Oil Market Report: 12 August 2009

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Highlights

  • Brent and WTI crude futures hover at $72/bbl and $69/bbl respectively, as a return of more bullish sentiment saw them rise by $8-10/bbl over the July average.  Brent's premium reflects rising US Midcontinent stocks and North Sea maintenance.  Light/heavy crude differentials narrowed on sustained OPEC cuts, boosting fuel oil prices.
  • Global oil supply in July rose by 570 kb/d to 85.1 mb/d, two-thirds of which stemmed from non-OPEC.  Total non-OPEC supply for 2009 is revised up 160 kb/d to 51.0 mb/d, largely due to stronger-than-expected Russian output, as in recent months.  Total non-OPEC supply is now seen rising 440 kb/d to an upward-revised 51.4 mb/d in 2010.
  • OPEC crude oil supply edged lower by around 100 kb/d in July, to 28.64 mb/d, in part due to record-low output by Nigeria.  Production by OPEC-11, which excludes Iraq, was down by 120 kb/d, to 26.12 mb/d.  The call on OPEC remains at 27.7 mb/d in 2009 and is trimmed to 27.8 mb/d in 2010.
  • Demand forecasts for 2009 and 2010 are revised up by 190 kb/d and 70 kb/d, respectively, given a stronger outlook for Asia for both years.  This barely dents the sharp demand contraction to 83.94 mb/d expected this year, while growth in 2010 is slightly lower than previously estimated, at +1.6% or +1.3 mb/d to 85.25 mb/d.
  • 3Q09 global refinery crude runs are revised down 0.4 mb/d to 72.0 mb/d on further weakness in European runs, rising floating distillate storage and continued refining margin weakness.  Expected annual growth slips to -2.0 mb/d for 3Q09, while growth from 2Q09 is just 0.4 mb/d, far below the normal seasonal increase of 1.0 mb/d.
  • OECD industry stocks rose counter-seasonally by 8.5 mb in June to 2,749 mb, 5.5% above last year's level.  The biggest gains came in European crude and North American light distillates, while North American crude posted the largest drop.  End-June forward demand cover was unchanged versus May at 61.7 days.

Dog days and judgement days

August is traditionally vacation time for a sizeable tranche of Europe, providing those still at work the time to catch up and take stock.  It is one of the reasons we release the Annual Statistical Supplement at this time, after the heat and dust of the release of non-OECD and OECD annual statistics, the MTOMR and the 2010 forecast roll-out in July.  Latest data also suggest a relatively quiet time in terms of OECD oil demand - with prevailing weakness remaining the key feature.  All told, European demand contraction widened to 0.9 mb/d in 2Q09, and the US 2009 gasoline season now seems to have fizzled out before getting started.  Preliminary US July gasoline demand stood 1.8% below 2008 levels, after a decline of 1.6% in June. Green shoots of economic recovery there may be, but motorists have curbed driving and, at the margin, schemes to encourage vehicle fuel efficiency may begin to have an increasing impact.

The persistent overhang in OECD middle distillate stocks, both on-land and offshore in floating storage, plus very weak distillate cracks, suggest that industrial activity and freight movement also remain depressed.  Another leading indicator for distillates is the level of German consumer heating stocks.  Now standing not far off traditional pre-winter highs, they suggest little imminent scope for a seasonal surge in consumer buying in Europe's biggest heating oil market in coming months.

In contrast, Chinese oil demand has rebounded, underpinning this month's 100-200 kb/d upward revision for projected global demand.  Uncertainties persist over the impact of China's domestic pricing reform, and the links between industrial output and oil demand.  However, signs that Phase 2 of China's strategic storage programme is proceeding apace could augment underlying crude demand there by late 2009.  With refiners worldwide hobbled by weak margins and low runs, news that Saudi Arabia has boosted direct crude burn for power generation may also help absorb otherwise surplus volumes, even if it dents fuel oil import requirements. However, persistent weakness in OECD products demand, exacerbated by competitive natural gas prices, leads us to keep 2009 global demand largely unchanged. Habitually accused of overstating demand growth, we are now among the bears for 2009 demand (-2.3 mb/d versus 2008).  Time will tell although, notably, consensus among other analysts for average demand change in 2009 shifted from around -1.5 mb/d in April, to closer to -2.0 mb/d most recently.  On the other hand, we do see recovery in economic growth in non-OECD countries prompting a demand rebound in 2010.

Judgements of a different kind are expected soon from regulators of derivatives and commodity futures markets. The CFTC and SEC are dividing up responsibilities for oversight of over-the-counter (OTC) derivatives trading.  The US Treasury Department is examining new OTC derivatives legislation, recommending enhanced position reporting by participants, higher capital requirements, standardised derivative contracts and the migration of transactions to centralised clearinghouses and exchanges.  Meanwhile the past fortnight has seen hearings by the CFTC into possible rules standardising position limits across commodity groups, including energy.  While oil market participants appear resigned to a tightening of position limits now being inevitable, intense debate continues over the depth and breadth of such limits and the need for exemptions to sustain essential market liquidity.  Parallel investigations by the European Commission and the UK Financial Services Authority continue, but may involve less direct intervention by regulators than in the US.  Harmonised international norms would minimise migration of trades between exchanges or to less regulated platforms, but these will likely take time to materialise.  Chairman Gensler of the CFTC has been invited to address the IEA's Governing Board at its 23 September meeting.

This whirlwind of regulatory activity potentially precedes storms of a more tangible variety.  August and September are traditionally peak months for the Atlantic hurricane season.  Our projections for 3Q09 and 4Q09 North American supply and refining incorporate adjustments based on five-year average levels of outages.  Prior to July this netted off 235 kb/d from expected US GOM production for 3Q09 and 280 kb/d from 4Q09.  Unusually, no Atlantic tropical storms had developed going into the second week of August, so the 2009 season may be poised to see less intense hurricane activity than average, implying some upside from currently projected levels of supply through end-2009.  But just as the industry needs to be watchful for any sting in the tail of proposed regulatory changes, so it is also premature to write-off the hurricane season just yet.

Demand

Summary

  • Forecast global oil demand in 2010 has been revised up by 70 kb/d to 85.3 mb/d, given a stronger outlook in non-OECD Asia.  However, growth (+1.6% or +1.3 mb/d year-on-year, almost entirely driven by non-OECD countries) is slightly lower than previously estimated following a larger upward adjustment for 2009 demand, now assessed at 83.9 mb/d (-2.7% or -2.3 mb/d versus 2008 and +190 kb/d higher than in our last report).  The revisions for 2009 were largely driven by OECD Pacific and non-OECD Asia.  However, these upward changes have barely dented the sharp demand contraction expected this year.  The evidence of a bottoming out of the global recession is patchy, and global gasoil demand - a key indicator of economic health - remains significantly subdued.
  • Forecast OECD oil demand in 2010 is broadly unchanged at 45.1 mb/d (+0.1% or +30 kb/d over the previous year and 25 kb/d lower than previously expected).  The estimate of oil demand in 2009 has been slightly revised up by 20 kb/d to 45.1 mb/d (-5.2% or -2.5 mb/d year-on-year), following a small adjustment in OECD Pacific demand.  Meanwhile, the latest data appear to confirm that the US gasoline season failed to materialise, for the second year in a row.


  • Forecast non-OECD oil demand has been revised up for both 2009 and 2010, largely following a reappraisal of Chinese demand prospects.  Demand in 2010 is now expected to average 40.1 mb/d (+3.3% or +1.3 mb/d year-on-year and +100 kb/d higher when compared with our previous assessment).  It should be noted that even though energy-intensive non-OECD countries will largely drive global demand growth, the rise expected next year will nonetheless be below the 2004-2008 average (+1.5 mb/d per year).  The revision for 2009, meanwhile, has been larger (+170 kb/d), owing to two additional developments (a persistent drought in India and much stronger direct crude burning in Saudi Arabia).  This puts 2009 demand at 38.8 mb/d (+0.4% or +140 kb/d versus 2008).

Global Overview

Has the global recession ended?  This question preoccupies oil market observers and economists alike.  However, despite the amelioration of some economic indicators in a few countries, the most that can be said is that the global economy may be stabilising - but even if this is confirmed, it remains far from evident that growth will resume strongly before the end of the year.  For example, a look at the latest industrial production data for the largest economies offers a contrasting and sobering picture.  Only in China and India is industrial production growth positive (and indeed quite strong in the former country).  Elsewhere, by contrast, industrial production growth remains firmly in negative territory, even though the pace of decline has somewhat slowed, notably in Japan and Russia.  More worryingly, industrial production has seemingly not reached the bottom in the US.

These poor industrial production readings are reflected in distillate demand, which is expected to plummet by roughly 1.0 mb/d or -4.1% in 2009.  And given that the brunt of the recession has been borne by developed countries, the sharp contraction in gasoil demand will largely occur in the OECD.  Admittedly, the year-on-year comparison is somewhat distorted by last year's stock building in China.  Yet, given the correlation between gasoil use and economic activity, as long as this trend of decline is not reversed, it will be hard to argue that the recession is really over.



As the impact of the massive fiscal and monetary loosening increases, the global economy is expected to rebound next year, underpinning our demand forecast for 2010.  (We have decided to keep our global 2010 GDP assumption of +1.9% based on the IMF April outlook, rather than integrate its last partial update, which posits a +2.5% expansion, as most other main economic forecasters maintain less bullish prognoses at around +2.0%.  We will instead reassess our GDP assumptions with the IMF update due in late September.)  Yet this begs the question of what will happen if and when this stimulus is withdrawn, with economists strongly arguing on whether these expansionary policies will crowd out private investment and end in hyper-inflation as governments inflate their way out of debt, or whether the stimulus will instead succeed in taming deflationary forces and restore long-term growth.

It is also unclear whether a rebalancing of the world economy will occur in the short to medium term, as there is little sign that private consumption in key exporting economies (Japan, Germany and China) is growing enough to offset its sharp fall in countries with large current account deficits, most notably the US.  China's recent economic rebound, indeed, has been largely due to an investment surge as opposed to domestic consumption, raising the spectre of overcapacity, rising non-performing loans in state-owned banks and real estate and financial asset bubbles, and suggesting that the country's economic growth could trend below levels seen in the recent past.  Finally, the outlook for global trade is unclear, as many industrial supply chains across several countries have been disrupted by the recession, although admittedly a large part of the trade contraction is related to the credit crunch, which should eventually recede.



OECD

According to preliminary data, OECD inland deliveries (oil products supplied by refineries, pipelines and terminals) contracted by 5.5% year-on-year in June, with all three regions recording losses for the fourteenth month in a row.  In OECD North America (which includes US Territories), oil product demand plunged by 7.5% year-on-year, with all product categories bar residual fuel oil posting losses.  In OECD Pacific, demand fell by 3.6%, despite continued strength in gasoline deliveries.  In OECD Europe, demand shrank by 3.4%, despite growing heating oil deliveries.



Revisions to May preliminary data were negligible (+10 kb/d), as weaker-than-anticipated demand for LPG, gasoline, diesel and residual fuel oil offset somewhat stronger deliveries of naphtha, jet fuel/kerosene, heating oil and 'other products'.  Overall, although June's preliminary readings are slightly better than May's (when OECD demand plummeted by 7.5%), to interpret them as clear evidence that the sharp oil demand fall since December 2008 has bottomed out would be a somewhat premature statement.  Altogether, the estimates of OECD oil demand for this year and the next have been only slightly revised up compared with the previous report.  Demand is expected to contract by 5.2% in 2009 to 45.1 mb/d; in 2010, growth is foreseen to be marginal (+0.1%).





North America

Preliminary data show that oil product demand in North America (including US Territories) plummeted by 7.5% year-on-year in June, the eighteenth monthly contraction in a row.  Yet again, the decline in both Mexico and the United States was prominent (-8.2% and -5.3% year-on-year, respectively), while Canada posted a somewhat lower contraction (-2.8%).



Revisions to May preliminary data (+140 kb/d) were essentially concentrated in the US, notably in the notoriously volatile 'other products' category.  By contrast, gasoline and diesel were again revised down.  Overall, total demand in North America fell by 7.5% in May, only marginally better than last report's estimate (-8.1%).  The outlook for total demand in 2009 remains broadly unchanged at 22.9 mb/d (-5.1% or -1.2 mb/d versus 2008), as revisions (May), preliminary data (June) and weekly US estimates (July) largely offset each other.  The forecast for 2010, by contrast, has been slightly revised down to 23.1 mb/d (+0.9% or +0.2 mb/d year-on-year and 40 kb/d lower than in the last report), largely owing to a reappraisal of LPG demand prospects in 1Q10, with potentially higher ethane demand for petrochemicals production being offset by weaker LPG deliveries for heating purposes.



Preliminary weekly data in the continental United States indicate that inland deliveries - a proxy of oil product demand - contracted by 6.1% year-on-year in July, with all product categories bar residual fuel oil and 'other products' featuring continued weakness.  This suggests that the recovery of the world's largest economy remains elusive.  In fact, the demand performance of two key products - gasoline and diesel - remains dismal.  It is now clear that, for the second year in a row, the summer driving season in the US failed to take off, as motorists were deterred by rising gasoline prices and by the economic gloom.  Meanwhile, the weakness in diesel demand - strongly correlated to economic activity - has, if anything, increased over the past three months.  As such, our outlook for US oil demand remains largely unchanged, at 18.4 mb/d in 2009 (-5.4% year-on-year) and 18.6 mb/d in 2010 (+0.9%).



In late June, Congress approved the so-called 'cash for clunkers' law, which entices US motorists to replace old, inefficient automobiles with new, more efficient cars, with the help of a federal rebate of as much as $4,500, depending on the vehicle's fuel efficiency.  The new legislation (the Car Allowance Rebate System), which was implemented on 24 July and mirrors similar moves elsewhere, notably in Europe, has been particularly successful:  by late July, applications for subsidised sales of new cars had totalled some 250,000 units.

In fact, the programme has been too successful - the $1 billion allocated for the scheme until November 2009 actually ran out in the first week after implementation, raising concerns that many applications will not be honoured (only 180,000 applications had actually been processed by mid-August).  The White House and Congress are now looking for ways to prolong the programme; the House passed a $2 billion bill, to be ratified by the Senate, which would cover some 500,000 vehicle purchases.  In any case, this is unlikely to support gasoline demand.  Even assuming that the owners of new vehicles were to drive more - an implausible proposition judging by the absence of a driving season - efficiency gains would probably result in flat, if not diminishing gasoline demand, a trend likely to continue in the years ahead as the existing vehicle stock is gradually replaced by more efficient models.

A Relentless Pursuit of Greater Efficiency

The recent moves in the search for greater motor fuel efficiency in the US are not limited to scrapping programmes.  First, in an end-June landmark decision, the Environmental Protection Agency (EPA) granted California the right to regulate fuel efficiency and carbon emissions from vehicles.  The ruling not only clarifies the respective regulatory role of several state and federal agencies (California's Air Resources Board, the EPA and the Department of Transportation) but also reverses an earlier decision by the previous administration, under which the EPA had opposed California's attempt to set its own efficiency and emissions standards.  Moreover, thirteen other states and the District of Columbia are expected to follow California's lead.  The state may now establish such standards in the 2009-2011 period, which effectively will be extended to the rest of the country along the lines announced last May; for 2012-2016, though, California will defer to federal standards.

Second, several federal lawmakers are promoting natural gas vehicles (NGVs) in order to reduce the country's dependence on foreign oil.  In late July, the House of Representatives appropriated $30 million a year for NGV research over the next five years.  In addition, a group of senators has proposed legislation to boost production of gas-powered vehicles by offering financial incentives.  However, it is unclear whether NGVs could transcend their current, niche market - the commercial vehicle fleets.  Indeed, the lack of extensive refuelling infrastructure remains a significant obstacle to the development of passenger NGVs.

Third, the debate on whether to reform the federal gasoline tax system has resurfaced.  In late July, during a congressional hearing before the Ways and Means Committee, the president and CEO of the American Automobile Association argued that such an overhaul might be needed to support highway construction and maintenance.  These are paid for by the Federal Highway Trust Fund, which is currently supported by a national gasoline tax of $0.18/gallon.  The Fund, however, has been shrinking since it was enacted in 1993, due both to inflation - as the tax has not been altered - and to efficiency gains, which have reduced gasoline sales relative to miles travelled.  Even though several reform proposals are on the table, the Obama administration seems disinclined to act on the issue.  Yet the fact that this politically sensitive issue is even being discussed - with a major car company (Ford) and two large refiners (Valero and Sunoco) supporting an increase of the federal gasoline tax - highlights how much perceptions and attitudes towards energy use in the US are changing.

Finally, in early August the White House announced that 48 selected projects focusing on the development of advanced electric vehicles (EVs) and batteries will receive $2.4 billion in federal grants.  The manufacturing, research, and demonstration projects encompass both purely electric vehicles and plug-in gasoline-electric hybrids, with the aim of achieving at least 100-mile range.  The programme's broader goals are to reduce both oil imports and emissions.  However, EVs will need to make substantial progress regarding their price and autonomy in order to become a viable alternative.  Moreover, it is unclear whether the adoption of EVs on a large scale would contribute to curbing net US greenhouse gases emissions - vehicle emissions would certainly fall, but power generation emissions might rise even if smart grids were widely developed, as about half of the country's power comes from coal-fired plants.  Yet some observers argue that recharging the batteries at night would optimise the grid's load (as base load plants continue to run even if electricity demand is low), thus limiting the rise in emissions.

Europe

According to preliminary inland data, oil product demand in Europe contracted by 3.4% year-on-year in June.  Moderately strong heating oil deliveries (+1.3% year-on-year) continue to somewhat mask an otherwise consistently weak demand picture.  Although the contraction in road transportation fuels is less pronounced than in previous months (gasoline and diesel fell by only 0.6% and 1.4%, respectively), industrial fuels such as naphtha (-13.3%) have seemingly not bottomed out yet, thus casting doubts on the prospects of an imminent end of the recession in Europe.  May's downward revisions, meanwhile, were large (-270 kb/d), suggesting that demand was much feebler than expected that month (-6.5%, roughly a third lower than previously estimated).



Europe's overall demand outlook remains unchanged for both 2009 and 2010, at 14.7 mb/d and 14.6 mb/d, respectively, implying a corresponding contraction of 4.3% and 0.4%.  It should be noted that the contraction rate for 2009 is slightly stronger, given a 65 kb/d upward revision of Belgian demand in 2008.



In what is becoming a familiar pattern for this year, resilient German heating oil deliveries (+2.8% year-on-year in June) once again contributed to partially offset the fall in demand for industrial oil products and transportation fuels.  Nonetheless, the pace of refilling of heating oil consumer stocks has sharply slowed down, compared with previous months (notably 1Q09).  Stocks, at 64% of capacity by end-June (significantly above the 45% level in the same month of the previous year), are gradually approaching their historical maximum filling of around 75% of capacity, potentially limiting purchases in coming months.  As such, total inland deliveries fell by 2.9% year-on-year, according to preliminary estimates.  Meanwhile, naphtha deliveries plummeted by 11.5% year-on-year in June, the fastest pace since February, commensurate with the continuous decline of German industrial production (-18% year-on-year).



According to preliminary data, oil product deliveries in France were virtually flat in June (+0.1% year-on-year).  Demand was supported by the somewhat surprising strength in gasoline (+5.7%) and distillate demand (diesel rose by +8.3% and heating oil by +12.6%), possibly related to the fact that the month had one extra working day compared with June 2008.  As in Germany, however, naphtha deliveries continue to fall (-20.0%), with industrial production contracting faster than in previous months (-13% year-on-year).

Pacific

According to preliminary data, oil product demand in the Pacific fell for the twelfth month in a row in June (-3.6% year-on-year), with all product categories bar gasoline recording continued losses.  Even though the rate of decline has somewhat slowed down compared with earlier months, demand in the region's largest economy - Japan - is still contracting sharply.  By contrast, demand in Korea showed some signs of revival.  Meanwhile, May's revisions, although positive (+130 kb/d), barely improved the picture:  demand plummeted by 9.5% that month.



Our OECD Pacific demand forecasts for this year and the next have marginally inched up by roughly +20 kb/d on average.  OECD Pacific demand is now expected to contract by 7.2% to 7.5 mb/d in 2009, and by 1.6% to 7.4 mb/d in 2010.



Japanese oil demand contracted by 8.2% year-on-year in June, about half the pace of upwardly revised May readings (-14.9%, instead of -18.1%).  This could herald a softening of the recession (naphtha and diesel deliveries fell by 'only' 3.5% and 4.7% year-on-year in June), but it is actually reflective of strong gasoline demand (+6.6%), which had been pummelled in the previous year by exceedingly high retail prices.  In addition, lower highway tolls enticed Japanese motorists to drive more.

Gasoline demand, however, is unlikely to arrest its structural decline, despite higher vehicles sales driven by a government subsidy.  Indeed, the subsidy (the so-called 'eco-tax' break, introduced in April) targets more efficient vehicles - in that sense, sales of the first-ever fully electric vehicle, Mitsubishi's iMiev, began in late July.  The Japanese government is reportedly considering introducing a scrapping incentive later in the year, but this will merely accelerate the adoption of more efficient models.



By contrast, demand jumped by 4.6% in June in Korea, with all product categories bar residual fuel oil posting gains.  As in Japan, part of the rise is due to stronger demand for transportation fuels relative to last year's weakness, but it may also stem from a more genuine economic rebound.  Whereas Japan's industrial production plummeted by 24% year-on-year in June, Korea's fell by a more modest 2% - the best reading since last December.

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) increased by 5.2% year-on-year in June, with all product categories bar gasoil posting strong gains.  The robust demand rebound over the past three months is largely related to the country's resurgent economy.  June's +10.2% year-on-year growth in gasoline demand, for example, has been arguably driven by the surge in passenger car sales (+48% year-on-year), supported by government subsidies and tax incentives - a trend likely to continue, considering that only some 2% of the population currently owns a private car.  Given these stronger data, we have revised up our forecasts for both this year and the next by roughly 130 kb/d.  As such, Chinese oil demand is expected to rise by 2.8% to 8.1 mb/d in 2009 and by 4.0% to 8.4 mb/d in 2010.



Nonetheless, the persistent weakness in gasoil demand is puzzling.  Although gasoil demand has slightly risen on a monthly basis since February, it remains well below last year's levels (-7.9% year-on-year in June) and appears out of line with the strong rebound in industrial production.  Until December 2008, apparent gasoil demand and industrial production had moved in tandem, but this relationship has been inverted since early 2009, with rising industrial production despite falling gasoil demand.  Of course, this mismatch could simply be explained by a drawdown of stocks, which had increased sharply since mid-2008 and which arguably inflated apparent demand last year.  Yet, on a month-on-month basis, reported gasoil stocks held by PetroChina and Sinopec have fallen much more than the estimated rise in demand - and part of this fall was arguably related to exports, which remain strong.  This would suggest that hoarding by private operators, ahead of the recent retail price increases, has been significant.  Private storage could be as much as half of the country's total capacity, according to some observers, but the lack of comprehensive stock data makes this impossible to verify.



The mismatch between industrial production trends and gasoil demand may also imply that economic data contain inconsistencies or gaps - something that, incidentally, would not be unique to China or to other non-OECD countries.  According to some reports, 1H09 GDP data show relatively large differences between provincial submissions and those provided by the central government.  The Chinese authorities are aware of, and have been taking steps to address, this issue.  Meanwhile, the speed of release of 1H09 data, using OECD data gathering and processing as a guide, suggests these may be prone to subsequent revision.  China, like much of the OECD, may indeed be experiencing first-hand the trade offs between timeliness and completeness of data.  While rapid dissemination is welcome, as long as Chinese economic data remain subject to uncertainties, it is difficult for outside bodies such as the IEA to be fully confident in appraisals of Chinese oil demand trends and prospects.

Fuelling Expectations

China's new price mechanism, introduced in early 2009, is set to trigger an adjustment to gasoline and gasoil 'guidance' (or ceiling) prices if a specific basket of crudes (Brent, Dubai, and Cinta) fluctuates by more than 4% over 22 days.  As such, many stakeholders - from refiners to motorists - have been able to anticipate such domestic price moves and build product stockpiles, even if other social and economic factors are also theoretically taken into consideration before implementing any price change.

The small cut in gasoline and gasoil guidance prices in late July (-3.3% and -3.7%, respectively), mirroring falling global crude prices in the second half of the month, had thus been largely expected and probably led to some de-stocking.  By the same token, the resumption of the crude price rally since early August could lead to a renewed bout of hoarding in anticipation of another retail price increase, perhaps by the end of the month.

The government thus faces a conundrum:  how to tame this emerging pro-cyclical behaviour, which distorts demand patterns and encourages speculative buying, while maintaining the welcome impetus towards price liberalisation.  In fact, state-owned Sinopec is reportedly lobbying the National Development and Reform Commission (NDRC) to seek changes to the price mechanism, which the company allegedly perceives as being too predictable and transparent.  However, it is as yet unclear whether the mechanism will be reformed, and if so, when or to what extent.



Other Non-OECD

According to preliminary data, India's oil product sales - a proxy of demand - surged by 13.0% year-on-year in June.  This strong rise is related to the previous year's low base and to delayed monsoon rains.  On the one hand, in June 2008 administered retail prices for key products, notably gasoline and gasoil, had been increased by 10%, thus taming demand for both fuels in that month.  On the other hand, the lack of normal seasonal monsoon rain (with precipitation some 20% to 40% lower than average depending on the region) boosted gasoil use for agricultural activities, notably for irrigation purposes, as well as electricity generation, since hydro-power output was almost 10% lower on an annual basis.  Moreover, this relative drought has extended well into early August, prompting an upward revision of some 25 kb/d to our demand forecasts for this year and the next.  Oil demand is expected to grow by 3.8% year-on-year to 3.3 mb/d in 2009, and by 3.3% to 3.4 mb/d in 2010, assuming normal monsoons.  However, there are upside risks to this forecast, especially in 2010, should economic growth be stronger than currently expected or if unforeseen weather disturbances occur.



The current drought has raised concerns regarding its potentially damaging effects on India's food grain production.  As such, the central and state governments decided to subsidise gasoil sales to farmers in the worst-affected areas between 15 July and 30 September.  Farmers would get gasoil at a 50% discount relative to market prices; the total subsidy amount, though, will be capped at the equivalent of roughly $21 per hectare and limited to a maximum of two hectares per farmer.  The subsidies are to be equally shared between central and local governments.  There is a risk, however, that subsidised gasoil may be diverted to other uses, notably adulteration of on-road diesel, a relatively common practice in India.



In Saudi Arabia, demand for direct-burning crude, used in power generation and included in the 'other products' category, has spiked since last April.  Indeed, 'other products' demand surged by an astonishing 90.5% year-on-year in May, thus boosting total oil demand (+14.1%).  By contrast, residual fuel oil demand has sharply fallen since March (-22.9% in May).  Direct crude use per se is estimated to account for about two-thirds of 'other products' demand, including power plants, refineries and other facilities related to upstream production.  Consequently, our 2009 oil demand forecast has been inched up by 15 kb/d to 2.6 mb/d (+5.6% versus 2008), but this adjustment has not been carried through to next year, assuming that the direct crude spike is temporary.  In 2010, demand should rise by a further +5.1% to 2.7 mb/d.





This shift in demand patterns from fuel oil to direct crude in the power sector serves three purposes.  First, it allows the kingdom to hike output at the giant Khurais field, which began production last month, while fulfilling the country's OPEC commitment to curb supply via exports.  Second, it will help curb and perhaps even altogether eliminate fuel oil imports this year.  Third, it contributes to meet stricter environmental rules (the crude, likely Arab Light from Khurais, has typically some 80% less metals content than fuel oil).

Supply

Summary

  • Global oil supply in July rose by 570 kb/d to 85.1 mb/d, of which around two-thirds stemmed from non-OPEC and the remainder from OPEC gas liquids.  Compared with July 2008, global oil supply is down by 2.6 mb/d, almost wholly due to OPEC crude production cuts.
  • OPEC crude oil supply edged lower by around 100 kb/d in July, to 28.64 mb/d, in part due to record-low output by Nigeria.  Production by the 11 members with output targets, which excludes Iraq, was down by 120 kb/d, to 26.12 mb/d.  OPEC-11 is now producing about 1.28 mb/d over the 24.845 mb/d output target.  Overproduction by Angola and Iran accounted for about 50% of the above target output.  OPEC NGL supply averages 5.1 mb/d in 2009 and 6.0 mb/d in 2010.
  • Saudi Arabia ramped up crude production over the past few months, though arguably the additional output volumes are to meet increased electricity demand at power and desalination plants during the peak summer months.  The decision to increase direct crude burn partly reflects the need to meet stricter environmental regulation on fuel quality used in electricity generation, as well as to help absorb new crude production coming online this summer.
  • Total non-OPEC supply for 2009 is revised up by 160 kb/d, again largely due to stronger-than-expected Russian output, but also to higher US NGL and Gulf of Mexico production, as well as a more rapid ramp-up at new Canadian oil sands mining operations.  Forecast 2010 supply is also raised by 200 kb/d, as many of the above factors are carried forward through the outlook.  As a result, total non-OPEC supply is now seen at 51.0 mb/d in 2009, rising by 440 kb/d to 51.4 mb/d in 2010.  Its 2009 growth over an unchanged 2008 is now estimated at 350 kb/d.
  • The 'call on OPEC crude and stock change' is revised up to 27.7 mb/d in 2Q09 on stronger non-OECD demand.  Thereafter, higher non-OPEC expected supply trumps upward demand revisions, marginally trimming the call for 2H09 and 2010.  It now averages 27.7 mb/d in 2009 and 27.8 mb/d in 2010.


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

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

OPEC Crude Oil Supply

OPEC crude oil supply edged lower by around 100 kb/d in July, with reduced production from Nigeria accounting for about 40% of the decline.  July output was assessed at 28.64 mb/d last month compared with a revised 28.75 mb/d in June.  The higher June production level reflects a 150 kb/d upward revision in Saudi supplies, to 8.35 mb/d, though increased output is being used to meet peak domestic electricity demand rather than exports.  The Saudi increase was partially offset by a downward revision in Angola's June output due to technical issues at several of its offshore fields.

Production by the 11 members with output targets, which excludes Iraq, was down by 120 kb/d, to 26.12 mb/d.  OPEC-11 is now producing about 1.28 mb/d over the 24.845 mb/d output target.  The lower output levels in July raised the group's compliance rate to around 69%.  Production by Angola and Iran accounted for about 50% of the above target output.



OPEC ministers will meet on 9 September in Vienna to review the market outlook and target levels.  Several OPEC delegates are on the record saying it is unlikely the producer group will lower output targets with crude oil prices trading around $70/bbl.  Both Iran and Algeria, however, have said a production cut may be needed if prices turn lower.  The producer group has also said they are concerned about the high level of crude and refined products inventories.  OECD oil stocks stand at 61.7 days forward cover as of end-June.

Other OPEC delegates have suggested a cut next month would be premature given the fragile state of the economy and ahead of the peak winter demand season.  After its September meeting, OPEC is scheduled to meet again on 22 December to review the market, this time in Luanda, the capital city for the current OPEC presidency.  Holding the meeting there could focus attention on the Angolan argument that  the country should receive special consideration with regard to its output target to help the economy recover from its 30-year civil war, which officially ended in 2002.



Saudi Arabia's production is assessed at 8.30 mb/d for July, slightly lower than a revised 8.35 mb/d for June.  The additional output volumes in recent months are earmarked for direct burn at power and desalination plants during the peak summer months.  The decision partly reflects the need to meet stricter environmental regulation on fuel quality used in electricity generation as well as to help absorb new crude production coming online this summer. At the same time, it also reduces fuel oil imports.

Implied direct burn crude at power plants averaged about 150 kb/d in 1Q09.  In 2Q, implied direct burn rose steadily month-on-month, with volumes estimated at 360 kb/d in April, rising to 565 kb/d in May and reached a steep 715 kb/d in June, according to data supplied to JODI.  Average 2Q crude in 2Q was 545 kb/d, up around 300 kb/d from the average 245 kb/d in 2Q08.  This represents roughly two-thirds of 'other product' demand than (see Saudi Arabia in Demand section).

The UAE also raised output in July, up by 20 kb/d, to 2.27 mb/d, due to higher output levels at offshore Lower Zakum.  Despite the higher output levels, the Emirates compiled 100% with their output target last month.

Angola's output in July was down 15 kb/d, to 1.70 mb/d from 1.72 mb/d, due to technical problems at several offshore fields.  At the Girassol field, a problem with a compressor reduced output at end-June and early July while the BP-operated Greater Plutonia field was operating at below 100 kb/d in early July due to technical problems.

Angola is on track to increase production, however. With the technical problems resolved, the export schedule for August is indicating volumes will rebound to around 1.8 mb/d in August and September estimates show an even higher 1.85 mb/d.  Higher output in the coming months will be augmented by the early start-up of Chevron's offshore Mafumeira Norte project in Block 0 on 2 July.  The first phase

Nigeria's Summer of Discontent

Nigerian crude oil production fell to the lowest level in more than two decades amid a widening conflict in the Niger Delta region last month.  Output was also undermined, to a lesser extent, by technical problems at several fields.  Production in July declined by a further 40 kb/d from the previous month, to 1.68 mb/d, the lowest level since 1988.  The lower output was partially offset by the restart of operator Shell's EA production, shut-in since early 2006 following militant attacks. Roughly 50 kb/d of the field's 115 kb/d is expected to be brought back online in August. Meanwhile, on 21 July, operator ENI lifted its force majeure on Brass River exports.  Pipeline attacks forced ENU to shut in 33 kb/d of Brass River production on 19 June and a further 24 kb/d on 8 July.

Technical problems with Amenam output forced operator Total to declare force majeure there from 13 July, affecting about 30 kb/d of output.  Addax also declared force majeure on its 70 kb/d of Antan crude output 16 July due to weather-related problems at its offshore platform. Meanwhile, militants attacked in mid-July the just-repaired Chevron pipeline linking Alero Creek through Abiteye to the Escravos export terminal in the Delta State.  Rebels from the Movement for the Emancipation of the Niger Delta (MEND) apparently waited until repair work on the pipeline damaged from an earlier bombing in June was completed before blowing it up for the second time. Despite a ceasefire agreement, MEND has said that companies that continue to restore damaged oil facilities will be targeted again.  By mid-July, there were seven instances of force majeure in place on Nigerian supplies, including exports of Bonny, Forcados, Escravos and Brass River crudes.

Nigerian officials are under attack from several fronts over oil policy changes that could shape the country's future production profile.  The government's proposed amnesty programme--aimed at halting attacks on the country's oil infrastructure - is in effect until 6 October.  The quid pro quo calls for militants to disarm in exchange for cash payments.  The response from the country's main rebel group MEND, however, has not been encouraging, with only a few figureheads actively negotiating an end to their militant activities.  MEND argues that the amnesty programmes fail to address their major complaints over oil revenue distribution and the government's neglect of basic services in the region.

Criticism of the amnesty plan is not just limited to the militants.  Analysts and oil company officials fear the initiative is short-sighted and fails to tackle the larger issues at the root of the militant criminal activity and broader civil unrest, including insufficient of job creation, educational opportunities and healthcare services.  Moreover, some government officials are proposing that oil companies help foot the bill for amnesty payments, which would likely create ethical and legal challenges for the firms.

class="Box">Nigeria's proposed oil law is also causing consternation among some companies and regional government leaders.  The controversial law, called the Petroleum Industry Bill (PIB), has received wide-spread praise for its plan to reform the chronically cash-strapped national oil company NNPC into a profit-oriented operating company and to implement anti-corruption policies. However, proposals to increase the government's take on offshore oil projects via increased royalties and taxes, renegotiation of contracts and drastic changes to the legal and fiscal regime could derail companies' plans to spend billions of dollars on further development. Public hearings held by the Nigerian Senate at end-July and early August brought companies out in full force to express their concerns, with many arguing that some of the measures would make some of the projects economically unviable and put at risks a staggering $80-95 billion in planned investments over the next five years. For their part, local governments contend they should have a larger share of the revenue split under any new law. The very public and vigorous debate is expected to slow the passage of the law for several months.

While the oil law and amnesty proposal are in limbo, the government has moved forward with plans to rehabilitate the country's crumbling pipeline network.  Nigeria signed a memorandum of understanding (MOU) on 30 July with Ruscorp, a Russian maintenance and security firm, to repair, upgrade and protect the country's sprawling and dilapidated oil pipeline network.  Nigeria's 6,000 km of ageing pipelines have been repeatedly sabotaged by militant attacks and damaged by oil theft. They also suffer from a chronic lack of maintenance--neglected due to militant activity. State-owned NNPC, which operates the pipelines, said the new contract will help improve export flows and minimise environmental damage. Nigeria's massive pipeline network links more than 600 fields to flow stations and export terminals as well as the country's four refineries, which have been operating at under 20% capacity this year, in part due to broken pipelines.

development of Mafumeira calls for peak production of 30 kb/d of crude by 2011.  Meanwhile, in neighbouring Block 14, Chevron said the Tombua Landana project is expected to come on stream ahead of schedule in 3Q09 and reach peak output of 100 kb/d by 2011.

Iraqi oil production in July rose to a post-war high of 2.52 mb/d.  Total Iraqi oil exports averaged 2.037 mb/d, up 112 kb/d from June levels.  Exports of Basrah crude from the south were up 77 kb/d, to 1.49 mb/d—the highest level since last July.  Exports of Kirkuk crude, which includes new output of Tawke and Taq Taq crude, rose to 535 kb/d compared with 500 kb/d in June. An additional 10 kb/d was exported to Jordan.  Production from the Tawke and Taq Taq fields in the Kurdish region of northern Iraq commenced on 1 June.  The Tawke field pumped 40 kb/d in July, of which 32 kb/d were exported.  Production at Taq Taq averaged 40 kb/d in July, with most of the output exported by tanker truck. The Kurdistan Regional Government (KRG) has said it expects to export 100 kb/d from the two fields after an initial ramp-up period.

In July, KRG commissioned a 20 kb/d refinery, fed by oil from the Khurmala Dome, part of the Kirkuk field in northern Iraq, as well as oil from the Taq Taq field. The refinery is envisaged to meet the fuel needs of the Kurdish region, dependent on future planned expansions.

Non-OPEC Overview

Total non-OPEC supply for 2009 is revised up by 160 kb/d, the fourth upward monthly adjustment in a row.  Once again, this is largely due to stronger-than-expected Russian output, but also to higher US NGL and Gulf of Mexico production, as well as a more rapid ramp-up at new Canadian oil sands mining operations.  Forecast 2010 supply is also adjusted up by 200 kb/d, as many of the above factors are carried forward through the outlook.  As a result, total non-OPEC supply is now seen at 51.0 mb/d in 2009, rising by 440 kb/d to 51.4 mb/d in 2010.  Non-OPEC 2009 growth over an unchanged 2008 is now estimated at 350 kb/d.



Given the inclusion of near-complete 1H09 reported output data for key non-OPEC producer countries and our cautiously more optimistic outlook, it would appear that the decision not to implement potential downside risk for short-term supply due to lower 2009 upstream capital expenditure (see 'Spending Cuts May Worsen Decline' in report dated 10 April 2009) was a prudent one.  That analysis was expanded in the recent Medium-Term Oil Market Report (MTOMR) published in late June this year, where we argued that although an expected cut in upstream spending of around 20% in 2009 could in theory have a direct impact on short-term non-OPEC oil supply, it would more likely affect future projects and expansions, many of which have indeed been delayed.



It also appears that a decline in costs is now partly offsetting the impact of lower upstream spending.  For instance, of the three relevant indicators measured by the US Bureau of Labor Statistics (BLS) related to the oil upstream business, drilling and support activities have declined by 18% and 11% respectively since respective peaks in November 2008.  Even machinery equipment costs, which when reviewed in the MTOMR, had not budged, have now fallen by 2% since November.  None of this of course precludes a delayed impact of the lower upstream investment, especially were oil prices to dip again from current levels around $70/bbl, or were the global recession (and hence lower oil demand) to remain protracted.

OECD

North America

US - Alaska July actual, others estimated:  Total US oil production is revised up by around 60 kb/d for both 2009 and 2010 on stronger-than-expected recent performance, including at several new field start-ups.  Total US oil production is now expected to rise from 7.89 mb/d in 2009 to 8.07 mb/d in 2010.  Total NGL output in May was adjusted up by 115 kb/d on stronger Lower-48 output, as natural gas production remains resilient so far in the face of low prices.  Fuel ethanol production also picked up again, as the economics of producing biofuels improved (see Biofuels Update below).  In the Gulf of Mexico, Murphy's Thunder Hawk field started production in July and is expected to reach peak capacity of 45 kb/d in early 2010.  The Tahiti field, which started pumping in May, has reportedly already touched its 125 kb/d capacity according to operator Chevron, several months earlier than we anticipated, though this may only stabilise at that level in several months.

A further upward revision stemmed from the elimination of the hurricane adjustment factor in July (around 40 kb/d, based upon the five-year average shut-in volume), after the month passed without incident.  According to most recent weather forecasts, this year's presence of El Niño in the Pacific may indicate that the occurrence of serious storms is less likely, or at least that there will be fewer storms.  The absence of any significant hurricane impact going forward would also result in an upward revision, as our current hurricane adjustment implies an average 300 kb/d shut-in for the remainder of 2009.  On the other hand, March data appear to indicate that shut-in volumes after last year's storms were higher than anticipated, as repairs took longer than expected.  Currently, and on the basis of the Mineral Management Service's (MMS) latest guidance, we have assumed that all volumes affected by last year's hurricanes will have been restored by the end of June (though small production volumes from destroyed platforms may effectively never resume output).



In late July, Shell reported a leak at its Gulf of Mexico Eugene Island pipeline, which caused its shutdown.  At the time of the rupture, around 100 kb/d were flowing through the pipe (of around 175 kb/d capacity), including volumes from Chevron's new Tahiti field.  However, Shell reported that all but 20 kb/d of this flow were rerouted through alternative pipelines, while repairs were undertaken.  We have assumed an average outage of 10 kb/d for July and August, based upon the brief loss of the full volume and around two weeks of lower throughput in August.

Meanwhile, Alaskan data for July (and June) confirmed earlier-than-usual seasonal maintenance, with total volumes down 150-200 kb/d from a recent peak in March.  Work was underway at the Prudhoe Bay field, as well as at Endicott, Milne Point and others.  Furthermore, nearly all northern Alaskan fields showed a slow-down or halt to production around 18-21 July, when the Trans-Alaska Pipeline System (TAPS) shut down for a brief 36h maintenance.  As for southern Alaska, the Cook Inlet field, which halted production due to the eruption of a nearby volcano, was due to restart output in mid-August, using a different loading terminal.

Canada - Newfoundland - June actual, others May actual:  Total Canadian oil production is adjusted up by 50 kb/d for 2009, largely due to a more rapid ramp-up at new oil sands mining operations.  A new batch of disaggregated data for the past months showed that some of the newer projects, including CNRL's Horizon operation, which only started output in February this year, were producing at higher levels than forecast.  As a result, total synthetic crude production was revised up by 40 kb/d in 2009.  Elsewhere, in a sign that the economic environment has changed somewhat in recent months, Connacher's Algar bitumen project was reactivated in July, having previously been suspended.  It is expected to add around 10 kb/d from end-2010.  Total Canadian oil production is forecast to rise from 2009's 3.22 mb/d to 3.27 mb/d in 2010.

Mexico - June actual:  June oil production in Mexico was reported 20 kb/d lower than expected, as NGL output was adjusted down, and once again, Cantarell production disappointed.  At only just over 600 kb/d, Cantarell output is down 35 kb/d from May, or over 400 kb/d since June last year (-40%).  According to Pemex, however, much of the June downtick was due to maintenance at both Cantarell and the Ku-Maloob-Zaap (KMZ) offshore field complex.  Total Mexican oil output is expected to dip from 2.93 mb/d in 2009 to 2.77 mb/d in 2010 as increases in new fields fail to offset the steep decline in mature assets.

North Sea

Norway - May actual, June provisional:  Norwegian production for 2009 and 2010 as a whole is revised only marginally, but recent months' production has dropped significantly due to extensive seasonal maintenance.  June total oil output was reported at a provisional 2.06 mb/d, down by nearly 550 kb/d since a recent peak in February.  As in the UK and some other non-OPEC producing countries, maintenance also appears to have taken place earlier than usual, perhaps due to low oil prices seen earlier in the year.

Several new Norwegian fields were added to our outlook.  The Tyrihans field complex started production in early July and is expected to reach full capacity of around 90 kb/d by 4Q10.  From 1Q10, the Vega fields will add condensate to the Gjoa stream, which is listed as part of the Sogn/Fram complex in our field-by-field database.  Lastly, the Oselvar field should add another 13 kb/d at capacity to the Ula complex, from around mid-2010.  Total Norwegian oil production is forecast to drop from 2.26 mb/d in 2009 to 2.07 mb/d in 2010.



UK - May actual:  Despite its continuing decline as fields mature, our forecast for the UK was revised up, adjusted by 5 kb/d for 2009 and 50 kb/d for 2010.  A series of fields have started up, and while previously included in our database, initial production volumes have been higher than assumed.  The Brodgar and Callanish fields are now reported separately by the UK Department of Energy and Climate Change (DECC), including volumes going back one year.  We had previously included some of this production in the Britannia field, to which they are tied back.  Newest data show Brodgar producing 20 kb/d of condensate and Callanish nearly 50 kb/d of crude - both near peak capacity.  Elsewhere, output for West Don, which started up in late April and is tied back to the Don field, is now being published and is expected to rise to its capacity of 35 kb/d by early 2010.  Similarly, Jacky (not to be confused with the Jacqui field), also started up in April, and is expected to reach peak 10 kb/d by early 2010.

Meanwhile, latest loading schedules for August indicate heavy maintenance at the Forties complex due to work on the Hound Point export terminal, with volumes assessed as being down nearly 300 kb/d in August from July.  Total UK production is expected to dip to only 1.1 mb/d in August, down 360 kb/d from July and 530 kb/d from February.  In part, the expected lower volumes are likely contributing to higher North Sea Brent prices and ICE Brent futures' near-month premia over Nymex WTI.  Total UK oil production is expected to decline from 1.50 mb/d in 2009 to 1.37 mb/d in 2010.

Pacific

Australia - May actual:  Australian crude production is adjusted down slightly, by around 10 kb/d for 2009 and carried through to 2010, on weaker-than-expected western offshore Carnarvon Basin output.  The Woollybutt field has remained offline since May, likely until November, as work continues on its Floating Production, Storage and Offloading (FPSO) vessel.  Similarly, disagreements over the operation of its FPSO have kept production at the Puffin field stalled since early June.  Both fields have a capacity of around 10 kb/d.  Lastly, the Vincent field restarted production in June, following a fire in mid-April.  Our forecast assumes a return to normal 40 kb/d production from July.  Total Australian oil production is forecast to rise from 550 kb/d in 2009 to 600 kb/d in 2010.

Biofuels Update

Global biofuels production for 2009 has been revised up by about 20 kb/d, based on stronger-than-expected 2Q09 output from US ethanol and European biofuels, which offset weaker Brazilian ethanol expectations.  Our estimate for 2010 global production has also risen, by about 15 kb/d.  US ethanol production rose to 670 kb/d in May, up from 640 kb/d in April.  Since mid-June, corn prices have trended downwards, aided by a favourable US Department of Agriculture acreage report and good weather.  As a result, US ethanol margins rose to 2009 highs and we see rising production continuing through 3Q09.  Though utilisation rates and margins remained weak in Europe, stronger-than-expected European biodiesel and ethanol production reported in 2Q09 has prompted an upward revision to European supplies by 15 kb/d for 2009 as a whole.



The production situation has become less optimistic in Brazil, by contrast.  Feedstock costs have risen significantly as sugar prices soared past the 20 US cents/pound mark, driven by drought in India and excess rain in Brazil's Centre-South.  The high sugar prices incentivise sugar production versus ethanol and the weather conditions will likely hurt overall sugar yields.  We have revised down our 2H09 production estimate by only 5-10 kb/d with the start-up of new mills in July providing some offset.  Still, production risks lie to the downside given the combination of weather, sugar prices and the continued negative impact of the credit crunch on production operations.

Former Soviet Union (FSU)

Russia - June actual, July provisional:  While June production was revised down by around 20 kb/d on lower-than-expected output at the Sakhalin 1 joint venture, preliminary July production came in a full 75 kb/d higher than forecast, despite significant upward revisions in last month's report.  Major producers Rosneft, Lukoil, TNK-BP, Gazpromneftegaz and Surgutneftegaz all saw production adjusted upward in the range of 20-30 kb/d in July.  As outlined in recent reports, in part this stems from sharply rising output at a string of new fields, including now for the first time, crude from Rosneft's huge Vankor field in Eastern Siberia.  Volumes there were supposedly around 35 kb/d in late July.  The field is expected to ultimately pump around 400 kb/d.  Meanwhile, Surgutneftegaz started production at its far smaller Alinskoye field in Eastern Siberia in July.  It will produce around 7 kb/d and is part of a group of fields that will feed into the Eastern Siberia-Pacific Ocean (ESPO) pipeline.  Coupled with some other small revisions, we have adjusted total Russian oil output upward by 45 kb/d in 2009 and 120 kb/d in 2010.  Our current forecast sees output declining from 2009's 10.07 mb/d to 10.00 mb/d in 2010.



Other FSU:  Azerbaijan - May preliminary; Kazakhstan - June actual:  Forecast production for Azerbaijan and Kazakhstan are nudged up slightly for 2009 and 2010.  Azerbaijan's key Azeri-Chirag-Guneshli (ACG) complex in the Caspian Sea continues to see recovery from shut-ins due to gas leaks last September, and was producing near capacity in July.  August and September are however expected to see some volumes shut-in again for seasonal maintenance.  Kazakhstan should also see production dip in July through October as the large Tengiz and Karachaganak fields undergo maintenance.  Lastly, 1Q09 production data for Turkmenistan prompt a slight upward revision of 10 kb/d for 2009 and 2010.  Total other FSU oil supply is anticipated to rise from 2.97 mb/d in 2009 to 3.31 mb/d in 2010, with expected increments of 260 kb/d and 85 kb/d respectively from Azerbaijan and Kazakhstan.

FSU net exports fell to 9.55 mb/d in June, after rising for three consecutive months supported by increasing Russian production.  Crude oil exports decreased by 2.7% month-on-month, to 6.60 mb/d, due to lower Novorossiysk, BTC and Druzhba volumes.  The drop was partly offset by a 3.0% rise in product exports to 3.00 mb/d due to higher fuel oil and gasoil shipments.  Crude oil exports in the next two months will be affected by maintenance on the Russian pipeline network in July and on the BTC in August, coupled with an almost 40% jump in Russian oil export duties in July and another smaller increase of 4% in August.  This will set the crude oil export duty at $212.6/mt ($29/bbl) in July and at $222.0/mt ($30.3/bbl) in August.  The export duty for light and heavy oil products stood at $155.5/mt and $83.8/mt in July and $161.9/mt and $87.2/mt in August.



The Russian Ministry of Economic Development recently proposed a law to equalise light and heavy oil product export duties from January 2012.  The light and heavy product export duties currently stand at around 70% and 40% respectively of the levy on crude oil exports.  The new proposal suggests a standardised product export duty at 55%, decreasing the tax on light products and increasing the tax on heavy products.  This should act as an incentive to upgrade refineries and therefore to boost output of higher-value refined products.

Other Non-OPEC

Brazil - May actual:  June data for Brazil were unavailable at the time of writing, so our Brazilian forecast is left largely unchanged.  Shell reported first volumes produced at its offshore Parque das Conchas (the appropriately named Shell Park or BC-10 field) in the Campos Basin in mid-July, slightly earlier than expected.  This is reportedly the first full-field development to use entirely subsea oil and gas separation and subsea pumping, a reflection of the technical challenges posed by some of Brazil's new offshore fields.  The field is expected to reach full capacity of 100 kb/d in 2010.  Meanwhile, production at Tupi, the first pre-salt field to be developed, has been interrupted for technical reasons, perhaps to last three to four months.  Production is only in a trial phase and start-up of full commercial production, due to start in 2010, is not expected to be affected.  Total Brazilian oil production is forecast to rise from 2.54 mb/d in 2009 to 2.82 mb/d in 2010, including an increase of 60 kb/d in fuel ethanol.

Various non-OECD Asia:  Chinese oil production in June is revised down by 90 kb/d on lower offshore production, possibly due to maintenance, as no outages were reported.  Annual levels are more or less unaffected, however.  In India, in early August, a sub-sea pipeline leak caused the shut-in of 40 kb/d at the Panna/Mukta fields offshore Bombay.  We have assumed that the outage will last at least two weeks.  Indonesia's government raised its crude plus condensate production guidance for 2010 to 965 kb/d, up minimally from 2009's 960 kb/d.  Our current outlook foresees corresponding production volumes of 950 kb/d in 2009 and 980 kb/d in 2010 (to which we add another 70 kb/d and 90 kb/d respectively 3of other NGLs).  Lastly, oil production in Vietnam was revised up by 10 kb/d and 15 kb/d respectively for 2009 and 2010 on evidence of higher-than-expected output at the key Bach Ho field, which is reportedly currently producing around 125 kb/d.  Total non-OECD Asia (including China) is forecast to see oil production rise from 7.5 mb/d in 2009 to 7.7 mb/d in 2010, with increments of 100 kb/d each in China and Other Asia, largely from India and Indonesia.



OECD stocks

Summary

  • OECD industry stocks rose counter-seasonally by 8.5 mb in June to 2,749 mb, as an increase in gasoline and distillate more than offset declines in crude oil and fuel oil.  A North American crude stockdraw outweighed crude gains elsewhere.  Lower June inventories plus a downward revision to May levels put OECD crude stocks within the five-year range for the first time since November 2008.
  • Despite maintaining historically high absolute levels, OECD industry stocks registered their smallest recorded second quarter build (+0.1 mb/d).  Crude stocks drew counter-seasonally by almost 0.5 mb/d and total Pacific stocks drew 0.2 mb/d.  As a result, OECD crude stocks have come more in balance relative to historical norms.  A positive imbalance in distillate stocks, however, continued to grow.
  • OECD stocks in days of forward demand stood at 61.7 days as of end-June, unchanged from a downward-revised end-May reading.  Crude days cover fell to five-year average levels in the Pacific, but remain above the five-year range in North America and Europe.  In products, residual fuel oil days tightened most of any category on the month but are trending along the top of the five-year range.
  • Preliminary July data indicate total OECD industry oil inventories fell by 3.6 mb, although the movements of crude and products differed.  Crude stocks drew by 12.9 mb, led by decreases in Japan and the EU-16.  Product stocks increased 9.3 mb, led by gains in US distillate stocks. 
  • Short-term crude floating storage levels declined to around 55 mb at end-July, from 70 mb at end-June.  Short-term products floating storage - mostly middle distillates - rose above 60 mb, from 50 mb at end-June.  Two-thirds of products floating storage sits off Europe or in the Mediterranean.


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



Despite increasing counter-seasonally by 8.5 mb in June to reach 2,749 mb, OECD commercial inventories have shown signs of becoming more balanced versus historical norms.  End-June OECD total oil stocks remained at a lofty 137 mb surplus to the five-year average, but this surplus has narrowed by 53 mb since end-March.  A small 2Q total inventory build of 0.1 mb/d, a counter-seasonal 2Q crude draw and 2Q OECD government stockpiling of 0.2 mb/d have helped sop up extra oil.  Yet, a growing dichotomy is emerging between crude and distillate.  While crude's surplus to the five-year average decreased from 79 mb at the end of 1Q09 to 26 mb at end-June, distillate's buffer increased from 75 mb to over 89 mb.  July preliminary data - both in onshore stocks and short-term floating storage - suggest little change in this trend.  Meanwhile, OECD gasoline and residual fuel oil inventories have displayed relatively more balance, with the latest absolute levels of both within 5 mb of the five-year average.



Of course, the picture looks less balanced from a days-of-forward-cover-standpoint.  At 61.7 days, OECD total oil days cover is 8.0 days above the five-year average and 5.9 days above levels of a year ago.  OECD crude days cover remains well above the five-year range and even relatively tighter categories, such as gasoline and fuel oil, are trending along the top of the five-year range.  However, present high forward demand cover is arguably more a reflection of weak demand rather than bloated stock levels.





Moreover, a sizeable downward revision of 27.7 mb to May OECD stocks played a prominent role in tightening absolute inventories.  Crude stocks were revised down by 27.0 mb, led by downward changes to Norway (-8.2 mb), the UK (-5.8 mb) and Canada (-5.7 mb).  In addition, sizeable revisions continued to the US 'other products' category, which was revised downward 11.3 mb.

Analysis of Recent OECD Industry Stock Changes

OECD North America

North American industry stocks rose 9.7 mb in June, almost wholly due to increases in gasoline, distillates and US other product stocks.  US crude stocks, by contrast, fell by 16.0 mb as refinery runs increased and imports remained low, even as evidence mounted of drawing floating storage.  Government crude holdings increased by 1.7 mb with continued filling of the US SPR.  Mexican industry stocks fell 1.2 mb.  Crude increased 0.5 mb but gasoline and distillate fell 0.4 mb and 0.6 mb, respectively.



July preliminary data point to an 8.4 mb total oil build and the highest weekly total US industry stocks reading since September 1990.  US crude stocks rose by 1.0 mb on the month aided by refinery run cuts and a temporary import spike above 10 mb/d - likely due to discharges of floating storage - in the second half of the month.  The build also benefitted from government SPR filling dropping to zero for the month.  Stocks at Cushing, Oklahoma, which mainly trended sideways in 2Q09, rose 3.8 mb on the month, possibly signalling another round of deepening contango in WTI futures (see Rising Cushing Storage Levels May Spell Another Bout of WTI Distortions).



US product stocks jumped 7.4 mb with gasoline and distillate showing gains of 0.5 mb and 4.3 mb, respectively.  Weak demand kept gasoline stocks trending along the top of the five-year range while distillates, particularly diesel stocks, continued to soar to new five-year highs.  Principal products as a whole rose 5.8 mb, as the change in total products was supplanted by a 7.4 mb rise in propane more than offsetting falls in 'other oils' and 'unfinished oils'.

Rising Cushing Storage Levels May Spell Another Bout of WTI Distortions

Crude stocks at Cushing, Oklahoma - the delivery point for the New York Mercantile Exchange (NYMEX) light, sweet crude contract  (also referred to as WTI) - registered counter-seasonal gains in July, increasing by 3.8 mb as refinery utilisation in the US Midcontinent and Gulf Coast decreased in the second half of the month while imports rose, particularly into the former area.  At 33.3 mb as of July 31, Cushing stocks are at their highest level since early March, which marked the endpoint of a stretch in 1Q09 when the WTI futures curve suffered periodic bouts of deep contango near expiry as Cushing spare capacity likely eroded.

The market continues to gauge how close current levels come to storage capacity, but indications come more readily in the form of WTI price responses rather than definitive pronouncements by storage owners.  A NYMEX official put current Cushing nameplate capacity at almost 50 mb, up from 47.5 mb in March.  However, this figure is acknowledged as an estimate, not the site's exact capacity.  Over the past few months, wire reports have carried snippets of storage expansions, maintenance and retirements by various operators, some of which will continue through this year and next, but complete capacity breakdowns remain elusive and private storage operators are not required to provide them. 

class="Box">Even given the NYMEX's 50 mb estimate and the assumption that only 80-90% of this capacity is usable, Cushing's effective capacity may still lie below 40 mb.  That is because storage operators have recently taken an unknown amount of Cushing capacity out of service due to federally mandated inspections and repairs, which occur every 10 years.  While Cushing may possess 'significant excess capacity' as indicated by the NYMEX, lack of clarity over recent net capacity changes and plans going forward may mean lower effective spare capacity than the headline numbers suggest.

The stock build has reinforced the recent deepening contango in WTI and a weakening WTI relationship versus Brent (see Prices section for further discussion of WTI-Brent pricing dynamics).  A similar bout of deep contango movements as occurred in January and February remains possible but tricky to predict.  While Canadian oil sands production (much of which goes to the US Midcontinent) should rise slightly through the remainder of 3Q09, refinery throughput rates in the Midcontinent and along the Gulf Coast are higher than in 1Q09.  With little scheduled maintenance on the horizon in both areas, crude intake will depend on the degree to which economic run cuts persist.  Short-term floating storage in the US Gulf remains another variable, potentially providing a surge in imports.

In addition, the growing WTI contango provides market players with a greater financial incentive to store oil until levels push capacity limits and increasing storage costs render the practice unattractive.  At that point, absent marginal uptake by refineries, barrels without a storage home may suffer deep discounts to find a buyer.  The wider market continues to guess when this may transpire.

Lack of clarity on Cushing effective storage capacity relative to fill levels means WTI's price movements provide the best clue to monitoring this underlying physical phenomenon.  Moreover, uncertainty over physical flows and storage capacity may cause futures markets to overshoot or undershoot equilibrium price levels in the front-month contract.  This month the CFTC has been debating ways to improve transparency and limit the overt influence of purely financial players in the oil market (see On Speculation and Regulation in the Prices section).  It is perhaps ironic that, at the same time, the lack of transparency over Cushing storage capacity, which critically affects localised physical fundamentals, continues to cause distortions in the world's most important pricing benchmark.

OECD Europe

European inventories rose by 9.0 mb in June, mostly due to a 13.4 mb increase in crude inventories.  Product inventories fell by 3.9 mb, though distillate and gasoline rose by 0.5 mb and 1.5 mb, respectively.  Increased pull from Asian markets helped residual fuel stocks to fall 1.3 mb.  A downward revision to May stock levels has put European crude stocks close to balance on an absolute level versus the five-year average.



Still, the distillate surplus continued to grow and Europe looks well stocked ahead of the heating season.  German consumer heating oil stock fill levels rose from 63% at end-May to 64% at end-June.  This puts those storage levels 19 percentage points above June 2008 levels and almost two percentage points above the five-year average reading for October, the beginning of the heating season.  Moreover, a glut of middle distillate short-term floating storage (about 40 mb) remained off Northwest Europe and in the Mediterranean as of end-July.



July preliminary data for onshore stocks show gasoil and jet/kerosene stocks held in NW Europe independent storage continuing to rise to new five-year highs, but gasoline, naphtha and residual fuel oil stocks all decreasing slightly.  Fuel oil inventories in NW Europe are now trending in the bottom half of the five-year range versus 1H09 when they mainly stood above the five-year average.  Overall OECD Europe fuel oil inventories through June had been trending above the five-year range, but increased exports to Asia may have sapped July levels.  Still, preliminary data from Euroilstock indicate EU-16 fuel oil inventories posted a slight 0.4 mb gain in July.  Overall EU-16 products fell, however, by 0.9 mb, led by gasoline, and EU-16 crude stocks decreased by 4.9 mb versus June.  EU-16 middle distillates continued to rise, increasing 1.4 mb.

OECD Pacific

Pacific industry stocks drew counter-seasonally by 10.1 mb in June, led by draws in distillates and fuel oil of 2.7 mb and 2.0 mb, respectively.  Of all OECD regions, Pacific stocks appear to have drawn down to levels most in balance on a days-of-forward-demand-cover basis, though most categories still remain above five-year average levels.  Crude forward cover is trending along the five-year average, products remain just above the five-year range and residual fuel oil has trended down towards the five-year average.  However, like other regions, a healthy surplus of distillate stocks remains.



Weekly data from the Petroleum Association of Japan point to a commercial stockdraw of 6.2 mb for July, with crude falling by 8.9 mb and products increasing by 2.7 mb.  Kerosene and naphtha stocks showed the largest builds, increasing by 2.6 mb and 1.2 mb, respectively.  Kerosene stocks continue to trend at five-year average levels in the run-up to the winter heating season.  Onshore crude stocks continue to trend near the bottom of the five-year range, but refinery utilisation remains weak.



Recent Developments in Singapore and China Stocks



Singapore product stocks contracted in July by 4.2 mb based on falling fuel oil stocks.  Increased bunker demand and tightening fuel oil supplies due to refinery run cuts spurred a draw of almost 6 mb (30%) of residual fuel oil stocks.  However, a large early August fuel oil build reversed this draw and put fuel oil supplies back to the top of the five-year range.  Light and middle distillate stocks in July increased 0.2 mb and 0.9 mb, respectively, and both categories sit at or above the five-year range.

China crude oil stocks reported by China Oil Gas and Petrochemicals (OGP) decreased by 7.7 mb (260 kb/d) in June, the first such decrease since February as increasing refinery runs (up 420 kb/d on the month) more than offset only slightly higher monthly net imports.  Product stocks, meanwhile, posted their first monthly gain since December 2008 as gasoline and gasoil rose by 1.7 mb and 2.5 mb, respectively.  High product exports were more than offset by higher refinery output for both categories.



Reports continued to emerge over developments in China's Phase 2 strategic crude oil stockpiling.  With the recent reported completion of the filling of 102 mb of Phase 1, China is in the midst of constructing a series of eight storage sites for Phase 2 totalling about 170 mb, some of which may reportedly be completed before end-2009.



Prices

Summary

  • A more bullish sentiment returned to the market by mid-July, with prices trading around $8-10/bbl above monthly averages by early August.  Unusually, the latest rally in oil prices to around $75/bbl has been spurred on by stronger Brent futures rather than the more volatile NYMEX WTI markets. Relatively robust Brent prices reflect tighter physical supplies while rising crude stocks in the US, especially in the Midcontinent, correspondingly depressed prompt prices of WTI.  Benchmark WTI was hovering around $69/bbl and Brent was just shy of $72/bbl  at the time of writing.
  • Price differentials between light and heavy crudes were also further distorted this month, as OPEC cutbacks of heavier sour grades continue to strengthen those grades relative to lighter crudes, at times even fetching a premium over their richer cousins.  The narrowing price spread between light and heavy crudes kept spot prices for fuel oil relatively strong thoughout the month.
  • Refinery margins mostly improved except in the USGC, as crude oil prices headed lower in early July.  Weaker gasoline crack spreads eroded complex configurations more than the simple units, particularly in the USGC where most margins decreased.  However, hydroskimming margins remained mostly negative.
  • Freight rates were down in July as the number of tankers used for short-term crude floating storage continued to decline, chartering enquiry levels remained weak and overall available tonnage increased.  Rates stood just above breakeven levels for most owners as of early August.  However, short-term floating storage continues to tie up a significant portion of the tanker fleet.  As of late July, more than 20 VLCCs were still engaged in the practice, over 4% of the existing fleet.


Overview

Against a backdrop of pervasive weak supply and demand fundamentals, oil prices moved in uncharted territory, with benchmark North Sea Brent breaching the $75/bbl threshold in early August.  Oil prices plummeted in the first half of July, pressured lower by a weaker-than-expected gasoline demand season.  By mid-month, however, prices resumed their upward path in tandem with stronger equity and financial markets.  Month-on-month, futures prices for WTI and North Sea Brent declined on average by between $3.50-$5.50/bbl in July, averaging around $64.30 and $65.75/bbl respectively.

After a wave of negative economic indicators early in the month, a more bullish sentiment returned to the market by mid-July, with prices trading around $8-10/bbl higher by early August.  Data released on 31 July showing the US economy contracted less than previously forecast in 2Q09 and reports on 3 August that Chinese stocks declined for the first time in four months renewed market optimism that the recession may have hit bottom.



The latest economic headline-driven oil price rally continues to overshadow underlying weak oil supply and demand fundamentals.  OPEC production levels edged lower in July but output is still 1.28 mb/d above the group's target level of 24.845 mb/d.  OPEC ministers will meet in Vienna on 9 September to review the market outlook.  Of particular concern to OPEC are stubbornly high global oil inventories.  OECD stocks remain at a steep 61.7 days of forward cover, or more than ten days higher than the target level Saudi Oil Minister Ali al-Naimi said is needed to balance the market. 



Spot Crude Oil Prices

Unusually, the latest rally in oil prices to around $75/bbl has been ignited by stronger Brent futures markets rather than more typically influential NYMEX WTI futures.  The relatively stronger increase in Brent prices reflects tighter physical supplies of the grade as maintenance work on North Sea fields curtailed production in recent weeks while record levels of stocks in the US, especially at the key Cushing, Oklahoma storage facilities, have correspondingly depressed prompt prices of WTI.

Brent's premium over WTI widened to around $2.75/bbl in recent weeks compared with around $1.50/bbl premium in July and a discount of roughly 40 cents/bbl in June.  Historically, Brent prices have traded at a discount of around $2.00-2.50/bbl to WTI but the pricing relationship has reversed on and off this past year due to persistently high US crude inventories combined with storage capacity constraints at the NYMEX contract delivery point in Cushing.



The relative strength of Brent reflects an unusually heavy maintenance programme at the North Sea's Forties complex.  The North Sea physical market underlies the ICE Brent futures contract.  Planned maintenance at the 200 kb/d Buzzard field, the largest in the system, and other smaller ones will reduce Forties output by 300 kb/d this month and into next.  There are more than 60 fields that make of the Forties system.  The loss of Buzzard output will have the unintended consequence of improving the overall quality of Forties crude.  Buzzard crude is heavier and more sulphurous than other field streams and its inclusion in the Forties blend reduces overall quality and value.  Forties values rose in early August to their highest levels this year ahead of the planned outages. Total production from Forties is scheduled to decline  to 330 kb/d in August, the lowest monthly output in three years.



By contrast to the tightening supply in the North Sea, the US market is oversupplied, especially at the landlocked Cushing, Oklahoma storage facilities.  (See Rising Cushing Stocks May Spell Another Bout of WTI Distortions in the OECD Stocks Section).  Brent may therefore retain its pole position until the restart of the Buzzard field.  Forties production is expected to return to more normal levels in October, with output expected to rebound to  600 kb/d in October.

On Speculation and Regulation

The increased volatility in oil prices over recent years has been blamed in part for the financial meltdown and general economic downturn.  Speculative activity has been seen as a key reason behind unpredictable prices for consumers and the unstable investment environment for oil producers and international oil  companies, and this has prompted a response by regulators and politicians. President Obama's tenure began with promises to tighten financial regulation. The aim is now to establish government oversight for the over-the-counter (OTC) derivatives market and set position limits for commodity traders. The legislation, if enacted, would amend the Commodity Exchange Act, and nullify the controversial Commodity Futures Modernization Act of 2000, which, arguably, created the so-called 'Enron loophole' in futures markets. The enthusiasm for regulation is no less elsewhere in the world. Calls for a more structured dialogue between producers and consumers to establish 'a reasonable price range' are coming from some G8 leaders and OPEC representatives alike. Current regulatory sentiment is said to show a willingness to err on the side of too much regulation rather than too little. Many market participants fear that there is a danger politicians will enact measures which 'over-regulate', bringing in restrictions possibly harmful to the functioning of the market.

class="Box">The US regulator the Commodity Futures Trading Commission (CFTC) is tasked with ensuring markets that are transparent and free from fraud, manipulation and other abuses. However, studies performed by the CFTC itself, the UK's Financial Services Authority (FSA) and the International Monetary Fund (IMF) have so far been unable to prove any systematic connection between 'financialisation' of commodities - financial flows into commodity markets - and price volatility.  Despite convergence in recent months between moves in the NYMEX WTI price and the movements of non-commercials net positions in NYMEX WTI futures, over a longer time span, the correlation is not significant, nor is the relationship between total open interest of non-commercials and the oil price.

More data gathering and further investigation of the linkages between OTC trading, index trading and price formation in oil markets has been recommended. The CFTC is expected to shortly release a new review re-examining the role of speculation in driving prices. The US Federal Trade Commission (FTC) will also tighten anti price-manipulation legislation, and has said it would fine traders and companies up to $1 million a day if they manipulate oil markets.

In recent weeks the CFTC held hearings to receive views on the proposed regulatory changes from various stake-holders. The concept of position limits for energy commodities trading does appear to have been accepted by exchanges and traders, although it remains to be seen how broad or deep they may be. The fears from the energy industry have been that a great deal of liquidity could be lost from the US market, possibly increasing volatility instead of reducing it. Hedging is used to manage risk and to ensure project financing. Energy companies worry that the emphasis on standardised OTC contracts will drive up hedging costs, tie up much-needed cash and eliminate the traditional practice of pledging assets in collateral. However, proponents counter that, through careful regulatory design, it should be possible to authorise the use of non-cash collateral to satisfy margin requirements and allow for the continued use of customised contracts, if a contract is not sufficiently standardised to be cleared or if one party does not qualify as a major market participant. CFTC Chairman Gary Gensler has made the, not universally accepted, point that position limits could aid liquidity by making participation less concentrated and more diversified.

For its part, the UK FSA held a private meeting on Wednesday 29th July with around 30 oil industry participants in London to discuss market transparency and regulation. No statement was issued from the meeting, but the FSA is thought to be much more reluctant to set position limits.  Energy markets in the US and the UK are inextricably linked through lookalike contracts and arbitrage. They have an information-sharing agreement and claim to work under equivalent regulatory conditions. Concerns have been expressed that a lack of uniformity in regulatory extent and coverage could merely see trade migrate.



Price differentials between light and heavy crudes were also further distorted this month, as OPEC production cuts of heavier sour grades continue to strengthen relative to lighter crudes, and at times even fetching a premium over their richer cousins.  The distorted price relationship between light, medium and heavy crude price structures is especially pronounced in the Atlantic basin market, with US WTI trading at a discount to Arab Heavy at times in recent months.

Spot Product Prices

Spot product prices tracked crude oil markets lower earlier in the month but crack spreads for the heavy end of the barrel strengthened in key markets by the end of the month and into early August.  Even prices for middle distillates improved by early July, although ample diesel and gasoil stocks both onshore and in floating storage offshore Europe are pressuring crack spreads.

The sharp downturn in economic activity has hit gasoline and distillate markets especially hard, with prices declining $3-7/bbl in July.  Despite the weak travel season, spot prices for jet fuel rose steadily in late July, with prices in early August some $10/bbl over July levels.  Distillate cracks are now just $5-6/bbl compared with $25/bbl six months ago and $35/bbl a year ago.



Fuel oil saw continued strength from economic run cuts as well as reduced supplies from OPEC of heavier, sour crudes for refinery operations.  Crack spreads for both high-sulphur and low-sulphur fuel oil against benchmark crudes in all regions narrowed throughout the month, with Singapore and New York Harbour posting the largest gains. The crack for LSFO 1% in NYH narrowed to WTI -$4.74 in July compared with -$9.22 in June.  In Singapore, the crack for HSFO narrowed to -$1.36 in July compared with -$6.25 the previous month.



Refining Margins

Except in the USGC, most benchmark refining margins improved in July. As argued in last month's report, the lack of profitability and low levels of demand pressured crude oil prices. Simpler configuration margins improved more than those of complex configurations. On the USGC, excluding a marginal gain in the Mars cracking margin due to stronger high-sulphur fuel oil prices, refining margins decreased due to gasoline crack spreads falling, as gasoline demand did not fulfill summer expectations.



In NW Europe and the Mediterranean, refining margins mostly improved in July, with hydroskimming margins posting the major improvements as premium gasoline crack spreads fell, favouring simpler configurations relative to cracking. However, hydroskimming margins remain negative.

In Singapore and China, refinery margins improved for most of the benchmark crudes. Daqing benchmarks reached positive levels while the rest stayed negative. The lack of support from gasoline and gasoil/diesel crack spreads favoured hydroskimming configurations to hydrocracking.



Upgrading margins decreased during the first half of July as gasoline crack spreads weakened and high-sulphur residual fuel oil cracks increased in this period. In the second part of the month, gasoline and low- sulphur diesel cracks strengthened and the high-sulphur residual fuel oil cracks spreads weakened, increasing upgrading margins. In the USGC, upgrading margins turned negative for most of the month, reaching positive levels by the month-end.

End-User Product Prices in July

End-user product prices on average increased by 0.9% in July, in US dollars, ex-tax, as a 1.5% fall in gasoline prices, month-on-month, was more than offset by 1.0%, 1.6% and 2.7% rises in diesel, heating oil and low-sulphur fuel oil prices, respectively.  The change in gasoline prices in the surveyed IEA member countries ran from a decrease of 8.6% in Germany to an increase of 7.4% in Japan.  Consumers in the US on average paid $2.53/gallon ($0.67/litre) for gasoline, in Japan ¥125.0/litre ($1.31/litre), in the UK £1.03/litre ($1.70/litre) and in continental Europe, prices ranged from a low of €1.02/litre ($1.44/litre) in Spain to a high of €1.28/litre ($1.82/litre) in Germany.  End-user product prices were 45.8% below July 2008 levels.

Freight

In July, dirty freight rates fell on the month as tankers employed in short-term crude floating storage continued to decline, chartering enquiry levels remained weak and overall available tonnage increased.  Rates stood just above break-even levels for most owners as of early August.  However, short-term floating storage continues to tie up a significant portion of the tanker fleet.  As of late July, more than 20 VLCCs were still engaged in the practice, over 4% of the existing fleet.

Middle East Gulf to Japan VLCC rates fell from over $11/mt at the beginning of July to just over $7/mt by month end.  Healthy fuel oil demand in Asia boosted trade to the East and, in turn, offered support to rates.  West Africa to US Atlantic Coast rates fell from almost $13/mt at the beginning of the month to under $9/mt by month end.  Chinese demand for Atlantic Basin crude had been offering rate support, but indications point now to lower off-take of West African grades in the near term.

Clean rates, by contrast, remained relatively steady on the month as products floating storage rose to over 60 mb by month-end.  Still, as in the crude tanker market, overall weakness persisted and rate increases towards the end of the month masked mid-month drops.  End-July Middle East Gulf to Japan Aframax rates remained steady at $21/mt versus early month readings.  Yet, rates fell as low as $18/mt during the middle of the month.  Northwest Europe to US Atlantic Coast medium-range (MR) rates increased slightly from under $15/mt at the beginning of July to almost $16/mt by month-end, though rates dropped as low as $13/mt in the middle of the month.



Despite overall weakness in rates and poor earnings, oil tanker deliveries continued in 2Q09 and available tonnage expanded given the long lead times involved in bringing vessels to market.  According to EA Gibson Shipbrokers, the net fleet size increased about 3.4% with 111 more vessels in operation by the end of the quarter versus the end of 1Q09.

Refining

Summary

  • Projected 3Q09 global crude runs are again revised lower this month to 72.0 mb/d, down 0.4 mb/d from last month's report.  Further recent cuts to European crude runs, rising floating storage of middle distillates and sustained low refining margins underpin the now-weaker projection.  Annual growth slips to -2.0 mb/d for the quarter, while sequential growth from 2Q09 is just 0.4 mb/d, significantly below the five-year average increase of 1.0 mb/d.
  • Chinese throughputs were again stronger than expected in June, reaching 7.8 mb/d.  Consequently, upward revisions to Chinese crude runs are carried through the outlook for the remainder of the year, even though it is unclear at this time how of much of this apparent demand is actual and how much is driven by changing stock levels, due to incomplete data.


  • OECD 3Q09 crude runs are assessed at 35.8 mb/d, an annual decline of 1.8 mb/d.  Once again, weaker European throughput, this time for June, results in further reductions in 3Q09 projections.  Early signs of continued restraint by refiners in the US, Japan and Europe, in the face of weak demand, appear to offer a glimmer of support to light product cracks.  However, narrowing fuel oil discounts have led to some refineries cutting throughputs at coking capacity, long the mainstay of complex refinery profitability, which could in turn further limit US Gulf Coast throughputs.
  • May OECD refinery yields increased for gasoline and 'other products' at the expense of naphtha, jet fuel/kerosene and fuel oil, while gasoil/diesel yields increased marginally.  Refinery yields reflected mainly the economic incentives of production in each region as depicted by crack spreads.  Total product gross output contracted 5% (2.24 mb/d) year-on-year.  Gross output increased only for gasoline; however, the higher gasoline gross output was accommodated by a switch from last year's May net-import position to a net-export position this year.

Global Refinery Overview

Continued weakness in refining margins and increases in middle distillate floating storage have contributed to further downward revisions to our 3Q09 projections.  The failure of the US driving season to materialise suggests there is little incentive for OECD refiners to significantly increase crude runs above current levels, barring an uptick in demand.  Consequently, estimated global crude runs for 3Q09 are reduced by 0.4 mb/d, driven entirely by further substantial reductions to European projections and despite upward revisions to Chinese estimates.

Weaker preliminary data for OECD Europe in June and continued pressure on diesel cracks suggest that the region will struggle to recover until such time as the distillate market rebalances, which looks increasingly remote given further increases to regional floating storage levels of middle distillate.  Conversely, a spate of refinery accidents both in the US and Europe have offered some of respite to gasoline markets, but here again the sheer scale of idle refining capacity suggest that any recovery will be short-lived, unless refiners maintain their already impressive discipline in curtailing runs in the face of anaemic demand.  Of more concern are the reports that some US refiners have started to impose restrictions on coking units as current upgrading spreads do not justify their full use.  As previously highlighted, upgrading margins have been the key driver for refinery profitability for more than a decade.  Although we have become accustomed to refiners idling catalytic cracking capacity due to poor gasoline production economics, the move to idle coking capacity indicates that refineries face continued, and indeed increasing pressure from the structural shifts in product and crude markets, see Refinery Upgrading Economics Under Pressure.

Despite weaker-than-expected European June crude runs, 2Q09 global estimates are revised up by 0.4 mb/d to 71.6 mb/d.  Higher-than-expected Chinese, Russian and Indian June throughputs, in addition to stronger-than-forecast crude runs in Brazil, Indonesia and Thailand for May, contribute to this upward revision, and are broadly consistent with this month's upwardly revised demand estimates.



Despite stronger 2Q09 data, forecast 3Q09 crude runs are reduced by 0.4 mb/d this month, to 72.0 mb/d.  Downward revisions are concentrated in the OECD, notably in Europe.  Elsewhere, Valero's decision to idle its 275 kb/d Aruba refinery for a minimum of three months lowers Latin American projections by 0.3 mb/d.  Offsetting these reductions are stronger Chinese crude runs for 3Q09 following record throughputs in June of 7.8 mb/d.  Another increase in crude runs is expected in July and possibly August, although at the time of writing the impact of weather-related disruptions may temper August activity, following the arrival of Typhoon Morakot in China's Fujian province, having already passed over Taipei and the Philippines.  North American throughput could prove stronger than shown here if significant hurricane outages fail to materialise in September.

Crude throughput forecasts are extended through to November, with a month-on-month increase of 0.3 mb/d and are expected to average 72.5 mb/d during the month.  Despite this increase, global crude runs remain 0.6 mb/d below levels of a year ago.  Higher OECD Pacific runs account for much of the increase, although much will depend on the seasonal uptick in Japanese kerosene demand.

OECD Refinery Throughput

Preliminary data for June were lower than projected, largely due to continued depressed activity in Europe.  OECD crude runs of 36.0 mb/d were 0.3 mb/d below last month's estimates, with Europe some 0.5 mb/d below estimate, offset by slightly better-than-expected OECD Pacific runs.  Pronounced weakness in European runs is now expected to continue throughout 3Q09, reducing estimates by an average of 0.5 mb/d, compared with previous projections.  3Q09 OECD crude runs are projected to average 35.8 mb/d, 0.5 mb/d below last month's forecast and, unusually, suggest a quarter-on-quarter decline of 0.2 mb/d, albeit depressed by the 1.2 mb/d hurricane disruption assumption which is applied to September's North American estimate.

Weak OECD demand continues to force refiners to maintain significant levels of voluntary economic run cuts, with some Japanese refiners pointing to as much as 1 mb/d of surplus domestic distillation capacity.  While Japanese refiners have suggested increasing exports to offset the collapse in demand - to levels last seen in the 1980s - competition from new capacity in China and India is more likely to force incremental refinery closures in the coming years.  Similar comments from independent refiners in the US and Europe point to the need for rationalisation of excess capacity noting that this is a slow and painful process.



OECD 2Q09 crude throughput is now seen averaging 36.0 mb/d, 0.1 mb/d below last month's report and 2.2 mb/d below 2Q08.  Official May data were broadly in line with initial estimates, while June, as already noted, was materially weaker than expected.  May data for the US indicate that crude imports from Saudi Arabia collapsed to just under 1.0 mb/d, nearly 40% lower than a year ago.  This is only the second time in the last fifteen years that imports dipped below 1 mb/d, but arguably reflects Saudi crude pricing policy in recent months.  Similarly, Japanese crude imports in June were 3.2 mb/d, nearly 15% lower than last year's level and consistent with provisional data that crude runs were under 3.0 mb/d for the month.

Refinery Upgrading Economics Under Pressure

US refiners have for some time reported cutting feed rates to catalytic cracking units due to unfavourable economics, as weak gasoline demand and resilient import levels have pressured gasoline cracks.  More recently, the stronger market for fuel oil and tighter heavy, sour crude markets, due to OPEC production cuts and declining production from long-term suppliers such as Mexico, have reduced upgrading spreads and contributed to run cuts at US refinery coking units.  Second-quarter financial results for several US refiners, including Valero and Frontier, highlighted the changes to crude slate selection that had resulted in lower utilisation of, and in some cases even idled, coking units.  Recent data from the US cover only the period up to May, but highlight the depressed level of throughputs.



Recent editions of the MTOMR have highlighted the prospect of reduced upgrading economics, driven by three key trends.  Firstly, global crude quality will improve in the short to medium term, with additional light, sweet crude streams and rising condensate supplies cutting the supply of atmospheric residue.  Secondly, OPEC production cuts have, in recent months, removed substantial volumes of heavy sour crude from the market.  Lastly, increases in upgrading capacity in Asia, notably the 580 kb/d expansion of the Reliance refinery in India, will reduce fuel oil supplies to the market.  All these drivers are working to narrow the upgrading spread, resulting in reduced incentives to maximise upgrading capacity.



Recent data point to catalytic cracking throughputs, which are more geared to gasoline production, recovering slightly with higher gasoline cracks.  However, there has been a significant decline in the utilisation of middle distillate-focussed hydrocracking capacity in the US, with throughputs falling counter-seasonally to below 1.2 mb/d in May.  Continued weakness in diesel demand and bulging floating storage suggest that subsequent data will reveal further weakness in hydrocracking feed rates during the remainder of 2Q09 and 3Q09, and quite possibly beyond.

Overall upgrading capacity utilisation is likely to remain under pressure, until product markets, most notably for middle distillates, rebalance.  This in turn will help restore the historical trend for heavy, sour crudes to trade at a substantial discount to lighter, sweeter grades.

3Q09 OECD crude throughput of 35.8 mb/d is 0.5 mb/d lower than last month's report, largely due to further reductions in European projections.  OECD crude throughput is expected to contract by 0.2 mb/d quarter-on-quarter and 1.8 mb/d year-on-year, well below the seasonal averages.  The centre of the year-on-year collapse in crude runs has shifted from North America to Europe (-1.2 mb/d) and the OECD Pacific (-0.6 mb/d).  This partly reflects the depressed baseline for comparison in the US, following the 2008 hurricanes, but also reflects the persistent weakness in middle distillate cracks, which has had a disproportionate impact on European refineries.  Recent data from Japan point to a seasonal low point having passed, in line with our projections, and reports of the restart of Shell's Clyde refinery in Australia during July will provide a further small boost to August and September throughputs.



June OECD North America crude throughput was marginally ahead of our estimate given better-than-expected Canadian and Mexican throughputs.  July crude runs are also seen marginally stronger than last month, although recent weekly US data suggest renewed weakness in refinery activity.  Several US independent refiners reported weak second-quarter results during July, highlighting the ongoing pressure on refinery profitability and upgrading economics in particular, given tight heavy/sour crude markets, forcing some refiners to run lighter, sweeter crudes.  Elsewhere, Pemex's maintenance at the Minatitlan refinery will lower Mexican crude runs in August, but overall 3Q09 estimates are broadly unchanged.

OECD Europe preliminary data for June indicate that crude throughput was 12.3 mb/d, nearly 0.5 mb/d weaker than projected.  Shortfalls in France, Italy and Turkey account for much of the difference.  Ongoing weakness in diesel cracks, the increasing level of middle distillate floating storage and above normal German consumer heating oil stocks suggest that the outlook for the remainder of 3Q09 is bleaker than previously assumed.  We have therefore reduced our 3Q09 estimate by a further 0.5 mb/d, following last month's 0.5 mb/d downward revision.  Furthermore, second-quarter results for several European independent refiners suggest that economic run cuts will be maintained, with Petroplus indicating crude runs will be 20-25% below 3Q08's level.  Elsewhere, capital expenditure reductions continue apace and comments from European refiners suggests that further cutbacks may be imminent.



OECD Pacific crude throughput appears to have reached its seasonal trough in June, with Japanese runs averaging just under 3.0 mb/d and the region as a whole steady at 6.0 mb/d.  Japanese crude imports picked up to 3.2 mb/d during the month, suggesting the recovery in Japanese crude throughput in weekly statistics during recent weeks marks the low point in crude runs.  Nevertheless, weak domestic demand leaves a question mark over the long-term future of some refineries, given that nearly 1 mb/d of excess capacity is likely to persist over the next few years.



Furthermore, despite the extraordinarily low Japanese crude runs seen in recent months, kerosene stocks are in line with the five-year average, and seasonal patterns suggest they should build over the balance of 3Q09.  Consequently, further demand weakness for kerosene may possibly trigger another round of run cuts if stocks rise substantially.  3Q09 projections are unchanged from last month, with the return of Shell's Clyde refinery in Australia, already factored into August and September estimates.

Refining Industry Consolidation - Blood in the Water

Urban myths suggest that sharks can detect traces of blood in the water up to one mile away.  Similarly, the recent increase in interest in the refining industry from investment banks, management consultancies and private equity groups suggests that some refiners appear vulnerable and potentially this may herald another round of industry consolidation.

Undoubtedly, some refiners have faced significant financial strain from the economic slowdown.  Planned levels of capital expenditure have been slashed to preserve balance sheet strength and allow companies some breathing room from banks and other creditors.  Equally important is the need to maintain credit rating agencies' assessments of debt quality, if refiners are to maintain access to capital markets.  Nevertheless, some refiners may face distressing times ahead and could be considering asset disposals to improve their business survival prospects.  Similarly, the well-worn path of non-core asset disposals by Supermajors has recently seen Shell's Stanlow, Heide and Harburg refineries reportedly being on offer.  Potential buyers are diverse and include Russian, Indian, Middle and Far Eastern companies.  However, a change of ownership per se does not alter the structural imbalances emerging in the OECD.

Real industrial change will only come when excess capacity is closed.  As already noted, several US independent refiners see this as a slow and often painful process.  Ultimately, the industry survivors may be those with the deepest pockets, rather than those with the most competitive assets.  However, high closure and site remediation costs undoubtedly stack the odds in favour of refineries being sold rather than closed.  Furthermore, the rehabilitation of debt and equity markets from last year's traumas may herald a new wave of industrial restructuring as cheap valuations tempt some to expand their operations.  According to some refiners, banks are attempting to generate interest in assets that are not necessarily for sale.  By the same token, there is very little in the world of refining that is not for sale if buyers are willing to pay a sufficiently high price for it.

Barring a rapid recovery in refining profitability, it seems likely that the sharks will continue to circle the industry and may look to pick off the weaker players.  However, weak global demand is likely to require longer-term solutions to resolve the structural imbalances that have emerged in recent months, rather than 'quick-fix' changes of ownership, which seem the preferred option for now.

Non-OECD Refinery Throughput

Forecast 3Q09 non-OECD crude throughput is revised up by 0.2 mb/d to 36.2 mb/d, following a further positive reappraisal of China's crude throughput projections and a lowered Latin American assessment.  Reported May crude throughput was stronger than expected in Algeria, Brazil, Indonesia and Thailand, as run cuts, related to weak regional demand, failed to materialise.  Preliminary June data were also stronger than forecast, with Russian, Indian and Iranian crude runs ahead of expectations.  Reported Iraqi crude runs of 0.2 mb/d appear exceptionally weak and, given apparently conflicting data from other sources, we have delayed incorporating them into our estimates pending further review.

Latin American crude throughput projections have been cut following Valero's decision to idle the 275 kb/d Aruba plant for 3Q09.  Its subsequent restart depends entirely on prevailing refinery economics, but for the moment we have altered our forecasts only through the end of September.  As noted above, Indian crude runs were stronger than expected in June, as the ongoing ramp-up of Reliance's Jamnagar expansion reaches its completion.  Reliance estimates that second-quarter crude runs averaged 0.3 mb/d, suggesting further increases in the coming months; we have marginally adjusted up our estimates accordingly.  Russian crude runs in June were 0.1 mb/d ahead of expectations at 4.8 mb/d.  The country's refinery throughput has recovered from seasonal maintenance to almost reach levels of a year ago, despite the economic slowdown, suggesting refineries have boosted export volumes to compensate for the slowdown in domestic demand.



June Chinese crude throughput of 7.8 mb/d was 0.3 mb/d higher than expected.  Quicker ramp up of new facilities and higher-than-expected crude runs at some key state-owned refineries underpin some of this outperformance.  It would appear that elsewhere refineries have also increased runs substantially in recent months, although visibility on this increase remains low.  Furthermore, lingering uncertainty as to the sustainability of the ramp up in Chinese crude runs (+1.7 mb/d since January 2009) remains, given falling state oil company sales figures and discrepancies over stock levels.  Nevertheless, in light of reports of further increases in July, and despite the potential impact of Typhoon Marokot, we have raised 3Q09 projections to 7.8 mb/d, in line with June.

OECD Refinery Yields

In May 2009, OECD refiners increased the yield of gasoline and 'other products' at the expense of naphtha, jet fuel/kerosene and fuel oil, while gasoil/diesel yields increased marginally.  OECD gasoline yields reached a record level with yields in the Pacific increasing by one percentage point to 23.9%, a level not seen since August 2003.  In Europe, gasoline yields increased by 0.5 percentage points, approaching the five-year average and in North America they increased marginally, staying above the five-year range.  OECD gasoil/diesel yields were at the top of the five-year range, with yields in Europe at 38.4%, above its five-year range, and yields in North America and the Pacific around their five-year average.



Refinery yields reflect mainly the economic incentives of production in each region as depicted by crack spreads.  In OECD Europe, relative strength in crack spreads boosted gasoline yields at the expense of naphtha but also to a lesser extent jet fuel/kerosene yields.  Weak gasoil spreads undermined gasoil yields relative to jet fuel kerosene, but supported them compared with fuel oil yields.  Balancing this picture, yields for the 'other products' category increased.



In OECD North America, May jet fuel/kerosene yields were hit not only by weak crack spreads but also by declining demand following the outbreak of the A/H1N1 virus in Mexico in late April.  Jet fuel/kerosene cracks in North America slipped below those of much stronger naphtha, supporting naphtha and gasoline yields.  Gasoil/diesel yields increased, even though gasoil/diesel cracks were slightly lower than those for jet fuel/kerosene.  Fuel oil yields increased by 0.4 percentage points to 4.8% this month, supported by higher crack spreads.







In the Pacific, strength in cracks for gasoline and jet fuel/kerosene boosted gasoline yields at the expense of those of naphtha.  Jet fuel/kerosene yields remained unchanged, with crack spreads at the same level as for gasoil/diesel; however, gasoil/diesel yields increased at the expense of fuel oil yields, justified by the significant difference between these two products' crack spreads.  Fuel oil yields decreased to 10.3%, 4.9 percentage points below their five-year average level.





OECD Refinery Gross Output

In May, OECD total product gross output recorded a contraction of 5% (2.24 mb/d) year-on-year.  Gasoline showed some resilience with gross output above its last year's level (+2% or 265 kb/d).  However, the higher gasoline gross output was accommodated by a switch from last year's May net-import position of 381 kb/d to a net-export position of 161 kb/d this year.  Net imports for 'other products' remained well below their five-year range, while net-import patterns for the rest of the products broadly within their historical range.

Gasoil/diesel gross output stayed above its five-year average level, but 707 kb/d below last year's, with North American output contracting by 454 kb/d.  Fuel oil gross output contracted the most (820 kb/d or 20%) while that of jet fuel fell by 10% (395 kb/d), followed by 'other products', with a 5% fall (343 kb/d), and naphtha, for which gross output shrank by 12% (243 kb/d).





On a month-on-month basis, OECD gross output for naphtha, jet fuel/kerosene and fuel oil contracted in May by more than seasonal norms, and 'other products' gross output increased seasonally, but by less than the historic average level.





In OECD North America, monthly gross output increased for all product categories bar jet fuel.  In OECD Europe, gross output increased only for gasoline, reaching the low end of the five-year range.  Gasoil/diesel gross output remained above its five-year average level in spite of a slight fall from April, influenced by the lack of support of crack spreads, which decreased across the board.  In OECD Pacific, gross output decreased for all product categories; however, the seasonal monthly fall in gasoline gross output, which is exacerbated by last year's tax issues in Japan, was attenuated by higher crack spreads, keeping May gasoline output above the five-year range.