Oil Market Report: 10 July 2009

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Highlights

  • By early July, benchmark crude prices reached eight-week lows around $60/bbl, as the four-month rally in oil prices stalled.  Growing concerns about the path of economic recovery, persistently high oil stocks and current weak demand undermined prices.
  • Global oil demand in 2010 is expected to rebound by +1.7% or +1.4 mb/d year-on-year to 85.2 mb/d, largely led by non-OECD countries.  The outlook for global oil demand in 2009 remains effectively unchanged (-2.9% or -2.5 mb/d versus 2008), given much weaker-than-anticipated preliminary data in the OECD and despite a large upward baseline adjustment for non-OECD countries.
  • Non-OPEC supply for 2009 is revised up by 330 kb/d, largely due to stronger-than-expected Russian output, and is now expected to grow by 190 kb/d to 50.8 mb/d.  Our 2010 forecast sees supply rising by a further 410 kb/d to 51.2 mb/d, with growth centred on Azerbaijan, Brazil, global biofuels, the US Gulf of Mexico and Canadian oil sands.  OPEC NGL supply is also expected to increase sharply next year.
  • Despite a wave of supply disruptions in Nigeria, June OPEC crude oil supply rose by 75 kb/d to 28.7 mb/d, its second successive monthly increase.  Output by OPEC-11 averaged 26.2 mb/d, suggesting compliance of about 68% with announced cuts.  The call on OPEC crude and stock change is suppressed through 2H09 and much of 2010.
  • OECD industry stocks rose seasonally by 27.8 mb in May to 2,768 mb, 7.0% above last year's level.  All three regions posted gains, though the bulk of the increases came in North American 'other products', European crude and Pacific distillates.  End-May forward demand cover rose to 62.5 days, 7.2 days higher than a year ago.
  • Global 3Q09 crude runs are revised down by 0.5 mb/d to 72.3 mb/d, following a deterioration in refining margins.  European refining activity is particularly hard-hit, with weaker middle distillate cracks and rising stocks both expected to weigh heavily on the region.

New decade, same uncertainties

The July Oil Market Report (OMR) traditionally sees the first quarterly look at market fundamentals for the forthcoming year - in this case 2010.  Baseline non-OECD revisions this month result in higher absolute 2009 demand.  But global 2009 demand contraction remains around 2.5 mb/d, premised on a GDP decline of 1.4%.  The underlying call on OPEC crude/stock change for the rest of 2009 rises from a 2Q low of 27.3 mb/d but remains 2-3 mb/d below equivalent 2008 levels.  An assumed rebound in GDP growth next year to +1.8% (the IMF's just-released, and more optimistic, outlook is discussed in this report, but came too late to be captured in our projections) sees global oil demand growth resume, driven by non-OECD countries, plus a modest rebound in OECD winter fuel and transportation requirements.  But a likely surge in OPEC gas liquids supply, and limited non-OPEC growth, could cap the call on OPEC crude for much of 2010.

Of course, estimates of supply, demand and inventory levels for 2009 will evolve further, so any view today on likely fundamentals 12-18 months hence is tentative, to say the least.  The late arrival (or continued absence) of a 2009 gasoline season, the fate of an emerging gasoil glut, OPEC compliance, the global economy, investment and new capacity start-ups for the rest of this year are all up for grabs, and will shift the starting point for subsequent analyses of 2010.

In an attempt to reflect prevailing economic uncertainty, the 2009 Edition of the Medium-Term Oil Market Report (MTOMR) last month highlighted two potential demand scenarios, based on a 2010 GDP growth 'envelope' of 1-2%.  While we avoid a scenario approach in the OMR, nonetheless 2010 demand in the weaker outlook could be around 300 kb/d lower than the current projection of 85.2 mb/d.  Focusing purely on demand, however, risks overlooking supply impacts.  A weaker economic prognosis for 2010 implies more anaemic demand and cash flow expectations, and could further erode upstream capex, knocking 300-400 kb/d off non-OPEC supply from the levels shown here.  This would eclipse already-modest 2010 non-OPEC growth altogether, although rising local gas requirements and committed LNG expansions could sustain OPEC NGL growth.  Given these offsetting risks, 2010 could see current, more comfortable, levels of spare OPEC capacity persist.  That at least takes one potential source of oil price volatility out of the equation, even if others remain.

Several themes developed in the MTOMR released on 29 June have been given added colour in recent weeks, but if anything these developments only highlight the uncertainty swirling around the oil market for 2009, 2010 and beyond.  Our demand projections in MTOMR stress the importance of middle distillate growth, and although this is likely to remain the case over time, the prompt distillate market is looking very sluggish.  End-May OECD inventories stand some 80 mb above the five-year average, and substantial volumes of middle distillate remain in floating storage.  Refinery throughput forecasts for 3Q09 have been cut as a result.  Arguably, middle distillates constitute a better barometer of the economic and industrial climate than gasoline, so the current sustained weakness only reinforces concerns about the timing and strength of much-heralded economic 'green shoots'.

The fall in crude prices in recent days towards $60/bbl reflects some of these more bearish physical market indicators.  Nonetheless, arguments rumble on over the role of speculative financial flows in driving oil and commodity price changes.  Proposals from the CFTC to provide more detail on trades by swap dealers and hedge funds in their weekly reports could add welcome extra visibility.  More extensive plans for the CFTC to enforce position limits are less consensual, with some commentators concerned about the impact on market liquidity, and that over-zealous curbs could worsen price volatility rather than staunch it.  Legitimate worries persist among G8 member governments and others that price volatility could stifle economic growth before it takes root.  But earlier, and in our view misguided, proposals to select and 'manage' an 'acceptable' price range do not appear to have gathered widespread traction, at least for now.

Demand

Summary

  • Global oil demand in 2010 is expected to bounce back by +1.7% or +1.4 mb/d year-on-year to 85.2 mb/d.  This strong rebound is led by non-OECD countries, but the OECD should also post a modest recovery.  This prognosis is based on IMF economic assumptions (World Economic Outlook, April 2009), which see global economic growth reaching +1.8% in 2010, compared with -1.4% in 2009  (given time constraints, this report did not integrate the last IMF partial update, which was released at the time of writing).  Meanwhile, the outlook for global oil demand in 2009, which now includes a large 2007 baseline adjustment for non-OECD countries, remains largely unchanged in terms of growth (-2.9% or -2.5 mb/d when compared with 2008), given much weaker-than-anticipated preliminary data in the OECD.
  • Forecast OECD oil demand in 2010 is projected at 45.2 mb/d (+0.2% or +100 kb/d over 2009) as most economies are expected to gradually emerge from their deepest slump in over half a century, with GDP expanding by +0.1% in 2010, compared with -3.7% in 2009.  Nevertheless, the engine of growth will arguably be North America, as the recovery in Europe and the Pacific is likely to be slow.  The estimate of oil demand growth in 2009 has been slightly revised down compared with the previous report (-5.1% versus -4.9%), owing to emerging evidence that a strong gasoline season in the US could fail to materialise for the second year in a row.  It should be noted that this report includes revised 2008 demand figures for all countries, but the adjustments were negligible overall (-10 kb/d).


  • Forecast non-OECD oil demand in 2010 is estimated at 40.0 mb/d (+3.5% or +1.3 mb/d year-on-year), close to levels seen in previous years and following zero growth in 2009.  China, the Middle East and to a lesser extent Latin America will play a prominent role with regards to this demand rebound.  Collectively, GDP activity in emerging countries is set to rise by +4.1% in 2010, over twice as much as in 2009 (+1.7%).  The outlook for 2009 growth, meanwhile, has been slightly adjusted up (from -0.3% to -0.1%) on the back of stronger-than-expected preliminary data in several Asian countries (notably China, India, Malaysia and Chinese Taipei).  The baseline, however, has been sharply revised up (by roughly +500 kb/d) following the inclusion of finalised 2007 data for all remaining non-OECD countries.  Interestingly, this revision indicates that non-OECD oil demand growth in 2007 was much stronger than estimated (+4.4% versus +3.6%), helping to explain the strong oil price rise during that year.

Global Overview

This month features our annual forecast rollout, with a detailed look at the 2010 prognosis.  The exercise is intrinsically perilous, given the great uncertainty regarding the pace and strength of the global economic recovery.  As we noted in our recently released MTOMR, there is a vigorous debate as to whether the rebound might be strong and sustained, or whether it might be weak and protracted.  In the last two months, many observers have confidently announced the bottoming out of the recession and a strong recovery in 2H09.  However, over the past two weeks the mood has suddenly changed, as many leading economic and energy indicators continue to show very weak readings, suggesting that the 'green shoots' have been largely driven by a rebuild in industrial inventories rather than by strong end-user demand.

This would vindicate our bearish view that global oil product demand is likely to contract sharply in 2009 (-2.9% or -2.5 mb/d year-on-year, unchanged versus our last report), despite the massive stimulus provided by loosened fiscal and monetary policies worldwide.  Furthermore, the most recent developments (notably the dwindling prospects for the driving season in the US and the continuing poor state of the distillate market) arguably indicate that oil product destocking had a much lesser effect upon weak demand readings that some had anticipated.  Destocking is probably largely over by now, yet demand data in key countries (predominantly the US) have if anything worsened in the past few weeks.

We thus remain sceptical regarding the much-trumpeted, strong 2H09 demand rebound, even if China exceeds expectations.  Indeed, as much as 2H09 demand is set to improve, the importance of China regarding global oil demand growth, albeit significant, should not be overplayed, at least at this juncture.  This outlook includes large baseline revisions for non-OECD countries (+500 kb/d in 2007, carried through to 2008 and 2009).  By contrast, the OECD baseline changes for 2008 were minimal (-10 kb/d).

In 2010, by contrast, the picture could be dramatically different.  As a starting point, this report uses IMF economic assumptions (World Economic Outlook, April 2009), which posit that global economic growth will reach +1.8% in 2010, compared with -1.4% in 2009 - that is, a swing of over three percentage points.  Under this scenario, oil demand is expected to rebound by +1.7% or +1.4 mb/d year-on-year to 85.2 mb/d - but still way below 2008 levels.  Unsurprisingly, this strong rebound is poised to be led by non-OECD countries, where demand should expand by +3.5% or +1.3 mb/d, close to levels seen in previous years and following zero growth in 2009.  China, the Middle East and to a lesser extent Latin America will play a prominent role.  The OECD, meanwhile, should also post a modest recovery (+0.2% or +100 kb/d) as most of its economies gradually emerge from their deepest slump in over half a century, with North America being arguably the engine of growth.



Is this forecast overly optimistic?  At first glance it looks like an outlier, but the 2010 'overshooting' stems in part from a rebound after the sharp fall expected in 2009, and is predicated on the basis that global financial and trade imbalances gradually improve and fuel economic activity, notably in emerging countries.  The forecast also assumes normal winter conditions and the prevalence of administered price regimes, notably the Middle East.  However, should economic growth turn out to be more subdued (in line with the 'lower GDP' scenario presented in the MTOMR), this 2010 demand forecast would indeed fail to materialise.  Yet economic observers are, if anything, revising up their assumptions for next year.  For example, the OECD recently inched up its prognosis for the area; the World Bank boosted its forecasts for China, Russia and India (but lowered those for the OECD); the IMF has marginally improved its outlook for next year; and several investment banks are issuing exuberant prognoses.



The World Economy:  Bouncing Higher?

On 8 July, the IMF released a partial update of its global economic prognoses, but unfortunately too late to be included in this report.  We will integrate these new projections, alongside those from other sources, such as the OECD, the World Bank and Consensus Economics, into our next report.

The Fund's revisions to the April edition of its World Economic Outlook were relatively minor.  The global economy is still seen contracting by roughly 1.4% in 2009, marginally less than the earlier appraisal, but is now expected to grow by a more substantial +2.5% in 2010, instead of +1.8% as previously assumed.  More interestingly perhaps, this change stems effectively from the OECD, given its weight relative to the world economy.  Advanced economies should now expand by +0.6% in 2010, rather than simply stall, while emerging and developing economies should also grow slightly faster (+4.7% versus +4.1%).

Given that the IMF's revisions are mostly concentrated in OECD countries - where oil demand is mature, thus limiting the scope for growth - our 2010 oil demand forecast may remain broadly unchanged.  Yet greater adjustments could occur in the autumn, since a full IMF update is due in late September.  By then it will arguably become clearer whether the global economy is on track to a sustained recovery - or not.

OECD

According to preliminary data, OECD inland deliveries (oil products supplied by refineries, pipelines and terminals) contracted by 7.4% year-on-year in May, with all three regions recording losses for the thirteenth month in a row.  In OECD Pacific, demand plunged by 11.2%, despite a rise in gasoline deliveries.  In OECD North America (which includes US Territories), oil product demand fell by 8.1% year-on-year, with all product categories posting losses.  In OECD Europe, demand shrank by 4.3%, despite being somewhat supported by rebounding heating oil deliveries.

Higher-than-anticipated demand for LPG, naphtha, residual fuel oil and 'other products' resulted in net upward revisions to April preliminary data (+480 kb/d), offsetting weaker deliveries of gasoline, jet fuel/kerosene and diesel.  Although these relatively large positive revisions - for the second month in a row - could be interpreted as a change in trend (that is, the bottoming out of oil demand fall), this would be misleading.  Indeed, demand is still contracting sharply:  April's OECD demand plummeted by 7.1% during that month, marginally less than previously estimated (-8.1%).  In fact, OECD demand has fallen uninterruptedly since December 2008.



It should be noted that our demand estimates now include the revisions for 2008.  Overall, these were negligible (-10 kb/d), with Europe and the Pacific offsetting North America.  On a regional basis, however, there were more substantial:  -110 kb/d in North America, +60 kb/d in Europe and +40 kb/d in the Pacific.

All together, the estimate of OECD oil demand growth in 2009 has been slightly revised down compared with the previous report (-5.1% versus -4.9%), owing to emerging evidence that a strong gasoline season in the US could fail to materialise for the second year in a row.  In 2010, as noted earlier, OECD demand is expected to increase by +0.2% or +100 kb/d to 45.2 mb/d.





North America

Preliminary data show that oil product demand in North America (including US Territories) fell by 8.1% year-on-year in May, the seventeenth monthly contraction in a row.  Once again, the decline in both Mexico and the United States was particularly pronounced (-11.0% and -8.4% year-on-year, respectively), while Canada posted a 2.6% contraction.

April's revisions to preliminary data (+390 kb/d) were essentially due to the US.  Yet the upward adjustments were concentrated in LPG, naphtha, residual fuel oil and 'other products', which are notoriously volatile.  By contrast, gasoline and middle distillates were sharply revised down.  Even after accounting for these revisions, moreover, regional demand remains very weak, falling by 6.3% during that month (rather than -8.4%).  Taken together the revisions (2008 and April 2009), preliminary data (May) and much weaker-than-expected weekly US estimates (June), the outlook for total demand in 2009 has been lowered by 300 kb/d to 22.9 mb/d (-5.1% or -1.2 mb/d versus 2008).  In 2010, by contrast, oil demand should grow by 1.0% (+240 kb/d), assuming that economic prospects improve, price levels do not diverge markedly from the prevailing futures strip and normal seasonal demand trends prevail.





Preliminary weekly data in the continental United States indicate that inland deliveries - a proxy of oil product demand - plunged by 8.1% year-on-year in June.  All product categories bar residual fuel oil posted sharp losses, casting further doubts on the country's much-trumpeted economic recovery.  The weakness in diesel demand (-13.4%) is particularly stark, as it is strongly correlated to economic activity.

US 2008 Demand Revisions

In July, the US Energy Information Administration (EIA) provided finalised US50 demand data for 2008.  The new figures entailed an upward revision of 80 kb/d.  (The latest preliminary monthly demand is derived from weekly data from the Weekly Petroleum Status Report, which are revised two months later in the Petroleum Supply Monthly and then finally adjusted in the Petroleum Supply Annual, usually in mid-year).  This annual adjustment was in line with the trend observed in recent years, when demand was typically - and often significantly - revised up (the only exceptions being 2003 and 2007).



Usually the revisions pertain to gasoline, middle distillates (jet fuel and gasoil) and 'other products'.  Excluding the anomalous revisions of 2003 and 2007, the 2008 adjustment is the lowest on record, suggesting that monthly data collection has improved, notably regarding the somewhat nebulous 'other products' category.  As such, our pre-emptive adjustment for 2008 - as this report attempts to anticipate annual changes based on the monthly average revisions of previous years - turned out to be almost exactly in line (a difference of only 2 kb/d).  For 2009, we are also factoring in an annual correction of 80 kb/d.

Yet perhaps the most important market development is the growing evidence that, for a second year in a row, the driving season in the US - which normally boosts gasoline demand during the summer - is petering out.  Indeed, rather than rising as expected, gasoline demand actually fell by an estimated 1.5% year-on-year in June, bucking the trend of what had seemed to be an auspicious Memorial Day weekend (which traditionally signals the start of the driving season).  At the time of writing, data for the first week of July, which normally register the seasonal peak for gasoline demand around the Independence Day holiday, was not yet available.  Nonetheless, auto industry associations such as the AAA were expecting a marked drop in vehicle-miles travelled.

US motorists are not only feeling the pinch from the deep recession, but also the effects of the recent rebound in retail gasoline prices.  In other words, the sensitivity of US drivers to retail price fluctuations depends largely on their income prospects.  As noted in the recently released MTOMR, gasoline prices passed $3.00/gallon in late 2007 just as the economic slowdown began showing signs of an abrupt recession in the making.  Consequently, gasoline demand first gradually stalled and then started falling as prices rose further to almost $4.00/gallon.  This phenomenon appears to be recurring this year - but the price threshold that triggers a demand contraction appears to be now much lower (around $2.40/gallon).



Looking forward, we expect US oil demand to rise by 1.0% to 18.6 mb/d in 2010 after plummeting by 5.4% in 2009.  This outlook assumes that the economy will recover from its current contraction (GDP growth, although nil, would be better than the -2.8% expected in 2009).

Preliminary May data for Mexico illustrate the disruptive effects of the A/H1N1 virus, which erupted in late April.  The country has indeed withstood the brunt of the slowdown in air traffic in North America.  US carriers, in particular, trimmed flights to and from Mexico as passenger bookings plunged.  American, Continental, United, US Airways and Delta all reduced their daily return flights by 26-60%.  Consequently, jet fuel/kerosene demand plummeted by 27.5% year-on-year.  Overall, total oil demand is poised to contract by 5.0% this year.  In 2010, it should rise by 0.4% to 2.0 mb/d as the economy emerges from recession, in tandem with the US.

Europe

According to preliminary inland data, oil product demand in Europe fell by 4.3% year-on-year in May.  A resumption of strong heating oil deliveries, which rose by 4.1% year-on-year, helped partially offset sharp losses in other product categories, such as naphtha (-12.0%) or diesel (-3.6%) - scarcely growth rates that would reveal a bottoming out of the recession in Europe.  April's revisions, meanwhile, were negative (-30 kb/d), suggesting that the demand outlook may have worsened again that month (March's adjustments, by contrast, had been positive).  European demand actually plummeted by 7.3% in April, half-a-percentage point more than previously estimated.

However, since the 2008 baseline changes were greater than the preliminary data revisions, this year's demand outlook in OECD Europe has somewhat improved.  Oil demand is now expected to contract by -3.9% or -600 kb/d to 14.7 mb/d in 2009, slightly less than previously anticipated.  In 2010, European demand should fall by only 0.4% or -60 kb/d, more in line with its expected structural decline, assuming that economic activity falls by only 0.2% (versus -4.0% in 2009).  However, the differences among the largest five countries will be significant:  only France, whose own recession has been relatively mild compared with its neighbours, is expected to post positive oil demand growth (+0.3%).  By contrast, Germany, Italy, Spain and the United Kingdom will all register a continued oil demand fall, commensurate with a less favourable economic outlook.





Once again, German heating oil deliveries (+45.0% year-on-year in May) helped limit the fall in demand for industrial oil products and transportation fuels, both in the country and in also the rest of the continent.  In fact, according to preliminary estimates, total inland deliveries actually rose by 2.8% year-on-year.  It is unlikely, though, that this strong pattern of buoyant heating oil sales will persist over the next few months.  Not only prices have risen, but consumer stocks, at 63% of capacity by end-May (sharply above the 44% filling registered in the same month of the previous year), are quickly approaching their historical maximum (around 75% of capacity).



In France, oil product deliveries plummeted by 8.5% year-on-year in May, according to preliminary data.  As in Germany, naphtha and LPG continue trending down (-20.0% and -15.5%, respectively), suggesting that the economy is not out of the woods yet.  More worrisome, diesel demand contracted sharply (-4.7%).  This could be related to the fact that May had several long weekends, though higher prices may also have played a role.

In the United Kingdom, total oil demand shrank by 6.7% in April (the last available data point), with all product categories posting losses.  However, the data may show a moderate demand rebound in transportation fuels or at least a less abrupt fall in June.  Indeed, the country became the last among the largest European nations to adopt a car-scrapping scheme, whereby drivers with vehicles at least ten years old are entitled to a £2,000 trade-in premium when purchasing a new car.  The scheme was launched in late May; preliminary data suggest that car sales rose in June.

Pacific

Oil product demand in the Pacific sank for the eleventh month in a row in May (-11.2% year-on-year), according to preliminary data.  Only gasoline demand (+2.1%) showed some signs of life, but largely because it had been very weak in the same period of the previous year.  As elsewhere in the OECD, the region's largest economy - Japan - shows little signs of recovering, and is dragging down overall demand.  April's revisions, although positive (+130 kb/d), provided little comfort:  demand still plummeted by 8.9% that month.



Together with the 2008 baseline revisions, these adjustments have slightly tempered the oil demand contraction expected in 2009.  OECD Pacific demand should fall by 7.5% (instead of -8.4%) to 7.5 mb/d, -610 kb/d below the previous year.  In 2010, the fall should be less pronounced (-1.4%), assuming that the region's economy expands by 0.7% (versus -5.1% in 2009).

Japanese oil demand plunged by 18.1% year-on-year in May - more than in April (-16.1%) and almost as much as in February (-20.4%), the worst month on record so far.  As we argued last month, April's rebound in naphtha demand (+5.6%), which had somewhat cushioned the fall in overall oil demand, was unlikely to be sustained unless export markets showed greater dynamism, but this has not been the case:  naphtha deliveries fell by 9.4% in May.  Only gasoline demand posted gains (+2.2%), largely given the weakness registered in the same period of the previous year, when taxing issues had distorted seasonal demand patterns.  In sum, it is far from clear whether Japan's economy has hit a bottom.  Nevertheless, on the assumption that GDP grows by +0.5% in 2010 (versus -6.2% in 2009), oil demand should contract by only 3.0% (compared with -12.4% in 2009).

In Korea, demand contracted by 2.0% in May, dragged down by middle distillates (jet fuel/kerosene and gasoil), even though naphtha deliveries remained strong (+4.2%).  Contrary to Japan, the country's prospects are brighter (GDP is set to rise by +1.5% in 2010, compared with -4.0% in 2009).  However, oil demand is likely to remain flat for the second year in a row, as strong growth in naphtha deliveries to the petrochemical industry is offset by structural declines in heating kerosene and residual fuel oil, which will continue to be substituted by natural gas (LNG).





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) jumped by 9.5% year-on-year in May, with all product categories bar gasoil and residual fuel oil posting strong gains.  This is the second month in a row that Chinese apparent demand surged.  As much as this oil demand rebound may suggest an ongoing economic revival (notably in the petrochemical industry), rising air travel and buoyant vehicle sales, it was also undoubtedly related to hoarding (so-called 'social storing') ahead of expected retail price increases.



As we noted last month, the price rise that took place in early June had been expected in late April, but the government hesitated, probably seeking to support the incipient economic recovery by keeping fuel prices low.  As such, suppliers had roughly two months - April and May - to build oil product stockpiles, which would be released with a significant profit once the price hike was implemented.  The scarcity of reliable stock data makes it difficult to estimate the underlying demand trend, as opposed to 'apparent' demand.  However, a significant portion of refinery output (+2.5% month-on-month in May) arguably fed private suppliers' stocks, for which no statistics are available.  Meanwhile, the fall in gasoline and gasoil stocks held by PetroChina and Sinopec was again most likely related to strong exports.  Possibly attempting to prevent another round of hoarding - since international oil prices continued to rise through June - and to restore the credibility of the new price mechanism, in late June the government announced another, unexpected increase to domestic gasoline and diesel prices (by roughly 9% and 10%, respectively).

These stocking trends beg the question as to whether actual domestic demand is less buoyant than it appears.  Gasoil is a case in point.  Although apparent gasoil demand has risen since December, its relative weakness compared with the same period of the previous year (-3.9% in May) is at odds with the much-trumpeted recovery of the export-oriented industrial sector (gasoil is both used in industrial applications and to run the trucks that move manufacturing goods).  Arguably, as long as export markets remain depressed, this sector will face difficult times, despite the massive fiscal stimulus.  Furthermore, the recent price increases could also influence the behaviour of Chinese motorists.  Dearer fuel is unlikely to prompt a sharp slowdown in gasoline demand, as in the US, given that the vehicle market is still mostly geared towards the most affluent consumers, who can afford moderate price increases.  Nonetheless, it could well affect purchasing patterns - sales of smaller, more efficient cars could become more of a norm.

Looking ahead, assuming that the recovery of the Chinese economy is sustained (with GDP growing by +7.5% in 2010 versus 6.5% in 2009, as previously expected by the IMF), Chinese oil demand could rise by +4.2% year-on-year or +330 kb/d to 8.3 mb/d.  This would be in line with the patterns observed in recent years (excluding of course 2009, when growth is expected to be +90 kb/d or +1.1% versus 2008, some 120 kb/d higher than previously expected).  Yet much will depend on the evolution of the price regime, the consolidation of the domestic downstream industry and, above all, on whether private domestic demand strengthens enough in order to compensate for weak exports and complement government spending.  A former senior Central Bank economist has indeed recently suggested that the recovery could be 'W-shaped':  economic growth could falter once the current fiscal and monetary stimuli wear off, before regaining momentum.



Other Non-OECD

According to preliminary data, India's oil product sales - a proxy of demand - rose by 0.9% year-on-year in May.  This relatively low reading is due to the previous year's high base, notably for transportation fuels, and to a sharp fall in naphtha demand, which has been displaced by domestic natural gas.  In April, indeed, Reliance Industries began pumping gas from its deepwater block in the Krishna Godavari basin, off India's eastern coast.  The gas is sold mainly to the fertiliser, steel and power industries, which are large naphtha users.  By the same token, imports of liquefied natural gas (LNG) have also declined (-1.4% year-on-year in May).  Nonetheless, preliminary oil demand estimates are usually revised up, sometimes sharply as in last month (April's year-on-year growth turned out to be +4.0%, rather than +0.9%).  This could happen again for May figures; arguably, reporting may have been somewhat disturbed by the country's general elections that took place over both months.

As noted in our last report, the re-election in May of a Congress party majority had been widely seen as auguring the gradual deregulation of India's administered price regime.  The new government has seemingly lived up to these expectations:  invoking the rising international oil prices, in early July it increased domestic retail prices for gasoline and gasoil by roughly 9%, but kept prices for cooking kerosene and LPG unchanged, ostensibly in order to cushion the country's poor.  The move will provide much needed fiscal relief given the high subsidy burden - the fiscal deficit stands at 6.2% of GDP - but could also fuel inflation and eventually trigger an economic slowdown if monetary policy were to be tightened.  Looking ahead, the government plans to set up an 'expert group' to advise on a 'viable and sustainable system of pricing petroleum products', which suggests that India may be looking to establish a price mechanism akin to China's, whereby domestic prices follow more closely the evolution of international benchmarks.



Following 2007 baseline adjustments and revisions to recent data, forecast oil demand growth for 2009 has been inched up to +3.0% year-on-year or +90 kb/d (versus +2.4%).  Next year, demand is expected to rise by 3.4% to 3.3 mb/d, as GDP growth accelerates from +4.5% in 2009 to +5.6% in 2010.



In Iran, the government has decided to abolish gasoline subsidies for private vehicles, according to an official news channel (although subsidies will be maintained in the case of commercial vehicles and fishing boats).  Currently, the country features a two-tier system, whereby drivers are entitled to 80 litres of gasoline per month at the equivalent of $0.10/litre.  Beyond that threshold, motorists can purchase unlimited volumes at $0.40/litre.  Compared with international benchmarks, retail gasoline prices in Iran are among the lowest in the world.

Whether this decision is related to June's controversial election - as a means to legitimise the administration of President Ahmadinejad, who has promised to hand out cash instead to selected constituencies - is unclear.  In any case, the removal of subsidies would probably provide welcome relief to the government's budget (albeit temporary if handouts were implemented), and help curb expensive - and vulnerable - imports.  It could also help renew Iran's vehicle fleet, which is generally old and quite inefficient.  Domestic gasoline demand, which had been relatively subdued in 1Q09, surged by 12.7% year-on-year in April.  Nevertheless, the government will have to tread carefully, as removing subsidies would stoke up the already high inflation rate and reignite social tensions in particularly delicate political circumstances.



Oil demand is poised to contract slightly this year (-0.7% versus 2008), mostly as a result of the introduction of a gasoil rationing plan since early 2009, which mimics the inconclusive gasoline scheme, and given the economic slowdown prompted by lower oil prices (relative to 2008) and production cuts.  In 2010, by contrast, demand should rise by +4.3% to 1.9 mb/d, assuming that the gasoil rationing scheme only tames demand temporarily (as happened in the case of gasoline) and that the government boosts spending significantly to strengthen its political position.

Supply

Summary

  • Global oil supplies posted a modest rise in June of 70 kb/d, to 84.2 mb/d in line with slightly higher OPEC output and unchanged non-OPEC production. The 'call on OPEC crude and stock change' is curbed by 200 kb/d for 2H09, to 27.7 mb/d.  Demand-side adjustments are behind the lower level.
  • OPEC crude oil supply in June rose for the second successive month despite a wave of supply disruptions in Nigeria.  Production was assessed at 28.7 mb/d, up 75 kb/d over May levels.  Output by the 11 members with production targets averaged 26.2 mb/d, equivalent to a compliance rate with output cuts of about 68%.
  • In Nigeria, escalating attacks by militant groups have forced the shut-in of around 300 kb/d in recent weeks.  In total, nearly one million b/d of output in the volatile Niger Delta region is currently offline.
  • Non-OPEC supply estimates for 2009 are revised up by 330 kb/d on the basis of consistently stronger-than-expected Russian output in the first half of the year, recovery at Azerbaijan's ACG fields, relatively robust US and North Sea production and some historical revisions on the basis of consolidated, annual data.  Non-OPEC supply is now expected to grow by 190 kb/d in 2009 to 50.8 mb/d, compared with a previously-assumed 100 kb/d contraction.
  • The roll-out of 2010 non-OPEC forecasts sees supply rising by a further 410 kb/d to 51.2 mb/d next year, with strong growth in Azerbaijan, Brazil, global biofuels, the US Gulf of Mexico and Canadian oil sands.  The UK, Norway and Mexico will see steadily declining output.
  • New OPEC NGL and condensate projects will add 2.0 mb/d to capacity over the 2009-10 period.  Middle East producers Saudi Arabia, Qatar, Iran and the UAE will provide 90% of the increase while Nigeria accounts for the remaining 10%.


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.

The non-OPEC supply overview and OPEC NGL section this month focuses on the roll out of our forecast to 2010, with discussion of key changes in production.  However, to avoid duplication, several of the themes underpinning this analysis are elaborated upon in the MTOMR 2009 Edition, released on 29 June 2009.  Readers should consult the MTOMR for more detailed discussion of factors affecting supply in 2010 and beyond.

OPEC Crude Oil Supply

OPEC crude oil supply in June was estimated 75 kb/d higher than May levels, at 28.7 mb/d.  The near doubling of oil prices over the past four months appears to have weakened the resolve of some members to adhere closely to output target cuts.  Iran, Angola and Qatar all posted small increases month on month.  By contrast, Nigeria suffered further production outages throughout the month as the security situation in the Niger Delta deteriorated further.

Output by the 11 members with production targets, which excludes Iraq, rose by 60 kb/d, to 26.2 mb/d.  OPEC-11 production is now about 1.34 mb/d above the 24.845 mb/d output target.



The slightly higher output levels in June reduce the group's compliance rate to around 68% compared with 69% in May.  Compliance rates are based on volume cuts announced for individual countries against OPEC estimates of September 2008 output levels.  OPEC did not assign individual country output targets in the last three rounds of cutbacks but instead published output reduction volumes for each member.  The OPEC Secretariat briefly published country-by-country production targets on its website last September but removed them due to strong objections by some members over their assigned output levels.

The cumulative 4.2 mb/d output reduction target reflects agreements reached at three different meetings last year.  In September 2008 OPEC announced members would rein in 500 kb/d of overproduction, then that it would trim a further 1.5 mb/d from allocated targets implemented on 1 November, and finally at their December meeting in Algeria cut an additional 2.2 mb/d effective 1 January 2009.

The lack of clarity and agreement over formal individual country allocations this past year has led to differing interpretations by some of their target levels, which likely weakens the group's ability to pressure overproducers for better compliance rates.  Overall the group had reduced production by June by 2.9 mb/d compared with the 4.2 mb/d in collective cuts agreed since last September.  OPEC's next ministerial meeting is on 9 September in Vienna to review the market outlook and production levels.

OPEC's effective spare capacity is now estimated at 5.2 mb/d, largely unchanged in May.  Saudi Arabia is on course to ramp up capacity by a gross 1.55 mb/d this year following the start-up of the Khurais, Shaybah and Nuayyim fields in June.  Combined, the new fields will raise Saudi Arabia's installed production capacity to 12.5 mb/d, although reports suggest maintenance at older fields and slow ramp up due to weak demand this year could constrain actual capacity at slightly lower levels.

Saudi Arabia's crude oil production was assessed at 8.2 mb/d last month, unchanged from upwardly revised May levels.  Saudi Arabia's output in May was revised up by 200 kb/d based on data submitted to JODI.  Shipping data indicate export volumes in June were similar to May levels.  After scaling back output below the country's implied target of 8.05 mb/d early in 2009, production levels in three of the last four months were higher.  Even with output above the target level, Saudi Arabia still accounts for almost 45% of the combined cutback in production volumes.

Political turmoil in Iran following the country's national election injected an element of volatility into markets due to security concerns over the major Middle East Gulf supply route.  However, oil production and exports were unaffected given that most of the civil unrest was in urban areas, away from oil installations.  Indeed, Iranian output in June increased by 80 kb/d, to 3.8 mb/d.  June production levels were around 465 kb/d above the country's implied output target of 3.34 mb/d.



UAE output is unchanged over the month at 2.25 mb/d.  The Emirates' production is down 400 kb/d since September, which is slightly more than the targeted 379 kb/d cut called for.  Abu Dhabi notified customers in Asia that crude allocations for July would be maintained at June levels of 18% below contractual volumes for all crudes but a steeper cut of 19% will be in effect for August.

Crude oil production in Qatar was assessed at 780 kb/d in June compared with 760 kb/d for May.  Qatar cut customers allocations of its medium-heavy Marine crude by 4% in May but restored full allocations in June.  Output is expected to decline again in July following a steep cut of 14% in allocations of Marine crude for Asian customers.  Unconfirmed reports said output was down due to unspecified production problems.  To make up for the sharper than expected decline in July, Qatar told customers that they would receive full contract volumes in August.

Nigerian Crude Oil Production Crippled by Increased Militant Attacks

Escalating militant attacks in the volatile Niger Delta region over the past 6-8 weeks have forced the shut in of around 300 kb/d, with total operating output constrained by nearly one mb/d of onshore production currently.  The OMR estimates an additional 500-600 kb/d has been shut in on a quasi-permanent basis due to militant attacks on the country's oil infrastructure, most of which has been offline since the Movement for the Emancipation of the Niger Delta (MEND) launched one of its first major wave of attacks at end-2005 and then again in February 2006.  State-owned NNPC reported on 25 June that 1.4 mb/d of crude oil production was offline.

The upsurge in violence in recent months appears to be in retaliation to the government's latest two-tiered approach to quell militant activity.  In May, the military launched a new offensive against warlords in the key Port Harcourt region and at the same time offered a new amnesty program calling for militants to abandon their fight in exchange for cash payments.  The government also offered to release from prison a prominent leader of MEND.  But MEND rejected the government's offer and has correspondingly increased the level of attacks on the country's oil infrastructure.  There are more than 600 oil and gas fields in the Niger Delta region and adjacent shallow water areas, with the bulk of the fields producing at an average rate of around10 kb/d and approximately 6000 km of pipelines which link production to flow stations and export terminals.  This massive web of infrastructure in remote locations makes it relatively easy for militants to carry out attacks at will and extremely difficult for the military to protect.  The major supply disruptions include the following:

  • Shell, the country's largest foreign operator, reported that production by its joint venture SPDC (NNPC 55%, Shell 30%, Total 10% and Agip 5%) of Forcados and Bonny crude streams has been cut to just 140 kb/d, about half of what the group was producing earlier this year and down from an average 850 kb/d produced in 2008.  Shell has enacted force majeure on Bonny Light and Forcados shipments since last March.  SPDC production capacity is estimated at 1 mb/d.  SPDC's operations include the Bonny and Forcados export terminals, 90 oil fields, 73 flow stations and 8 gas plants.
  • ENI reported 24 kb/d of Brass River crude was offline due to pipeline sabotage on 8 July. This follows the shut in of around 33 kb/d of Brass River crude production due to an attack on a pipeline linking output to the Brass River export terminal.  ENI declared force majeure on Brass River exports on 23 June.
  • Chevron reported on 25 May that militant attacks forced the shut in of 100 kb/d of Escravos production, or about a third of the company's production in the country. Chevron reported that most of the pipelines that move production from offshore operations to onshore have been sabotaged.


Iraqi production increased to 2.5 mb/d in June, up 15 kb/d over May.  Production estimates (measured as exports plus domestic use) for May were revised up by 40 kb/d, to 2.49 mb/d based on higher domestic use of crude.  Domestic crude run at refineries and for power use was pegged at around 580 kb/d for both May and June.

Iraqi exports were up around 20 kb/d, to 1.93 mb/d compared with 1.91 mb/d in May.  Exports from the south averaged 1.42 mb/d last month compared with 1.39 mb/d in May.  Iraqi exports from the north to Turkish Ceyhan terminal on the Mediterranean Sea were down a slight 10 kb/d, to 500 kb/d in June.  Iraq exported about 10 kb/d to Jordan last month.

Angola's crude oil output rose to the highest level in six months, up by 50 kb/d, to 1.8 mb/d.  Production is now almost 285 kb/d above the country's widely reported target of 1.52 mb/d.  Angola has been singled out for consistently ignoring its output allocation. Angolan officials previously have said they believe country's output target should be a higher 1.65 mb/d.

OPEC NGLs

OPEC NGL and condensate projects slated for start-up over the 2009-10 period will add 2.0 mb/d to capacity when output levels reach peak.  Despite the current weak market outlook, the long-lead time expansion projects are moving forward.  Almost all the projects currently slated to come online over the next 18 months have been plagued by delays related to construction, engineering and other technical complications.  A shortage of skilled labour has also slowed the project timelines.  Middle East producers Saudi Arabia, Qatar, Iran and the UAE will provide 90% of the increase while Nigeria accounts for the remaining 10%.

The critical need to boost natural gas output for reinjection at aging oil fields is a key focus for many of the projects.  In the Middle East, a shortage of gas supplies needed to meet rapidly rising domestic demand from the power sector, at desalination plants and for industrial use has also ensured that expansion plans  stay the course.



Saudi Arabia's capacity increases account for 34% of the growth over the 2009-10 period, with peak capacity additions totalling 660 kb/d.  The non-associated Hawiyah NGL Recovery Project will provide about half of the growth, with peak capacity of 300 kb/d reached around 2011. The project's start-up was delayed from 2008 to 2009.  The Khursaniyah gas processing facility has also been overwhelmed with delays and installed capacity of 290 kb/d NGL production is not expected to be operational now until end-2009.  An additional 70 kb/d of condensate capacity is linked to the massive 1.2 mb/d Khurais oil field development, which formally launched in June, 2009.  It is unclear, however, when the new capacity will be fully brought online given Saudi Aramco's challenge of adjusting its surplus crude operating capacity in the current weak demand environment.

After overcoming considerable construction and technical delays, Qatar is on track to ramp up gas liquids by a further 545 kb/d by end 2010 with six projects at the prized North Field.  Major capacity increments are expected from Qatargas Trains 4, 5 and 6 with a combined capacity of 460 kb/d.  Start-up of the Al Khaleej Gas Phase 2 Project (AKG-2), which is being developed as part of the Ras Laffan LNG expansion project, will contribute 40 kb/d to condensate production capacity.  AKG-2 is being developed to supply natural gas to domestic markets while associated condensate and natural gas liquids is for export.

Iran plans to increase its condensate and NGL capacity by about 245 kb/d over the 2009-10 period.  Iran's massive South Pars project has suffered delays and costly overruns but completion of Phases 6-10 is expected to provide the lion's share of the growth in capacity.  The gradual start-up of capacity at South Pars 6, 7 and 8 is key to the country's enhanced oil recovery project at the onshore Aghajari field.  The gas reinjection project is designed to boost output levels by about 100 kb/d but technical issues, the field's age, and challenging corrosive issues with the pipeline, may limit the recovery rate.

Other projects in Iran, such as the Anaran development, are on hold for now. StatoilHydro pulled out of the project earlier this year, in part due to the costly overruns the company suffered during the development of Phases 6-8.

The UAE plans to add around 340 kb/d of installed capacity by end 2010, with start-up of the delayed 270 kb/d Habshan OGD3 processing facilities slated for later this year.

Nigeria's start-up of the Total-operated Akpo gas/condensate project will increase Nigeria's installed capacity by a further 175 kb/d.  The Akpo development came online ahead of schedule, in April 2009. Nigeria's gas liquids capacity will also be augmented this year as production from the Agbami and EA fields, brought online in the second half of 2008, ramp up to peak levels, to 50 kb/d and 40 kb/d, respectively.

The 2010 Outlook for Non-OPEC Supply

Overview

Non-OPEC supply in 2010 is forecast to grow by 410 kb/d to 51.2 mb/d, led by increases in the Caspian region, Brazil (both crude and fuel ethanol), the US, China, India and Australia.  This magnitude of year-on-year growth would bring 2010 approximately in line with 2006 and 2007, the last two relatively hurricane damage-free years.  Total non-OPEC supply declined in 2008 and growth is assumed to be less pronounced in 2009 (indeed, until recent upward revisions, we had assumed a year-on-year decline in 2009).  As is true for the 2009-2014 period highlighted in the 2009 Edition of the MTOMR, net 2010 growth almost exclusively stems from higher NGL and non-conventional output (together +260 kb/d) and global biofuels (+190 kb/d).  Crude output meanwhile shows a more meagre increment (+50 kb/d) and refinery processing gains decline (-90 kb/d), in part as incremental condensate and NGL supplies back out crude throughputs.

The weak non-OPEC profile is a reflection of trends discussed previously in this report, including chronic project slippage and cost inflation.  Indeed, many of the upstream projects expected to start up in 2010 were originally scheduled to commence earlier and have thus slipped into 2010 and beyond.  In addition, the main impact of the financial crisis and economic recession on  oil supply has been to halve oil prices and curb upstream investment.  Beyond unplanned project slippage, we have therefore seen conscious delays or even cancellations, with for example many Canadian oil sands projects such as Algar, Carmon Creek 1, Athabasca 2 and Firebag 3 put on hold.





However, at the time of writing, oil prices continued to hover around $60/bbl, compared with a low of around $35/bbl reached in February 2009, and against a background of ongoing vigorous debate over the timing and pace of economic recovery.  While stronger-than-expected actual 1H09 production data subtly change the baseline supply picture from the one painted in the June 2009 MTOMR, it remains the case that non-OPEC supply growth, and conventional crude in particular, faces the prospect of stretched lead times and still slower growth in the medium term.



OECD

OECD oil supply is forecast to decline in 2010, albeit at a slower pace than in 2008 and 2009, now contracting by 170 kb/d to 18.9 mb/d.  Assuming a five-year average hurricane impact, total North American supply is set to grow by 125 kb/d in 2010, in strong contrast to 2008's hurricane-affected decline of 360 kb/d, and modest expected growth of 50 kb/d in 2009.  The US is expected to see a total increase of 180 kb/d as new fields in the Gulf of Mexico come on stream or ramp up production.  These include first oil from Chinook/Cascade, Droshky and Thunder Hawk, as well as increased output at Great White, Marlin, Perdido, Shenzi, Tahiti, and the full ramp-up at Thunder Horse, amongst others.  NGL and biofuels output will also increase in 2010.  In contrast, oil production in Alaska, California, Texas and other Lower-48 will see continued decline.



In Canada, total oil sands production, including both in-situ output and production from mining operations, should prove one of the larger contributors to overall non-OPEC supply growth, growing by 140 kb/d in 2010.  This should help to offset decline in conventional crude, with total Canadian supply increasing by 90 kb/d, an improvement from overall declines in 2008 and 2009.  Total 2010 oil output is expected to reach 3.27 mb/d.  Oil supply in Mexico will contract by 150 kb/d to 2.81 mb/d in 2010, as a sharp decline at key mature fields, notably Cantarell, fails to be offset by attempts to increase output at Ku-Maloob-Zaap (KMZ), now Mexico's largest producing field, and a gradual rise at the onshore Chicontepec complex.

OECD Europe production is forecast to decline by a sharp 360 kb/d to 4.08 mb/d in 2010, its steepest contraction since 2006, though on a similar trend.  Oil production in the UK is forecast to fall by 180 kb/d to 1.32 mb/d in 2010.  Despite some new field start-ups in 2009 and 2010 such as Brodgar & Callanish, Chestnut, Curlew, the Don satellites, Emerald, Ettrick, Grant, Grouse, Maria and Perth, steady decline in the mature basin appears unavoidable.  Norway is a similar story, with total output set to fall by 160 kb/d to 2.08 mb/d in 2010.  While decline rates in general are not quite so steep, the list of new start-ups is shorter, including Tyrihans, Vilje/Klegg and Yme.  Other OECD Europe is forecast to see small contractions across the board, with total production falling 30 kb/d to 680 kb/d.



Oil production in the OECD Pacific should rise by 70 kb/d to 740 kb/d in 2010.  Australia is set to see a sizeable increase of 50 kb/d, with ramp-up at Angel and Puffin increments, and start-ups at Pyrenees and Van Gogh offsetting decline elsewhere.  NGL output is also expected to increase in line with increased gas production.  Total 2010 oil supply should reach 620 kb/d, its highest since 2002.  New Zealand will also see output increase, by 20 kb/d to 90 kb/d, as the Maari and Kupe fields ramp up and add new crude and condensate production respectively.

Non-OECD

Non-OECD countries, in contrast to the OECD, will see total oil supply rise by 600 kb/d to 29.7 mb/d.  Regionally, most growth stems from Latin America, largely due to higher Brazilian crude and fuel ethanol production, but individually, Azerbaijan is set to see the highest increase in oil production.  FSU production should rise by 210 kb/d, while output in China and Other Asia will grow by around 100 kb/d each.  Africa and the Middle East in contrast will see production dip by 30-40 kb/d.



Total FSU supply is forecast to rise by 210 kb/d to 13.2 mb/d in 2010, with increases in Azerbaijan and Kazakhstan of 280 kb/d and 75 kb/d respectively offsetting a decline of around 150 kb/d in Russia.  For a discussion of Russia's production outlook, see below.  Azerbaijan, which was hit by problems at its offshore Azeri-Chirag-Guneshli (ACG) fields in late 2008, is expected to see a return to full output and more in 2009 and then another 300 kb/d increment at ACG in 2010, offsetting small declines from mature onshore areas.  Total production is seen at 1.33 mb/d in 2010, thus showing the largest single-country increase in 2010.  Oil production in Kazakhstan is set to increase by 75 kb/d in 2010, reaching 1.55 mb/d, with steady increases at the large Tengiz and Karachaganak  complexes.

Russia:  Strong 1H2009 Performance Prompts Upward Adjustment

Six consecutive months of higher-than-expected production from Russia have prompted us to revise up our forecast for the rest of this year and 2010 by 110 kb/d and 260 kb/d respectively.  Widespread pessimism surrounded prospects for Russian supply at the turn of the year and early signs of higher output data were seen as potentially temporary due to new field start-ups and other factors.  But half a year's worth of data paints a picture of rather more robust production for the whole of 2009.

class="Box">Some of the factors earlier envisaged as restraining Russian oil production have changed.  The fiscal environment has relaxed slightly, with lower and more frequently calculated export duties, but also tax breaks for some new fields and other incentives perhaps in the offing.  The pick-up in oil prices from February has clearly helped, as has the weaker rouble, encouraging exports and strengthening the impact of cost reductions.  Most importantly, new fields, including Lukoil's Yuzhno-Khylchuyuskoye, TNK-BP's Uvat expansion and increments at Sakhalin 1 and 2, have undoubtedly contributed to the higher production levels reported so far this year, having built up more rapidly than originally expected.  Indeed, with the exception of Yuzhno-Khylchuyuskoye, which has reportedly already nearly reached its capacity of 150 kb/d, the other fields may yet contribute even more growth.  Significantly, Rosneft's imminent start-up of its huge Vankor project should add more crude in the second half of the year.  As a result, we have boosted the production forecast for these companies, but remain more downbeat on some others.

The result is that Russia is now expected to see a small increase in output in 2009 of around 30 kb/d to 10.03 mb/d, compared with a decline of 80 kb/d we had assumed in the last report.  Trend-wise however, we still foresee a dip towards the end of the year as the winter stoppages kick in and the above-mentioned new fields reach capacity (excepting Vankor, expected to reach peak capacity around 2015).  For 2010 we also remain more cautious, anticipating a decline of 150 kb/d to 9.88 mb/d, though this also represents a less sharp contraction from a higher base.

Russian oil production trends will remain difficult to predict.  There is huge uncertainty about the likely direction of oil prices as well as much-discussed changes to the fiscal and legal environment in Russia.  It is possible that attitudes towards foreign investors are changing, though this also remains far from certain (see On Russia and the IOCs).  Some more large upstream projects are mooted besides Vankor, notably other fields in Eastern Siberia to fill the Eastern Siberia-Pacific Ocean (ESPO) pipeline.  More generally, Russia still has much potential to hike output; beyond greenfield start-ups, increased drilling, the application of new technology, enhanced oil recovery (EOR) and satellite developments could all serve to boost production.  Importantly, export infrastructure, once considered an obstacle to further growth, should no longer be an issue, if all planned pipeline expansions come on stream as planned (a detailed discussion of various FSU export pipeline projects is included in the 2009 Edition of the MTOMR).

In other words, our cautious stance notwithstanding, there is arguably more potential upside to Russian oil production than in many other countries currently experiencing a plateauing of output.  Given Russia's current position as the largest oil producer in the world, but also taking into account all the uncertainties listed above, there is arguably also more downside risk to Russia's oil production profile than in many other producers.

Total non-OECD Asia including China is expected to see oil supply increase by around 200 kb/d to 7.7 mb/d in 2010.  Around half of this growth stems from China, where production will rise to 3.94 mb/d on steady increases from newer offshore production, notably a doubling of output at the Penglai complex to 120 kb/d.  Coal-to-liquids (CTL) output will also increase by around 40 kb/d, while production at older, mature fields such as Daqing, Shengli and Liaohe will dip.  Another source of growth in Asia is India, where the imminent start-up at a group of fields in Rajasthan, including Mangala, Bhagyam and Aishwariya (the latter two albeit only contribute towards the end of 2010) will boost output by 90 kb/d in 2010.  This offsets decline elsewhere and contributes to a 70 kb/d rise in 2010 to 870 kb/d total output.  Indonesia should also see total oil production rise by around 50 kb/d to 1.07 mb/d in 2010, with increments at the Cepu, Bukit Tua, North Belut and Chevron's steam flood project at North Duri.  Lastly, the inclusion of consolidated, annual data for Pakistan has lifted its baseline output by around 15 kb/d.

Oil supply in Latin America is forecast to rise 280 kb/d to 4.69 mb/d in 2010, almost wholly due to increases in crude and fuel ethanol production in Brazil.  There, crude output is set to grow by 225 kb/d to 2.2 mb/d, while ethanol production should increase by 55 kb/d (and NGLs by 5 kb/d).  Higher output will stem from ramp-up at several recent offshore platform additions, including Frade, Jubarte, Marlim Leste and Marlim Sul 2, Parque das Conchas and the Tupi pilot, the first pre-salt development.  Total Brazilian total liquids supply will reach 2.81 mb/d in 2010, thus remaining one of the most promising areas of increasing non-OPEC production.  Most other countries in Latin America are expected to show little change in 2010, but inclusion of annual data for NGLs in Argentina and total oil supply in Cuba see baseline revisions of around +20 kb/d and -5 kb/d respectively.

In Africa, total oil supply will see a decline of around 30 kb/d to 2.47 mb/d in 2010.  Sudan, Mauritania and Gabon will increase production by 20 kb/d, 15 kb/d and 10 kb/d respectively, not quite offsetting declines in Equatorial Guinea (-35 kb/d), Egypt (-30 kb/d) and Chad (-10 kb/d).  Revisions to historical data include downward adjustments to Ivory Coast and Gabon of around 30 kb/d and 20 kb/d respectively, while baseline production in Tunisia was raised by around 15 kb/d.

Lastly, total oil production in the non-OPEC Middle East will dip by 40 kb/d to 1.57 mb/d in 2010.  This is almost wholly due to a 35 kb/d decline in output in Syria, where production will slide to 335 kb/d in 2010.  While oil supply from Oman is not expected to change significantly in 2010, we have now adjusted output there to match data from the Joint Oil Data Initiative (JODI), which causes an upward adjustment of around 25 kb/d for 2007 and 2008 and a baseline rise of around 60 kb/d for 2009 and 2010.

FSU Exports

FSU net exports rose for a third consecutive month to an all-time high of 9.64 mb/d in May, supported by increases in both crude and product exports.  Higher BTC and Druzhba pipeline volumes were partly offset by lower Baltic shipments and CPC deliveries, the first affected by Primorsk pipeline maintenance and the latter by work on the Tengiz field in Kazakhstan, the main source of crude for the CPC pipeline.  Druzhba volumes were up by 3.1% as Russian oil companies resumed flows to Germany and Poland after earlier trading disputes.  Product exports increased by 4.9%, backed by higher fuel oil, gasoil and gasoline exports following the end of the refinery maintenance season in Russia.

Oil exports in June and July should approach seasonal levels as an export volume drop is expected on all routes due to lower loading schedules, planned maintenance on Russian pipelines during the summer and an increase in Russian oil export duties.  In July, the crude oil export duty will stand at $212.6/mt ($29/bbl), up almost 40% from $152/mt ($20.7/bbl) in June.  The export duty for light and heavy oil products is $155.5/mt and $83.8/mt, up from $115.2/mt and $62.2/mt, respectively.

On Russia and the IOCs

Recent weeks have seen some signs of what might be a thawing in the attitude towards International Oil Companies' (IOCs) gaining upstream access in Russia.  On 24 June, Total announced that it had signed an agreement for a 49% stake in exploring and developing Novatek's Termokarstovoye gas field in West Siberia.  In itself this is a modestly sized project; however the partnership with Novatek could be valuable, with Total eyeing the prospect of cooperation on an LNG project for the massive South Tambey gas field.  A few days later, on 27 June, Prime Minister Putin offered Shell the possibility of the operatorship for Sakhalin 3 and Sakhalin 4.  Both IOCs are apparently also seen as potential candidates for the huge Yamal LNG project, and Total is hoping for an enhanced role in the later phases of the giant Shtokman offshore gas development, where phase 1 is due for its final investment decision in 2010.

Should all that happen, it would mark a new leaf in the saga of Russia and the IOCs.  For several years Russia tightened its grip on national resources by putting pressure on IOC partners, while tempering the appetites of others with a generally hostile investment climate.  A recent row between ExxonMobil and the Russian government concerning the Sakhalin 1 project's budget for 2008 and 2009 delayed the start-up of the Odoptu and Arkutun-Daginskoy fields with a combined 300 kb/d crude capacity by at least a year, before an agreement was reached in April this year.  This led to fears that the Russian government's aim was ultimately to take on a larger share of the PSA, or even squeeze out Exxon - somewhat similar to Sakhalin 2, where Shell and Japan's Mitsui and Mitsubishi were forced to relinquish parts of their share and Shell's operatorship in favour of Gazprom in late 2006.  That same year Total looked as if it might lose its production license on the third Russian PSA, the Kharyaga field, and in 2008 BP saw the edging out of its appointed CEO in its joint venture with TNK, and even expropriation worries over its ownership share in TNK-BP.

Resource nationalism tends to coincide with tighter markets and higher prices, while a downswing in the cycle can encourage more open access and receptive investment policies, particularly among countries struggling to sustain overall production.  Russia has been hit harder than most by the economic recession and lower oil prices, and a lack of investment has caused project slippage and more rapid decline from mature fields.  In times when loans are difficult to obtain, foreign direct investment might seem more attractive.  IOCs are keen to get access to Russia's much-prized reserves and in return offer to help the resource giant realise more of its production potential.  Russia could benefit from IOC expertise in helping to stem mature field decline, develop LNG and other complex vertically integrated projects.

Russian companies have also recently shown an increased appetite for overseas deals.  A few days before Total closed the Novatek deal it had secured a 45% ownership share for Lukoil in the French major's Vlissingen refinery in the Netherlands.  Furthermore both Total and Shell have made tentative offers to Russian companies to join them in various African projects.  The IOCs and Russia in theory have a lot to offer each other, but it remains to see if recent developments really do herald a change in attitude.  IOCs in any case will probably still factor in  substantial country risk when evaluating investments in Russia.





Elsewhere, construction work on the Baltic Pipeline System 2 (BPS-2), from Unecha, a junction on the Druzhba pipeline near the Belarusian border, to the Russian Baltic port of Ust-Luga, started in June.  Transneft will issue bonds worth Rbs135 bn (US$ 4.3 bn) to cover the construction of the line, which will have an initial capacity of 600 kb/d.  Pipeline capacity will be later boosted to 1 mb/d and, if Transneft and Surgutneftegaz agree on financing, a spur to the latter's Kirishi refinery should also be built.  (A detailed discussion of various FSU export pipeline projects is included in the 2009 Edition of the MTOMR.)

Other Sources of Supply Growth - Biofuels

After a 2009 in which annual growth slows to only 60 kb/d, global biofuels production in 2010 should increase by 190 kb/d.  Almost 40% of this growth stems from US ethanol, which we see expanding by 75 kb/d to 730 kb/d.  Despite near-term hardships and poor margins faced by operators, industry restructuring continues and some plants are being restarted - e.g. Valero is running six of the seven ethanol plants it acquired from bankrupt VeraSun and plans to start the seventh one in July.  The US Renewable Fuels Standard, which requires the blending of 780 kb/d of conventional ethanol in 2010, provides a production floor and improving margins may emerge with next year's US summer driving season.

Brazilian ethanol accounts for 30% of 2010 growth as it is expected to rise 55 kb/d, predicated on continued capacity expansion.  Yet, persistently high sugar prices, which induce switching away from ethanol production, and slower capacity expansion have led us to temper 2009's expected growth to 40 kb/d from a previous 60 kb/d.  After a difficult 2009, European biodiesel production should rise 20 kb/d in 2010 as blending targets continue to increase.  Still, we doubt whether domestic production alone can help the EU meet its target of 5.75% renewable fuels in the transport pool for next year.

OECD stocks

Summary

  • OECD industry stocks rose seasonally by 27.8 mb in May to 2,768 mb, as a decline in crude and gasoline stocks only partially offset an increase in distillates and 'other products'.  All three regions posted inventory gains, though the bulk of the increases came in North American 'other products', European crude and Pacific distillates.
  • OECD stocks in days of forward demand increased to 62.5 days at the end of May from 62.3 days at the end of April, with rising stocks and downward OECD demand baseline revisions outweighing a seasonal increase in demand.  On a days cover basis, gasoline stocks remain closest to normality with total OECD, North American and European inventories trending at or just above the five-year average.
  • Preliminary June data indicate total OECD industry oil inventories rose counter-seasonally by 12.2 mb, led by gains in US product stocks.  US total stocks rose 9.9 mb and principal products gained 14.6 mb as gasoline and distillate increased by 9.6 mb and 7.2 mb, respectively.  Japanese stocks fell 5.5 mb as product draws of 9.8 mb outweighed a crude build of 4.3 mb.  Euroilstock data show EU-16 inventories rose 7.8 mb with products and crude increasing by 6.7 mb and 1.2 mb, respectively.
  • Short-term crude floating storage levels continued to fall steadily to around 60 mb by end-June from 85 mb at end-May.  Yet, products short-term floating storage - mostly middle distillates off Europe - increased to almost 50 mb at the end of the month from 30 mb the previous month, with some reports indicating levels as high as 60 mb during mid-June.


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

Total OECD commercial inventories rose seasonally by 27.8 mb in May to reach 2,768 mb.  Over the past five years, the May total oil inventory build has normally been the largest of the year, averaging over 48 mb, with crude and middle distillates typically posting monthly gains.  However, this year's stock change is marked by larger than normal draws in crude as North American refineries increased their intake to take advantage of rising gasoline cracks.  These draws occurred despite the shedding of 30 mb of short-term crude floating storage globally during the month as contango in the crude futures curve narrowed.



As a result, the gap between OECD crude stocks and the five-year average continued to narrow to, an albeit still lofty, surplus of 44 mb, down from over 60 mb in April.  By contrast, the middle distillate surplus to the five-year average remained over 80 mb with a short-term floating storage position that grew during the month.  Preliminary June data suggest a continuation of these trends.  Meanwhile, gasoline stocks, whose deficit to the five-year average grew in May to 14 mb, may have stabilised in June with preliminary data pointing to a counter-seasonal rise of 14.6 mb.

Still, May's stock change is dominated by a 24.8 mb build in the 'other products' category in the US.  As noted previously, this category includes a wide range of products - naphtha, liquefied petroleum gases, petroleum coke, white spirits, lubricants, bitumen, and others - subject to a high degree of revisions, which may ultimately result in a more modest May products build than the provisional headline number indicates.  Over the past twelve months, the US 'other products' category has experienced monthly revisions ranging from an upward adjustment of 10.9 mb in September 2008 to a downward move of 13.3 mb in October 2008.



Indeed, 'other products' stocks in April experienced the largest revision of any category as US levels were revised down by 10.4 mb.  By comparison, total OECD industry stocks were revised down by 12.4 mb for the month.  North America contributed most strongly to the April revisions.  In addition to the change in 'other products', US crude was revised down by 10.3 mb and Canadian crude was revised up by 5.3 mb.

Analysis of Recent OECD Industry Stock Changes

OECD North America

North American industry stocks rose by 16 mb in May as a large gain in US 'other products' stocks (+24.8 mb) outweighed draws in crude and gasoline.  An examination of US weekly data underpinning the May stock change shows that 25% of the 'other products' rise can be accounted for by increases in propane stocks.  The remainder, however, falls under the US Energy Information Administration's (EIA) 'other oils' moniker.  EIA estimates these levels (they are not reported in weekly surveys), which include an opaque range of naphthas, NGLs, light/middle distillates and residuals.  US monthly crude stocks decreased for the first time since July 2008, by 11.2 mb, as imports fell and refinery runs increased to take advantage of higher gasoline margins.  Filling of the US Strategic Petroleum Reserve (SPR) increased government crude holdings by 2.9 mb.  Mexican industry stocks rose 1.5 mb as crude increased 2.7 mb, more than offsetting a gasoline fall of 1.1 mb.



June preliminary weekly EIA data point to a 9.9 mb build and the highest US total industry stocks since September 1990.  US industry crude stocks fell by 16.2 mb, as refinery runs continued to increase and imports remained low.  Despite evidence of some short-term crude floating storage discharge, US crude stocks drew down faster than the five-year average change.  Government crude holding increased by a further 2.3 mb, but the SPR filling rate is now expected to stay at zero until September.



Product stocks jumped 26.1 mb in June with gasoline showing a counter-seasonal gain of 9.6 mb and distillate increasing by 7.2 mb.  Higher refinery output of gasoline as well as somewhat healthier imports helped gasoline stocks return to above five-year average levels by month-end.  US diesel stocks continue to be buoyed by consistently low distillate demand readings.  Principal product stocks (gasoline, distillate, jet/kerosene, residual fuel oil) accounted for just over half of the products build, though, as they rose 14.6 mb.  More volatile categories such as propane (+9.8 mb) and 'other oils' (+3.8 mb) continued to constitute a significant portion of the monthly change.

OECD Europe

European inventories rose by 10.4 mb in May, mostly due to an 8.2 mb increase in crude inventories.  Product inventories rose by 3.4 mb as distillate increased 2.3 mb, residual fuel rose 2.0 mb and gasoline fell slightly.  The region's healthy distillate buffer continued to grow as primary stocks increased in parallel with German consumer heating oil stocks.  End-May readings showed that capacity fill levels increased from 62% at end-April to 63% (a 2.0 mb build).  This puts German consumer heating oil stocks fill levels almost twenty percentage points above May 2008 levels and already higher than the five-year average reading for October, the beginning of the heating season.  In addition, a sizeable amount of distillate floating storage remains offshore.

European gasoline stocks continued to trend well below the five-year average on an absolute basis in May, but have increased above the five-year average on a days of forward cover basis.  Atlantic Basin arbitrage opportunities provided a destination for European gasoline supplies in the early part of June, but weakening US gasoline margins in the later part of the month caused this outlet to contract.  The balance between more limited export opportunities to the Middle East and domestic refinery problems in Nigeria, another export destination, may influence the gasoline stock position ahead.



Indeed, June preliminary data showed gasoline stocks held in NW Europe independent storage rising on the month back to five-year average levels.  Overall product stocks fell slightly on the month, with gasoil and residual fuel oil posting declines.  Preliminary data from Euroilstock indicate EU-16 inventories also posted a gasoline increase, with levels rising by 5.1 mb in June.  Overall products rose by 6.7 mb and distillate stocks grew by 2.7 mb while EU-16 crude stocks edged up by 1.2 mb.

OECD Pacific

Pacific industry stocks increased by 1.4 mb in May, as a rise in products more than offset a decline in crude.  Product stocks rose 5.0 mb on the back of a 6.2 mb rise in distillates.  Gasoline and residual fuel oil both posted small decreases of 0.8 mb and 0.5 mb, respectively.  Crude declined by 5.4 mb.





Japanese weekly data from the Petroleum Association of Japan point to a commercial stock draw of 5.5 mb for June with crude rising by 4.3 mb and products falling by 9.8 mb as refinery runs remained at historically low levels.  Gasoil and naphtha stocks fell by 2.4 mb and 2.1 mb, respectively.  Gasoline changed little and kerosene built by 1.2 mb.

Most major product categories stand at or above the five-year average.  Naphtha stocks, the exception, are running at three-year lows on an absolute basis, but look healthier than last year's readings on a days cover basis.  Despite overall weak refinery utilisation, onshore crude stocks continue to trend in the bottom half of the five-year range.

Recent Developments in Singapore and China Stocks

Singapore product stocks expanded in June by almost 4 mb to reach new five-year highs as all product categories increased.  Light distillate stocks rose by 1.4 mb and middle distillate stocks increased by 1.6 mb.  Residual fuel oil inventories rose by 0.9 mb.



China crude oil stocks reported by China Oil Gas and Petrochemicals (OGP) increased by 1.1 mb (35 kb/d) in May as an increase in crude net imports to their highest level since March 2008 offset higher monthly refinery runs.  At 284 mb, end-May crude stocks stood 25.7 mb (10.0%) above levels of a year ago.

Evidence of product destocking continued as Sinopec and Petrochina reported their gasoil inventories decreasing by 4.0 mb, despite still strong net imports, and gasoline stocks staying level on the month.  Yet, an anticipated rise in retail product prices at the end of May likely contributed to 'social storing', the practice of stockpiling by wholesalers and retailers as described by OGP.  May marked the fifth consecutive month of measurable product draws.  At 57.0 mb, combined gasoline and gasoil inventories stood 11.3 mb (24.7%) above levels of a year ago.





Prices

Summary

  • The four-month rally in oil prices stalled in mid-June.  Economic optimism consistently overshadowed anaemic oil supply and demand fundamentals in the first half of the year.  The upward price path, however, reversed course by mid-June as expectations for a recovery in the global economy receded further into the future and hopes for a more normal peak gasoline season faded.
  • Supply and demand data only partially explain price moves this year as oil futures have also tracked the upward momentum in equity markets and a weakening dollar.  Prices for WTI and Brent rose on average by almost $11/bbl last month, to $69.70/bbl and $69.27/bbl, respectively.  However, growing concerns about the path of economic recovery forced traders to focus on the persistently high oil stocks and collapsing demand and, by early July, benchmark crude prices plunged to eight-week lows, last trading in a range of $60-62/bbl.
  • The deep recession in the US has undermined the beginning of the much-anticipated summer gasoline season.   Moreover, the sharp downturn in global economic activity is having the greatest impact on distillate use, with industrial and transport demand hard-hit in all the major consuming regions.  With the gasoline season disappointing so far, swelling stocks of distillates have cast a cloud over the market outlook for 3Q09.  A marked increase in refinery throughput rates to maximise gasoline output for the summer made a dent in the global crude inventory surplus, but also translated into a corresponding build in stocks of refined products.
  • Refinery margins steadily eroded after mid-month as product price were outpaced by double-digit increases in crude oil prices.  Higher throughput rates by US, Asian and European refiners largely translated into growing stockpiles of refined products, especially middle distillates, depressing refining margins across all the regions.


Overview

Prices for benchmark crudes scaled eight-month highs by mid-June, with WTI trading over $72.50/bbl, fueled largely by robust gasoline markets.  But the upward price path slowed markedly as June progressed and reversed course by mid-month as hopes for a more normal peak gasoline season faded and the realisation that a recovery in the global economy remained elusive.

Futures prices for WTI and North Sea Brent rose on average by almost $11/bbl last month, to $69.70/bbl and $69.27/bbl, respectively.  A sharp increase in gasoline crack spreads ahead of the peak summer driving season in North America and increased demand for spot crude as refiners came out of turnaround supported prices early in June.  A flurry of new forecasts by some investment banks raising their price outlooks for this year and 2010 also appears to have helped fuel the rally.

A year ago, futures prices for WTI reached a milestone when they closed at $145.29/bbl on 3 July.  After sliding almost 75% to a low of $34/bbl in February, prices more than doubled to over $72/bbl in mid-June.  Unlike last July's runaway escalation in prices, the realty of a more persistent global economic downturn appears to have put the brakes on this year's otherwise at times perplexing rise in prices.

By July, prices were some $10/bbl lower than average June levels as the deep recession in the US undermined the beginning much-anticipated summer gasoline season and economic optimism gave way to a cloud of pessimism.

Heightened political tensions in Iran and an escalation in militant attacks on Nigeria's oil infrastructure initially tempered the downturn.  Yet a steady rise in OPEC crude supplies and increased spare OPEC production capacity then dampened supply worries over Iran and Nigeria and added further downward pressure on prices.  Crude oil production by OPEC members rose for the third month in June, up 75 kb/d to 28.68 mb/d. Indeed, the latest concerns over Nigerian and Iranian oil supplies may have had the unintended consequence of focusing traders' attention on substantial increases in OPEC production capacity planned for this year and next (see OPEC Supply).

However, supply concerns were overshadowed by growing worries over the pace and depth of a recovery in global economic markets.  The bullish market sentiment in financial markets turned decidedly weaker as a steady stream of worse-than-expected economic data and talk of 'green shoots' being overdone intensified.  Despite more positive reports from international organisations such as the IMF and OECD for an economic recovery, when the US government issued an exceptionally negative labour report this acted to deflate some otherwise positive expectations.  The World Bank's downward revision for GDP growth in a number of developed countries also struck a chord.



Non-commercial players have increasingly linked their portfolios to oil markets as a hedge against fears of mounting inflationary pressures and the weaker dollar this year.  Latest CFTC data show non-commercial investors hold long-positions equivalent to 600 mb in June, up around 30% since the start of the year.

Investment funds were initially betting that an economic recovery would take hold by the second half of the year. While some analysts see this adding upward momentum to oil prices in recent months, the correlation between price shifts and non-commercial net positions remains tenuous at best.  Some analysts argue even a bleaker economic outlook holds a silver lining since oil-linked indices are also a tool to hedge against inflation and a weaker dollar.  But that argument may be moot as concern about inflationary pressures and a relatively stronger dollar may prompt investment funds to reduce their positions in oil markets.

Spot Crude Oil Prices

Spot crude oil markets moved higher earlier in the month on brisk buying by refiners ahead of the gasoline season.  Both light and heavy crudes posted month-on-month increases of around $9-$12/bbl.  US and Asian refiners made a dent in the huge crude inventory overhanging the market by cranking up refinery runs but the higher throughput rates largely translated into higher stock levels of refined products.  Despite the crude drawdown, oil stocks remain at stubbornly high levels.  OECD oil inventories were estimated at 62.5 days of forward cover as of end-May.  Short-term floating storage of both crude oil and refined products are estimated at more than 110 mb by end-June.

By mid-month crude markets tracked the downturn in gasoline markets as refiners scaled back runs amid weakening refining margins.  Prices for sour crudes, including Dubai, Mars Blend in the US and Russian Urals, maintained their relative strength, supported by lower OPEC  output of similar sour grades.



Spot prices for Urals in both Northwest Europe and the Mediterranean were higher due to reduced export volumes in June and indications are July shipments will also be down.  Lower exports reflect a sharp 40% increase in Russian oil export duties in July (see FSU Exports).



OPEC's cutback of heavy and medium sour crudes has supported spot prices for similar grades in recent months.  The shifting market sentiment saw the light versus heavy differentials narrowing by mid-June.  Despite the rise in refinery runs in June, demand for heavy crude oil was lower due to reduced runs of coking units. The spot price differential for Brent and Iranian Heavy plummeted to just around $0.50/bbl by early July from over $2/bbl in June and a peak of over $5/bbl back in January.



Spot crude prices in Asia were relatively stronger than US and European markets, in part because refiners there have borne the brunt of OPEC supply cutbacks.  Prices were also supported by incremental Chinese buying for the country's stockpiles as well as increased refinery runs.  Increased Chinese crude demand was partly offset by reduced purchases by Japanese and Korean refiners who are awash in crudesupplies.



Militant attacks on Nigeria's oil infrastructure in June and early July initially alarmed markets, but the impact was muted by bloated crude inventories both onshore and offshore.  Escalating attacks by the Movement for the Emancipation of the Niger Delta (MEND) over the past six weeks have forced Chevron, Shell and ENI to shut in a further 275 kb/d.  Total Nigerian production shut-in is estimated at more than one mb/d. Despite the loss of supplies, spot prices for Nigerian crudes eased as refiners shyed away from gasoline-rich crudes.

Spot Product Prices

Spot prices for refined products rose on hopes of a stronger summer driving season in the US this year triggering a sharp rise in gasoline crack spreads and raised expectations for an overall improvement in demand fundamentals.  Overly ambitious refiners ended up flooding the market with unwanted gasoline supplies in all major regions. Equally important, in the process refiners glutted the market with distillate fuels, especially in Europe.

With US retail gasoline prices averaging over $2.50/bbl ahead of the key 4 July holiday, battered consumers defied expectations, with demand for transportation fuels weaker than expected.  Spot gasoline prices in New York Harbour fell from a high of $86.23/bbl on 16 June to $70.85/bbl by 7 July.  Preliminary June data show US demand down 1.5% from last year's already exceptionally weak levels.

The US gasoline market provided central support for the products complex on a global basis in May and June so the impact of the falloff has had far-reaching repercussions for Europe and Asia.  Mirroring the downturn in European gasoline demand, off 4.1% in June, spot prices in Northwest Europe slid from a high of $88.14/bbl on 16 June to $70.30/bbl on 7 July.  Spot prices for gasoline in Singapore were down a relatively more modest $9/bbl, from a 16 June level of $78.53/bbl to $70.63/bbl by 7 July.



The downturn in economic activity is having the greatest impact on distillate demand, with industrial and transport demand for diesel particularly hard-hit. Jet fuel and gas oil demand have not done much better, especially in the US and Europe.  Gas oil stocks in OECD Europe are above the 5-year average.  The steady flow of middle distillates from the US to Europe and Latin America have also ended up in stocks, some of this offshore.



Lacklustre industrial and transport demand coupled with higher refinery throughput rates in June led to a glut of middle distillates, with stocks at both the secondary and tertiary level ballooning.  Much of the near 50 mb of products in floating storage is reportedly sitting offshore Europe.  The steep distillate contango and cheap tanker rates encouraged traders to lease onshore tanks or floating storage to stockpile excess fuel in expectations of better demand in the 2H09.  With storage levels brimming, fears are growing that Europe's record inventories of distillates could trigger another sharp downward correction in oil prices in coming months.

Middle East refiners provided pivotal support to distillate markets in recent months as they sought to augment supplies ahead of their peak summer cooling period and while refinery operations were curtailed for seasonal turnaround. That incremental buying has now disappeared, with stocks reportedly more than ample and refineries are coming back on line.



Refining Margins

In June, refinery margins mostly decreased as product price gains could not compensate for the two-digit crude oil price increases. Exceptions to this were coking margins for which high distillate yields coupled with distillate product price increases were enough to outweigh crude oil price rises. The other exceptions were China's Daqing hydrocracking and hydroskimming margins as a relatively low crude price increase allowed for a margin improvement.  Cracking margins worsened across the board as the increase in residual fuel oil prices this month could not compensate for lower distillates yields when compared with coking configurations.

As in last month's report, simple refining configurations were the worst affected. Hydroskimming margins now dive deeper between -$2.20/bbl for Brent in NW Europe and -$8.15/bbl for Cabinda crude in China, with Mediterranean margins at -$5.48/bbl on average.  Most probably, this lack of profitability will weigh on refinery crude runs and bring some pressure on crude oil prices as product demand remains constrained.



In the US Gulf Coast, upgrading margins decreased during the second half of the month. Comparing coking to cracking configurations, coking provide higher distillate yields at the expense of residual fuel oil yields, so comparatively speaking, a decrease in distilate prices will have a greater impact on coking than on cracking configurations. In June, gasoline prices fell during the second half of the month thus affecting coking configurations harder. Besides this, residual fuel oil prices increased, which favours cracking relative to coking. In Europe, upgrading margins decreased in the second half of the month as well, as gasoline prices fell, affecting cracking margins more than hydroskimming margins.



End-User Product Prices in June

End-user product prices on average increased by 12.9% in June, in US dollars, ex-tax.  The surveyed IEA member countries saw a 15.5% hike in gasoline prices, month-on-month, with the highest increases of around 19% in the USA and Germany.  Consumers in the US on average paid $2.63/gallon ($0.694/litre) for gasoline, in Japan ¥121.0/litre ($1.244/litre), in the UK £1.01/litre ($1.651/litre) and in Europe, prices ranged from a low of €1.035/litre ($1.457/litre) in Spain to a high of €1.336/litre ($1.881/litre) in Germany.  Both diesel and heating oil prices on average rose by 10% and low-sulphur fuel oil price increased by 16.1%, in US dollars, ex-tax.  End-user product prices were 43.0% below June 2008 levels.

Freight

In June, dirty freight rates improved with a tightening tanker supply-demand balance, even as short-term floating storage decreased by about 25 mb.  Decreases in early-July rates have eroded some of the gains.  Still, a significant portion of the dirty tanker fleet continues to store crude, and a few VLCCs have been chartered to store products.  As of early-July, almost 30 VLCCs were being used for short-term floating storage.

Middle East Gulf to Japan VLCC rates rose from their 2009 lows of around $5.50/mt at the end of May to over $11/mt at the end of June.  This doubling of rates significantly improved spot daily earnings for ship owners in the face of rising bunker fuel prices.  The increase reflected several factors, including greater enquiries for Middle East liftings, higher demand for bunker fuel in Asia, healthier East-West fuel oil trade and tightening vessel supply.  Still, rates in the second half of the month into early July failed to sustain the upward momentum seen in the first half of the month given continued overall market weakness.  Early-July rates have fallen back to under $10/mt.

West Africa to US Atlantic Coast rates showed similar early-month buoyancy, rising from around $8.50/mt at end-May to over $17/mt in the second half of June.  Gains on this route proved more ephemeral though, as early July rates retracted to back under $12/mt as militant attacks in Nigeria curbed exports.



Clean rates displayed more of a mixed pattern, with routes to Asia showing more upward momentum than transatlantic trade.  Increased products short-term floating storage provided overall support, as levels rose from 30 mb at end-May to almost 50 mb by end-June.  Middle East Gulf to Japan Aframax rates rose from around $16/mt at end-May to over $21/mt by end-June.  Early-July rates have retracted slightly, to just over $20/mt.  Despite an end-month uptick, Northwest Europe to US Atlantic Coast medium-range (MR) rates generally declined in June.  They fell from over $17/mt at the end of May to around $15/mt at end-June as transatlantic gasoline trade waned and the Middle East tempered its demand for European gasoline cargoes.  Early-July rates stood at just over $15/mt.

Refining

Summary

  • Global 3Q09 crude runs are revised down by 0.5 mb/d to just 72.3 mb/d, following a deterioration in refining margins for most regions surveyed.  The outlook for European refining activity is particularly uncertain, with weaker middle distillate cracks and rising stocks both expected to weigh heavily on the region.  Global crude run projections remain depressed compared with the five-year historical range, and some 1.7 mb/d below the 3Q08 level.  2Q09 estimates are 0.1 mb/d lower than last month, as weaker OECD Europe May crude runs and weak margins reduce June estimates by 0.4 mb/d in total.
  • A lower global 3Q09 projection masks upwardly revised Chinese forecasts, as again stronger than expected crude runs, this time for May, are carried through much of the outlook.  Chinese crude throughput has risen by 1.3 mb/d from the low point in January.  However, despite the start-up of several new refineries, substantially higher runs may fail to materialise if weaker crude prices reverse the recent incentives to stockpile inland supplies ahead of increases to administered product prices.


  • OECD crude runs are assessed at 36.3 mb/d in 3Q09, an annual decline of 1.3 mb/d.  This comparison is flattered by the inclusion of last September's extremely weak US crude throughput, following the hurricane-related shutdowns.  Non-OECD 3Q09 crude runs are broadly unchanged from last month, as higher Chinese projections offset weaker African estimates.
  • Despite weak 2009 demand and refinery throughput, OECD gross output of gasoil/diesel and gasoline remains above five-year average levels, but other products are subdued.  April OECD gasoline yields decreased slightly, with North America dropping one percentage point.  Although gasoil yields decreased slightly, gross output actually increased marginally, due to both higher crude runs and yields in Europe and a smaller increase in North American gross output.

Global Refinery Overview

Lower global crude runs estimates for 3Q09 and, to a lesser extent for 2Q09, follow weaker preliminary data for OECD regions and the ongoing deterioration in refining margins.  The collapse in margins across all regions has continued into early July, suggesting little respite is likely in the coming weeks.  Although prompt product prices in Europe may be under pressure as offshore storage is brought onshore, the decline in margins in all regions suggests that the refining industry remains caught between a tightening crude oil market and weakening product markets.  It seems likely that the only way refiners can recapture pricing power is to cut runs further.  Consequently, this report contains markedly lower throughput projections for Europe, but the probability of further reductions elsewhere cannot be dismissed until the refining industry's profitability is restored to levels seen previously.

Weaker preliminary June data for Japan and the downward revisions to Europe cut estimated global crude throughput for the month by 0.4 mb/d to 71.6 mb/d.  Overall 2Q09 throughput is 0.1 mb/d lower at 71.2 mb/d, as stronger-than-forecast May Chinese crude runs offset weaker-than-expected runs in Russia, Nigeria and Turkey.  April data are broadly unchanged on aggregate, despite weaker Canadian estimates, as upward revisions to Brazilian and Indonesian crude throughputs estimates counteract the Canadian downgrade.



The now-lower forecast for 3Q09 implies crude runs will post a 1.7 mb/d year-on-year decline, with 1.3 mb/d, roughly 75%, of the decline in OECD regions.  Quarter-on-quarter growth is trimmed to 1.1 mb/d.  As already noted, the muted driving season in the US and brimming middle distillate stocks in the Atlantic Basin, Singapore and Japan suggest that further reductions to our forecast are possible.

We have rolled over our forecast to include October, with global crude throughput now projected to recover to 72.3 mb/d from the hurricane-affected September forecast of 71.8 mb/d.  This recovery is despite higher maintenance assumptions in Europe and the OECD Pacific weighing on runs.  Year-on-year growth drops to -0.5 mb/d, from +0.3 mb/d in September, as the 2008 baseline continues to be distorted by the impact of 2008's hurricanes on US refining activity, albeit to a lesser degree than in September.

OECD Refinery Throughput

Official data for April OECD crude runs were 0.2 mb/d lower than last month's preliminary estimates, largely due to weaker Canadian crude throughputs.  Elsewhere, slightly weaker-than-expected crude throughput in the Netherlands, Norway and Japan was matched by upward revisions to Mexico, Australia, Austria and the UK.

Increased voluntary run cuts underpin much of May's lower crude throughput, based on the provisional data and a lack of visible maintenance.  OECD crude throughput averaged 35.8 mb/d, down 0.4 mb/d on the month and -2.5 mb/d versus May 2008.  Annual declines of around 0.9 mb/d in North America and Europe are in addition to the OECD Pacific's 0.6 mb/d annual decline.  OECD Pacific crude runs averaged below 6.0 mb/d for the first time since June 2002, and for only the second time since 1996, reflecting the impact of declining demand, heavy seasonal maintenance in Japan, and deteriorating margins.



OECD 2Q09 crude throughput is now seen averaging 36.1 mb/d, 0.3 mb/d below last month's report and 2.1 mb/d below 2Q08.  Lower Canadian April data and European May data, in combination with the downwardly revised European and Pacific estimates for June, account for the change.  Conversely, US June throughputs were marginally ahead of our estimates, reflecting stronger gasoline cracks in the early part of the month and a pick-up in Midwest refinery activity to its highest level since last December.

3Q09 OECD crude throughput of 36.3 mb/d is 0.4 mb/d lower than last month's report and implies quarter-on-quarter growth of just 0.2 mb/d compared with a five-year average of 0.6 mb/d.  The depressed margin environment and the fact that US crude runs appear to be close to their seasonal peak, limits this increase.  The year-on-year decline would be much greater than the estimated 1.3 mb/d, were it not for last year's hurricane disruption to US throughputs in September, which dropped runs by 2.2 mb/d, compared with this year's assumption of a decline of 1.1 mb/d, which is in line with the five-year average.



OECD North America crude throughput continues to lag the five-year range, although weekly US data suggest that the deficit narrowed during the course of June compared with May.  However, as already highlighted, US crude throughput is projected to be flat from current levels for the remainder of 3Q09.  Further weakness in refining margins might result in another downward step in US throughputs, as refiners reinstate heavier run cuts to try to restore profitability.



Preliminary data for May show OECD Europe crude throughput 0.3 mb/d weaker than forecast at 12.4 mb/d, and some 0.2 mb/d below April's level.  Year-on-year contraction in crude runs of around 0.9 mb/d remains in line with the year-to-date trend.  A re-evaluation of the prospects for June crude runs, in light of the weaker margin environment, sees them revised down by a hefty 0.5 mb/d to 12.7 mb/d.  Overall 2Q09 throughput is now seen averaging 12.6 mb/d, 0.2 mb/d lower than last month's report.  Similarly, 3Q09 throughputs are now forecast to average 12.9 mb/d, 0.3 mb/d below last month's report.  However, the notable slowdown in crude runs over the second half of 2008, results in the annual decline in runs narrowing to just 0.7 mb/d, from 0.8 mb/d in 2Q09. 



OECD Pacific crude throughput fell again in May to just below 6.0 mb/d, the lowest monthly average since June 2002, and only the second time since 1996 that runs have breached the 6 mb/d level.  Weak Japanese throughputs of just 3.2 mb/d explain half of the region's annual drop of 0.6 mb/d, and Korean crude throughput of 2.1 mb/d the remainder.  Weekly Japanese data suggest that June crude runs will fall to below 3.0 mb/d, the weakest monthly average level since June 1991.  The decline of Korean throughputs and the absence of reported maintenance suggest that economic run cuts are becoming more widespread in the region and that the outlook for crude runs remains bleak in the face of rising Chinese activity levels.  That said, the expected return in July of Shell's 85 kb/d Clyde refinery in Australia, following its shutdown in December 2008, should provide a small boost to regional crude throughputs.

Non-OECD Refinery Throughput

Forecast 3Q09 non-OECD crude throughput is broadly unchanged from last month's report, as upwardly revised China crude throughput projections offset the now-lower Nigerian outlook, following the collapse in refining activity there.  The upward revisions to Chinese estimates stem largely from the start-up of further crude distillation capacity and, again, stronger than expected data, this time for May.

Chinese May crude throughput reached a new record level of 7.3 mb/d, representing a cumulative increase in crude runs of 1.3 mb/d since January's low-point.  New capacity additions of around 0.5 mb/d underpin much of the increase in throughputs to May.  The reported level of crude runs for May exceeded our estimate for the fourth consecutive month, this time by some 0.5 mb/d and seem particularly strong given we estimate that around 0.5 mb/d of capacity was offline for maintenance during the month.  Looking forward we have raised June and 3Q09 estimates by 0.2 mb/d, to 7.4 mb/d, which may yet prove too conservative, although there is as yet little maintenance incorporated into our forecasts.

Furthermore, despite recent data to the contrary, the incentive to stockpile products ahead of almost certain price rises for Chinese deliveries may also have pushed refineries to maximise runs in recent months.  As world oil prices have risen, so refiners have been presented with an opportunity to lock-in additional profit by building stocks inland, even at the tertiary level, so long as the Chinese authorities implement the price reviews in line with the declared methodology.  It will be interesting to see how crude runs fare if prices weaken substantially over a period of months, thus presenting an incentive to minimise inland stock levels, ahead of reductions to administered prices. 



Elsewhere, non-OECD crude runs were stronger than expected according to data reported for April, with higher than estimated crude runs in Brazil, Indonesia and Thailand.  Preliminary May data for Russia, Kuwait, Saudi Arabia, and Nigeria were all slightly weaker than anticipated.  Nigeria's problems appear chronic, with ongoing disruption to crude supplies and electricity hampering operations.  By late June, Nigerian refineries were reported to be operating at just 10 kb/d, compared with a notional capacity of around 450 kb/d.  We have therefore assumed that Nigerian crude runs will effectively be zero for much of the third quarter, pending confirmation of a resumption of sustainable operating rates.  This lack of domestic supply of products ex-refinery may provide a boost to export demand for European gasoline.  However, even here, competition from Asian refiners will be tough.

OECD Refinery Yields

The severe economic contraction has strikingly depressed 2009 product demand and refinery throughputs.  However, as shown in the graphs below, gasoil/diesel and gasoline gross output levels have remained relatively resilient this year, above five-year average levels, driven by higher yields despite lower runs.  On the other hand, gross output of jet fuel and fuel oil, as well as other products, has remained subdued below five-year range levels.





In OECD Europe, only gasoil/diesel gross output has held up, with levels in the five-year historical range and heading to the top of the range in April.  Gross output levels for the rest of the products have remained below the five-year range.  In OECD North America, the only products showing some strength are gasoline and gasoil/diesel, with gross output above the five-year average and, in the case of gasoil/diesel, growing net exports that have surpassed five-year-range levels.  In OECD Pacific, only gasoline gross output has remained above the historical average.

After increasing strongly in March, OECD gasoline yields decreased slightly in April, albeit staying above the five-year average.  In absolute terms, refinery gross output increased just above last year's April level, with imports from non-OECD countries decreasing counter-seasonally.



A decrease of one percentage point in OECD North American gasoline yields was partially compensated by higher refinery runs leading to a slight decrease in gross output, which remained at the top of the five-year range; net imports also decreased counter-seasonally in this region.  In OECD Pacific, an increase of 1.2 percentage points in gasoline yields was undermined by a contraction in refinery throughputs, resulting in unchanged gross output.  In contrast to the five-year historical trend, the Pacific region became a net exporter of gasoline this month.  European gasoline yields increased as well as gross output, in line with seasonal patterns.  However, 2009 gross output levels remain depressed at below five-year-range levels.

OECD gasoil/diesel yields decreased slightly in April, but nevertheless remain at the top of their historical range.  However, gross output increased slightly as higher yields and crude runs in Europe along with a slight increase in gross output in North America outweighed lower yields and crude runs in the Pacific.  European yields remained well above the five-year range, supported by wider crack spreads.



However, in terms of gross output, OECD gasoil/diesel level is only slightly above the five-year average and 570 kb/d below last year's level.  Gross output in Europe rebounded to near last year's April levels, with net imports decreasing as demand remains constrained.

OECD jet fuel/kerosene yields retained last month's level after having fallen strongly in March.  Gross output showed a slight counter seasonal increase, as higher yields and crude runs in both Europe and North America outpaced a seasonal yield decrease and lower crude runs in the Pacific, where demand has been severely hit.  Yields saw the greatest rebound in Europe, supported by wider crack spreads and stronger month-on-month demand.



OECD fuel oil continued its downward trend in terms of both yields and gross output, only slightly offset by a counter-seasonal increase of net imports coming from non-OECD countries.  April's OECD fuel oil gross output shows a year-on-year contraction of 732 kb/d and a contraction of 950 kb/d compared with the five-year average.



OECD Trading Patterns

Regarding year-on-year changes in gross output and trade, a marginal decrease in European gasoil/diesel gross output (-33 kb/d or -0.6%) was more than offset by much stronger imports (543 kb/d higher or about 3 times the April 2008 level), while demand shows a contraction of 434 kb/d. Some of the additional import volume came from OECD North America where gasoil/diesel net exports increased by 238 kb/d although gross output in this region decreased by 354 kb/d. As net exports from the Pacific decreased, the balance of European net imports was sourced from non-OECD countries.



Another striking difference is North American and European total net trade positions in April. While North America became a marginal net products exporter, from a net import position of 548 kb/d in April last year, Europe saw the opposite trend and became a net importer of 761 kb/d of refined products, from a net export position of 141 kb/d last year. Finally, OECD Pacific net import position decrease by 352 kb/d (from 941 kb/d to 589 kb/d) equivalent to a decline of 37%.