Oil Market Report: 13 March 2009

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Highlights

  • Crude oil prices posted steady gains in early March on mounting evidence of increased OPEC compliance with targeted output cuts. Benchmark crudes scaled to two-month highs, trading in a $41-45/bbl range, with WTI back above Brent for the first time since late 2008.
  • Global oil supply in February is estimated at 83.9 mb/d, down 1.0 mb/d month-on-month and 3.4 mb/d year-on-year.  OPEC crude supply, at 28.0 mb/d, was down 1.1 mb/d from January.  Full compliance with agreed cuts - above the current 80% - would take OPEC output 1.6 mb/d below the 2009 'call', implying a potential draw in OECD stocks.
  • Non-OPEC supply growth for 2009 is revised down by 380 kb/d to zero, following a reappraisal of ongoing problems at Azerbaijan's ACG fields.  Non-OPEC supply for 2008 is kept steady at 50.6 mb/d, as fourth-quarter upward revisions to UK North Sea production were offset by weaker non-OECD output.  OPEC NGLs, however, should add 0.3 mb/d in 2009.
  • Forecast global oil demand for 2009 is revised down slightly to 84.4 mb/d, -1.5% or -1.2 mb/d year-on-year, on a reassessment of demand prospects in the FSU, Asia and OECD North America.  The oil demand estimate for 2008 remains unchanged at 85.7 mb/d (-0.4% or -0.4 mb/d versus 2007).
  • OECD industry stocks rose by 9.0 mb in January to 2,712 mb, with European and Pacific product draws partially offsetting North American crude builds.  An upward revision to December inventories plus increasing January stocks pushed end-January forward demand cover to 58.7 days, 4.6 days higher than a year ago.
  • Global crude runs are expected to remain weak through 1Q09, but completion of maintenance at refineries in the Atlantic Basin and start-up of new Asian capacity offer the prospect of higher runs during 2Q09.  OECD throughput in January collapsed by 2.1 mb/d on a yearly basis, with capacity utilisation at its lowest since 1995.

Striking a balance

We have consistently cautioned against a one-eyed view of the market that focuses solely on demand-side weakness.  True, the demand collapse has been staggering, based on the whirlwind nature of the slump in the global economy.  Naturally, slowing economic activity leads to less energy and oil demand, but the obvious flip-side to this is that lower prices also lead to a supply response.  Normal supply-side impacts are being intensified by a credit squeeze, affecting not only investment in new productive capacity, but also operational spending among more cash-strapped companies.  Technical problems on the supply-side are also an ever-present.

While our 2009 demand estimates this month are trimmed by an average 0.3 mb/d, there is an offsetting 0.4 mb/d cut for non-OPEC supply, albeit this time largely technically-driven.  For demand, weakness is evident in the US, with December numbers coming in around 200 kb/d below earlier estimates.  This, plus downgrades for fuel oil and LPG amid very low competing natural gas prices, leads to a 140 kb/d reduction in expected US 2009 demand.  We have also cut 130 kb/d from Russian 2009 demand amid signs that economic slow-down there is gathering pace.  As demand estimates have weakened, OECD forward stock-cover has increased, reaching 58.7 days in January.  Meanwhile, the bulk of this month's supply adjustment comes from Azerbaijan.  Unofficial estimates now leave 2009 Azeri output flat in a 900-950 kb/d range, compared with widespread expectations of 1.2 mb/d back in December.  Problems after recent gas leaks at the offshore  Azeri-Chirag-Guneshli complex underpin the lower forecast.



This month's supply-side revisions nullify previously expected 2009 non-OPEC supply growth altogether, leaving the total flat at last year's 50.6 mb/d, down from 50.7 mb/d in 2007.  Combined supply and demand side changes leave the call on OPEC crude and stock change for 2009 at 28.9 mb/d, 0.1 mb/d above last month's level, but still 1.5 mb/d below the 2008 average.  Faced with a declining call amid collapsing demand and brimming stockpiles, it is not surprising that OPEC has opted for production restraint.  And the organisation has indeed cut supplies significantly, removing 3.3 mb/d from the market between September and February.  That is near-80% compliance with planned 4.2 mb/d reductions, and further trimming of actual output is likely during March and April.  Also, Nigeria and Iraq may face further non-voluntary cuts if recent production and export disruptions persist.

OPEC Ministers meet on 15 March in Vienna to consider production policy.  Public statements have ebbed and flowed between improving compliance and new cuts upwards of 1.0 mb/d.  This report does not predict OPEC decisions, nor do we forecast OPEC forward supply levels.  But a scenario of OPEC attaining current target by April and holding output flat through 2009 would quickly tighten OECD stocks (see above), even in the face of our forecast global demand decline of 1.2 mb/d.  A more severe demand scenario, involving a drop of 2 mb/d in 2009, would still see inventory cover fall within seasonal norms by 3Q09.  Ultimately, prices should always find a level that balances the market, and for the longer term this will partly reflect supply costs and the need for investment.  But arguably, in the short term, an easing of the burden for oil importing countries of anything up to $1.2 trillion, depending on 2009's average price, could give the fragile global economy some much-needed breathing space.  The last thing the world's industrial base needs at present is to be thrown further off balance by a sudden surge in fuel input costs.

Demand

Summary

  • Forecast global oil demand for 2009 has been revised down slightly, given the reassessment of demand prospects in the FSU, Asia and OECD North America.  Global oil demand is now projected at 84.4 mb/d in 2009 (-1.5% or -1.2 mb/d when compared with the previous year and 270 kb/d lower versus our last report).  The demand estimate for 2008 remains unchanged at 85.7 mb/d (-0.4% or -0.4 mb/d versus 2007).
  • Forecast OECD oil demand for 2009 has been adjusted down following 4Q08 and 1Q09 revisions in North America, notably in the US, which have been largely carried forward through 2009.  Oil demand is expected to average 45.9 mb/d (-3.4% or -1.6 mb/d from 2008), some 80 kb/d lower than previously estimated.  The demand appraisal for 2008 remains unchanged at 47.5 mb/d (-3.4% or -1.7 mb/d versus 2007).


  • Forecast non-OECD oil demand for 2009 has been revised down by roughly 190 kb/d to 38.5 mb/d (+0.9% or +0.4 mb/d versus the previous year) following the reappraisal of the demand outlook in the FSU (Russia) and Asia (Chinese Taipei).  Russia, whose economy appears to be deteriorating more quickly than previously expected, accounts for the bulk of this revision.  Demand in 2008, by contrast, remains largely untouched at 38.2 mb/d (+3.5% or +1.3 mb/d versus 2007).
  • The aggregated oil use of the world's 12 largest consumers, which collectively account for roughly 70% of global demand, has fallen continuously since mid-2008.  The eventual resumption of global demand growth will largely depend upon stronger economic performance among these top consumers.  Although the latest news is not encouraging, the IMF's forthcoming World Economic Outlook, to be published in late April, should be a guide to whether the recent flurry of fiscal and monetary policy initiatives by governments and central banks of the world's leading economies will help engineer a gradual recovery by late 2009, and whether such recovery will be sustained.

Global Overview

The aggregated oil use of the world's 12 largest consumers (defined as those consuming at least 1.5 mb/d), which collectively account for roughly 59 mb/d or 71% of global demand, has continuously diminished since mid-2008.  Although such decline is partly related to structural reasons, the eventual resumption of global demand growth will largely depend upon much stronger economic performance than is currently the case among most of these top consumers - the United States, the five largest European economies (France, Germany, Italy, Spain and the United Kingdom), China, Japan, India, Russia, Brazil, Saudi Arabia, Canada, Korea, Mexico and Iran.

However, the latest news is not encouraging, particularly in the OECD.  US economic activity fell in 4Q08 by 6.2% year-on-year, almost twice as much as the preliminary estimate (-3.8%).  The contraction would have been worse but for increased government spending, since private consumption and investment and, perhaps more crucially, exports posted sharp declines.  Naturally, the effects of US woes are spreading to its neighbours, with GDP in both Canada and Mexico also contracting.  Europe's main economies now appear certain to experience a sharp recession this year; in December manufacturing output contracted by 12-14% in France, Germany, Italy and the UK.  The Pacific is looking even grimmer, with Japan and Korea facing collapsing domestic consumption, investment, industrial activity and exports (notably to China, whose own shipments to the United States, Europe and the rest of the world have

stalled).  Economic activity in Japan and Korea shrank respectively by 12.7% and 3.4% year-on-year in 4Q08; for Japan, which has also seen the yen appreciate sharply, this was the worst performance since 1974.  To cap it all, worries over the solvency of the banking sector are increasing in both the US and Europe, given their exposure to yet un-quantified risks and shrinking capital reserves.

Outside of the OECD, the economic outlook is less dismal as most of the main emerging economies are still likely to experience some growth.  A notable exception, though, is Russia, which has been battered by the global turmoil.  The ultimately unsuccessful attempts to support the rouble have been costly in terms of foreign exchange reserves (down by almost 40% since August), while the country's economic slowdown has intensified in the past two months.  Industrial production plummeted by 10.1% year-on-year in December, and the country's economy is likely to slide into recession this year, after almost a decade of buoyant expansion.  Elsewhere, GDP growth, albeit positive, is set to slow down to a greater or lesser degree.  Although China's economic growth in 2009 is expected to reach an enviable 6.7%, this would be about a half to a third lower than in recent years, with tens of millions of workers having lost their jobs over the past few months.  Other emerging economies such as Brazil and Saudi Arabia are expected to see GDP growth halve when compared with recent years.  By contrast, India's economy, albeit also slowing, has been so far remarkably resilient to the global economic slowdown.  Although the country's exports have fallen (-16% year-on-year in 4Q08), these consist mostly of services, rather than goods - hence a much more limited impact upon industrial production (-2.0% in December).  In addition, arguably loose fiscal and monetary policies help cushion the downturn (but may possibly stoke future inflation).

The IMF's forthcoming World Economic Outlook, to be published in late April, will arguably demonstrate whether the recent flurry of fiscal initiatives in the US, Europe and Asia and loosening monetary conditions in the world's largest economies will help engineer a gradual recovery by late 2009, and whether such recovery will be sustained.  Several IMF officials have hinted that another sharp cut to global GDP prognoses is likely, but given the lack of more precise figures we have kept our GDP assumptions unchanged versus last month.  Nonetheless, we have slightly adjusted down our 2009 global oil demand forecast to 84.4 mb/d (270 kb/d lower than previously expected), given a reassessment of demand prospects in the FSU (Russia), Asia (Chinese Taipei) and OECD North America (US).  By contrast, our 2008 appraisal remains unchanged at 85.7 mb/d.  In terms of growth, this means that global oil demand contracted by 0.4% year-on year or 0.4 mb/d in 2008, and that it will further decline in 2009 by 1.5% or 1.2 mb/d versus 2008.



OECD

Preliminary data show that OECD inland deliveries (oil products supplied by refineries, pipelines and terminals) contracted by 5.5% year-on-year in January.  All three regions recorded losses for the ninth month in a row, with most advanced economies firmly in recession.  In OECD North America (which includes US Territories), oil product demand fell by 5.2% year-on-year, with all product categories posting losses.  In OECD Europe, despite strong heating oil deliveries due largely to cold weather conditions, total demand shrank by 5.1%.  In OECD Pacific, demand plunged by 7.2%, despite a strong rebound in gasoline and jet fuel/kerosene deliveries.



Revisions to preliminary figures were on aggregate positive, with the largest changes corresponding to European data.  December's OECD demand estimates were adjusted up by 240 kb/d, indicating that demand fell by 4.0% during that month, rather than by 4.5% as previously estimated.  Coupled with adjustments to October (-100 kb/d) and November (-40 kb/d) figures, 4Q08 demand has been revised up by 35 kb/d.  As such, OECD demand averaged 47.5 mb/d in 2008 (-3.4% or -1.7 mb/d versus 2007, barely changed versus our last report).  In 2009, following the inclusion of preliminary data for January and the reappraisal of prospects in North America, OECD demand is expected to contract by 3.4% on a yearly basis (-1.6 mb/d) to 45.9 mb/d (80 kb/d lower when compared with our previous assessment).





North America

According to preliminary data, oil product demand in North America (including US Territories) plummeted by 5.2% year-on-year in January, a decline for the thirteenth month in a row.  Persistent demand weakness in the United States (-5.4% year-on-year) was compounded by losses in both Canada, for the sixth consecutive month (-4.4%), and Mexico, for the fourth month in a row (-4.9%).



Revisions to December preliminary data (-170 kb/d) were essentially driven by the US.  Demand in OECD North America was thus weaker than anticipated, plummeting by 6.0% year-on-year in that month, instead of 5.4%.  Regional oil demand averaged 24.3 mb/d in 2008 (-4.8% or -1.2 mb/d on a yearly basis, some 20 kb/d lower than our last assessment).  In 2009, demand is expected to reach 23.5 mb/d (-3.2% or -0.8 mb/d versus 2008), about 160 kb/d lower than previously anticipated on the back of a reappraisal of the US demand outlook following the release of preliminary weekly data.



Adjusted preliminary inland deliveries - a proxy of oil product demand - in the continental United States declined by 4.9% year-on-year in February, with all product categories posting significant contractions, most notably naphtha (-20.1%), jet fuel/kerosene (-15.6%), distillates (-4.5%) and residual fuel oil (-18.2%).  The dismal state of the economy continues to weigh on oil demand, while relatively mild weather (after a very cold January), amid falling natural gas prices, further tempered power and heating needs - and ultimately heating oil and residual fuel oil demand.  Indeed, although the number of heating-degree days in February was slightly higher than the 10-year average, it was much lower than in the same month of the previous year.  City-gate gas prices in the East Coast (New York City), meanwhile, have fallen to about $5.8/mmbtu, compared with about $8.6/mmbtu for heating oil and $5.8-7.0/mmbtu for high- and low-sulphur residual.  The fall in gas prices results from a combination of higher supply and collapsing demand, notably among car manufacturers and chemical companies - but also in the household sector as, according to some reports, strained consumers look to reduce expenditures and housing foreclosures rise.



The only source of optimism, if any, is the fact that gasoline demand declined by only 0.5% year-on-year in February, its lowest fall since May 2008.  It should be noted that this calculation is based on EIA's unadjusted weekly data.  Comparing current, unadjusted weekly figures with adjusted year-ago data is misleading, since it tends to overestimate demand growth, because weekly figures are usually revised down sharply.  Yet, somewhat counter-intuitively (given worsening economic circumstances), many commentators have rushed to declare that US demand increased for the first time in months, when it actually kept on contracting.

Our revisions to preliminary weekly data (-200 kb/d) in December were relatively limited relative to total US demand, suggesting that our pre-emptive adjustment has been relatively successful in anticipating a large chunk of the EIA's weekly-to-monthly revisions (-770 kb for the month).  The adjusted data show that December's year-on-year annual decline reached 7.1%, a full percentage point more than previously estimated.  As such, US oil demand is estimated to have contracted by 5.7% or 1.2 mb/d year-on-year in 2008 to 19.5 mb/d, about 20 kb/d lower than previously anticipated.  Looking ahead, based on December's revisions and preliminary January and February data - which point to poor prospects with regards to naphtha, jet fuel/kerosene and residual fuel oil - oil demand is expected to fall by 3.5% or 690 kb/d in 2009 to 18.8 mb/d, about 140 kb/d lower when compared with our previous report.

In Mexico, preliminary data indicate that oil demand fell sharply in January (-4.9% year-on-year), providing further evidence of the ongoing economic slowdown.  Diesel deliveries, in particular, plummeted by 5.9%.  This fall may possibly intensify in February, not only due to worsening economic conditions, but also because of a truckers' and bus drivers' strike that erupted in mid-February, affecting 18 of the country's 32 states.  Some 500,000 drivers suspended activities for one day in protest against high diesel prices, absent from January's stimulus package (which froze gasoline prices and reduced both electricity and LPG prices).  Unless the government cuts diesel prices from $0.53/litre to $0.41/litre as requested, the transportation unions have vowed to escalate their protests.

Europe

According to preliminary inland data, oil product demand in Europe fell by 5.1% year-on-year in January, following two months of marked decline.  The continent experienced in January one of the most severe cold snaps in decades (the number of heating-degree days was significantly higher than both the 10-year average and the same month of the previous year), which boosted heating oil (+7.9% year-on-year), a product that accounts for almost a fifth of European demand during the winter months.  This failed, however, to offset sharp declines elsewhere, notably in naphtha (-19.6%), jet fuel/kerosene (-5.9%) and diesel (-6.7%).

More interestingly, the effects on oil demand of January's Russian disruption to European natural gas supplies appear to have been relatively limited, at least as far as the largest countries are concerned.  Smaller and highly gas-dependent countries were less fortunate; for example, fuel oil demand in Slovakia surged by an astonishing 825% year-on-year in January, while the Czech Republic registered a 43.8% spike in fuel oil, followed by Poland with +20.3%.  Although preliminary data may be revised next month, the relatively limited volumes involved (heating oil and residual consumption in these three countries add up to only 110 kb/d, which is less than demand in, say, Switzerland) explain why the effects of the gas disruption were negligible on a continental scale.

Meanwhile, December data were revised up by 340 kb/d, mostly with respect to products driven by weather conditions (such as heating oil and residual fuel oil).  As such, 4Q08 demand was adjusted up by 110 kb/d, bringing our estimate for 2008 oil demand to 15.2 mb/d (-0.6% or -90 kb/d versus 2007).  In 2009, oil demand in OECD Europe is expected to average 14.7 mb/d (-3.2% or -480 kb/d compared with the previous year).  Both appraisals are virtually unchanged (25 kb/d higher on average than previously anticipated).





According to preliminary estimates, inland deliveries in Germany tumbled by 6.3% year-on-year in January, as a rise in heating oil demand (+25.6% year-on-year) driven by extremely cold temperatures failed to offset losses in all other product categories.  Heating oil consumer stocks, at 60% of capacity by end-January, were well above the previous year (52% in January 2008) and only slightly below the previous month (63%).  By contrast, oil demand in the industrial sector reached new lows amid collapsing exports (machine-tool shipments plunged by 47.0% year-on-year).  LPG and naphtha demand - mostly used in the production of plastics and petrochemicals - plummeted by 27.0% and 37.9% year-on-year, respectively.  Naphtha's free fall has been particularly dramatic: demand has plunged from 400 kb/d last August to 240 kb/d in January - a period where consumption is normally mostly flat.  Similarly, residual fuel oil demand was noticeably weak (-13.3%) in the face of lower industrial electricity needs (according to RWE, the second-largest German utility, industrial power demand could fall as much as 10% in 2009).



In France, by contrast, demand surged by +5.1% year-on-year in January, mostly pulled up by strong deliveries of heating oil (+20.2%) and residual fuel oil (+70.1%), which outweighed losses elsewhere.  The surge of both fuels was directly related to the weather, as cold temperatures led to higher heating and power needs.  Moreover, as heating in France is increasingly electric, power demand surged.  Utilities reportedly used 137% more fuel oil to meet the peak load in January; nevertheless, on average, nuclear power accounts for 76% of total electricity output, while thermal sources (which include natural gas and fuel oil) represent only 13%.  Yet the steady and strong growth in 'domestic' power demand (which includes households, small business, the public sector and services) has largely offset falling industrial electricity demand (car manufacturing, chemical and steel industries), which has been severely curtailed by the economic slowdown (-17.9% year-on-year in December).



In Italy, total oil product deliveries shrank for the fourth month in a row, by 9.0% year-on-year in January, as the country slides into a deep economic recession.  As in Germany, falling industrial production has resulted in lesser oil and energy use, be it products such as naphtha (-29.5% year-on-year in January, after three consecutive months of 50% annual decline) or electricity (-10.0%).  In fact, despite the cold weather, residual fuel oil deliveries, which as in France serve to meet peak power demand, actually fell - by contrast to the spike recorded in the previous episode of Russian gas disruption in early 2006.  Nonetheless, it should be noted that the country has made significant progress in diversifying its natural gas supplies; during the latest crisis, it increased imports from North Africa and Northern Europe.

Pacific

According to preliminary data, oil product demand in the Pacific dived for the eighth month in a row in January (-7.2% year-on-year).  Since mid-2008, economic activity has continuously slowed down in both Japan and Korea - the global economic downturn has indeed hit export-oriented countries particularly hard.  January's contraction would have been steeper in the absence of cold weather (heating-degree days were noticeably higher than both the 10-year average and the same month of the previous year).  Jet fuel/kerosene demand grew by 1.5% (kerosene is normally used for heating in the region).  In addition, gasoline demand was relatively buoyant (+1.8%), arguably reflecting the sharp fall in domestic retail prices.  By contrast, naphtha, residual fuel oil and 'other products' deliveries continued to decline (-8.6%, -17.5% and -49.9%, respectively).

Upward revisions to December preliminary data were relatively minor (+80 kb/d), mostly from Australia and to a lesser extent Japan.  Therefore, the region's oil demand appraisal for 2008 has remained largely unchanged at 8.0 mb/d in 2008 (-3.8% on a yearly basis or -320 kb/d over 2007).  The 2009 demand forecast, meanwhile, has been revised up slightly (+60 kb/d) to 7.7 mb/d in 2009 (-4.2% or -330 kb/d versus the previous year), in order to reflect slightly higher-than-expected demand for naphtha in Korea and gasoline in Japan.





In Japan - the world's third largest oil consumer - oil demand is in free fall, as the country falls prey to an unprecedented recession, which further compounds its structural decline in oil use.  Demand has contracted by 11.1% year-on-year on average in every month since August 2008.  Naphtha, the quintessential industrial feedstock, continues to sink (-24.5% year-on-year in January) in tandem with industrial production (-20.0%).  Moreover, as in other advanced economies, the economic downturn has also curbed power needs (-6.4% year-on-year in January, the largest monthly drop in almost four years), with deliveries of residual fuel oil and 'other products' (which include crude for direct burning) contracting by 25.4% and 45.2%, respectively.  In addition to falling electricity demand, nuclear power utilisation reached a five-month high of 67.2% of installed capacity, further weighing on oil use.



Meanwhile, the potential restart of one of the seven reactors of TEPCO's giant Kashiwazaki-Kariwa nuclear power plant - which would further slash oil use for electricity generation - could again be delayed.  As noted in our last report, national and local authorities were cautiously considering allowing the company to resume operations at the plant, which had been shut in mid-2007 following a major earthquake, as early as late 2009.  In early March, however, a fire erupted in an underground cooling pump cabin.  Although quickly contained, it was the eighth blaze since the shut-in, prompting Japan's Nuclear and Industrial Safety Agency (NISA) to order a review of safety procedures - a pre-condition to obtain initial approval from both the Niigata Prefecture and the village of Kariwa (the city of Kashiwazaki has already lifted its operation-suspension order).  At the time of writing, the three local governments, supported by a group of experts, were due to decide whether the restart of the Unit 7 1.4 GW reactor could proceed or not.

Non-OECD

China

According to preliminary data, China's apparent demand (refinery output plus net oil product imports, adjusted for fuel oil, direct crude burning and stock changes) fell in January (-5.7% year-on-year), for the third consecutive month since June 2005.  This would seem to confirm that the country is in the midst of a marked economic slowdown.  However, two important observations must be made.  First, this estimate is based on our own assumption of refinery runs for the month (6.3 mb/d), since at the time of writing no official data on refinery activity had been released due to the Lunar New Year holiday (trade data, by contrast, had been published).  Second, last year's holiday occurred in February; as such, year-on-year growth rates in both January and February 2009 will be distorted.  Meanwhile, December's oil demand estimate was minimally revised to 7.5 mb/d (-10 kb/d versus our previous report).



Nevertheless, we have slightly revised down our oil demand forecast for 2009.  The March issue of China Oil, Gas & Petrochemicals published updated figures on gasoline and gasoil stocks held by PetroChina and Sinopec up to January 2009, which reached a three-year high of 89 mb (based on data series back to January 2006).  The increase of gasoil stocks is particularly noteworthy, suggesting that demand is feebler than previously thought.  Moreover, revised December data indicate that gasoil demand was indeed weaker, together with naphtha, but that demand for 'other products' was much stronger.  Overall, Chinese oil demand is now expected to grow by 0.6% to 7.9 mb/d (10 kb/d less than previously anticipated).  However, this forecast is prone to change once refinery data for January and February are released and, more importantly, when the IMF publishes its latest GDP assumption for China in late April.



Other Non-OECD

Preliminary data show that India's oil product sales - a proxy of demand - rose by 2.2% year-on-year in January, led by gasoline (+11.5%), naphtha (+8.6%), residual fuel oil (+3.8%) and gasoil (+2.1%), which together account for two-thirds of total demand.  This contrasts favourably with the country's neighbours, and indicates that - so far - the economy is holding its ground, despite having also slowed down (car sales, for example, rose by 10% month-on-month in January).

India's retail pricing policies continue to be influenced by political imperatives.  In early February, the government had finally decided to deregulate the price of gasoline, gasoil, LPG and kerosene, given the slump in international oil prices.  A month later, however, it actually chose to defer the move, ahead of India's forthcoming general election next May.  Under current international prices, the liberalisation of domestic oil product prices would arguably result in another retail price fall (prices have already been twice cut by decree by about 20% since December) - but if international prices were to rise ahead of the polls, so would domestic prices.  However, if the current Congress Party-led government coalition is re-elected, the liberalisation may well occur.  That would be a paradox - the same coalition re-imposed price controls when it gained power for the first time in 2004.



Given the worsening economic outlook for Russia, coupled with dismal oil demand readings for January, we have sharply revised down our oil demand prognosis for 2009.  Total oil product demand contracted by 7.2% year-on-year in January, according to preliminary data, with all product categories bar gasoline posting sharp losses.  In particular, LPG, gasoil, naphtha and residual fuel oil - barometers of industrial production and power demand - shrank by 21.2%, 7.3%, 5.1% and 4.0% year-on-year, respectively.  Meanwhile, a product associated with both consumer confidence and air freight - jet fuel/kerosene - fell by 10.4%.



The only bright spot concerns gasoline demand, which rose by 3.6% - but only partially offsetting December's 6.2% fall.  As such, oil demand is now expected to contract by 3.3% in 2009 to 2.8 mb/d (130 kb/d lower compared with our last report).  We still see demand for gasoline and residual fuel oil growing - the former is the main transportation fuel, while the latter should gain as domestic natural gas is diverted to meet Russian export commitments - but we expect demand for all other product categories to contract.

Iran is again abuzz with rumours regarding yet another scheme to tame gasoline demand, having seen it surge by 5.0% year-on-year in 2008, after a brief dip in 2007 following the introduction of a gasoline-rationing scheme.  That scheme, however, failed to achieve its three main objectives: to curb gasoline consumption (including waste and the smuggling out of Iran), reduce the government's subsidy burden (since the administered retail price is very low) and lessen the country's vulnerability to imports in the context of geopolitical tensions.  Indeed, even though the pace of gasoline demand growth is about half that recorded in the early 2000s, it remains high (and could conceivably accelerate); meanwhile, demand has surpassed by far pre-rationing levels.

The gasoline import bill, expected to reach some $6 billion this year - amid falling crude export revenues - has brought the vexing issue of runaway gasoline demand back to the fore.  The government is reportedly mulling three options to reduce the subsidy cost, one of which could be adopted imminently, ahead of the new fiscal year starting on 20 March:

  • Doubling the subsidised price (currently $0.10/litre);
  • Generalising the above-quota price (currently $0.40/litre) to the whole market;
  • Allowing the domestic price to fluctuate by setting it at 90% of the FOB import price.

The first option would be a rough mid-point between the current subsidised price and the above-quota price.  The second would in effect come closer to liberalising the gasoline market, since the above-quota price was closely reflective of the rate prevailing in the black market when the rationing scheme was introduced.  The third option would entail an (almost) fully blown liberalisation and most likely a sharp price increase.  The government, torn between the political need to curb Iran's already high inflation rate and the urgency to improve its fiscal position if its ambitious spending plans are to be realised ahead of the forthcoming presidential elections, faces indeed a difficult choice.

Supply

Summary

  • Global oil supply fell 1 mb/d in February to 83.9 mb/d as OPEC members curbed output further in their aim to compensate for lower demand.  Global production was down 3.4 mb/d year-on-year.
  • Total non-OPEC supply for 2009 is revised down by a sharp 360 kb/d, largely on a reassessment of Azeri output, which is now expected to stay flat due to ongoing problems at the offshore ACG complex.  This eliminates previously-forecast 2009 growth.  In contrast, 2008 non-OPEC supply is kept steady at 50.6 mb/d, despite a 4Q08 upward revision of 130 kb/d on higher UK North Sea production.  October data for the US show that the impact of Hurricanes Gustav and Ike on federal offshore output was probably greater than originally thought, though this is largely offset by upward revisions elsewhere.
  • OPEC crude supply in February fell to an estimated 28.0 mb/d, down 1.1 mb/d from January levels.  A concerted effort by some members to rein in production in line with lower output targets and, to a lesser extent, operational disruptions in other countries, led to OPEC's near 80% compliance rate in February.  The latest decline in production has predictably translated into an increase in OPEC's effective spare production capacity to 5.2 mb/d.


  • The call on OPEC crude and stock change stands at 28.9 mb/d for 2009, around 1.5 mb/d below 2008, after counteracting supply and demand changes.  However, current OPEC targets, if observed, would take theoretical OPEC output over 1.5 mb/d below that level, implying a tightening market even without further cuts in the target at the 15 March meeting.

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

OPEC Crude

OPEC crude supply in February fell to an estimated 28.0 mb/d, down 1.1 mb/d from January levels.  A concerted effort by some members to rein in production in line with lower output targets and, to a lesser extent, operational disruptions in other countries, led to near 80% compliance rate in February with the cumulative 4.2 mb/d target cuts agreed since last September.  Although OPEC never detailed individual country allocations, statements by officials have confirmed the new targets were based on the September production levels as published in the OPEC Monthly Oil Market Report.  February's strong performance compares with a compliance rate of 60% in January, its historical average.



OPEC's 11 members with output targets, which excludes Iraq, produced 25.73 mb/d in February, down 944 kb/d month on month but still about 890 kb/d over the group's 1 January 2009 target of 24.85 mb/d.

While the global economic malaise has served to concentrate the minds of some member countries on strong quota discipline in a bid to shore up oil prices, compliance by a few members has been uneven at best. At one end of the spectrum, Saudi Arabia has delivered almost half the group's collective 3.3 mb/d production cuts since September and this past month may have produced below its nominal target.  By contrast, Iran, Venezuela and Angola have collectively only reduced output by around 600 kb/d, or half the pledged 1.17 mb/d.  Combined, they account for 63% of current overproduction versus target.

Disparity in compliance will vie with discussion of further cuts in target levels when ministers meet on 15 March in Vienna to assess the market impact of their latest target implemented from 1 January.  Saudi Arabia is reportedly said to want the conference to focus on stricter compliance rather than debate new official reductions in production levels.  OPEC has announced cuts in production targets three times since its September 2008 meeting, for a total reduction of 4.2 mb/d.

By contrast, Venezuela has been publicly calling for further production cuts at the mid-March meeting, arguing that global oil stocks were still too high. Venezuelan output was down in February by 80 kb/d, to 2.1 mb/d. The lower levels partly reflect reduced rig operations due to a dispute over contract terms with oil service companies as well as cutbacks at the Orinoco fields.



Unusually, Iran has been silent about the need for further cuts, perhaps mindful of its own compliance level with current output targets.  Indeed, Iranian Oil Minister, Gholamhossein Nozari, appears prepared to shift emphasis at the forthcoming meeting by proposing that, rather than discuss production targets, the group should focus on "a mechanism to repair prices."

While the worsening economic crisis will clearly weigh heavy on ministers in Vienna, preliminary indications show improved adherence by some members. Voluntary cuts by others for March and April should put the group within striking distance of its current target level in the short term.  It is always difficult to predict OPEC's actions ahead of the formal meeting, and this time not least because the full impact of the current target levels may not become apparent until April at earliest.

The latest decline in production has predictably translated into an increase in OPEC's effective spare production capacity to 5.2 mb/d.  While the de facto rise in spare capacity may be causing concerns in the near term given the backdrop of weaker demand,  even more worrisome is the prospect of financial constraints leading to delays or cancellations of new projects or expansion plans of existing fields is setting the stage for an equally sharp future contraction in surplus capacity.

Iraqi production (measured as exports plus domestic use) was down in February by 110 kb/d, to 2.26 mb/d, with supplies lower from both the northern and southern regions of the country. Total exports last month were assessed at 1.82 mb/d compared with 1.9 mb/d in January.  Iraqi exports by the northern Ceyhan terminal were disrupted for about a week, reportedly due to a payment dispute between Baghdad and Turkish officials, while weather-related delays interfered with southern shipments. Domestic crude used at refineries and for power use declined by about 20 kb/d in February, with intermittent power outages affecting pipeline flows to the country's largest refinery, Baiji, sharply reducing operations there at times during the month.

Saudi Arabia's willingness to shoulder additional cuts in production may be tempered by a lack of compliance by other key members. The Kingdom reduced production in February by a further 150 kb/d, to 7.95 mb/d, which is 100 kb/d below its current target. However, rumours circulating in the market in early-February that Saudi Aramco planned to reduce output by an additional 300 kb/d failed to materialise, but not before leading many to speculate that a formal cut in quotas would be announced at the March gathering.  There may also be a resistance to implement a further cut in production because of the corresponding reduction in associated gas output, which is needed for domestic use at power plants and for use in petrochemical manufacturing.

Indeed, it appears that state-owned Saudi Aramco plans to maintain current levels of production based on reports that customer nominations for all regions would remain largely unchanged for April. Asian customers, which buy about half of all Saudi crude exports, had expected another cut in supplies for the month. In the US, though Aramco kept nominations unchanged, according to customers an increase in price formulas may temper purchases.

February production by Iran, OPEC's second largest producer, declined by 140 kb/d to 3.65 mb/d, but output was still 310 kb/d above the country's 3.34 mb/d target. The lower output level partly reflected a disruption in production at the offshore Abuzar field due to a gas leak. Production at Abuzar fell by 40 kb/d, to around 100 kb/d.

Crude oil production in Kuwait was assessed at 2.3 mb/d for February, down 160 kb/d from the previous month. Kuwaiti compliance is now at 79% and output may even go below the target level next month as previously unplanned oil field maintenance work is implemented.  Kuwait said it was scheduling field maintenance work, affecting about 100 kb/d this month, given current market conditions.

The UAE reduced production by 110 kb/d from January levels in February, to 2.25 mb/d.  Target adherence is now pegged at 93% and expectations are that the Emirates will near full compliance in March due to field maintenance work and cutbacks in customer nominations. Maintenance work at gas plants at offshore fields in February is expected to continue this month.  April term contract allocations for Asian buyers of Murban, Lower Zakum and Umm Shaif crudes were cut by a deeper 15% compared with a 10% decline in March while heavy sour grade Upper Zakum was cut by 17% versus 15% in March.

Crude oil production in Nigeria declined by 60 kb/d, to 1.78 mb/d, as a result of heightened security concerns in the volatile Niger Delta region. Royal Dutch Shell was forced to shut-in 90 kb/d of Bonny Light crude for several weeks in February. Production was slowly restored in early March, with volumes reaching 200 kb/d by 5 March 2009.  However, a fresh wave of militant attacks on the Escravos pipeline at end-February, which also moves Forcados crude to the export terminal, forced the shut-in of an estimated 70 kb/d.  Shell declared force majeure for March and April exports. The latest attack follows the end of a cease-fire announced last month by Nigeria's main militant group, the Movement for the Emancipation of the Niger Delta.

Partially offsetting chronic supply disruptions at Nigeria's onshore and shallow water production fields, the Total-operated Akpo deepwater offshore oilfield began production in early March ahead of schedule. The field produces predominately condensate, which is outside of OPEC target guidelines, and is expected to ramp up to around 175 kb/d by 4Q09 and reach peak production of 225 kb/d in 2010.

Angola's crude oil output edged lower in February, to 1.65 mb/d from 1.76 mb/d, despite the return of Greater Plutonia output after a three-week shutdown in January due to operation problems.  Angola's production is still 130 kb/d above the country's widely reported target of 1.52 mb/d, though it appears Angola officials are disputing the validity of the oft-quoted output target. Angolan officials have said that it is their understanding the first round of quota cutbacks in September did not apply to them since they were already producing below quota. In this light, they see only the last two reductions as applicable, so the country's output target should be a higher 1.65 mb/d.

Non-OPEC Overview

Non-OPEC supply for 2009 is revised down by a sharp 360 kb/d to 50.6 mb/d, eliminating all previously expected growth.  This is largely due to a reassessment of Azeri crude output, which is now deemed to remain flat at 2008 levels in 2009, as volumes shut-in due to gas leaks in September last year look likely to take far longer to return than previously anticipated.  Crucially, this assumed 'normalisation' in Azeri supply, on the back of already-rising production, had formed the backbone of our forecast 2009 growth.

Indeed, were it not for global biofuels growth and a slight pick-up in processing gains, total non-OPEC supply would decline by 360 kb/d year-on-year.  However, this does not, in itself, imply a permanent plateauing of crude output, as we now assume that the key Azeri fields will resume growth towards the end of 2009 and during 2010.  But given the current environment of both falling oil demand and constrained credit, more instances of project slippage are likely as investment is curbed.



In contrast, 4Q08 non-OPEC supply is revised up by 130 kb/d on higher output in OECD countries, which is only partly offset by lower non-OECD production.  Within the former, oil supply in the UK North Sea, the US and Canada is revised higher, raising our total non-OPEC supply in 2008 slightly to 50.6 mb/d.  Regarding the non-OECD, 4Q08 output is revised down in Egypt, Argentina, Syria and, to a lesser extent, in Turkmenistan, Kazakhstan and Vietnam.



OECD

North America

US - Alaska February actual, others estimated:  February oil supply in the US was revised up by 100 kb/d to 7.9 mb/d on higher Alaskan and Gulf of Mexico output.  This also implies a rise versus January of 250 kb/d, approximately evenly split between crude and NGLs.  In mid-February, the Minerals Management Service (MMS) published a 'Final Update' on the aftermath of Hurricane Ike, indicating around 120 kb/d still shut-in but implying that volumes would have recovered fully by end-March.  We have cautiously factored in shut-in volumes of 100 kb/d in March and a remaining 50 kb/d in April.  Meanwhile, on a month-by-month basis, weekly aggregated EIA data suggest ongoing steady recovery.

October actual data show a sharp upward revision for Louisiana onshore and North Dakota, the former presumably having been hit less than anticipated by Hurricane Ike.  On the other hand, October data for the US Gulf of Mexico federal offshore were revised down by 200 kb/d, indicating that MMS assessments here had underestimated volumes shut-in by hurricanes (see US Gulf Oil Production Hit Harder Than Thought by Hurricanes Gustav and Ike).

In Alaska, a small leak at the Prudhoe Bay complex was reported by BP in mid-February, though this is reported to only be 1-2 kb/d.  Meanwhile, Eni reported a delay to the start-up of its Nikaitchuk field (peak production capacity of 60 kb/d) of around 6-12 months, pushing it from late-2009 into the latter half of 2010, apparently due to the lower oil price environment.

US Gulf Oil Production Hit Harder Than Thought by Hurricanes Gustav and Ike

A full set of actual October production data for the US appears to indicate that outages to US Gulf of Mexico offshore production last year were higher than preliminary Minerals Management Service (MMS) data suggested.  The MMS, in daily and later bi-weekly and monthly updates, listed estimated total shut-in volume for the region, which this report factored into its breakdown of US production.  We habitually revise outage levels retrospectively as final state-specific production data become available.

Specifically, October production data for the Gulf of Mexico, as reported by the EIA, came in 200 kb/d lower than we had previously assumed.  In part, this is masked by collective upward revisions of the same magnitude elsewhere, notably in Louisiana onshore (+44 kb/d), North Dakota (+16 kb/d) and the removal of our own field reliability factor (+103 kb/d).  The latter is based upon historical average technical field outages and taken out once actual data are available.

While October's lower GoM output may derive either from higher physical shut-ins or underperformance at fields still producing, either way a downward adjustment to total GoM supply is warranted.  On the basis of our assumptions listed above, our recalculated five-year average hurricane outage assumption has been nudged up to an average -250 kb/d for 2H09 and following years, peaking in September at almost -600 kb/d.

Meanwhile, the latest ethanol production data for December 2008 showed the first month-on-month dip since June last year - albeit only by 10 kb/d - to 650 kb/d.  Previously, ethanol output had shown a consistent and steady rise, increasing by 100 kb/d in 2007 year-on-year and by a further 180 kb/d last year.  It remains to be seen to what extent ethanol (and other liquid biofuels) production is hit by the double challenge of lower oil prices and the wider financial crisis, with several producers in the US indicating plant closures and even some bankruptcies.  On the other hand, the Energy Independence and Security Act (EISA) of December 2007 mandates specific volumes to be blended into the US gasoline pool, underpinned by subsidies, a policy which appears (so far) unlikely to be changed by the new Obama administration.  Lower natural gas prices also provide some offsetting economic benefit for ethanol output.  We will revisit biofuels output prospects in the forthcoming Medium-Term Oil Market Report (MTOMR), due to be published mid-2009.

Canada - Newfoundland January actual, others December actual:  Canadian oil production was nudged down 30 kb/d in January on lower conventional crude output.  December total supply was left unchanged, as upward revisions to Saskatchewan production (+40 kb/d) and bitumen (+15 kb/d) were offset by both lower Albertan crude (-35 kb/d) and reduced syncrude output (-20 kb/d).  The latter appears to be due to lower production at the Suncor project, which suffered a fire in late November and possibly curbed December volumes.



Mexico - January actual:  January data for Mexico came in slightly lower than forecast and continued its downward trend.  At 3.06 mb/d, output is at its lowest since November 1995.  Notably, combined Ku-Maloob-Zaap (KMZ) production for the first time ever overtook output from the giant Cantarell field, long the mainstay of Mexican oil production.  Concerning the latter, Pemex officials noted in February that the Cantarell complex would end the year producing around 700 kb/d, down from January's 770 kb/d, implying a drop of nearly 14% year-on-year, despite efforts to maintain output levels.  This report currently assumes an even greater decline to around 600 kb/d in 2009 on average.

North Sea

UK - November actual:  UK actual data for November came in 130 kb/d higher than anticipated.  October historical data were also revised up by 260 kb/d, not least because of a previous inadvertent retention of our assumed field reliability factor, which is normally removed once actual output data are available.  In sum, 4Q08 was nudged up by 170 kb/d, or +45 kb/d in 2008 as a whole.  December should also see the delayed start-up of Fiddich, part of the Eastern Trough Area Project (ETAP) stream and of Grouse, a tie-back to the Kittiwake field, both at sub-5 kb/d volumes.  On the basis of weaker-than-anticipated performance in 2008, we have also decided to trim Buzzard production for 2009 by -5 kb/d.  Total 2009 production is revised up by 25 kb/d to 1.34 mb/d, nonetheless a decline of 225 kb/d year-on-year.

Pacific

Australia, New Zealand - December actual:  While overall December data for Australia came in slightly lower than forecast, it appears that we overestimated the impact of that month's Cyclone Billy on Carnarvon Basin crude streams.  This was however offset by lower NGL and crude output elsewhere, bringing down total 4Q08 production by around 10 kb/d from previous forecasts.  February saw further storms hit Australia's Northwest, leading us to trim output by around 20 kb/d in aggregate.  In New Zealand, operator OMV started up its Maari oilfield offshore North Island in late February, with first volumes expected to be exported from April.  In total, we expect OECD Pacific oil supply to grow by 70 kb/d in 2009, to 720 kb/d.

Former Soviet Union (FSU)

Russia - January actual, February provisional:  Russian oil production for January was revised up by 100 kb/d on the receipt of final monthly data.  Apparently, preliminary January data had failed to include production-sharing agreements, which include the two large Sakhalin projects, both of which were seen producing higher volumes than December.  Prospects for the Sakhalin 1 venture have been cast in doubt, however, after operator ExxonMobil suspended work on the satellite Odoptu and Arkutun-Dagi fields due to a budget overrun argument with the Russian administration.  This implies that projected start-ups in 2012 and 2013 respectively could be delayed.  However, work on the associated Chaivo field apparently continues.  Preliminary February Russian data meanwhile were also raised by 70 kb/d, as higher-than-anticipated output by Lukoil and, to a lesser degree, Tatneft, more than offset lower Rosneft production.  Lukoil is apparently further ramping up output at its new South Khylchuyskoye field.  In 2009, Russian crude production is forecast to average 9.3 mb/d, a drop of 230 kb/d year-on-year.

Azerbaijan - January actual:  Azeri reported production for January came in sharply lower than expected (-230 kb/d), indicating that recovery at the offshore Azeri-Chirag-Guneshli (ACG) complex in the Caspian Sea is not proceeding as expected.  Gas leaks and power problems had affected the production complex since last September and the most-affected Central Azeri platform reportedly restarted production in late December.  But these lower January actual figures, coupled with pessimistic semi-official government statements in mid-February indicating no growth in 2009, have led us to postpone recovery at ACG until late in the year, prompting a total downward revision for 2009 of -330 kb/d.  In contrast to our previously-assumed normalisation of ACG production, this delay now effectively cuts any growth in non-OPEC supply in 2009.



Other FSU:  Lower-than-forecast January data for Kazakhstan have led us to nudge down both historical and forward data.  In late February, the CPC pipeline was briefly shut in, but reportedly this did not affect exports, as volumes were sold out of storage, but we have cautiously assumed marginally lower February output.  Reports also indicate some maintenance on the Tengiz field in March and April, which led us to curb output slightly.  In sum, these changes leave 2008 virtually unchanged, but shave nearly 20 kb/d off 2009 output.  Similarly, new data for Turkmenistan for October and November bring downward revisions of around -10 kb/d for 4Q08 and throughout 2009.  Ukrainian production in 2009 is also nudged down marginally.  Overall, we now foresee total FSU production falling by 230 kb/d in 2009, to 12.5 mb/d.

FSU net exports hit 9.20 mb/d in January, up by 3.3% from December 2008.  Both crude and product exports continued to increase despite higher shipping fees, as Russian oil export taxes were cut further and the rouble weakened against the dollar.  The Russian crude oil export duty was cut from $192/t ($26.2/bbl) in December to $119/t ($16.2/bbl) in January.  Export taxes on light and heavy products were set at $92.6/t and $49.9/t, respectively, almost 35% lower than in December 2008.

FSU crude oil exports rose to 6.42 mb/d, supported by higher Black Sea, Arctic and Far East shipments.  Despite stormy January weather, Black Sea deliveries rose by 11% on higher loadings in Novorossiysk and Pivdenne, which offset a 10% drop in Baltic deliveries due to maintenance at the pipeline leading to Primorsk, and a 7% fall in BTC shipments.  Exports through the Druzhba pipeline were 1.20 mb/d as deliveries to Germany rose by 20% after Lukoil reassigned its export allocation to TNK-BP and despite low volumes to Poland due to a dispute.



Weaker Russian demand and stronger European consumption due to the gas row between Ukraine and Russia boosted product exports in January.  FSU product exports rose by 3.2% from December, supported by a 14% increase in gasoil exports, as well as a rise in exports of gasoline and naphtha.  Despite higher Russian fuel oil exports to the Mediterranean and the Black Sea, total FSU fuel oil exports dropped by 11%. The main driver was a decrease in shipments from Belarus and Ukraine as both governments banned fuel oil exports in order to keep their domestic market well supplied in the view of gas disruptions.

According to preliminary data and loading schedules, crude oil exports in February and March should remain around January levels.  Russian crude export duties decreased further to $100.9/t ($13.8/bbl) in February but rose to $115.3/t ($15.7/bbl) in March following a stabilisation of oil prices on world markets.  Baltic shipments are expected to regain seasonal levels after pipeline maintenance.  Meanwhile the BTC should reportedly pump higher volumes.  The offsetting decrease is expected from even lower February deliveries to Poland via the Druzhba pipeline and lower Black Sea loadings affected by CPC and Novorossiysk pipeline closures.  The CPC pipeline was shut down at the end of February for two days following an oil leak.  Russia was forced to suspend loadings at Novorossiysk due to a leak and a fire on a pipeline leading to the port at the beginning of March.  Crude flows resumed five days later after the repairs on the damaged pipeline were completed.

For the longer term, the Russian government is seeking to diversify its oil exports.  Besides a $25bn loan agreement with China (see China Investing in Supply Through the Down-Cycle), Russia resumed talks with Croatia about the reversal of the Druzhba - Adria pipeline, which would enable the export of Russian crude oil from Omisalj on the Adriatic.  Currently a pipeline pumps the crude from Omisalj to several refineries in Croatia, Serbia and Hungary, however, the reversal of this section and a connection to the Druzhba would allow direct pipeline access of Russian crude to the Mediterranean, bypassing the congested Bosporus.

China Investing in Supply Through the Down-Cycle

Reports abound of both private sector companies and NOCs curbing spending in the face of lower oil prices, crumbling demand and the credit crunch.  However, Chinese companies and government agencies are bucking this trend to secure supplies for when demand begins to recover.  A number of deals announced in recent months by Chinese entities show a determination to ensure supplies for the future, to take advantage of lower prices and easier access terms, and potentially also to diversify sizeable government foreign exchange reserves, estimated at around $2 trillion. This is despite many outside forecasters seeing Chinese GDP growth slowing to sub-7% levels in 2009, the lowest in nearly 20 years, and oil demand growth potentially stagnating.

Plans to increase strategic crude oil storage levels are well documented, even if fill rates have been shrouded in secrecy.  The past month saw suggestions that strategic oil purchases would be stepped up using government foreign exchange reserves as a way of diversifying risk away from US treasury bonds while also taking advantage of low prices.  This is part of a target of attaining at least 88 mb in strategic reserves by 2010 at four existing sites - Zhenhai, Aoshan, Qingdao and Dalian.  Subsequent unverifiable press reports cited China Shipping Company suggesting that these sites were already full and that further capacity could be built by buying oil tankers for offshore floating storage. Phase two of China's onshore strategic storage plan aims to have a total of 280 mb of capacity in place by  2011.

Chinese companies' direct equity participation in foreign upstream activity is also well known, with China holding stakes in overseas projects producing over 2 mboe/d, albeit the majority of this oil is sold on the international market. A parallel approach of loans-for-oil was also illustrated with the signing of deals in February whereby China Development Bank (CDB) will make loans to Russian and Brazilian companies in return for access to future crude oil deliveries.  In the Russian case, state-sponsored producer Rosneft and pipeline company Transneft signed a deal with CNPC for crude supplies of 300 kb/d to begin from January 2011. A combined $25 billion loan will be used partly by Transneft to build a 300 kb/d spur to China from the East Siberia Pacific Ocean (ESPO) pipeline, with the spur due to be completed by 2010.  Rosneft will reportedly use its share of the loan to help develop reserves in its East Siberian Vankor field which would feed into ESPO.

Meanwhile, Brazil's state producer Petrobras will supply China with 100-160 kb/d of crude in return for $10 billion of loans from CDB which will be targeted at developing Santos Basin subsalt oil reserves.  Sinopec will get 60-100 kb/d and PetroChina 40-60 kb/d, although delivery dates were not specified.

On a more tentative basis, Chinese diplomatic activity in February involved Venezuela, where there are plans to boost 2008's 130 kb/d of exports to China to potentially 1 mb/d by end-2012, and Saudi Arabia, although the latter involves Chinese company participation in infrastructure development rather than upstream oil or gas deals per se.  While moves that could secure extra oil from the MEG region (which provides 50% of China's imports currently) make sense for both parties, there may be some doubts about Venezuela's ability to increase deliveries to this degree on an economic basis, given current problems sustaining upstream investment in that country.

Meanwhile Africa remains a key oil sector focus for China.  Angola was China's second largest 2008 crude supplier after Saudi Arabia at nearly 600 kb/d of imports.  There have been reports that Chinese companies are examining further acquisitions of independent producing companies with significant upstream growth potential in Africa, including Tullow Oil, which holds resource-rich acreage in Uganda and Ghana.

Other Non-OPEC

Other Asia:  Higher February actual production from Indonesia prompted us to nudge up our 2009 crude output total by 20 kb/d to 840 kb/d.  Malaysian January data were lower than expected, which is carried forward, causing a downward revision to total 2009 output of -15 kb/d to 750 kb/d.  In the Philippines, we have once again slipped the restart of the Galoc field to end-February, resulting in a small downward revision.  Other minor adjustments were made to Vietnam, Thailand and Myanmar, but are broadly offset by higher assumed Indonesian crude production.  As such, our forecast overall remains steady, projecting non-China Asian output to rise 40 kb/d in 2009, to 3.7 mb/d.



Latin America:  December production data for Argentina were revised down by 55 kb/d, which is partly carried forward, resulting in slightly lower 2009 output of 730 kb/d.  For Brazil, official December data were unavailable at the time of writing, but preliminary data from Petrobras prompted a hike to crude production for January and beyond, on the assumption that the P-51 and P-53 platforms on the new Marlim Sul and Marlim Leste fields respectively were ramping up output faster than expected.  Brazilian crude output in 2009 now averages 2.06 mb/d, one of the few major sources of incremental non-OPEC supply now expected for 2009.

Middle East/Africa:  A reappraisal of Omani production caused an upward revision of around 20 kb/d to Petroleum Development Oman (PDO) condensate in 2H08 and for 2009.  This was offset by a downward revision to Syrian output of around -15 kb/d upon receipt of full-year 2008 data.  Newly reported yearly data for Egyptian oil production 2006-2008 caused a downward revision to production of -20 kb/d.

OECD stocks

Summary

  • OECD industry stocks rose by 9.0 mb in January, to 2,712 mb, as Europe and Pacific product draws only partially offset rises in North America crude.  North America crude stocks jumped 19.9 mb as storage filled to take advantage of the wide contango in the WTI futures curve.  Europe and Pacific distillate and other product draws brought total stocks lower in those regions.
  • OECD stocks in days of forward demand reached 58.7 days at end-January spurred by an upward revision to December baseline stocks plus increasing January inventories. While North America and European demand cover remain above five-year highs, Pacific readings are within the five-year range.
  • Preliminary February data indicate OECD industry oil inventories fell by 2.0 mb, led by declines in US gasoline stocks.  US inventories fell 5.5 mb as crude rose 4.5 mb and products declined 10.0 mb.  Japanese stocks rose 4.9 mb, with both crude and products posting small gains.  According to Euroilstock, EU-16 inventories fell 1.4 mb, led by crude, which declined 1.2 mb.
  • February short-term crude floating storage levels stabilised in the 50-55 mb range as new charters balanced out cargoes discharged into the spot market.  As of early March, floating storage remained close to that range.  However, recent narrowing of the WTI and Brent crude futures curves has made the practice less economically attractive and reports indicate the selling of more cargoes.


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

Total OECD inventories rose counter-seasonally by 9.0 mb in January, closing the month at 2,712 mb.  While Europe and the Pacific saw stock draws in line with seasonal norms, North American inventory levels jumped 24.5 mb on the back of larger than normal rises in crude and gasoline and a counter-seasonal build in distillates.





An upward revision to December total OECD inventories of 30.2 mb boosted baseline stock levels.  Official data for crude and distillates, particularly in Europe where both categories rose about 15 mb, drove the gains.  In crude, the Netherlands and Sweden provided the biggest European increases and on the distillate side inventories in the Netherlands, Germany and Denmark showed upward moves.  Distillate stocks in both North America and the Pacific saw upward revisions near 3 mb each, but downward revisions to crude oil in both regions partially offset the gains.  Due to the changes, the 4Q08 OECD total stock build was revised to 500 kb/d from 170 kb/d in last month's report.  Europe and North America inventories built by 460 kb/d and 280 kb/d, respectively.  The Pacific region still maintains a stock draw of 240 kb/d.



These revisions, combined with rising January inventory levels, increased OECD total oil forward demand cover to 58.7 days at the end of January.  A revised December forward demand figure stood at 57.9 days.  January days of demand cover increased to 6.3 days above the five-year average with readings in North America and Europe well above the five-year range.  Of all major categories, only Pacific gasoline and distillate stocks remain at or below their five-year averages.

OECD Industry Stock Changes in January 2009

OECD North America

North American industry stocks jumped 24.5 mb in January, led by US crude stocks, which rose by 23.0 mb.  Low refinery utilisation and a deepening contango in the WTI futures curve prompted steep US crude stock builds, particularly in areas linked to Cushing, Oklahoma, the delivery point for the Nymex Light, Sweet Crude contract.  Crude stocks in Mexico, by contrast, fell by 3.1 mb on the month on lower crude production and higher refinery runs.  Sizeable gasoline and distillate inventory builds of 8.5 mb and 7.3 mb in the US and smaller builds in Mexico reflected a weakening demand picture.

February weekly US data point to tempered crude stock builds and tighter gasoline inventories.  Crude stocks levelled off in mid-February and ended the month 4.5 mb higher than end-January levels.  Inventory levels at Cushing, Oklahoma reached an all time high of 34.9 mb in early February, but generally declined through the rest of the month.  As of early March, they stood at 33.6 mb.



The slowing of dramatic US crude builds which had taken place since early-January reflects changes in storage economics and tightening crude balances in the US Midcontinent and Gulf Coast.  A narrowing of time-spreads in the WTI futures curve reduced financial incentives to store oil, together with a month-on-month contraction of imports into the US Gulf Coast of around 550 kb/d - partly reflecting tighter OPEC supplies - and an end-month surge in PADD 3 refinery throughputs.  These factors, along with an increase in the US Strategic Petroleum Reserve fill rate from 70 kb/d in February to 215 kb/d this month, should continue to pressure commercial crude stock levels in March.  Still, with a sizeable amount of floating storage sitting in the US Gulf, the onshore draw down could prove uneven.



According to weekly data, US product stocks fell by 10.0 mb in February, led by gasoline, which tightened by almost 5 mb at a time of year when stocks normally still build.  By contrast, distillate stocks, which usually draw in February, rose by 0.7 mb.  The divergence in movement between diesel (+3.0 mb) and heating oil stocks (-2.2 mb) reflected the tug of war between slower economic growth and seasonal cold weather patters, with the former trumping the latter in terms of influencing distillate balances.

OECD Europe

European inventories declined by 7.5 mb in January in a broad-based move that saw all major categories fall except for gasoline.  Despite the contango in the ICE Brent futures curve as well as a growing amount of floating storage in the North Sea (implying decreased onshore storage availability), European crude stocks fell slightly on the month, possibly reflecting the impact of reduced imports from the Middle East.  This constituted a downward revision from Euroilstock data reported last month showing a 4.2 mb January crude build.  As in the US Gulf, significant, though diminishing, stocks of crude in floating storage remain in the North Sea, with some reports placing it currently at just below 10 mb.

European distillate stocks showed the largest movement within products categories, falling by 4.8 mb on the month.  January weather, far colder than the 10-year average, likely contributed to the fall.  German middle distillate draws of 2.3 mb, in particular, drove the change.  Falling German consumer heating oil stocks reinforced this movement; fill levels declined from 63% at end-December to 60% at end-January.



Preliminary data from Euroilstock indicate EU-16 inventories fell 1.4 mb in February.  Crude stocks decreased by 1.2 mb on higher refinery utilisation.  Product stocks fell slightly by 0.2 mb led by declines in naphtha and fuel oil.  Yet middle distillate stocks posted a 1.6 mb rise.  Northwest European product stocks held in independent storage generally declined in February after posting three consecutive months of gains.  Gasoil and jet/kerosene stocks began retracing from their lofty heights above the five-year range, though early March readings indicate a spike back upwards in both categories.  Gasoline and fuel oil stocks continued their declines while naphtha stocks reached five-year lows.

OECD Pacific

Pacific industry stocks fell 8.0 mb in January, led by crude and distillate declines in Japan.  Japanese crude stocks fell 6.0 mb and distillates declined 5.8 mb as kerosene stocks continued to draw.  By contrast, crude and distillate stocks in South Korea rose on the month by 6.1 mb and 4.6 mb, respectively.  A January surge in crude imports, up 24% month-on-month, ahead of a 1% rise in February import tariffs, may have partially driven the stock change.  They may do so again in February ahead of another 1% tariff rise in March.  OECD Pacific crude stocks continue to trend below the five-year average, but on a forward cover basis they remain at five-year highs.  Middle distillate days of forward cover remain in line with the five-year average despite being near the bottom of the five-year range on an absolute basis.



Weekly data for February from the Petroleum Association of Japan (PAJ) indicate higher onshore crude stocks and a small counter-seasonal build in kerosene stocks.  A jump in February refinery utilisation and weaker demand helped product stocks to build by 2.6 mb in February, a time of year when they normally draw.  All product categories increased except for gasoil/diesel, which fell by 1.1 mb.  Though both gasoline and kerosene stocks remain below their five-year averages, February saw a narrowing as both stock categories returned to within their five-year ranges.



Recent Developments in Singapore Stocks

Singapore stocks drew slightly, by 0.2 mb, from end-January to end-February with March fundamentals pointing to tighter light distillate and residue inventories versus weak middle distillates.  Light distillate stocks rose slightly on the month, but their position remains only in line with the five-year average.  Furthermore, early March naphtha fundamentals tightened from increased petrochemical feedstock demand from South Korea, the reported restart of a Chinese Taipei cracker and a Singapore condensate splitter outage.  Middle distillate stocks retracted slightly, by 1.4 mb on the month.  Yet, regional gasoil demand has shown little sign of strengthening, arbitrage economics to Europe have weakened and inventories remain flush.  Fuel oil stocks rose slightly on the month.  Although demand remains weak, decreased fuel oil volumes from the Middle East point to a likely contraction in March stocks.





China's Inventory Picture - More Colour But Still Hazy

In its early March issue of China Oil, Gas & Petrochemicals (OGP), state news agency Xinhua released China's first ever set of monthly domestic crude inventories covering 2008 and January 2009.  The data showed that China's crude stockpiles built by around 65 mb, or 180 kb/d in 2008.  At end-January 2009, data show inventories at about 270 mb.  At forecast throughput rates, this level constitutes about 42.4 days of forward refinery demand and 78 days of China's net crude imports in 2008.  Adding reported gasoil and gasoline stocks held by Sinopec and CNPC (about 90 mb total), would bring total inventories to 360 mb, equivalent to 90 days of net total oil imports in 2008.

The OGP data provide another measure for benchmarking Chinese crude stock changes, supplementing Joint Oil Data Initiative (JODI) reporting and implied calculations made from OGP data on crude production, refinery runs and net imports.  A comparison of the three sources shows OGP reported levels and implied data consistent in terms of direction and magnitude, with the latter seemingly overstating crude builds and understating draws.  This may stem from unaccounted refinery runs by smaller, independent refineries in the implied calculations.  The JODI data, however, sometimes differ considerably from the other two sources.  Of course, with only one year of OGP data available it is difficult to discern concrete differences.



Yet, the stock levels reported by OGP seem to corroborate reported underlying fundamental trends in 2008.  Significant crude and product stock building took place both in the run-up to the Olympics and in the lower crude price environment in the wake of the global financial crisis.  Gasoil and gasoline stocks held by CNPC and Sinopec built by 150 kb/d from January-August, helping to tighten distillate markets in particular, as Chinese authorities sought to avoid product shortages during the Olympics.  While crude stocks built by 440 kb/d from February-May, dramatically higher import prices for crude during the summer resulted in refineries drawing down stocks rather than purchasing on the spot market.  After prices collapsed, crude stockpiling resumed as refineries ratcheted down their processing and the Chinese government likely found it more cost effective to boost strategic stock building.

Despite the additional colour these Chinese monthly data provide, questions remain over their accuracy and completeness.  First, the line between industry and government-held stocks in China remains blurry; neither the latest data nor previous government pronouncements have adequately distinguished between the two.  In late December, the head of China's National Energy Administration, Zhang Guobao, acknowledged the completion of phase 1 strategic storage construction (four facilities holding 100 mb).  Earlier this week, China Shipping (Group) Co President, Li Shaode, said that those strategic reserves had reached the 100 mb mark, but the government has never officially disclosed fill levels.  It is unknown if OGP's reported levels would include the alleged 100 mb or not.  Moreover, it is unclear if the reported stocks count inventories held by state-owned majors only or include other players.  The lack of data on other products also clouds the picture, suggesting total oil stock levels possibly much higher than those reported.

Prices

Summary

  • Crude oil markets in February edged lower month-on-month but by early March moved to a higher trading range on evidence of increased OPEC production restraint, with the cutback in heavier sour grades having the greatest impact.  OPEC ministers are meeting on 15 March in Vienna to assess the impact of new production targets that went into effect at the start of the year  on global supplies.
  • Benchmark crudes scaled two-month highs in early March, with futures prices for WTI trading above Brent for the first time in more than three months. Futures prices for both WTI and North Sea Brent were last trading in a $41-$45 range.  However, relatively high global oil stocks, especially in the US, continue to exert downward pressure on markets.
  • The worsening global economic outlook continues to wreak havoc on refined product markets. Asian distillate markets have been especially hard hit by the downturn, with even China reverting to being a net exporter in recent months. One exception is the apparent, albeit tenuous, recovery in gasoline demand in the key US market.
  • Refining margins fell across the board in February, as a sharp fall in distillate crack spreads outweighed rising light distillate and most fuel oil differentials.  Margins fell most on the US Gulf Coast, with a further dip in early March dragging cracking margins into negative territory.
  • February crude freight rates continued to languish at five-year historical lows as reduced export flows from OPEC producers and a deterioration in oil trade were only partially offset by continued high short-term floating storage levels.

Overview

Crude oil markets in February edged lower month-on-month but by early March moved to a higher trading range on evidence of increased OPEC production restraint, supply disruptions in Nigeria and the FSU and  an apparent, albeit tenuous, recovery in gasoline demand in the key US market.

Benchmark crudes scaled two-month highs by early March, with futures prices for both WTI and North Sea Brent trading in a $41-45/bbl range. Futures prices for WTI rose $10/bbl off mid-February lows in early March but then eased again under the weight of yet more bad economic news.



WTI traded above Brent in early March  for the first time in more than three months. The WTI-Brent futures price differential averaged about $3/bbl over the past month but slowly narrowed in the second half of February as WTI appreciated, likely due to an unexpected dip in Cushing stocks and a subtle shift in gasoline demand sentiment.  Differentials finally turned about face on 6 March, with WTI trading at a 67 cent/bbl premium over Brent and then widening to $2.94 the following day before easing again.  The WTI-Brent reversal may be fleeting as storage tanks at the Nymex contract delivery point at landlocked Cushing, Oklahoma were filling up again as traders took advantage of the widening WTI futures curve.  Crude oil stocks at Cushing were last estimated at 33.6 mb versus an operating capacity of 36 mb.



Oil markets took a respite from the relentless stream of worsening economic news, as traders shifted their attention to OPEC's 15 March Ministerial meeting in Vienna.  OPEC crude supply for the 11 members with targets in February was down 944 kb/d to an estimated 28.0 mb/d, with the compliance rate a significant 80% but output is still 880 kb/d above January's 24.85 mb/d target.  Indeed, the disparity in compliance will vie with discussion of further cuts in target levels when ministers meet on 15 March in Vienna to assess the market.

While traders took note of OPEC's healthy  compliance of just under 80% for February production levels, a steady stream of gloomy economic data sparked fears of further downgrades to demand forecasts for 2009 and 2010.  Latest OMR projections show global oil demand declining by 1.5% or 1.2 mb/d for 2009, given worsening economic developments in the FSU, Asia, and OECD North America.

Spot Crude Oil Prices

Spot crude prices posted mixed results in February as weaker demand and an extensive refinery turnaround schedule pressured prices lower, while reduced OPEC supplies of heavier sour grades boosted demand for replacement barrels.  Refineries are expected to operate at reduced levels through the end of the first quarter although demand for sour crudes is on the rise.



Spot crude prices moved to the upside again in early March aided and abetted by supply disruptions for some key grades. A fresh wave of militant attacks in Nigeria took an estimated 70 kb/d of Forcados crude off the market, with operator Shell declaring force majeure for March and April liftings.  A fire and resulting leak along a key crude oil pipeline running to the Black Sea ports forced the shut-in of the 1 mb/d link to Novorssiysk to Tuapse for a week but repair work is now complete.



OPEC's steep cutback of its heavier, sour grades has had the unintended consequence of boosting demand for replacement crudes.  In addition, Saudi Arabia and Iran increased prices for most of the grades, making alternatives economically attractive. Asian refiners have markedly increased purchases of Russian Urals as well as Nigerian crudes.  Indeed, Russian volumes to Asia are expected to continue to rise in coming years.

Spot Product Prices

Crack spreads for almost all products narrowed in February and early March on weak fundamentals, despite refineries cutting throughputs.  The recovery in gasoline cracks seen in January and first-half February appears to have petered out amidst indications that the pace of US demand decline may be ebbing.  In addition, US gasoline stocks are now below their five-year average (based on weekly EIA data), which stands in considerable contrast to other products.



But weaker gasoline, in combination with further declines in distillate cracks, is crushing refining margins.  In a pronouced reversal of fortune, Asian gas oil/diesel markets saw margins drop to five year lows on limited demand.  In all regions distillate stocks are high after refiners had boosted yields.  But the heating season will soon be over (in the northern hemisphere) while diesel consumption has taken a hit due to the economic slump.  Weaker demand for diesel in transportation use, gas oil for manufacturing and industrial use, and falling jet fuel demand have combined to knock the wind out of the middle distillate market.

In contrast to weak distillate demand, a surge of buying interest emerged for high-sulphur fuel oil in the US Gulf Coast refining region.  Lower exports of OPEC heavier sour crudes have made competing grades dearer and also translated into stronger demand for the grade as straight-run fuel.



End-User Product Prices in February

Retail gasoline prices on average rose by 9% month-on-month, in US dollars, ex-tax.  The US and UK posted the largest increases, of 12.6% and 12% respectively, while Japan saw smaller gains of  3.5%.  In February, consumers in the US on average paid $1.92/gallon ($0.508/litre) for gasoline, in the UK £0.896/litre ($1.291/litre), and in Japan ¥109/litre ($1.175/litre).  In Europe, prices ranged from a low of €0.896/litre ($1.149/litre) in Spain to a high of €1.170/litre ($1.499/litre) in Germany.  The rise in gasoline prices was offset by 3.1% and 5.1% decreases in diesel and heating oil prices, respectively, both in US dollars, ex-tax.  Retail prices in the surveyed IEA countries were on average 40% below February 2008 levels, in US dollars, ex-tax.

Refining Margins

Refining margins fell across the board in February, as a sharp fall in distillate crack spreads outweighed rising light distillate and most fuel oil differentials.  Margins fell most on the US Gulf Coast, with a further dip in early March dragging cracking margins into negative territory. Unlike in other areas, low-sulphur fuel oil discounts to crude widened here, adding to refining margin weakness.  Meanwhile, trends in US West Coast margins were mixed but remain largely positive in overall terms.



Singapore margins largely declined in February, again on sharp losses in diesel and jet/kerosene crack spreads.  Asia is suffering perhaps more than other regions from a weak distillate market, with China reverting to being a net exporter in recent months.  Despite gains in gasoline cracks in February (month-on-month), trend-wise, gasoline spreads fell throughout the month and in early March, ultimately pressuring margins.  Thus, in February and early March, all calculated margins turned negative.  In Europe, trends were similar, with previously positive margins mostly turning negative in early March on distillate weakness.  Only Urals cracking margins in Northwest Europe remain modestly positive.

Refining Margins Annual Update

In collaboration with Purvin & Gertz Inc., we have completed the annual update of our refining margin calculations.  For all models, there have been changes to operating costs, related to financial cost changes and the impact of this on fixed cost components.  These levels have been applied retroactively starting in 2005.  Additionally, we have updated the Worldscale (WS) freight rate indexes for 2009.  Given sulphur prices rose strongly in early 2008, the models have been updated to reflect this.  However, global economic conditions have reversed this trend and sulphur prices are assessed to be much lower in 2009.

For the North West Europe (NWE) and Mediterranean models, small yield changes have been made in order to reflect product quality changes in these regions.  Updated input prices, such as 10 ppm ultra-low-sulphur gasoline, 10 ppm ultra-low-sulphur diesel and 0.1% sulphur gasoil are also now incorporated.  For NWE, Brent yield vectors have been replaced with those of Forties in order to take into account the increased role of lower-quality Forties in setting the price of the Brent-Forties-Oseberg-Ekofisk (BFOE) benchmark.  The Brent price is used as before, but the yield vectors reflect the Forties quality available in the market.

Regarding the US Gulf Coast (USGC) models, we have also based our imported sweet margin indicator on the Forties crude oil assay instead on Brent, starting from 2007.  Yields have being reoptimised to capture various market and operating changes.  They now reflect an increasing output of distillates, as opposed to yields maximising gasoline production.  Yields now account for current product market specifications - particularly ultra-low-sulphur diesel requirements, and are back dated to 2007.  Initial attempts have been made to segregate refinery grade propylene in order to reflect its attractive economics.  Taking into consideration the increased average plant size, fixed cost components have been reduced (reducing fixed cost per barrel somewhat), but countered by the overall costs related to the financial cost changes (insurance, maintenance, etc.).

Changes to US West Coast (USWC) models are similar but less pronounced.  There have been some changes in the blending stocks for fuel oil in the FCC margin calculations, due to expansion of hydrotreating capacity for diesel manufacture.  In the process of this annual update, we identified some corrupted Worldscale quotations in our database which had significantly reduced the calculation (-$3.78/bbl on average for 4Q08) of USWC Oman cracking margins since October 2008. This problem has been fixed and now our Oman assessments incorporate these corrections.

The Asian yields have not been modified in this update, but as already mentioned, costs in this region have been affected by changes in financial costs.

The impact on margins varies and is illustrated in the table opposite.

Freight

February crude freight rates continued to languish at five-year historical lows as reduced export flows from OPEC producers and a deterioration in oil trade were only partially offset by persistently high short-term floating storage levels.

Middle East Gulf to Japan and West Africa to US Atlantic Coast rates staged a mild recovery in the first half of February before falling by month end.  Expectations of further OPEC export reductions as the producer group complies with agreed production cuts continues to generate bearish sentiment.  Moreover, a narrowing of the contango in WTI and Brent futures curves has tempered expectations for increased floating storage.  As of early March, VLCC rates showed little sign of recovery, though Suezmax demand in West Africa, the Mediterranean and North Sea supported rates for those vessels.  Early March transatlantic trade to satisfy US refinery demand for fuel oil has also provided some rate support.

After an upward swing in the first half of February, clean rates have softened through early March.  The early February upswing derived from gasoil arbitrage opportunities from Asia to Europe (particularly from South Korea) and an open naphtha arbitrage window from Europe to Asia to satisfy South Korean cracker demand.

However, by early March, both trade windows had effectively closed as European gasoil demand no longer supported differentials and outages at South Korean and Chinese Taipei crackers undermined Asian naphtha demand.  As a result, clean rates withdrew at the end of February to levels at or below end-January readings.  Still, early March transatlantic gasoline trade has provided some counteracting support to rates.



Refining

Summary

  • Global crude runs are expected to remain weak through the end of 1Q09, but completion of maintenance at refineries in the Atlantic Basin and start-up of new capacity in the Middle East, China and Other Asia offer the prospect of higher runs over the course of 2Q09.  1Q09 crude throughput is now seen averaging 71.4 mb/d, 0.6 mb/d below last month's report and 2.7 mb/d below a year ago.
  • Preliminary January data indicate that crude runs were weaker than expected in OECD Europe, India, and Russia.  Conversely, crude runs were stronger than estimated in Canada, Mexico and Japan.  Weekly data point to continued strength in Japanese and potentially US runs, although much of the US recovery depends on the recent rally in gasoline cracks sustaining refinery profitability, now that diesel cracks have collapsed.


  • Crude throughput forecasts have been rolled out to June, with 2Q09 crude runs now forecast at 72.3 mb/d, an annual decline of 1.8 mb/d.  Nearly two-thirds of the annual decline is in the OECD, although by June an increasing proportion derives from the growing year-on-year deficit in Chinese crude throughputs.  There is the potential for Chinese crude runs to exceed our current forecasts, given the capacity increases possible in coming months.  However, the continued high domestic distillate stocks and weakening demand growth suggest that runs may well be constrained, unless export incentives improve, allowing Chinese refiners to move surplus middle distillate supplies into an already sluggish Asian market.
  • December 2008 OECD refinery yields increased for gasoline, jet fuel/kerosene and gasoil/diesel, at the expense of naphtha and 'other products'.  OECD gasoline yields approached their highest level since 2003, driven by the continuing surge in North American yields, which rebounded 1.4 percentage points to the upper part of the five-year range at 47.4%.  Jet fuel/kerosene yields fell in the region, as the continued focus on diesel output pressured yields.

Global Overview

Global crude throughput continues to struggle in the face of weak demand and the collapse of middle distillate cracks from recent healthy levels.  Official December data for OECD countries now peg crude throughput at 37.5 mb/d, an annual decline of some 2.1 mb/d.  Furthermore, the non-OECD growth trend moved negative in December, swinging to -1.2 mb/d, from +18 kb/d in November.  Consequently, global crude runs are now estimated at 72.3 mb/d for December, -3.4 mb/d year-on-year.  The year-on-year deficit continued into January, with crude runs now assessed at 71.4 mb/d, some 3.3 mb/d below January 2008.

Our forecast for 1Q09 and 2Q09 remains finely balanced between the impact of increased capacity in India, China and the Middle East and continued weak demand in the OECD and elsewhere.  In the short run, with excess crude available from storage, there is the possibility for refinery runs to exceed demand, if price discounts incentivise incremental crude runs.  However, rising stocks and collapsing cracks for middle distillates suggest that this cannot continue unchecked indefinitely.  Tighter crude markets, as a result of OPEC removing further additional supplies in coming months, will ultimately limit refiners' ability to increase runs, potentially stoking a recovery in margins at some point in the future.

Furthermore, the collapse in diesel cracks in the US, Europe and Asia suggests that another drop in refinery runs may be needed to clear excess inventories.  Middle distillate cracks have long been the crutch on which refiners relied for making a profit from refining crude.  The relative bias towards or away from middle distillates has dictated, to some extent, the level of refining activity in a particular region.  The US, with its heavy bias towards gasoline production, has seen greater declines in operating levels, despite efforts by refiners to increase diesel yields substantially over recent quarters.  Conversely, the higher diesel and jet fuel/kerosene yields in Europe and the OECD Pacific have lent some strength to runs there.  Arguably, the same is true of Chinese crude runs, which have only recently started to come under pressure.

The end of heavy US maintenance offers the potential for runs to rebound much more strongly than assumed in our North American forecasts.  Preliminary weekly data suggest that in recent weeks US gasoline stocks have fallen short of the seasonal build and demand contraction is easing year-on-year, as the lower price starts to have an impact.  US refineries certainly have the potential to meet any seasonal rebound in demand, associated with the start of the driving season late in the second quarter.  However, such is the level of offline US capacity for economic reasons, collectively they run the risk of collapsing the gasoline crack if all were to restart simultaneously.

Global Refinery Throughput

January global crude throughput is estimated at 71.4 mb/d, 0.5 mb/d below last month's report.  Provisional data suggest that OECD crude runs were weaker than expected, notably in Europe, where French crude runs declined to their lowest level in nearly 15 years.  Conversely, Canadian and Mexican crude runs were ahead of expectations.  Elsewhere, data indicate that Russian and Indian crude runs were weaker than expected, the latter despite the start-up in late December of the Jamnagar refinery expansion.  Lastly, we have incorporated monthly JODI data for Papua New Guinea and provisional 2007 annual data for several non-OECD countries, notably Belarus and Serbia into our forecasts.  These changes raise global crude throughput by just under 0.1 mb/d on an underlying basis.

Estimated 1Q09 global crude throughput of 71.4 mb/d is 0.6 mb/d below last month's report.  Weaker demand estimates and January provisional data, contribute to the lower forecast.  The poorer outlook for middle distillate cracks and higher maintenance estimates both weigh on European crude runs.  1Q09 global crude throughput is now estimated to be 2.7 mb/d less than a year earlier, with January 2009 crude runs some 3.3 mb/d lower than a year ago.  The OECD accounts for 60% of the 1Q09 drop in crude runs, compared with 90% in 4Q08.

This month's forecast extends to June, with crude runs seen increasing seasonally in the Atlantic Basin, assuming a typical driving season in the US, and a seasonal dip in the Pacific as maintenance reaches a peak there.  Elsewhere, runs are forecast to increase in China, with crude runs rising following the start-up of Sinopec's Fujian refinery expansion.  Only minimal volume contributions are included from this project and the reportedly imminent start of CNOOC's Huizhou refinery, given our concerns that demand weakness may yet limit Chinese capacity utilisation rates.  The completion of maintenance in Latin America, the Middle East and Africa also boost June crude throughput.  Consequently, the forecast for 2Q09 is that crude runs will average 72.3 mb/d.  In common with our 1Q09 forecast, year-on-year growth remains heavily negative, at 1.8 mb/d, with the OECD accounting for around 60% of the decline.



OECD Refinery Throughput

Provisional data indicate that January 2009 OECD crude throughput was 37.0 mb/d, just 0.1 mb/d below the estimate in last month's report.  Regionally, North American throughputs were 0.3 mb/d stronger than estimated, perhaps reflecting the impact of stronger gasoline cracks, whereas European crude runs were 0.5 mb/d below our previous estimate.

Year-on-year, OECD throughput has collapsed by 2.1 mb/d, led by European refining activity, which, at 12.8 mb/d, was at its lowest level since 2002.  In addition to a 1.0 mb/d drop in Europe, both North America and the Pacific saw annual declines in the region of 0.5-0.6 mb/d.  Average January capacity utilisation fell to its lowest level since 1995 (the start of the current monthly data series) with the exception of the September 2008 hurricane-affected level.  Official December submissions were also weaker than last month's provisional OECD estimates by 0.3 mb/d, almost wholly due to downward revisions to US and Canadian throughputs.

Forecast OECD 1Q09 throughput has been reduced by 0.3 mb/d this month.  Lower European crude runs are carried forward, following January's weaker number, on the back of heavier maintenance and heavier economic run cuts.  Conversely, North American estimates have increased, notably for the US.  A collapse in gasoline cracks may well undermine this upward revision, but for now, it appears that we overly penalised US refineries in last month's report.  Pacific crude runs are similarly revised up as Japanese and Korean refiners have started to exceed expectations, although here again renewed weakness in naphtha and jet fuel cracks could undermine the recovery, at least in Japan.

OECD North America crude throughput increased again in January, albeit against a downward revised December level.  Despite weekly data showing a run-up in US crude throughput to its highest level since the beginning of the year, we expect runs to drop back over the course of March, before the end of maintenance allows runs to rise again over the course of the second quarter.  1Q09 crude throughput is now forecast to average 17.1 mb/d, rising to an average of 17.2 mb/d in 2Q09.



However, crude runs may well understate the true level of refinery activity and product supply in the coming months, as tighter heavy sour crude markets, as a result of OPEC production cuts, incentivise refiners to increase processing of atmospheric residue, notably Russian M100.  The economics of creating heavy sour crudes, from blending heavy sweet and medium sour crudes with residue appears increasingly attractive to some US full conversion refineries.



OECD Pacific January crude runs were 0.1 mb/d ahead of forecast, with Japanese and Australian crude intake slightly ahead of our estimates.  Japanese crude throughput continued to run ahead of our forecast in February and into early March, leading us to revise up 1Q09 forecasts for the region by 0.1 mb/d.  Furthermore, the start of maintenance in Japan suggests the peak in the Japanese runs is imminent and that runs will soon start to decline, albeit less rapidly than previously assumed.  Consequently, we have adopted a more positive view on OECD Pacific runs in 2Q09, although crude runs remain 0.2 mb/d below levels of a year ago.

Industry restructuring efforts have stalled in recent weeks, with the previously announced merger of Nippon Oil and Nippon Mining delayed by SEC filing requirements until 2Q 2010.  Similarly, the creation of a joint venture between Nippon Oil and CNPC to operate the 115 kb/d Osaka refinery, which is currently operated by a subsidiary of Nippon Oil, has slipped until the second half of 2009, pending clarification of the JV's structure.



OECD Europe crude throughput fell heavily in January to its lowest level since May 2002, led by the collapse in French crude runs.  French crude throughput, at 1.4 mb/d, is the lowest since 1995 (the start of the current monthly series of data), but there were also material declines in German and Italian crude runs during the month.  We have adopted a more downbeat view on European crude runs, with 1Q09 average throughput cut by 0.6 mb/d.  This reflects the heavier maintenance now foreseen in the region, weak regional demand and rising gasoil stocks as we approach the end of the winter heating season.  Europe's structural bias towards gasoil/diesel (with yields hitting a record 39.2% in December) suggests they are more structurally exposed to the recent collapse in gasoil cracks.  Nevertheless, we assume that the structural shortage of diesel in Europe will support regional runs at the expense of the marginal refiners that export diesel/gasoil to Europe from Asia, the Middle East and the US.  Consequently, we forecast that 2Q09 throughput will average 13.5 mb/d, almost flat with 2Q08's level, although the risks to the forecast lie clearly to the downside.



Non-OECD Refinery Throughput

Forecast 1Q09 non-OECD crude throughput is revised down this month by 0.3 mb/d, following announcements of additional maintenance in Latin America and Asia, as well as the impact of weaker demand estimates.  Year-on-year growth slips to -1.0 mb/d during the quarter, compared with -0.2 mb/d in 4Q08, with China and Other Asia each accounting for a decline of 0.4 mb/d.  The 2Q09 trend is similarly negative, albeit the 0.7 mb/d fall is cushioned by new capacity additions in India and China.

Chinese estimated 1Q09 crude throughput is broadly unchanged, in the absence of monthly data from China's National Bureau of Statistics at the time of writing, due to the Chinese Lunar New Year Holiday.  However, January crude runs are lowered by 0.1 mb/d, in line with demand revisions, and results of utilisation surveys of the larger refineries, to 6.3 mb/d, but some unconfirmed reports suggest runs may have fallen as low as 5.8 mb/d during the month.  Current Chinese throughput forecasts potentially understate crude runs during the first and second quarters, based on the new refinery additions that may start during the coming months.  However, against this optimistic outlook must be weighed reports of persistently high stock levels of gasoline and diesel that suggest refiners are currently limited in their ability to move additional supplies inland, due to weak demand.  Higher exports have been suggested as a solution, although the economic rational for such a move remains an unresolved question.  Lastly, some refiners have been instructed to switch away from their long-standing focus on maximising diesel/gasoil yields in favour of gasoline in the coming months.

Forecast 1Q09 and 2Q09 crude throughput reflects the balance between the numerous reports of imminent start-up at CNOOC's 240 kb/d Huizhou refinery and Sinopec's Fujian expansion and the apparent lack of demand for existing production.  Consequently, 2Q09 average throughput of 6.5 mb/d is only 0.1 mb/d above 1Q09.

Other Asia forecasts are lowered this month following reports of renewed run cuts from some refiners, the collapse in the gasoil crack to its lowest level in five years and the drop in Singapore hydrocracking margins in early March to amongst the lowest levels since the late 1990s.  Provisional data for January suggest that Indian crude throughputs fell by nearly 3% year-on-year to 3.1 mb/d, despite the start-up of the Jamnagar expansion, largely due to lower runs at the original Jamnagar site.  Despite this new capacity, and the start of crude processing at Vietnam's Dung Quat refinery in February, year-on-year throughput is seen falling by 0.4 mb/d during the first half of 2009.  There remains the potential for much higher declines if regional refiners cut runs further in the face of deteriorating economics, driven by further weakness in the gasoil crack.

OECD Refinery Yields

In December 2008, OECD refiners increased the yield of gasoline, jet fuel/kerosene and gasoil/diesel, at the expense of naphtha and 'other products' yields.  Some of the changes appear counter-intuitive, suggesting a distortion from low throughput levels on yields may have been a contributory factor.  Notably, OECD gasoline yields approached five-year highs, despite crack values hovering around zero during the month, while naphtha yields declined again, despite some recovery in crack spreads, albeit remaining negative.



Naphtha yields reached a record-low level of 4.1 percentage points, which represents a year-on-year decrease of 24%.  Both North American and European yields decreased counter-seasonally, whereas OECD Pacific yields increased according to seasonal patterns but remained low, just above the lower end of the five-year range.  The striking decrease of naphtha yields highlights, on the one hand, weak economic returns to produce naphtha as a feedstock for petrochemicals and, on the other hand, a better return as a gasoline feedstock.  The yield for 'other products' remains below the five-year range and could similarly be related to the incentive to maximise gasoline production over petrochemical feedstock production since this category includes some aromatic and olefins products which can be incorporated into the gasoline pool.

OECD gasoline yields reached their highest level since 2003, driven by the continuing surge in North American yields, which rebounded 1.4 percentage points to the upper part of the five-year range at 47.4%.



Even though gasoil/diesel cracks weakened, yields remained above the five-year range, reaching a new record level of 31.3%, supported by a strong seasonal increase in Europe and a counter-seasonal increase in the Pacific.  European yields reached 39.2%, representing a year-on-year increase of 4% and an increase of 7% over December's five-year average.  Both gasoline and gasoil/diesel yields in North America increased in December, squeezing jet fuel/kerosene yields, cracks of which have been weakening since November 2008.



OECD fuel oil yields stayed low at 8.8%, probably due to improved production economics for the more complex refineries and the relative strength of middle distillates and gasoline markets, (both factors should keep fuel oil yields subdued throughout 2009 at below or close to the lower end of the five-year range).  In the Pacific, fuel-oil yields seem to have stabilised around 12% since July 2008, which, in contrast to a five-year average yield of 15.3%, suggests a yield transfer of 3.3 percentage points to lighter products from the recently commissioned upgrading capacity in this region.