand for three key products (naphtha, gasoline and gasoil, which together account for almost two-thirds of total oil product use) remain subdued, Chinese oil demand should rise by a paltry 0.7% to 7.9 mb/d (30 kb/d less than previously anticipated).  In particular, gasoil use (a third of demand) is set to stagnate or even fall slightly this year if industrial production fails to pick up (the fuel is unlikely to be used for power generation, as coal-based installed capacity should catch up with demand given the economic slowdown).



However, this prognosis arguably faces upside risks.  First, the stimulus package could well exceed expectations.  The government announced in mid-January that it would imminently unveil detailed plans concerning ten key industries: oil refining, petrochemicals, car manufacturing, steel, construction, shipbuilding, textiles, nonferrous metals, equipment manufacturing and electronics.  This could conceivably boost oil product demand.  Second, the government has hinted that it will take advantage of low oil prices to continue filling its third strategic petroleum reserve, which would further inflate apparent oil demand, given the lack of reliable inventory data.

Other Non-OECD

Preliminary data show that India's oil product sales - a proxy of demand - rose by 3.9% year-on-year in December, largely driven by sustained sales of gasoline (+5.7%), gasoil (+1.4%), and naphtha (+31.7%), which together account for over half of total demand.  Gasoline and gasoil have benefited from successive retail price cuts (in early December and late January), ostensibly to pass on lower international oil prices to consumers.  However, since both products (plus kerosene) are heavily subsidised, the cut was arguably as much related to the forthcoming general elections.



More interestingly, perhaps, is India's newfound naphtha strength.  This product - mainly used as a feedstock by petrochemical and fertiliser industry and, to a lesser extent, as a fuel for power generation by steel producers - was until recently facing structural decline, being increasingly substituted by growing imports of liquefied natural gas (LNG).  However, Asia's sharp economic downturn has resulted in a glut of naphtha and hence falling prices, while the rupee depreciation has made LNG much less attractive (Shell India, the largest LNG player, is reportedly struggling to sell its cargoes).  Naphtha prices have dropped so much that even imported naphtha - helped by a temporary waiver of its 5% duty - can compete with LNG.   As such, naphtha demand rose slightly in 2008 (+0.8% versus 2007), a trend that could prevail this year as well.

However, continued oil demand growth will ultimately depend on the health of the Indian economy, which is expected to expand by 5.1% in 2009, well below its recent performance.  Although services account for two-thirds of the country's GDP, exports (notably of information and communication technology) have fallen as elsewhere in the region.  Similarly, industrial production and domestic spending have slowed down.  Moreover, the government can barely afford a massive fiscal stimulus, as the country has run very large budget deficits for years.  Consequently, oil demand growth, estimated at +4.6% in 2008, is expected to almost halve to 2.7% in 2009.

Russia is another country that has fallen prey to the ravages of the global economic downturn.  Oil product demand plummeted by 8.1% year-on-year in December, with most product categories showing steep falls.  The industrial sector - encompassing industries such as construction, oil refining, petrochemicals and metals production - has been severely hit, as dwindling access to credit has compounded the fall in demand.  Consequently, gasoil demand (a fifth of total oil product consumption) plunged by 13.7% year-on-year in December, closely matching the performance of industrial production (-10.1%).  Similarly, gasoline demand (a quarter of the total) contracted by 6.2%, after having grown almost uninterruptedly for the previous three years.

The outlook for 2009 is not encouraging, given that commodities - the backbone of the Russian economy - are likely to remain subdued given the global economic downturn.  The IMF expects GDP to contract by 0.7% - a long way from its +5.5% forecast back in October.  Since August, the Central Bank has spent some $200 billion, about 40% of the country's foreign exchange reserves, to prop up the currency.  Nonetheless, the rouble has dropped by about 25% - yet the Bank has vowed to support it further.  Similarly, there are diverging opinions regarding fiscal policy options.  The government has announced it will recapitalise the country's banks so that they can lend to a virtually insolvent private sector, at the expense of a large budget deficit - but some senior officials have actually argued that the budget should be balanced this year.  In terms of oil demand, growth is expected to fall to 0.9% in 2009, compared with 2.8% in 2008, mostly driven by LPG and residual fuel oil (and to a lesser extent, gasoline), assuming that natural gas for households and power generation will increasingly be diverted to meet the country's export commitments.



The Middle East has - so far - escaped the global recession relatively unscathed.  The slowdown should be relatively limited, since most regional governments - with the notable exception of Iran - amassed substantial foreign exchange reserves during the oil boom and reduced external debt.  They are therefore well positioned to support their economies and boost industrial production and construction activity, despite falling oil receipts.  The region's GDP is thus set to grow by about 3.5% in 2009, down from the 5.0% average registered over the past eight years but still respectable.  This, combined with heavily subsidised end-user prices, is set to support oil consumption.  Still, oil demand growth should almost halve to +260 kb/d in 2009, compared with an estimated +440 kb/d in 2008.

It should be noted, though, that oil demand growth in 2008 was exceptional.  It was boosted by the de facto failure of Iran's gasoline rationing scheme (with growth back to pre-rationing levels), natural gas shortages and ensuing increase in fuel oil use (notably in Saudi Arabia, Iran and Kuwait) and a construction-driven surge in diesel consumption in most of the region's countries.  As economic activity slows down, some of these factors may subside.  For example, preliminary data for November show that Saudi fuel oil consumption has fallen sharply, possibly because of lower electricity needs (however, crude production cuts and hence lower availability of associated gas could again boost fuel oil demand, notably in the summer).

Supply

Summary

  • Global oil supply fell by 520 kb/d to 85.2 mb/d in January, largely due to lower OPEC output, but with reduced volumes from Norway, Russia and others.  Year-on-year, monthly production is down by 1.82 mb/d, reflecting weaker fundamentals after the dramatic turnaround in market conditions.
  • OPEC crude supply in January fell by an estimated 950 kb/d to 29.0 mb/d (now excluding Indonesia, whose OPEC membership was suspended effective 1 January) as efforts were made to curb supply in line with targets agreed at the mid-December OPEC Ministers' meeting. OPEC output was last at similarly low levels in spring 2004.  Lower production was widespread, voluntary or otherwise, but was concentrated in Saudi Arabia, Venezuela, UAE and Iran. However, target compliance varies, and several countries appear to be phasing cuts over January-March.  Effective OPEC spare capacity now stands at 4.4 mb/d.
  • The 'call on OPEC crude and stock change' for 2009 (after adjusting for Indonesia's departure) now stands at 28.8 mb/d, at least 1.7 mb/d below 2008.  Although production from OPEC members subject to quota in January stood 1.8 mb/d above their latest target, current supply curbs, if observed, could take OPEC-12 output to around 27.3 mb/d, 1.5 mb/d below the 2009 call.  This implies a substantial draw in stocks later in the year unless demand again trends weaker, or non-OPEC supplies prove stronger than expected.
  • Non-OPEC supply forecasts for 4Q08 and 1Q09 are revised downwards by 110 kb/d and 40 kb/d respectively on lower Chinese December production and revisions to Norway, Canada, Australia, New Zealand and Malaysia.  Total non-OPEC supply in 2008 and 2009 is revised downwards by 20 kb/d and 110 kb/d respectively, resulting in yearly production of 50.5 mb/d and 50.9 mb/d.  Non-OPEC supply for the first time includes Indonesian supply following its suspension of OPEC membership, which adds around 1 mb/d to the total figure.
  • Estimates for OPEC NGL and condensate supply have been reduced sharply this month on further evidence of project delays and a scaling-back of associated gas production in line with crude supply curbs. Total output now averages 4.7 mb/d in 2008 and 5.0 mb/d in 2009, respectively 0.3 mb/d and 0.6 mb/d less than our earlier forecast.  Although reclassification of Indonesia accounts for 0.2 mb/d of the adjustments, sizeable reductions also accrue to Saudi Arabia, the UAE and Nigeria.


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 Supply

(Please note this month's change in categorisation, with our data and analyses now reflecting current OPEC-12 composition throughout - see inside cover.)

OPEC crude supply in January fell by an estimated 950 kb/d to 29.0 mb/d (now excluding Indonesia, whose OPEC membership was suspended effective 1 January), as efforts were made to curb supply in line with output targets agreed at OPEC's mid-December ministerial meeting. Output from the current OPEC-12 producers was last seen at levels as low as this in spring 2004. January output reductions were most pronounced from Saudi Arabia (300 kb/d), followed by Venezuela, UAE and Iran (around 100 kb/d each). Iraqi crude supply (measured  as exports plus domestic crude use) remained stable at 2.4 mb/d, with lower domestic refinery runs offsetting higher Kirkuk exports from Ceyhan.

OPEC target compliance varies, with some countries' January reductions being due more to unplanned stoppages, maintenance or export rescheduling, rather than voluntary output restraint per se.  However, several countries do appear to be progressively phasing-in cuts over the January-March period, making it likely that accurate assessment of OPEC's intentions will only really become possible around the time of the next scheduled OPEC meeting on 15 March.  Indeed, comments from traditionally hawkish members such as Algeria, Iran and Venezuela support the expectation that producers will wait until March before announcing further action, in the absence of another marked downturn in prices.



Installed OPEC crude capacity is now assessed at 34.6 mb/d, compared with 35.8 mb/d last month.  The removal of Indonesian capacity from OPEC calculations accounts for 850 kb/d of this change, but a net downgrade of 280 kb/d accrues from minor adjustments to Saudi Arabia, Venezuela, Nigeria, Libya, UAE and Ecuador. These are only partly offset by modest upgrades to capacity estimates for Algeria and Angola.  We have pushed back assumed start-up dates for the Shaybah and Nuayyim projects in Saudi Arabia, but nonetheless expect incremental oil later in the year from these fields, plus Khursaniyah and Khurais, to take Saudi Arabia's crude capacity close to 12 mb/d by year-end 2009. While uncertainty continues to surround Venezuelan production and capacity, a spate of reports of reduced drilling levels over several months, allied to markedly lower apparent monthly output, leads us to nudge down capacity for Venezuela by 100 kb/d to 2.5 mb/d. Effective OPEC spare capacity now stands at 4.4 mb/d.

The 'call on OPEC crude and stock change' for 2009 (after adjusting for Indonesia's departure) stands at 28.8 mb/d, at least 1.7 mb/d below the level for 2008.  The expected decline in the 'call' is similar to that evident in the January report, as further demand forecast reductions are matched by lower expected OPEC NGL and non-OPEC output. Although OPEC production from members subject to quota in January stood 1.8 mb/d above the 24.8 mb/d target, planned supply curbs could take OPEC-12 output down to around 27.3 mb/d, 1.5 mb/d below the 2009 call.  This would imply a substantial draw in stocks later in the year, unless demand again trends much weaker or non-OPEC supply proves stronger than expected.

Export data for Saudi Arabia, which have been revised lower, cut our estimate of December crude supply from 8.45 mb/d to 8.4 mb/d.  Early indications suggest markedly lower supply again in January, at around 8.1 mb/d, compared with the Kingdom's OPEC production target of 8.01 mb/d.  There have been suggestions that output could be choked back further to around 7.7 mb/d in February, depending on prevailing price levels.  However, the Kingdom may be unwilling to push output beneath a 7.5 mb/d to 8.0 mb/d range for long if this were to risk undermining domestic associated gas supply.  Moreover, the Kingdom will likely want to see other OPEC producers moving closer to their respective targets before shouldering more of the burden of cutting supplies itself.

This month's report includes a substantial scaling back of expected Saudi NGL supply, partly because of the likelihood of much lower crude supplies in first-half 2009, and also on evidence that gas processing facilities, due onstream in late 2008/early 2009, have been either delayed or are operating at sharply reduced levels. NGL supply from Saudi Arabia (including ethane) is now estimated at 1.43 mb/d in 2008 and 1.44 mb/d in 2009, compared with earlier estimates showing near-200 kb/d growth for 2009.



Estimated Venezuelan crude supply is trimmed to 2.3 mb/d for December, with a further fall to 2.2 mb/d seen for January.   Several joint venture partners with conventional production were instructed to cut output in December, followed by curbs on one or more of the Orinoco heavy oil projects in January.  The Petromonagas project (formerly Cerro Negro) was reportedly told to curb supply by 90 kb/d last month.  Moreover, state PDVSA also announced in early January that supplies to two US refineries operated by ExxonMobil and ConocoPhillips would be reduced by a combined 120 kb/d.  Total production cuts of some 190 kb/d requested of operating companies in January, and likely being implemented in January and February, would take output close to Venezuela's apparent target of 2.01 mb/d.

Venezuela has since last autumn ceased payments to a number of contractors and service companies, asking companies to cut costs by 40%.  The result has apparently been a sharp scaling back of drilling levels, which if sustained could seriously undermine production capability. Venezuela, like all producer countries, faces the prospect that lower prices and curtailed revenues will curb current and future supply, with the added pressure that state PDVSA is required to divert funds from oil sector investment to ambitious social programmes in the country.  A potential vicious circle of declining prices and declining output might be expected to force some host governments to try to entice greater foreign company upstream investment.  However, it remains to be seen whether the Venezuelan government would be willing to effectively reverse some of the renationalisation measures implemented over the past decade.

January crude supply from the UAE is estimated down by 90 kb/d versus December, at 2.36 mb/d. Further cuts are expected for February, when exports of Murban and Upper Zakum crude will be 15% below contract and Lower Zakum and Umm Shaif will be curbed by 10% each.  The cuts result in part from gas plant maintenance affecting onshore oilfields occurring in both February and March.  An accident at the 50 kb/d onshore Shah oilfield in Abu Dhabi, which killed three workers on 3 February, has reportedly had no impact on current production.

Crude oil apart, forecast gas liquids output from Abu Dhabi is also downgraded, with likely start-up of the OGD3 processing facilities, which will eventually generate some 270 kb/d of NGL and condensates, pushed back to second-half 2009, rather than the end-2008 start we had assumed in earlier forecasts. Total gas liquids supply from the UAE is now expected to average 530 kb/d in 2008 and 550 kb/d in 2009.

Estimated Iranian crude supply in January of 3.8 mb/d compares to 3.9 mb/d in December.  As such, Iran, alongside Angola, looks to have been slow to curb supply in response to the latest OPEC agreement, with January output still 15% above target.  While Iran stated in December that production cuts of 545 kb/d would begin from 1 January, it looks likely that, along with other major producers, actual supply cuts may be phased-in over two to three months. Asian customers reported that January term supplies would be cut by 10-15%, with similar curbs kept in place for February.  Early tanker tracking data show export sailings in January down by around 150 kb/d, although this was likely offset in part by higher domestic crude runs, leaving supply (measured as exports plus crude runs) down by only 90 kb/d for the month.

Unlike the major downward revisions for some other key OPEC producers, Iranian NGL expansion appears to be proceeding, with gas from phases 9 and 10 of the South Pars development due to start imminently. This could ultimately yield around 100 kb/d of additional gas liquids.  In total, Iranian condensate and NGL supply is seen increasing from 390 kb/d in 2008 to 460 kb/d in 2009, with contributions from both the South Pars 6-8 and South Pars 9-10 projects.

Angola, like Iran, produced around 15% above its new target in January, at an average 1.75 mb/d.  The country's deputy oil minister cited current production at 1.8 mb/d earlier in the month, with an aim to gradually scale back to 1.65 mb/d by March.  Confusingly, the latter number was quoted as Angola's new output target, although most analysts calculate that lying closer to 1.5 mb/d, albeit the issue is clouded by the convoluted arithmetic and lack of individual reference points of OPEC's past couple of agreements. Angola's recent accession to the OPEC Presidency might have been expected to see it take a proactive line in production policy, but in reality the country is grappling with the need to sustain foreign upstream investment for new deepwater projects.  Moreover, its gradual approach to curbing supplies may be affected by the 30 January restart of the Greater Plutonia field after a three-week operational stoppage. Incremental Plutonia volumes in February could partly offset declines elsewhere.

Nigerian crude supply in January fell an estimated 70 kb/d to 1.84 mb/d, its lowest level since May 2008.  Despite both Shell and Chevron recently lifting force majeure on loadings, scheduled crude export levels for 1Q09 seem to have fallen to around 1.7 mb/d on average, compared with 1.9 mb/d in 4Q08.  In addition, continued disruption to domestic refinery operations has pushed crude runs below 100 kb/d.

While some of the resultant lowering in Nigerian supply may be due to curbs in support of OPEC targets (1.7 mb/d in Nigeria's case), upwards of 0.5 mb/d of Nigerian output remain offline due to Niger Delta unrest and technical outages.  Indeed, an early-January pipeline explosion again hit Brass River supplies, albeit only to the tune of around 12 kb/d of lost production.  Further attacks on oil service vessels and personnel occurred in January, and there are threats of two separate oil sector strikes in February over employment of foreign export monitors and security for oil workers in the Delta region.  This raises the prospect that supply cuts may again in coming months be due more to unplanned outages than voluntary production restraint.

With the significant scaling back of expected Middle East Gulf NGL production increases for 2009, Nigeria becomes one of the main contributors to OPEC NGL/condensate growth as supplies increase from last year's 215 kb/d to 300 kb/d in 2009.  A recent NNPC announcement put likely start-up of the Total-operated offshore Akpo gas/condensate project in April, in line with our existing 2Q09 assumption, with the project likely to eventually attain liquids output of 175 kb/d.

Non-OPEC Overview

Non-OPEC supply data for 2008 and 2009 were revised downwards by 20 kb/d and 110 kb/d respectively, resulting in yearly production of 50.5 mb/d and 50.9 mb/d.  This stems from downward revisions to 4Q08 and 1Q09 actual data - where available - which feed into the remainder of 2009.  Volumetrically, the largest revisions were to Chinese data, but cuts were also made to Norwegian condensates and NGLs, Canada, Australia, New Zealand and Malaysia.  In contrast, forecast data for Russia were nudged up slightly on higher assumed Lukoil output, though yearly Russian supply is still seen to decline.  A reappraisal of Syrian data prompted a slightly higher historical and forecast number.

For the first time, this report includes Indonesia in the non-OPEC supply data following the suspension of its OPEC membership as of 1 January 2009.  Non-OPEC production data, both historical and forecast, now uniformly exclude all OPEC members as of 1 January 2009.  In total, non-OPEC supply growth for 2008/07 now comes in at a revised -165 kb/d.  Meanwhile, 2009 non-OPEC supply is forecast to grow by +400 kb/d year-on-year, down from last month's +500 kb/d.

Preliminary full-year 2008 data for some countries - albeit liable to revision - now enables a slightly better take on 2009, prompting downward revisions to Norwegian NGLs and German crude production, for instance.  But thus far it remains difficult to get more of an angle on 2009 developments amid a flurry of company announcements on spending plans in recent weeks.  We maintain our position that delays are rather more likely to affect production beyond 2009 in terms of new field start-ups, though in mature producing areas, reduced drilling is likely to accelerate decline (see Upstream Also Feeling the Squeeze).  In as much as we try to capture upstream activity on an ongoing basis, it is worth noting that the global 2009 capacity forecast has been scaled back by 1 mb/d since last summer (including OPEC crude capacity), reflecting not only project slippage, but companies' own declining expectations for short-term output.  Non-OPEC supply accounts for 0.3 mb/d of this 'downgrade'.





Upstream Also Feeling the Squeeze

Unlike headline-grabbing changes on the demand side, which have curbed the 2009 global forecast by 3 mb/d since last summer, the impact of lower prices and the credit squeeze on supply has been less easy to discern.  Nonetheless, stripping out downward revisions to the 2008 baseline, forecast 2009 oil supply capacity has been cut by around 1 mb/d in the same period.   The concern among market watchers is that the current lower price environment may curb investment and leave inadequate new capacity available when demand growth eventually recovers.  That could sow the seed of a sudden reversion to much higher prices, and further intense price volatility, with all the adverse impacts on economic growth that this would imply.

46% of the net change in our own supply forecast for 2009 has derived from OPEC gas liquids and condensates, with recent OPEC crude cutbacks affecting associated gas supplies and the gas liquids normally stripped out from that gas.  Indeed much of the revision for NGLs makes itself felt in adjustments applied this month, notably for Saudi Arabia and the UAE.  New projects have also slipped in those two countries and in Qatar, further cutting into hitherto-expected record growth, although still leaving OPEC NGLs growing from 4.9 mb/d to 5.2 mb/d between 2008 and 2009.

28% of the downward revision for 2009 comes from OPEC crude capacity (here including ex-member Indonesia), now seen averaging 36 mb/d for the year as a whole, compared with 36.4 mb/d last summer.  There may well be more slippage to come in terms of OPEC capacity with, for example, Saudi Arabia and Abu Dhabi reportedly looking to shave 10-15% off contractor costs for the longer-term Manifa and Sahil/Asab/Shah (SAS) projects respectively.  Recent comments from OPEC Ministers have also tended to support the expectation that previous capacity expansion targets are now unlikely to be met on the original schedule. That said, our projections for OPEC capacity seem to have borne up relatively well (acknowledging that publicly available data on actual installed capacity are scarce).  This is partly because the projections made last year already factored in project slippage and relatively aggressive decline rate assumptions for most OPEC countries.

This leaves 270 kb/d that has been cut from the 2009 non-OPEC forecast since last July, net of 2008 baseline changes. Some envisage more downward adjustments to come, with oil company spending tending to flat-line or be cut in 2009 compared with 2008.  Spending surveys by Barclays Capital and IHS Herold point to a 10-15% cut in upstream capex for 2009, the first drop in several years.  Much of the reduction is concentrated in North America and Russia, where spending looks to be down by 20% or more.   In contrast, some NOCs, such as Pemex, CNOOC and Petrobras seem to be sustaining high levels of spending.  Part of the fall in investment is cost-driven, since costs for raw materials like steel and cement have already fallen sharply.  However, labour and equipment costs have stayed relatively strong.  Indeed industry insiders see typically a 12-18 month lag between falling crude prices and falling overall project costs.  Moreover, while the cyclical component of this decade's cost increases is likely to recede, the structural driver for higher overall costs (complex projects in hostile, technologically challenging and therefore capital intensive environments) is likely to persist.  A classic example of this structural shift is the Canadian oil sands in Alberta.  The list of oil sands project deferrals grows by the week, with up to 1 mb/d cut from industry forecasts of 2015 output.

However, the immediate impact of reduced 2009 spending is likely to derive less from new project deferrals this year and in 2010 (a factor for production levels in 2012 and beyond, given project lead times)  and more because of reduced spending on areas like pressure maintenance, fracturing, infill drilling and enhanced oil recovery.  Companies take these measures all the time to curb decline in existing, mature fields.  Work by the OMR and World Energy Outlook (WEO) oil teams implies net decline for global baseline production around 5% per year.  The MTOMR saw that as equivalent to losing 3.5 mb/d of global production capacity every year.  This is managed decline, however, requiring heavy levels of spending.  If spending is being curbed, even for the short term, decline could accelerate further.  An additional 0.5-1% decline for baseline non-OPEC supply in 2009 would cut 300-500 kb/d of supply, effectively eclipsing current expected non-OPEC growth altogether.

Then there is the question of likely production shut-ins if oil prices were to fall substantially lower.  Although the major resource-holders in the Middle East enjoy cash production costs for baseload output substantially below $10/bbl, for much of the rest of the world, cash operating costs can lie as high as $15-20/bbl (although again, a cyclical component of these costs is now likely falling).  Estimates for higher cost output such as the Canadian oil sands and US stripper well output (which both account for around 1 mb/d of present output) generally have operating costs in a $25-35/bbl range.  Not much output may be shut-in because of current field economics, but further sharp falls in prices would begin to undermine even our own relatively modest expectations for 2009 non-OPEC growth.  Detailed production data for the last part of 2008 and the early months of 2009 will be highly instructive in helping to gauge the immediate short-term impact of lower prices on supply.  We will be examining the trends in more detail as that data becomes available in the months to come.

OECD

North America

US - January Alaska actual, others estimated:  January supply in the US was virtually unchanged overall compared with our forecast, though with some state-by-state divergence.  Total crude output was assessed some 70 kb/d higher than expected, but was offset by lower NGL production on the basis of weaker-than-expected December and January weekly data from the EIA.  Alaskan production in January was slightly higher than anticipated, despite weather-related issues affecting loadings in Valdez Bay and flows through the Trans-Alaskan Pipeline.

Going further back, September data for Texas was 90 kb/d higher than assumed, as, contrary to our assumption, Hurricane Ike had virtually no impact on onshore production.  Louisiana production for September was also higher than previously assessed, with onshore production reported around 100 kb/d higher than estimated.  On the other hand, September production in the Gulf of Mexico was revised downwards by 200 kb/d, with the Thunder Horse ramp-up among other things delayed by the hurricanes.  This had the effect of increasing our hurricane outage figure, which in turn raised our five-year rolling average hurricane adjustment for September by 30 kb/d (to 580 kb/d).  A mid-January report from the US Minerals Management Service (MMS) noted that 145 kb/d of GOM production was still shut-in post-hurricanes, around 45 kb/d lower than our previous assumption.  We assume this level of outage persists through March, when pipeline repairs are expected to have been completed.

Lastly, monthly ethanol figures are still rising and outstripping assumptions, despite news reports indicating that many producers are hard-hit by the credit crisis.  Until the full impact becomes more clear, we have decided not to revise our forecast (we are assuming 680 kb/d output for 1Q09), though we are in the process of an in-depth reappraisal of our capacity numbers for integration into the Medium-Term Oil Market Report (MTOMR) to be published mid-year.

Canada - Newfoundland December actual, others November actual:  December data for the offshore Terra Nova and White Rose fields both came in 20 kb/d lower than expected.  Disappointing full 2008 data for the latter field prompted a downward revision of 2009 production by around 20 kb/d to around 100 kb/d.  These numbers were partly offset by higher bitumen output in November and - it is assumed - December.  In sum, 2009 total oil supply is unchanged at 3.23 mb/d, flat from 2008.   This picture contrasts strongly with earlier expectations of strong growth and is underpinned by recent, revised forecasts by both the Canadian Association of Petroleum Producers (CAPP) and energy consultancy the Canadian Energy Research Institute (CERI), who each see a slowing of growth due to lower oil demand, the high cost of developing Canadian oil sands, far lower oil prices and the recent financial crisis.



North Sea

Norway - December actual, January provisional; UK - October actual:  December data for Norway were reported around 30 kb/d higher than anticipated, with higher volumes from some of the main crude streams only partly offset by lower total condensate output.  January data were revised upwards by 80 kb/d based on preliminary figures from the Norwegian Petroleum Directorate (NPD), mainly due to higher Statfjord/Gullfaks output.  Looking ahead, however, we revised downwards 2009 NGL production by around 20 kb/d based on weaker-than-expected 2008 output.  On a net basis, total Norwegian oil supply was revised downwards by 20 kb/d for 2009 and is now forecast at 2.2 mb/d, or down 270 kb/d from 2008.



Actual October data for the UK came in 100 kb/d lower than forecast, apparently on higher autumn field maintenance.  Around half of this revision stemmed from the West of Shetlands area, and other volumes from the Forties and Flotta streams.  November and subsequent months were revised upwards slightly, including for instance an earlier-than-anticipated start-up of the Grouse field, a tie-back to the Kittiwake system.  Total UK supply is now forecast to decline by 200 kb/d to 1.3 mb/d in 2009.

Pacific

Australia:  Tropical Cyclone Dominic briefly shut in around 230 kb/d of production in the Northwest Shelf area in late January, though quickly weakened, allowing a rapid restart.  Assuming a maximum three days of shut-in, January output was only nudged down by around 20 kb/d, as not all fields were reportedly affected.  According to news reports, the Stybarrow, Cossack, Enfield, Vincent, Mutineer-Exeter, Griffin, Stag and Legendre fields were shut-in.  New Zealand supply data also showed slightly lower-than-expected production for November at 50 kb/d.  Total OECD Pacific supply for 2009 is thus revised downwards by 20 kb/d to 720 kb/d, but still implies 70 kb/d growth over 2008.

Former Soviet Union (FSU)

Russia - December actual, January provisional:  December supply in Russia was revised upwards by 30 kb/d as smaller producers hiked production.  This was likely due to the reformed export duty regime, which had previously made crude exports verge on the uneconomic and likely hit smaller crude producers harder, as they have fewer or no alternatives, unlike integrated operators who can redirect flows into their domestic refining systems.  January brought an even greater upward revision of +50 kb/d.  Lukoil hiked production 70 kb/d over forecast as it ramped up its new South Khylchuyskoye field in the Timan-Pechora region more rapidly than expected, again, to benefit from lower export duties but possibly also to capture higher revenues in January with the lower Mineral Extraction Tax regime for new fields, effective 1 January 2009.  Tatneft also saw higher-than-forecast production of +22 kb/d, while Rosneft and Gazprom's output was revised downwards by 15 kb/d and 33 kb/d respectively.  Gazprom was forced to lower liquids output in January in parallel with shut-in gas production due to the dispute with Ukraine concerning gas exports.

On a net basis, 2009 total Russian supply is revised upwards marginally, but output is still forecast to decline by 260 kb/d to 9.73 mb/d.  However, a review of 2009 upstream spending shows that Russia is one of the key areas where capex will fall, possibly in excess of 20%.  Given a generally unfavourable investment climate and the fact that several key companies have high debt, a further curtailment of investment may cause an even steeper-than-forecast decline in 2009 and beyond (see Upstream Also Feeling the Squeeze).



Azerbaijan - November actual; Kazakhstan January provisional:  November Azeri production was revised upwards by 50 kb/d as ACG production gradually recovered from technical problems in September.  The Central and West Azeri fields are seen restarting and ramping-up respectively in January, reaching 2009 average output of 250 kb/d and 225 kb/d.  Our forecast envisages further steady recovery and strong growth in December and throughout 2009, with total production reaching 1.26 mb/d in 2009 as a whole, up by 360 kb/d from last year.  Meanwhile, Kazakhstani December supply was revised down 20 kb/d.  For 2009, Karachaganak condensate was revised downwards based on lower 2008 output, resulting in total 2009 production forecast around 30 kb/d lower at 265 kb/d.  Nonetheless, Kazakh production is still expected to rise by 30 kb/d to 1.44 mb/d in 2009.

FSU net exports rose 10% month-on-month to 8.91 mb/d in December as both crude oil and product exports increased in more profitable export conditions created by a cut in Russian oil export duties.  This cut encouraged companies to release crude oil stockpiled in November and crude oil exports rocketed by 20%, backed by the increases in shipments from major Russian ports in the Black Sea and Baltic.  High Russian crude oil exports supported a 12.4% increase in total FSU crude shipments, reaching 6.28 mb/d.  Flows through the BTC also rose sharply in December, as did Druzhba pipeline exports.  FSU product exports rose to 2.67 mb/d in December, boosted by a 13.8% increase in gasoil exports and 50% increase in gasoline exports.



Preliminary data show that January exports fell modestly, as exports from Russia regained lower, more seasonal levels. Lower loading schedules were amplified by pipeline maintenance at Primorsk in the Baltic and stormy weather in the Black Sea.  Russian exports became more profitable as the crude oil export duty has been cut further from $26/bbl to $16/bbl and the rouble also lost ground against the dollar in January.  However, Transneft's pipeline tariffs increased, as well as tariffs in several other CIS countries.  Exports through the BTC rose in January following continued recovery of Azeri production from the Central Azeri platform after a gas leak in September.  Additionally, Druzhba pipeline flows increased in January, boosted by higher deliveries to Germany and Poland.

Other Non-OPEC

China - December actual:  December Chinese oil supply was revised downwards by 220 kb/d to 3.7 mb/d.  Some offshore fields performed less well than anticipated, accounting for around half of the downward revision.  Xinjiang production was also around 30 kb/d lower than assumed.  Another 100 kb/d were trimmed  from December due to the elimination of our (positive) adjustment factor.  On the other hand, Daqing production picked up slightly, as did the complex of new offshore fields, the main area of growth in future Chinese oil production.  We have assumed the start-up of the Penglai-2 increment from December, with a new FPSO and a gradual ramp-up thereafter.  Total Chinese supply is estimated to average 3.9 mb/d in 2009, up by around 100 kb/d from 2008.



Other Asia:  Indonesia has been included in our non-OPEC numbers for the first time following its suspension of OPEC membership effective from 1 January 2009.  We forecast total Indonesian supply to dip slightly from 2008's 1.03 mb/d to 1.02 mb/d in 2009 as small gains in NGL production fail to offset the steady decline in crude output since 1996.  Malaysian numbers for November and December 2008 were both lower than anticipated, which led us to nudge down 2009 production by around 25 kb/d to 760 kb/d.  In the Philippines, the restart of the offshore Galoc field, which had problems after bad weather, has been delayed from January to mid-February.  This cuts our 2009 Philippine forecast to 32 kb/d.  In India, a reappraisal of NGL production based on near-complete 2008 data led us to nudge down 2009 production slightly.  Meanwhile, we have assumed an earlier start-up of the Mangala field in Rajasthan, now due to start pumping in 3Q09 rather than 4Q09.  This should eventually add 50 kb/d by early 2010.  Total 'Other Asia' production, including Indonesia, is forecast to grow only marginally in 2009 to 3.7 mb/d, leaving China and OECD Pacific as the key regional engines of growth.

OECD stocks

Summary

  • OECD industry stocks fell by 20.1 mb, or 650 kb/d, in December to 2,673 mb, as a 17.7 mb decline in the Pacific and a small decrease in Europe more than offset slightly higher inventories in North America.  North American gasoline and distillates had the largest increases.  Yet European and Pacific distillate declines and other North American product draws washed out the gains.
  • Despite the December fall, 4Q08 OECD inventories built counter-seasonally by 170 kb/d.  The build contrasts with a 730 kb/d five-year average draw and stems from low refinery runs and weak demand.  4Q08 OECD crude stocks built 200 kb/d versus a 130 kb/d five-year average draw.  Only the Pacific saw a 4Q08 stock draw, due to falling distillates. 
  • Stocks in days of forward demand were 57.0 days at end-December, 0.2 days lower than an upwardly revised November number but 4.5 days above levels of a year ago.  Of all major product categories, only Pacific distillates are below their five-year average in days of forward cover, reflecting continued tightness in Japanese kerosene stocks.
  • Preliminary January data indicate total OECD industry oil inventories built by 8.1 mb last month.  Japanese stocks fell by 16.9 mb, mostly in products, but US stocks rose by 27.2 mb on the back of a 22.5 mb crude build.  Euroilstock reporting showed European stocks falling by 2.2 mb.
  • Floating storage reached higher levels, offset by reduced trade flows that curbed oil in transit. Though estimates vary widely, industry and shipping sources put end-January short-term floating storage at unseasonably high levels of 50-80 mb.  Recent reporting indicates some selling of cargoes.  4Q08 data show floating storage increased by 260 kb/d.  Yet, slowing trade flows reduced oil in transit by an offsetting 220 kb/d, leaving our Table 1 floating storage/oil in transit estimate largely unchanged for the quarter.


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

Total OECD inventories fell by 20.1 mb in December, closing the month at 2,673 mb.  Declines in Pacific and European inventories drove the change while North American inventories increased marginally.  Draws in Europe and Pacific distillates reduced the effect of builds in North American gasoline and distillate.  A draw in 'Other Oils' stocks (a broad category including NGLs, feedstocks and other hydrocarbons) in North America and the Pacific  represented over 50% of the OECD total oil fall.  Year-on-year comparisons show total inventories 104 mb higher than in December 2007, down from a 117 mb year-on-year surplus in November.





Despite the decline in December inventories, 4Q08 stocks for the OECD posted a 170 kb/d counter-seasonal build, contrasting five and 10-year average fourth quarter draws of 730 kb/d and 840 kb/d, respectively.  Subject to revisions, this would represent the first 4Q OECD inventory build since 1985.

December's total oil forward demand cover remained at five-year highs, at 57.0 days.  An upward revised November number of 57.2 days indicates that demand cover fell slightly in December from the previous month.  Still, it stands 4.5 days above the December 2007 reading of 52.5 days.  In North America and Europe all categories are trending near or above five-year highs, except for residual fuel oil in the former and distillate in the latter, which are both only in the upper half of the five-year range.  In the Pacific both distillate and fuel oil are near five-year average levels.



November revisions boosted OECD inventories by 35.2 mb and overturned the small draw highlighted in last month's report.  Upward revisions to crude in Canada and Japan and increases in gasoline and distillate in the US and Germany contributed most strongly to the changes.

OECD Industry Stock Changes in December 2008

OECD North America

While North American inventories remained virtually unchanged at 1,308 mb in December, gasoline and distillate stocks in the US saw notable gains of 10.4 mb and 8.6 mb, respectively.  Increases in these product categories propelled both up above five-year average levels and reflected weak transport demand, warmer-than-normal December temperatures in the US Northeast and higher refinery yields, implied by weekly data, as gasoline cracks began to climb out of negative territory.  US refinery runs fell 100 kb/d on the month and crude production rose, supporting a US crude inventory build of 3.9 mb in the face of falling imports.  Draws in NGL, feedstock, fuel oil and other product stocks, however, provided offsets to the gains above.

January weekly data point to builds in crude and principal products, with crude stocks at Cushing, Oklahoma - the delivery point for NYMEX light, sweet crude - pushing operational limits (see WTI Benchmark: Past Imperfect, Future Tense).  Crude stocks rose by 22.5 mb in the US as a whole and 3.3 mb in Cushing in January to 346 mb and 34.3 mb, respectively.  With Cushing stocks nearing capacity and scant evidence of a tighter crude market, a February repeat performance of WTI's dramatic contango widening ahead of physical expiry could recur.  Cushing stocks could remain swollen if imports remain healthy, refinery utilisation remains low and particularly if 20-25 mb of floating storage begins to discharge from the US Gulf of Mexico.  While the US government's resumed filling of its Strategic Petroleum Reserve - January fills were 2 mb and 1.9 mb are planned for February - and OPEC supply cuts may ultimately change the stocks situation, these factors seem unlikely to dramatically reduce the Cushing over-hang in the immediate short-term.



Weekly data show January builds in US product stocks of 4.7 mb, with gasoline and distillate rising by 9.7 mb and 5.3 mb, respectively.  Total product inventories continued to trend above the five-year average.  Gasoline stocks, however, look slightly tighter, at around their five-year average on both an absolute and demand cover basis, possibly providing some support to February refining margins.  In addition, the distillate stockbuild comprised a 7.1 mb increase in diesel stocks while heating oil fell by 1.8 mb on the month.  Sharply colder January weather in the US Northeast relative to December has left heating oil stocks there and on the US East Coast as a whole at or below five-year averages.



OECD Europe

European industry oil inventories declined by 3.1 mb in December to 958 mb, but stand 26.5 mb higher than 2007.  The decline stemmed from a drop in middle distillate inventories, particularly in Germany, where they fell by 3.0 mb on the month.  Colder weather contributed to a 7.7% rise in heating oil demand in December, and German consumers continued to maintain tertiary stocks at healthy levels.  Both factors contributed to a draw in primary stocks.  France and the UK contributed smaller draws in distillate stocks.

A rise of 70 kb/d in regional refinery throughputs aided a crude stock draw of 1.3 mb, though runs remain at historically low levels.  Crude inventories drew most heavily in the Netherlands, by 6.7 mb, but built by smaller amounts in both Germany and France.  Looking to January, Brent futures almost $4 premium to WTI may have attracted more Atlantic Basin cargoes, helping to boost crude stocks.  However, Brent's still strong contango, combined with falling freight rates, has made floating storage in the North Sea attractive, with estimates of around 15 mb sitting offshore as of early February (see Floating Storage: Stranded at Sea or Smooth Sail to Shore?).



Regional product inventories overall declined by 0.9 mb in December.  Builds in fuel oil and gasoline of 3.7 mb and 0.7 mb, respectively, dampened the larger distillate draw.  Revisions to European product stocks in November included an increase in distillate stocks of 13.4 mb and a smaller increase in gasoline levels of 5.3 mb.  The relatively healthy position of European distillate stocks in 4Q08 compared with previous quarters likely contributed to some of the softening in gasoil cracks since mid-November.

Preliminary data from Euroilstock indicate European inventories fell by 2.2 mb in January, with product stocks declining by 6.4 mb, but crude stocks rising by 4.2 mb.  The product draws were roughly evenly distributed across middle distillates, fuel oil and naphtha.  January temperatures in Europe far colder than 10-year norms likely played a contributing factor in the product draws.  By contrast, Northwest European stocks held in independent storage in January indicate middle distillate builds well above five-year averages.  Some of this strength may reflect higher storage capacity there relative to previous years, but contango in ICE gasoil and the continued arrival of distillate supplies from the US and Asia likely played a role in buoying storage levels.  With storage constraints looming, recent reporting indicates some market participants have found it economic to store jet-fuel on offshore vessels.

OECD Pacific

Pacific industry stocks declined by 17.7 mb in December to 407 mb.  Draws in Japanese middle distillates led the way, falling by 5.7 mb.  Although refinery activity picked up by 220 kb/d in Japan, colder weather and increased demand for heating fuels aided in the draw. Crude oil inventories fell by 1.5 mb in the Pacific as a whole, but rose in Japan by 0.8 mb while falling in Korea by 2.2 mb.  A downward movement in gasoline stocks in both Japan and Korea has left them trending along the bottom of the five-year range, though they remain near five-year highs in days of forward demand.



Japanese weekly data from the Petroleum Association of Japan (PAJ) for January indicate continued falls in kerosene and gasoline stocks, as both trend below the five-year range, and lower crude stocks versus end-December.  Higher January refinery activity pushed onshore crude stocks down by 4.8 mb.  Yet, throughputs and product output remain low.  Kerosene stocks as of end-January stood almost 7 mb below levels of a year ago after declining 5.3 mb during the month.



Recent Developments in Singapore Stocks

January Singapore weekly stocks increased by 7.5 mb with all product categories rising.  Light and middle distillates increased strongly in the first half of the month before levelling off at or above their five-year range.  Weak jet-kerosene and gasoil demand from China buoyed stocks and shipments are also moving to Europe to take advantage of higher prices there.  Indonesia's intention to export gasoil for the first time further underscores the health of regional distillate stocks.  Fuel oil stocks reversed their December draws to build above the five-year range as Chinese buying waned.  Yet stocks may tighten in February with reduced Middle East output and buying from South Korea for winter power needs.

Floating Storage:  Stranded at Sea or Smooth Sail to Shore?

Alongside dramatic crude builds in Cushing, the most prominent storage issue so far in 2009 has been the large glut of crude oil that has built up on offshore tankers, primarily in the US Gulf of Mexico and the North Sea.  Market participants have opted to store oil offshore as onshore tanks have filled to take advantage of deep contango, where future barrels sell for more than prompt barrels, in both paper and physical crude markets.  Falling freight rates further enhanced the economics of storing oil at sea.

The OMR captures quarterly changes to floating storage and oil in transit in our Table 1, World Oil Supply and Demand Balance, but on an aggregated basis.  Our floating estimate reflects both short-term and semi-permanent storage (some semi-permanent storage, in Libya for example, has been in place for almost two decades).  In 4Q08, floating storage increased by 260 kb/d, with much of it concentrated in December, for reasons noted above.  However, a fall in oil trade following lower economic activity and OPEC production cuts reduced oil in transit by 220 kb/d, leaving only a net 40 kb/d gain in 'Floating Storage/Oil in Transit' for the quarter as a whole.

End-January estimates (50-80 mb) of floating storage vary widely.  Yet, some reporting fails to denote the short-term nature of these figures and does not compare them against the background amount of oil normally stored on water, which includes semi-permanent storage.  Available data suggest floating storage has averaged about 70 mb in the past five years, with most of this as semi-permanent in nature.  After adding current semi-permanent storage (about 60 mb) to the 50-80 mb range, one then sees floating storage at the unseasonably high levels suggested by current market dynamics.  The bottom end of that range (implying total floating storage of 110 mb) would still exceed that of May 2008, when Iran offshore crude storage increased as much as an estimated 30 mb.

Methodological differences in counting vessels also cloud the picture.  Some estimates count only those ships currently used for storage.  Other figures also include vessels that have storage options attached to their charter, but are not currently employed as floating storage.

Moreover, recent reporting has indicated the selling of some storage cargoes.  It remains unclear to what degree owners are sending barrels onshore or merely transferring offshore charters to other parties.  During the last two weeks of January, large crude builds of 4.2 mb and 4.6 mb, respectively, along the US Gulf Coast may have signalled some discharge underway.  Yet, taking conservative estimates, it appears 40-50 mb of short-term storage remains offshore as of early February, with about 15 mb in the North Sea, 20-25 mb in the US Gulf vicinity and smaller amounts in the Mediterranean and West Africa.  Reporting also indicates Iran started storing 2 mb of excess gasoil off its coast two months ago.

How might the floating storage scenario play out?  Rising freight rates or increased refinery demand for crude in the US or Europe could incentivise moving oil onshore.  Yet, freight rates are still falling due to OPEC supply cuts and refinery activity in the US looks likely to stagnate until 2Q09.  A forecast February increase in European runs may soak up some of the North Sea cargoes.  US Strategic Petroleum Reserve filling could also take in some of the Gulf Coast barrels.  Yet, February and March fills will amount to 1.9 mb and 6.7 mb, respectively, less than the amount of floating storage in the Gulf.  More than likely, as oil moves onshore to take advantage of any selling opportunities, OECD stocks will swell and depress prompt markets, creating incentives for more floating storage and injecting volatility into any drawdown.  This circular pattern will likely persist until the effects of OPEC production cuts or rising demand tighten prompt markets, allowing OECD onshore inventories to begin drawing on a more sustained basis.  Either way, floating storage should keep a ceiling over near-term prices.  While barrels should eventually make their way ashore, the sail back to more normal floating storage levels looks anything but smooth for some time yet.



Prices

Summary

  • After an early-January surge, benchmark spot crude oil prices seem to have stabilised, for now, in a $40-45/bbl range as further evidence emerges that OPEC is making good on its pledges to reduce the global crude overhang.  US crude markets continue to be distorted by high inland Cushing stocks, leaving futures markets in steep contango and sustaining WTI discounts to other crudes.
  • Light distillate cracks improved significantly over the course of January, recovering from negative or near-negative levels to around parity for naphtha and to as much as $10/bbl in Europe, $15/bbl in Singapore and even more in New York Harbor for gasoline.  High-sulphur fuel oil discounts also narrowed due to increased demand on colder weather and a tightening of alternative sources of supplies, while distillate cracks moved lower amid weak demand.
  • Refining margins improved in all regions in January as product price gains easily offset smaller increases to crude oil.  The largest improvements occurred in the US West Coast, but significant gains were recorded on the Gulf Coast and in Europe as gasoline cracks improved materially.  Singapore margins were supported by higher petrochemical and power demand.
  • Crude freight rates fell to five-year lows at end month, after staging a mild recovery in the first half of January, as the effect of OPEC export cuts overtook increased demand for floating storage.  Clean rates, on the other hand, while decreasing in the first half of the month, held firm or increased towards end-January on the back of increased gasoil shipments from Asia to Europe.

Overview

After an early-January surge in crude oil prices, supported by increasing evidence of tighter OPEC supplies, record cold weather in Europe and the US Northeast, the Russian/Ukraine gas disruption and violence in the Gaza Strip, prices subsequently fell and stabilised in a $40-45/bbl range.  The decline from the early-month highs of around $50/bbl followed from further stock increases, continued weak crude and product demand, more depressing economic news, a resumption of gas flows to Europe on 20 January and a negotiated ceasefire in the Gaza Strip



Further evidence emerged during the past month that OPEC has indeed made good on its commitment to reduce crude supplies and that further cuts might take place during the February and March period.  Preliminary assessments show a 950 kb/d reduction in supply in January compared with a month earlier, leaving total OPEC-12 crude production at just over 29 mb/d.  Although cuts were seen across the board, the largest reductions came from Saudi Arabia, which is assessed producing within 100 kb/d of its current quota of 8 mb/d.  Indications from Saudi officials suggest a further 300 kb/d cut in February to 7.7 mb/d.  Adding to voluntary cuts in production, OPEC January supplies were further reduced due to unplanned outages at Angola's Greater Plutonio field and lower Nigerian volumes as Shell declared force majeure on Bonny Light exports, following attacks to vessels near the export terminal.

Additional downward pressure on oil prices came from more depressing economic news, including record low US consumer confidence, plummeting industrial output, massive job losses and an even gloomier outlook for economic activity for this year and next year.  The IMF released on 28 January a second update to its October World Economic Outlook, revising global 2009 GDP growth down to only +0.5% compared with a projection of 2.2% in November and 3.0% in October.  OECD countries are now seen firmly in recession (-1.7%) while the non-OECD posts one of the lowest growth rates in recent history at +3.4%.  China, whose GDP forecast for 2009 was revised down from 8.5% to 6.7% in the latest IMF update, also published very weak 4Q08 GDP and apparent oil demand figures.  4Q08 GDP growth is reported at just under 7% annually, dragging down the pace of economic activity for the year to 9% and the lowest rate since 2001.  Oil demand estimates for the end of 2008 were equally negative, with apparent oil demand in 4Q08 merely 0.1% higher than a year earlier at 7.6 mb/d.

As OPEC's efforts to reduce the global crude supply overhang have for now seemingly halted the slide in crude prices, steps taken by refiners worldwide to deal with the current product demand slowdown have shored up refined product prices and refinery margins.  Global refinery crude throughputs are estimated at 71.7 mb/d in January, 0.9 mb/d lower than a month earlier and 2.9 mb/d below on a yearly basis.  A steep recovery was seen in naphtha and gasoline cracks in January, and HSFO gained support from increased demand due to cold weather and a tightening of alternative fuel sources.

Cold weather in Europe and the US Northeast in January was compounded by a complete halt of Russian gas supplies to many European customers for more than two weeks following a gas-pricing dispute between Russia and the Ukraine.  On 19 January, the countries involved reached an agreement regarding gas prices leading to resumed gas exports to Ukraine and Europe.

Futures

The NYMEX WTI front-month contract spread widened further in January, reaching another near-record high of $8.14/bbl on 15 January before narrowing sharply with the expiry of the February contract.  The contango remained in place, however, widening again to $6/bbl in early February, driven by weak prompt demand and distorted by storage limitations at Cushing, the delivery point for the NYMEX contract (see WTI Benchmark: Past Imperfect, Future Tense).  The price spread of the Brent ICE front months on the other hand remained stable at around $2/bbl throughout the month, leaving the WTI-Brent discount in place and mirroring WTI swings, briefly touching $10/bbl in mid-January.



WTI Benchmark:  Past Imperfect, Future Tense

US West Texas Intermediate (WTI) crude traded on the New York Mercantile Exchange has reigned for decades as the most important pricing benchmark in global oil markets despite its tangible logistical flaws.  Inherent operational problems related to the WTI contract delivery point in landlocked Cushing, Oklahoma have periodically triggered a disconnect with international crude oil prices, prompting industry participants to question the viability of WTI as a suitable benchmark for global oil markets.  Past discontent with WTI has been quelled when market dynamics eventually correct the largely localised pricing aberrations.

WTI gained international stature after the New York Mercantile Exchange (Nymex) selected the crude as the basis for its light, sweet crude oil contract in 1983.  WTI is not one specific grade but made up of a blend of domestic crudes that share similar qualities.  Production of WTI averaged about 1.3 mb/d when the contract was launched but volumes are down more than 75% since then, to around 300 kb/d currently.

Nymex selected land-locked Cushing, Oklahoma as the physical delivery point for the contract because of its massive pipeline network and distribution infrastructure. This existing infrastructure for processing, transporting and storing oil has metamorphosed into the largest crude oil pipeline gathering facility and transportation hub in North America.

Uneasy Lies the Crown

The unprecedented collapse in the WTI pricing structure over the past six weeks has, once again, called into question the relevance of WTI as a global price benchmark.  Sharply lower oil demand, rising Canadian crude oil flows into the region and swelling crude inventories at storage tanks in Cushing have collectively exerted enormous downward pressure on prompt month WTI prices and turned upside down traditional pricing relationships with domestic and foreign crudes. Volatile WTI is sending mixed and misleading price signals not only to the market but to economic forecasters, government officials and policy makers.

Prompt WTI has been trading at steep discounts relative to forward trades, lower-value domestic grades as well as to its traditional Atlantic basin competitor, North Sea Brent.  The WTI-Brent price spread, typically positive to the tune of between $1.50/bbl and $2.50bbl, overturned in early December.  At peak, Brent traded at a $10.06/bbl premium to WTI on 15 January. Moreover, WTI's pricing anomalies have upended the crude's value as a basis for setting physical spot and contract prices for other domestic grades and also an estimated 5 mb/d in crude imports.

WTI's woes have been compounded by the contango in oil markets, where prompt prices trade at a discount to forward values.  Refiners and traders, among others with ready credit, have seized the opportunity to buy relatively cheaper prompt barrels, store the oil at both onshore storage facilities and offshore in floating tankers, and then turnaround and sell at the higher forward prices.  The WTI price discount between prompt and forward prices ballooned ahead of expiry to a high of $8.49/bbl in December and $8.14/bbl in January.

Crude oil stocks at Cushing have been steadily rising since October and were reportedly nearing operational capacity by end-January, at 34.3 mb.  Since almost all pipelines flow one way into Cushing, there is no outlet to move  crude south to the key Gulf Coast refining centre when storage gets backed up. By contrast, floating storage offers the seller flexibility to move the crude to the market with the best return (see Floating Storage: Stranded at Sea or Smooth Sail to Shore?).

Unlocking the Bottleneck

Storage capacity at Cushing is estimated at 45 mb, but only about 80%, or roughly 36 mb, is operational capacity. A steady increase in Nymex hedging activity in the past decade, by Wall Street hedge funds, traders end-users such as airlines, created additional demand for storage.  A further 750 kb of storage is planned to come on line this year.

Dubbed 'the pipeline crossroads of the world,' Cushing is made up of a complex web of underground pipelines and hundreds of storage tanks that cover more than nine square miles (23km2).  The pipelines carry crude up from the Gulf of Mexico in the south and down from Canada in the north, and intersect with a vast network that links to refineries across the country.

The influx of Western Canadian crude to Cushing since 2006 has created further bottlenecks.  US imports of Canadian crude increased from an average 1.6 mb/d in 2005 to just over 2 mb/d by end-2008, up 350 kb/d. Canada sends 99% of its crude exports to the US.  Before the recent downturn, Canada had some 1.4 mb/d of new production project start-ups planned between 2009 and 2013.  To meet this increased demand for export routes to the US, Canadian producers have more than $5 billion in potential pipeline projects on the drawing board to increase outlets to the Midcontinent refining hubs, including Cushing.



While the new pipelines would ease the capacity crunch from rising Canadian supply, an outlet to move crude oil from land-locked Cushing to the Gulf Coast has also been touted as a critical step in alleviating logistical constraints strangling WTI.  Reversing the flow of the existing 350 kb/d Seaway pipeline to flow from north to south has been studied for years but so far little interest has been shown by the owners to take the project forward.

Short of opening a physical link to the US Gulf Coast, Nymex could alleviate existing problems with WTI by designating a second delivery point along the US Gulf Coast and increasing the number of crudes that can be delivered under the contract.  Nymex already allows sellers to deliver Brent and Norwegian Oseberg at small fixed discounts to the settlement price, while Nigerian grades Bonny Light and Qua Iboe, and Colombia's Cusiana can be fixed at a small premium.

The recently distorted price structure for WTI has raised doubts among many market participants about the future of the bellwether crude.  In the near term, record stock levels at Cushing, anaemic oil demand and plans by refiners to sharply cut throughput rates in February and March could keep downward pressure on WTI prices.  Further deterioration in the fragile WTI pricing mechanism would only serve to reinforce the view that the crude has become an irrevocably broken benchmark.  Others argue that, though imperfect, WTI's reputation as a global price benchmark remains intact.  Structural changes to expand the existing pipeline infrastructure, including a line to the US Gulf Coast, may also make for a more perfect union between WTI and Cushing by the end of the decade.

Spot Crude Oil Prices

Bench spot crude prices were slightly higher on average in January, rebounding from end-December lows as OPEC production cuts started to filter through to the market, balancing globally weak refinery demand.  As predominantly sour crudes have been taken off the market, sweet-sour differentials have mostly narrowed further, although Tapis to Dubai spreads recovered from recent lows on healthier naphtha prices.  About 40% of Australian production was shut-in briefly in January due to damage caused by cyclones Dominic, further supporting equivalent light-sweet Tapis.



West African discounts to benchmark North Sea Dated narrowed over the course of January as both Angolan and Nigerian supplies tightened.  Shut-in capacity at the medium sweet Greater Plutonio field in Angola and force majeure on Bonny exports after attacks on vessels near the export terminal supported regional grades.  Urals, meanwhile, was supported in Northwest Europe following tighter schedules at the Baltic port of Primorsk and as OPEC cuts reduced the arrival of competing Saudi and Iranian crudes.

The US market continues to be distorted by WTI weakness, as record high stocks at Cushing and limited tank availability depress near-term prices (See 'WTI Benchmark: Past Imperfect, Future Tense').  WTI's discount to Brent and other domestic light sweet grades such as LLS widened further over the course of the month, touching a record low of $9/bbl mid-month before strengthening slightly.  As elsewhere, lower availability of OPEC heavy crudes (Venezuelan exports to the US have reportedly been reduced by at least 120 kb/d) has pushed up medium/sour differentials significantly and even to a premium at times for grades like Mars and Poseidon.



Refining Margins

Refinery margins improved for all regions in January as higher gasoline, naphtha and fuel oil cracks more than offset lower distillate differentials.  The largest gains came in US West Coast Kern margins, which continued their steep increases seen since November, as extremely low refinery operations at the end of 2008 and the beginning of 2009 tightened product markets.  US Gulf Coast coking margins equally improved significantly over the month of January, moving into positive territory as gasoline cracks recovered.  High gasoline-yielding light crudes saw the largest gains, while distillate-rich grades saw smaller increases but from a higher starting point.

European refinery margins mostly improved.  Urals margins in the Mediterranean in particular saw strong gains, following increased product demand from the Middle East and as regional refinery maintenance and outages tightened product markets further.  Singapore margins also moved higher following strong gains in gasoline, naphtha and to a lesser extent HSFO prices.  Increased petrochemical activity supported light product price gains, while the HSFO discount to benchmark crudes reached its narrowest level in three years following a tightening of alternative sources of supply in line with reduced regional crude production.



NB:  In the process of our annual refining margins methodology overhaul, 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 altered.  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

Spot product prices rose for all categories and in all regions in January.  Divergent trends, however, were seen in product crack spreads, with significant gains recorded for light and heavy products while middle distillates saw their profit margin mostly deteriorate over the course of the month.

Naphtha recorded the strongest gains in January and early February, and rose by more than $10/bbl from a month earlier in both Europe and Singapore.  Since their low point in early November, naphtha cracks have seen a remarkable recovery from a $20-30/bbl discount to benchmark crudes to parity or even positive territory by the end of January.  Lower global refinery runs, increased petrochemical and power demand in Asia and the Middle East seem to have tightened markets and shored up prices lately.  Lower availability of competing gas liquids, in association with reduced Middle Eastern crude production and project slippages likely also contributed to the recovery.  Ethylene production has recently picked up in Asia, and Korean naphtha crackers were reportedly running at 95% in January, compared with only 75% in November.  Increased demand for naphtha also came from India, where lower domestic prices made it attractive for power generation.



More remarkably, perhaps, gasoline cracks also saw significant improvements in January, rebounding from negative or near-zero levels in early December to as much as $20/bbl in New York, $15/bbl in Singapore and close to $10/bbl in Europe.  Although the gasoline cracks in New York Harbor are exaggerated by weak WTI, spot Super Unleaded gasoline has gained more than $20/bbl since their low-point at the end of December.  But gasoline demand remains weak globally and particularly in the US, and prospects are not strong for a further marked improvement in the near term, despite lower retail prices.  Lower refinery utilisation and yields favouring more profitable middle distillates have tightened gasoline supply relative to crude and other products.  US gasoline stocks were at 220 mb at the end of January, 10 mb below 2008 and close to their five-year average.  The most recent weekly data from the EIA show an improvement in product supplied (a proxy for demand) in that week, with total gasoline supplied returning to historical averages.

Middle distillate cracks, on the other hand, were lower in general in January as spot prices only moved marginally higher, failing to match benchmark crude price increases.  The exception was the US Northeast, where cold weather supporting New York Harbor heating oil was compounded by a weak and distorted WTI.  Singapore gasoil differentials fell by more than $3/bbl as regional demand continued to plummet.  Chinese gasoil exports surged to about 50 kb/d in December, the highest level seen since August 2005, amid continually shrinking domestic demand and reportedly brimming storage.



The Asian product supply picture is set to change further over the coming months.  Most notably, the start-up of India's 580 kb/d Jamnagar export refinery expansion will substantially improve product availabilities in the region.  India is expected to export 25 medium range cargoes of gasoil a month, displacing mostly Japanese and Korean volumes.  Vietnam, another large regional importer, will start operations at its first refinery at the end of February.  The 140 kb/d Dung Quat refinery will further increase regional supplies by lowering import requirements from Vietnam.  In addition, Indonesia, which normally imports between 150-200 kb/d of gasoil, is also planning to export 1.6 mb of gasoil in February as domestic stocks have swelled due to weak demand.  This is the first time ever that state-owned Pertamina has received permission from the government to export gasoil.

Cold weather and the Russia/Ukraine gas dispute failed to support European markets on a sustained basis as supplies were plentiful as illustrated by brimming storage.  The contango in gasoil and jet fuel has left industry stocks full and supplies were even kept waiting to unload in tankers at ports, according to industry sources, pulling cracks lower.



Fuel oil differentials narrowed sharply in all markets in January, and Asian HSFO discounts reached their slimmest level in three years.  HSFO prices were supported by increased demand from power generation due to cold weather and reduced availability of gas from Russia and of NGLs and associated gas in the Middle East.  An export ban for HSFO by the Belarusian government also provided support.  Belarus, which normally exports around 40-60 kb/d of fuel oil, has been stockpiling the product for domestic use as Russian gas prices increased from 1 January.  Demand from the Middle East is also likely to have increased as alternative gas and NGL supplies have been shut-in due to project delays and a scaling-back of associated gas production in line with crude supply curbs.

End-User Product Prices in January

In January, retail product prices on average fell 8.2% from the previous month, in US dollars, ex-tax.  End-user prices for heating oil during the peak winter demand period were down 7.4% month on month, with prices in the UK down the steepest at 13.4% while Germany posted the smallest decline at 5.2%.  Weaker industrial consumption was behind the 11.6% decline in ender-user prices for low sulphur fuel oil for the European countries surveyed by the IEA.  By product, retail prices for diesel posted the second largest month-on-month decline, off 9.4% in January.  Gasoline prices in January on average fell 4.4% month on month and are down 46.5% from levels of a year ago.

Freight

Crude freight rates staged a mild recovery in the first half of January, but by the end of the month had fallen back to five-year historical lows.  Early February dirty rates have thus far shown little indication of recovery.  Clean rates, on the other hand, while decreasing in the first half of the month, held firm or increased towards the end-January.  Early February product freight rates continued to consolidate those gains.  Crude freight activity continues to vary according to the opposing dynamics of continued OPEC export cuts versus increased demand for floating storage.  Clean rates, while still at low levels, have seen recent increases partially on the back of increased gasoil shipments from Asia to Europe.

Increased demand for floating storage (see Floating Storage: Stranded at Sea or Smooth Sail to Shore?) in early January helped boost VIC chartering costs from the Middle East Gulf to Japan from $10.50/tonne at end-December to over $13/tonne by mid-January.  West Africa to US Atlantic Coast rates staged a bigger rally, from $12/tonne at end-December to over $23/tonne by mid-January, before falling back to $13.50/tonne at month's end.

Both physical and psychological factors relating to floating storage may have driven rates up.  Confusion over actual short-term floating storage levels in early January may have fuelled increased perceptions of tanker tightness, beyond physical availability.  Estimates of short-term floating storage continue to vary widely (50-80 mb as of early February), clouding analysis of freight fundamentals.  Still, decreased loadings by Middle East Gulf producers through January and announcements of lower February loadings have outweighed floating storage as a bearish factor on rates in the short term.

Weakening product demand kept clean tanker rates lower in January, but rates firmed in the second half of the month as gasoil arbitrage opportunities from Asia to Europe opened and product trade picked up across most regions.  Middle East Gulf to Japan 75 kit freight rates fell from $24/tonne at end-December to below $20/tonne by mid-month before rising again to just below $23/tonne at end-January.  Transatlantic UK-US Atlantic Coast rates fell below $16/tonne at mid-month before recovering somewhat to over $19/tonne at end-January.



Piracy continues to play havoc with tankers in the vicinity of the Gulf of Aden and Somali coast.  On 29 January, Somali pirates hijacked a German LPG tanker with capacity of about 40 kb.  Somali pirates continue to hold hostage at least eight ships including another carrying 24 kt of oil products.  Foreign navies from the US, EU, China, India, Malaysia and Russia have all stepped up efforts to thwart potential attacks, with as many as 20 warships patrolling the area.

Refining

Summary

  • Global 1Q09 crude throughput is forecast to average 71.9 mb/d, 0.3 mb/d below last month's report.  Ongoing downward revisions to demand, run cuts by independent refineries in the US and Japan, and heavier-than-estimated US refinery maintenance underpin much of the reduction to our forecast.  1Q09 throughput is 2.0 mb/d lower than a year earlier, with the majority of the decline occurring in the OECD.  Weakness in non-OECD crude runs is concentrated in China and Other Asia, with annual declines of 0.4 mb/d for each region.
  • Reported crude runs for December were broadly in line with expectations.  Crude runs were weaker than forecast in Russia and China, but these were offset by higher-than-expected runs in the OECD.  Provisional weekly data for January indicate that US refinery activity was marginally ahead of forecast at 14.3 mb/d.  Conversely, Japanese January activity levels lagged behind expectations with refineries continuing to rely heavily on product imports to meet demand.


  • Refiners continue to respond vigorously to the effects of demand weakness in an attempt to re-establish some degree of pricing power.  Run cuts remain widespread throughout much of the OECD and are increasingly prevalent in some non-OECD regions.  However, upside risks to our throughput forecast remain, if regional pockets of product market tightness re-emerge.  Notably, the downward revision to OPEC NGLs in this report materially reduces the prospect of heavily over-supplied naphtha markets in the coming quarters, although they do not completely remove the overhang highlighted in the MTOMR Refining and Product Supply Outlook - December 2008 Supplement.
  • OECD gasoil/diesel yields increased in November to a new record level of 30.8% on the back of strong crack spreads, with month-on-month growth driven by North America and Europe.  Naphtha yields continued their downward trend, driven by weaker naphtha cracks, which reached -$32.67/bbl in Singapore during November.  Gasoline yields rebounded to near the five-year average, even though crack spreads deteriorated, as refineries blended more naphtha into gasoline.  Jet fuel/kerosene yields improved to near the five-year range, encouraged by the persistence of healthy crack spreads.

Global Refinery Throughput

Fourth-quarter weakness in global crude throughputs continued into January as refiners struggled to adjust to weak demand and high product stocks.  Middle distillate cracks, long the mainstay of refinery margins, came under increasing pressure during the course of January, raising the prospect of further economic run cuts if the recent rebound in naphtha and gasoline margins is not sustained.  The year-on-year decline in January crude is now estimated at 2.7 mb/d, as US refiners registered some of the lowest utilisation levels since 1992 and Japanese refinery utilisation levels similarly well below seasonal norms.

Refiners face one of the toughest macroeconomic environments seen since the late 1990s.  Nevertheless, refiners have sought to maintain and protect a modicum of pricing power through run cuts, effectively transferring the financial pain onto upstream producers.  It is only by reducing product stocks that refiners can hope to re-exert some degree of pricing power.  Current contango indicates that there is further work to be done by refineries to achieve this objective, in the face of weakening gasoil demand in Asia, and gasoline demand in the US.  Nevertheless, the extent to which refiners in the US, Europe and Japan have restrained output continues to surprise, given the apparent incentive to run incremental light sweet barrels of crude.

Estimated December global crude throughput of 72.8 mb/d is 0.1 mb/d above last month's report.  OECD data were broadly in line with expectations, with the exception of Korea and the UK.  As highlighted last month, Korean refiners again failed to implement economic run cuts to the degree we had assumed, possibly reflecting their improved competitive position, following an expansion of upgrading capacity.  Similarly, UK crude runs increased more than expected, despite the reports of run cuts at several locations.  Non-OECD runs were lower than expected, following the large drop reported in crude throughput in Russia, China and the UAE.  These shortfalls were only partially offset by higher runs in Ecuador and Indonesia.



1Q09 global crude throughput of 71.9 mb/d is some 0.3 mb/d below last month's report.  Weaker forecasts for Russian crude runs and heavier US maintenance assumptions, most notably for March, account for much of the downward shift in expectations.  Upside potential for refiners to exceed our current crude throughput estimates is significant, but we think it will require healthier levels of demand to emerge.  That said, the rebound in gasoline and naphtha cracks from the dismal fourth quarter levels offers a glimmer of hope, as lower OPEC NGL volumes are assumed to have tightened light distillate markets in recent weeks.  January global crude runs are estimated to have averaged 71.9 mb/d, according to preliminary data, 0.3 mb/d below last month's report, with now weaker estimates for Russia, Iraq and Bulgaria contributing to the decline.  Elsewhere, US crude runs of 14.3 mb/d were marginally ahead of our estimates.

Forecasts include both the planned ramp-up in Reliance's 580 kb/d Jamnagar refinery expansion, plus the start-up of Vietnam's first refinery at Dung Quat in February.  Conversely, our forecasts continue to exclude 0.4 mb/d of new Chinese crude distillation capacity that has been widely reported as coming on line in early 2009 due to uncertainty as to when Chinese state oil companies will actually start commissioning following weak demand and reports of brimming product stocks.

Nevertheless, the two Asian refineries will add 0.7 mb/d of new distillation capacity and generate a significant shift in regional and global trade flows.  Vietnam will increasingly reduce the need for product imports, as it slowly brings the 140 kb/d refinery fully on line, while the start-up of exports from Reliance's 580 kb/d Jamnagar refinery will add supplies of diesel, jet fuel and gasoline to global markets.  Furthermore, the move by Indonesia's state oil company, Pertamina to start exporting gasoil in the face of demand falling by as much as 40% year-on-year, will only add to the abrupt structural shifts occurring in Asian gasoil markets.  This raises the potential for higher export volumes from the region to both the US and Europe, at a time when refiners there already face challenging demand trends.



Global crude throughput during 1Q09 is 2.0 mb/d lower than a year earlier, with the majority of the decline in the OECD.  Weakness in non-OECD crude runs is concentrated in China and other Asia with annual declines of 0.4 mb/d seen for both.  April forecast crude runs are reduced by 0.6 mb/d from last month's report, to 71.9 mb/d.  This reflects the downward adjustment to demand forecasts and the more cautious view now taken over Russian crude runs.  Initial assessments of May crude throughput levels foresee crude runs continuing to increase seasonally to 72.6 mb/d, as higher North American and European runs offset the start of seasonal maintenance in the OECD Pacific.

OECD Refinery Throughput

December 2008 OECD crude throughput averaged 37.8 mb/d, 0.2 mb/d ahead of last month's report, but 1.9 mb/d below a year earlier.  Korean refineries were 0.1 mb/d ahead of forecast, as the previously highlighted assumption of economic run cuts were again too heavy.  Elsewhere, higher than expected crude runs in the UK and Mexico offset slightly weaker than expected runs in other OECD countries.  Refinery utilisation rates hovered around the 80% mark in the US, Japan and several European countries, reflecting the impact of weak demand and high product inventories.

OECD North America crude throughput eked out a small monthly gain in December, despite lower US throughputs, as Mexican runs increased, following the completion of maintenance work at Pemex's Tula refinery in November.  US refinery utilisation fell to one of the lowest levels seen since the early 1990s in December, (excluding the hurricane-depressed levels of September 2005 and 2008) and stayed at or close to these levels for much of January.  Despite this low level of throughput, January North American crude throughput of 17.1 mb/d based on weekly US and Canadian data, is 0.2 mb/d above last month's assessment.  However, following a review of US maintenance plans, the seasonal peak now appears more likely to occur in March.  Consequently, we have revised up February crude runs to 17.0 mb/d, but cut March's forecast to 16.5 mb/d, which is barely 1.0 mb/d above the hurricane-affected level of September 2008.  1Q09 throughput is forecast to average 16.9 mb/d, 0.7 mb/d below last year's level.



It now seems certain that US throughput will be spared the disruption of a strike by refinery workers, following a successful conclusion to negotiations between Union of Steel Workers representatives and refinery operators.  However, as highlighted last month, Big West's 80 kb/d Flying J refinery in Bakersfield which filed for Chapter 11 protection in December has failed to secure a consistent crude supply and the refinery remains closed, awaiting resolution of the issue.  Some refinery operators foresee further refinery closures in the longer-term, with a sustainable number of US refineries approaching 100-125, compared with the near 150 active today.  Fourth-quarter results from refinery operators have again highlighted the need for refineries to minimise the cash drain on their businesses, with Valero announcing further reductions to planned 2009 capex, to just $2.7 bln, following the deferral of several planned projects by 12-24 months.  Similarly, Marathon has slowed down its upgrading project at their Detroit refinery in order to reduce capex.  More generally, it appears increasingly obvious that, where possible, refiners are renegotiating contracts to reduce project costs to ensure future returns are acceptable.  However this potentially adds 6-12 months to completion times, and is likely to have significant implications for the product supply forecasts in the next MTOMR.



OECD Pacific December crude runs were 0.2 mb/d ahead of forecast, with Korean crude intake 0.1 mb/d ahead of our forecast.  The benefit of recent upgrading investment by Korean refineries is evident in the increased processing of cheaper, heavy/sour, Middle East crude, and less demand for expensive light-sweet West African grades.  This, in part, will have contributed to the more robust crude throughputs reported by Korean refineries, despite weak naphtha cracks.  Elsewhere, Japanese and Australian crude runs were slightly higher than our assumptions.  Japanese refiners continue to limit throughputs, preferring instead to boost imports of kerosene to meet the seasonal uptick in demand associated with recent colder weather.  1Q09 Pacific crude runs are marginally reduced this month, following slightly weaker than expected January runs, based on preliminary weekly data.  The extension of the regional forecast through May sees the start of maintenance, initially in Japan, starting to weigh on crude runs.



OECD Europe crude throughput inched up in December, thanks to increases in Italy, the Netherlands, Spain and the UK.  However, crude runs failed to produce the seasonal bounce typical for December, which is normally associated with the lack of maintenance scheduled for that month.  We believe this reflects the weak demand for products, rising product inventories and financial market constraints.  French crude runs were marginally weaker during December as the impact of the strike at the port of Marseilles reduced some refineries' operating rates.  Furthermore, the unscheduled shutdown of GALP's 200 kb/d Sines refinery, in Portugal has lowered European 1Q09 estimates by a further 0.1 mb/d.

Future throughput levels will partly depend on how distillate cracks develop, with market reports pointing to growing stocks of gasoil and jet fuel, some of which are kept in floating storage.  With continued heavy Europe-bound sailings reported from Asia and the US, the prospect for further imports will reduce the likelihood of a rebound in crude runs.  Only the ongoing cold weather appears to be supporting distillate demand.  Further signs of industry restructuring have emerged, with Petroplus announcing it will either sell or close its 117 kb/d Teesside hydroskimming refinery, which is among the least sophisticated in Europe.  The plant exclusively runs light sweet Ekofisk crude due to its location, and sells its naphtha output to nearby petrochemical plants.  Given the weakness in naphtha cracks, the fourth quarter was presumably a particularly painful financial environment to operate in, despite the plant only running at 30% utilisation, thus prompting management to consider rationalising the company's portfolio.

Non-OECD Refinery Throughput

Forecast 1Q09 non-OECD crude throughput is again revised down this month (-0.2 mb/d), following the weaker demand forecast in this month's report.  Much of the reduction is linked to lower Russian crude throughputs, which are now forecast to average 4.8 mb/d, following weak December throughputs and tax changes, which have reduced the incentive to maximise crude runs.

Chinese crude runs fell for a second month in December to 6.4 mb/d, as capacity shut-ins and weak demand hampered crude throughput.  1Q09 crude runs are assessed this month at 6.4 mb/d, nearly 0.1 mb/d below last month's report and down 0.4 mb/d when compared with a year earlier.  Future crude throughput will depend on domestic demand and the timing of new capacity additions.  Sinopec is reported to be preparing the 160 kb/d Fujian expansion for commissioning in 2Q09, while the 200 kb/d Tianjin expansion has slipped from the third to the fourth quarter.  Similarly, CNOOC's 200 kb/d Huizhou refinery is expected to be commissioned in the coming months, having originally been forecast for start-up in late 2008, but little progress has been reported recently.  Consequently, we remain cautious on Chinese crude throughput levels in April and May, which offer the potential for upward revisions to current forecasts, pending further confirmation of project timings.

Other Asia forecasts are revised up this month with the ongoing build-up in crude throughput at Reliance Petroleum's 580 kb/d expansion of its Jamnagar refinery.  Indian December crude runs were 0.2 mb/d above our estimates and we have pushed this increase through the balance of the forecast.  Further upward revisions are possible if the full commissioning of the upgrading capacity and the switch to heavy sour crude, from the current diet of light sweet grades, is more rapid than assumed.  However, for now, we retain a cautious build-up in volumes within our forecasts.  Furthermore, the start-up of Vietnam's first refinery, the 140 kb/d Dung Quat facility, is scheduled for late February.  It is assumed it will build up slowly to full utilisation, with crude runs of 30 kb/d in March, rising to 70 kb/d by May and full capacity by year-end.

OECD Refinery Yields

OECD refinery gasoil/diesel yields reached a new record level in November of 30.8%, from  30.2% in October, due to strong crack spreads.  Increases in North America and Europe offset a decline in the Pacific, where refiners moved to raise jet fuel/kerosene yields in line with seasonal trends.  Record North American gasoil/diesel yields nonetheless remain the lowest within the OECD at 26.6%, due to the historical refinery bias towards gasoline production.  European gasoil/diesel yields also increased to a new record of 38.1%.  Year-on-year growth in percentage points remains around 0.8, driven by gains of 1.1 in Europe, 1.0 in North America and a decrease of 0.2 in the Pacific.  Seasonal trends would suggest that yields likely increased again in December, but thereafter a weakening of gasoil/diesel cracks relative to other grades may exert downward pressure.



Naphtha yields continued their downward trend as cracks deteriorated to a low of -$32.67/bbl during early November in Singapore.  November naphtha yields decreased to 4.2%, well below the five-year range, driven by a collapse in Pacific naphtha yields to the bottom of their five-year range at 10.2%.  Production likely remained subdued in December on high inventories, but the recovery in crack spreads, reaching positive territory by the end of January, and increased utilisation of ethylene crackers in Asia, offers the prospect of a rebound in naphtha yields in early 2009.

OECD gasoline yields remained near the five-year average level of 33.5%, albeit with some regional divergence.  Europe's yield of 22.3% was the highest in 12 months, as refineries sought to maximise naphtha blending into the gasoline pool, given the near $20/bbl differential in cracks.  Similar trends are discernable for both North America and the Pacific, but the move towards higher jet fuel/kerosene yields outweighed the impact in both regions.  It is worth noting that gasoline cracks in November were near zero for the USGC, Mediterranean and Northwest Europe and negative for Singapore, this last region showing a heavy month-on-month decrease of $13.3/bbl to -$1.4/bbl.  Furthermore, the different regional pattern of yield changes highlights the underlying bias for each region towards a specific product, e.g. gasoline in North America, diesel in Europe and naphtha/kerosene in the Pacific.



The striking decrease in OECD jet fuel/kerosene yields in October discussed in last month's report reversed in November, with higher yields in all OECD regions.  Although still low compared with the five-year range, yields increased most significantly in North America and the Pacific, as highlighted above.  Despite weakening demand, the persistence of positive crack spreads reflects the tightness of middle distillate markets relative to light distillates and fuel oil, and the longer-term bias in demand growth towards diesel and jet fuel.  However, rising stocks, most notably in Northwest Europe, will start to undermine crack spreads, unless demand growth re-emerges, exerting downward pressure on yields in early 2009.



OECD fuel oil yields remain below their five-year range at 8.6%, as refiners, notably in the Pacific, continue to benefit from recently commissioned upgrading capacity.  However, upgrading spreads have narrowed dramatically in recent months and the rebound in profitability of hydroskimming margins in Northwest Europe and Asia offers the potential for increased fuel oil yields during December and January.  Furthermore, fuel oil yields tend to increase seasonally in December, which could further be supported by this improvement in price spreads, particularly for high-sulphur fuel oil.