Oil Market Report: 11 August 2010

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Highlights

  • Crude oil futures trended higher in July on stronger financial markets and supply outages in the US Gulf of Mexico and the North Sea. By early August, prices rose to their highest level in three months before retreating on more comfortable supplies and concerns over the global economic recovery. WTI and Brent currently stand near $80/bbl.
  • Global oil demand for 2010 and 2011 is revised higher on stronger GDP assumptions and baseline adjustments. Demand is seen at 86.6 mb/d in 2010 (+2.2% or +1.8 mb/d year-on-year) and 87.9 mb/d in 2011 (+1.5% or +1.3 mb/d). Weaker economic recovery, a third lower than the base case, would cut the 2010 and 2011 prognoses by 290 kb/d and 1.2 mb/d, respectively.
  • Global oil supply rose 850 kb/d to 87.2 mb/d in July, as Norwegian maintenance ended and OPEC boosted supplies. Non-OPEC supply estimates for 2010 are hiked to 52.6 mb/d, rising to 52.9 mb/d in 2011. BP has plugged its leaking well in the Gulf of Mexico, but we now identify 60 kb/d of potential lost output due to regional project delays in 2010, rising to 100 kb/d in 2011.
  • OPEC crude oil supplies edged up 220 kb/d to 29.2 mb/d in July, on higher output from Nigeria and the UAE. The 'call on OPEC crude and stock change' is reduced by 100 kb/d for both this year and 2011, to 28.8 mb/d and 29.1 mb/d, respectively. OPEC NGLs are forecast to rise by 600 kb/d to 5.9 mb/d in 2011, similar growth to 2010.
  • Global refinery crude throughputs are revised up 425 kb/d for 2Q10 on strong European runs. At 73.9 mb/d, 2Q10 global runs are 1.8 mb/d higher year-on-year, with growth underpinned by expansions in China and a recovery in US refinery activity. Forecast 3Q10 runs are hiked to 74.7 mb/d, 1.1 mb/d above 3Q09.
  • OECD industry stocks fell by 0.8 mb in June to 2 760 mb, or 61.0 days of forward demand cover. Preliminary data point to a seasonal 21.5 mb build in the OECD in July, driven by product increases in the US, while crude and products held in short-term floating storage fell.

Learning from history

Legislators often like to depart for summer recess having left their mark by pushing through a raft of new rules. This year has been no exception. The OMR team at the IEA has less lofty ambitions, but also likes to leave subscribers with something useful in August - the Annual Statistical Supplement (ASS), which summarises the last 15 years' oil market data. Hegel once said, "we learn from history that we learn nothing from history". Maybe so, but revisiting historical market data provides at least some clues on market direction for the years ahead, even if many uncertainties remain.

IEA crude oil import costs stood near $15/bbl back in 1994, but rose to average $28/bbl in 2000 and $60/bbl in 2009, having reached an annual peak near $100/bbl in 2008. Imports of crude and key oil products into the OECD rose by nearly 3 mb/d in that period, with crude and fuel oil imports stable, but middle distillates imports having doubled and gasoline imports nearly trebling. Despite current refining over-capacity, meeting buoyant demand growth for clean transport fuels, diesel and jet fuel in particular, remains a key challenge for the refining industry in the longer term, as we discussed in MTOGM 2010.

More broadly, 2009 world oil demand was 15 mb/d, or 20%, higher than in 1995, with all the net growth coming from non-OECD markets. OECD demand in contrast peaked in 2005 just short of 50 mb/d. Demographic and income growth in the dynamic emerging economies will remain the engines of oil market growth in the next decade, a trend exaggerated by end-user price subsidies. Countries like India, China and Iran are grappling with the social and political challenges of subsidy phase-down, but progress cannot happen overnight, even though subsidies distort the passing on of pricing signals to consumers.

Major energy consumers, refiners and producers alike face multi-billion dollar investments in the next decade to cover fuel purchases and new supply technology development. Resource nationalism leaves cheaper, easier oil off limits to international companies, pushing up supply costs which ultimately are passed on to consumers. OPEC crude has generated 25% of incremental supply during 1995-2009, requiring non-OPEC and non-conventional oil to fill the gap. Assuming OPEC continues to ration supply in support of price management objectives, massive investment in new non-OPEC barrels will be needed, with a corresponding requirement for companies to be able to manage the associated investment risk.

This is why emerging legislation in several countries is being so closely watched. Access to reserves and investment terms are under review in, among others, Russia, Brazil, Nigeria and Kazakhstan, all of whom are already, and will remain, major oil suppliers. This year's Macondo disaster in the deepwater US Gulf highlights ever-present supply risks, with hurricanes, tanker attacks, pipeline explosions and refinery outages in July alone re-emphasising the inherent fragility of oil supply.

But Macondo also places the ability of the industry to access important new reserves on a knife-edge. Some 30% of existing global oil, and nearly 50% of new supplies by 2015, needs to be sourced from offshore, much of it from deep water. Operating and regulatory standards may be tightened, and sensitive frontier areas may see permitting delays, but fortunately few host governments worldwide appear to be contemplating blanket bans on deepwater development. That said, fledgling US energy and climate change legislation focuses on unlimited operator liability for offshore oil spills. That potentially makes deepwater development unaffordable for many smaller and medium sized companies

The ability of physical market players to hedge risk in future may also be affected by the US' recently passed (and elegantly titled!) Dodd-Frank Wall Street Reform and Consumer Protection Act, and parallel legislation under consideration in Europe and Asia. While regulators have rightly been given greater powers of oversight and a mandate for more transparency in hitherto opaque over-the-counter derivatives markets, the formulation of precise regulations after the enabling legislation has passed will be crucial. US regulators thankfully seem well aware of the need for internationally consistent standards. They also appear to acknowledge potentially damaging unintended consequences were overly onerous collateral requirements or position limits to be applied in commodity financial markets

Demand

Summary

  • Forecast global oil demand for 2010 and 2011 is revised up by 80 kb/d and 50 kb/d, respectively, on slightly higher economic assumptions and baseline adjustments. Based on the IMF's World Economic Outlook Update (July 2010), complemented by prognoses from both the OECD and Consensus Economics, global economic activity is seen expanding by 4.5% this year but remains capped at 4.3% next year. Oil demand is thus expected to average 86.6 mb/d in 2010 (+2.2% or +1.8 mb/d year-on-year) and 87.9 mb/d in 2011 (+1.5% or +1.3 mb/d). However, concerns that the global economic recovery may falter from 2H10 pose a significant downward risk to the forecast. Assuming that GDP growth is a third lower than the base case, a sensitivity analysis suggests that global oil demand would be some 290 kb/d and 1.2 mb/d less in 2010 and 2011, respectively.
  • Forecast OECD oil demand for 2010 and 2011 is adjusted up by 30 kb/d on average on slightly higher readings in Europe and a minor reappraisal of US demand prospects. Total demand is projected at 45.5 mb/d in 2010 (+0.2% or +80 kb/d year-on-year) and 45.3 mb/d in 2011 (-0.4% or -200 kb/d). However, if predictions of a 'double-dip' recession affecting key OECD countries were to be realised, this year's growth would be negligible or flat and next year's expected decline steeper.


  • Forecast non-OECD oil demand is raised by 55 kb/d to 41.0 mb/d in 2010 (+4.5% or +1.8 mb/d year-on-year), but remains largely unchanged at 42.6 mb/d in 2011 (+3.7% or +1.5 mb/d). The revisions for this year reflect higher economic assumptions, as well as stronger-than-expected readings in Asia and the FSU. Yet under a lower GDP case, 2011 non-OECD demand growth, by virtue of the region's much higher income elasticity, would come in at 950 kb/d less.
  • As non-OECD demand becomes the main driver of global oil demand growth, it is also starting to alter the world's demand seasonality, which until now followed the mould of OECD demand. Indeed, as much as 2Q oil demand falls quarter-on-quarter in the OECD, it normally rises in the non-OECD. Eventually, as non-OECD oil demand overtakes OECD consumption over the next few years, the first quarter could come to feature the lowest demand level within any given year. Although somewhat distorted by the recession, preliminary demand readings have already provided a glimpse of the future: at 86.6 mb/d, 2Q10 global demand is some 600 kb/d higher quarter-on-quarter.

Global Overview

Is the global economic recovery faltering? The answer to this question is elusive, as recent figures point to contradictory trends. For example, the latest industrial production data (June) for the key economies indicate that growth is slowing down. Only the US is so far exhibiting a flattening trend, but other countries are featuring either a mild deceleration (the Eurozone) or a marked one (notably Japan and India). Still, with industrial production growth hovering around 10-15% on average, concerns about an impending global economic slowdown would appear exaggerated - were industrial production in the OECD back to its pre-recession levels. However, industrial production in the most advanced economies - the US, the Eurozone and Japan - is still some 10% below January 2008.



Some analysts argue that OECD economies face the risk of falling into a 'liquidity trap' - being so weak as to render monetary policy ineffective since a highly leveraged private sector is reluctant to invest and consume amid pervasive high unemployment, despite ultra-low interest rates. From this perspective, only continued government spending would ensure that the momentum is maintained and that a 'double-dip' recession is avoided. However, another round of fiscal expansion is far from guaranteed, given concerns that public indebtedness is reaching unsustainable levels. Indeed, many OECD governments, notably in Europe, have announced some degree of fiscal retrenchment in the short to medium term.

However, other indicators paint a less gloomy OECD picture. Bond markets remain buoyant, indicating a risk of deflation, rather than government-fuelled inflation - thus suggesting that fears of potential sovereign defaults have eased. Corporate profits have been strong, and 2Q10 GDP growth in key countries such as Germany and the UK has surprised on the upside. In the US, even though 2Q10 growth, at +2.4% year-on-year, indeed softened relative to 1Q10 (+3.7%), it remains relatively high - albeit 2009 real GDP growth was revised down from -2.4% to -2.6%, indicating that the recession was deeper than previously thought. The quarterly slowdown appears to be mostly related to the inventory cycle, as stock rebuilding eases after the spurt of growth that followed the massive recession-induced stock liquidation. Investment appears to have taken the baton and private consumption, albeit subdued, held its ground, rather than worsening. Thus, US data are ambiguous and could be interpreted either way.

By contrast, most of the largest emerging economies - particularly China, where industrial production is some 70% higher versus its pre-recession levels - have clearly staged a remarkable recovery. Still, many observers fret about the short-term outlook of the Chinese economy, as the government seeks to burst real estate and financial asset bubbles, curb runaway investment and encourage domestic consumption. However, the expected deceleration in China's economic activity (from about 11% in 1H10 to 9% in 2H10, according to the consensus view) can hardly be called 'sharp', although it may actually help tame inflationary pressures. Nevertheless, a further slowdown is arguably unlikely if the government seeks to avoid harming the economy's main pillars of growth - investment and, to a lesser degree, net exports - just ahead of a crucial change in the country's political leadership.

Yet this suggests that China's 'rebalancing' in favour of consumption-driven growth will only take place in the longer term. If private consumption growth in exporting economies with large current account surpluses, namely Japan, Germany and China, fails to offset the decline in countries with sizable current account deficits, such as the US and the UK, the world economy could again face imbalances of the same magnitude as those evident prior to the recession in just a few years. According to the International Monetary Fund, current account imbalances will reach 2007 levels (the highest ever) by 2015. Clearly, not all countries will be able to simultaneously export their way out of recession.

In sum, the short-term global economic outlook is highly uncertain, presenting significant downside risks to future oil demand growth. A bullish assessment, expecting global economic activity to be sustained in 2011, suggests that oil demand growth will be relatively strong next year (with some observers reckoning that growth will be even higher than this year). Conversely, a bearish view featuring a marked slowdown in global economic conditions would result in much weaker oil demand growth.

These outcomes can be modelled under a GDP sensitivity analysis. Our base case is largely derived from the last IMF World Economic Outlook Update (released in mid-July), complemented by prognoses from both the OECD and Consensus Economics. Compared to its April assessment, the Fund now sees slightly higher global GDP growth in 2010, mostly on higher-than-anticipated 1H10 readings, while keeping its 2011 forecast largely unchanged. However, given our assumption that economic activity will gently moderate in 2H10, our demand outlook is only marginally revised up relative to last month's report, with growth expected to reach +1.8 mb/d (+2.2% year-on-year) in 2010 and +1.3 mb/d (+1.5%) in 2011. Our lower case, meanwhile, examines how oil demand would evolve should global GDP growth feature a marked deceleration in 2H10, which would continue in 2011.



If global economic activity were to expand by a third less (bringing down overall GDP growth to +3.0% in 2010 and to +2.8% in 2011), global oil demand would be some 290 kb/d and 1.2 mb/d less in 2010 and 2011, respectively, versus the base case. For this year, assuming that 1H10 demand figures are largely final, this implies that 2H10 demand would be some 580 kb/d lower. Moreover, the non-OECD - by virtue of its much higher income elasticity - would account for roughly 70% of the difference. It should be noted that, contrary to our recently released Medium-Term Oil & Gas Markets 2010 report, this analysis is undertaken under a ceteris paribus condition - that is, holding all variables but GDP constant. As such, it does not account for likely oil price and oil intensity effects, and is therefore merely illustrative.



OECD

According to preliminary data, OECD inland deliveries (oil products supplied by refineries, pipelines and terminals) rose by 0.7% year-on-year in June. Resilient demand in OECD North America (which includes US Territories), mostly underpinned by gasoline and diesel demand, offset a decline in OECD Pacific on the back of poor distillate and fuel oil readings. Meanwhile, oil demand in OECD Europe remained flat, as weak deliveries of gasoline, fuel oil and 'other products' counterbalanced rising demand for naphtha and distillates.



Revisions to May data were sizable (-380 kb/d), driven largely by North America (-245 kb/d), as US diesel deliveries turned out to be much weaker than suggested by preliminary weekly figures, and the Pacific (-135 kb/d), with changes concentrated in Japan's 'other products'. European readings, on the other hand, were virtually unchanged. Total OECD demand thus rose by only +2.4% year-on-year in May, roughly a third lower than implied by preliminary data. However, the adjustments for the whole of 2010 are relatively minor (+30 kb/d), with Europe (+40 kb/d) and North America (+10 kb/d) largely offsetting the Pacific (-25 kb/d), with total OECD demand expected to average 45.5 mb/d (+0.2% or +80 kb/d year-on-year). The prognosis for 2011, meanwhile, is raised by 35 kb/d to 45.3 mb/d, mostly on a minor reappraisal of US demand prospects. Still, this upward revision is insufficient to overturn an overall OECD decline (-0.4% or -200 kb/d year-on-year).



North America

Preliminary data show oil product demand in North America (including US territories) rising by 2.1% year-on-year in June, following a 4.8% increase in May. June featured strong diesel readings and increases in petrochemical feedstocks, which outweighed declines in jet fuel/kerosene and heating/power generation fuels. Regional gasoline demand posted a third consecutive month of growth, though year-on-year comparisons appeared more modest than in April and May. Despite the incorporation of higher regional 2010 and 2011 GDP assumptions, as put forth in the IMF's latest update, economic sentiment has soured with recent data releases pointing to further deceleration in the recovery. Still, evidence of renewed economic slowdown borne out through weakening preliminary oil demand data appears inconclusive for now.



May preliminary data were revised down by 245 kb/d, mostly due to a downward correction to US diesel and 'other products', which outweighed an upward revision to gasoline and heating oil. North American oil demand for 2010 is seen rising to 23.7 mb/d (+1.5% or +350 kb/d year-on-year and 10 kb/d higher versus our last report). Looking forward, 2011 oil demand should fall slightly to 23.6 mb/d (-0.2% or -40 kb/d and 50 kb/d higher than our last report), with stagnant gasoline consumption and declines in petrochemical feedstocks and heating/power generation fuels outweighing growth in middle distillates.

Adjusted preliminary weekly data for the continental United States indicate that inland deliveries - a proxy of oil product demand - grew by +1.9% year-on-year in July, following +1.4% in June. July data featured year-on-year gains in all categories bar heating oil. Even though diesel demand grew at +3.8% (versus +9.9% in June), its underlying strength as reflected in weekly data remains tenuous. Our May diesel estimate, in part derived from an assumed split of weekly distillate figures, was revised down by 440 kb/d with the inclusion of official monthly data. High exports may have inflated weekly estimates and, indeed, market reports indicate sustained diesel exports during June and July (though recent activity appears to be waning), particularly to Latin America. While we assume a split of distillate between diesel and heating oil based on historical patterns, we continue to forgo our normal weekly-to-monthly pre-emptive adjustment in June and July given the uncertain impact of exports. Moreover, despite continued monthly and annual gains in rail freight and strong shipping activity at the Los Angeles/Long Beach ports, other indicators look more muted than in our last report. The American Trucking Association's seasonally adjusted tonnage index fell month-on-month in both May and June, while manufacturing growth, as indicated by the ISM index through July, has slowed for the past three consecutive months.



Gasoline demand has featured modest but consistent strength during the summer driving season. The inclusion of monthly data raised May gasoline consumption by 175 kb/d versus our previous estimate based on weekly figures. June and July consumption, according to these estimates, grew by 1.1% and 1.0%, respectively, while the April-July period showed year-on-year growth averaging 1.2%. Average regular gasoline retail prices have remained remarkably steady in a $2.70-$2.78/gallon range since early June (nominally about ¢15-20 higher than the same period last year), but seemingly not at a high enough level to outweigh income effects on demand. Rather, persistent high unemployment continues to weigh upon growth rates, with the private sector struggling to create jobs and non-farm payrolls data in July showing the unemployment rate unchanged at 9.5%.

The outlook for gasoline demand in 2011 looks slightly more optimistic than in our last assessment, owing to the incorporation of a higher GDP assumption, as well as a lifted 2010 baseline. Still, demand is expected to fall by 0.1% next year (versus -0.5% in our last report), based on continued improvements in fleet efficiency offsetting the economic growth impact. An upside risk, though, is that fleet turnover proceeds at a slower pace than anticipated while aggregate driving increases in line with its historical relationship to income.

Mexican oil demand continued to post strong growth, rising by 7.1% year-on-year in June. Yet concerns have surfaced over the sustainability of Mexico's strong industrial recovery, particularly regarding car manufacturing, given its strong linkage to the US economy, whose outlook remains uncertain. Nevertheless, preliminary data showed continued increases in diesel (+3.8%), jet fuel/kerosene (+22.3%) and LPG (+1.8%). Gasoline demand growth moderated to 0.8%, while residual fuel oil posted a third consecutive month of strong gains (+17.5%).

No Surprises: US 2009 Demand Revisions in Line With Recent Trends

At the end of July, the US Energy Information Administration (EIA) provided finalised US-50 demand data for 2009 with the release of the Petroleum Supply Annual (PSA). US50 preliminary monthly demand is derived from the Weekly Petroleum Status Report, which is revised two months later in the Petroleum Supply Monthly (PSM) and then finally adjusted in the PSA, usually in mid-year. The new 2009 data showed an upward revision of 85 kb/d, in line with trends seen during the past decade and very close to our own pre-emptive annual correction (+80 kb/d). From 2000-2008 the average annual revision was +100 kb/d, with 2003 and 2007 featuring the only negative adjustments.



The 2009 revisions were led by an upward adjustment to the other products category (+60 kb/d), followed by LPG (+30 kb/d) and gasoline (+10 kb/d). Typically, 'other products' - which include unfinished oils, lubricants, waxes, petroleum coke, asphalt and others - have represented the largest revisions, given the difficulty associated in tallying such disparate and sometimes nebulous products. The upward revision to LPG reinforces trends borne out in monthly data, namely that the US economic recovery was led by a strong rebound in the petrochemical sector. The small positive gasoline adjustment came in lower than the 2000-2008 average (+30 kb/d), reinforcing the notion of only a marginal rebound in 2009 gasoline consumption. Residual fuel oil posted a negative revision of 10 kb/d, while middle distillate and jet/kerosene were essentially unchanged versus monthly data.

Overall, the low value of the 2009 adjustment, similar in magnitude to 2008, suggests that improvements in monthly data collection have remained consistent, particularly concerning the main products. For 2010, based on the monthly average revisions of previous years, we are factoring in an annual correction of 85 kb/d.

Europe

According to June preliminary inland data, oil product demand in Europe was unchanged versus the same month of the previous year, as weak deliveries of gasoline, fuel oil and 'other products' offset rising naphtha and distillate requirements. Germany provided most of the offsetting momentum, with strong demand for naphtha and heating oil. Naphtha use was supported by resilient industrial activity, while heating oil deliveries were seemingly boosted by households taking advantage of relatively lower prices to partly replenish their tanks (at 53% of capacity, filling is slightly above its five-year average, but much lower than the 64% posted in June 2009).



Revisions to May preliminary demand data were negligible (-5 kb/d), as weaker-than-expected readings for naphtha (Germany), diesel (Belgium and Turkey), residual fuel oil (Belgium) and 'other products' (Belgium and the Netherlands) offset much stronger figures for LPG (the Netherlands) and heating oil (Greece, Ireland and Sweden). Overall, total OECD Europe demand is revised by +40 kb/d to 14.3 mb/d in 2010 (-1.4% or -200 kb/d compared with the previous year). Oil demand is expected to decline further in 2011 to 14.2 mb/d (-0.5% or -70 kb/d versus 2010 and unchanged versus last month's report).



Pacific

Preliminary data show that oil product demand in the Pacific fell by 2.2% year-on-year in June, as a result of poor distillate and residual fuel oil readings. In terms of countries, the decline was led by Japan (-6.1% year-on-year), the largest monthly fall since July 2009. At 3.8 mb/d, this was reportedly the country's lowest oil demand level since June 1988, with all product categories bar naphtha posting sharp contractions. Interfuel substitution, notably in favour of natural gas and nuclear power, coupled with fuel efficiency improvements and sluggish economic activity, help explain the fall.



May data revisions were relatively large (-135 kb/d), mostly centred on diesel and 'other products'. As anticipated in the last report, the implausible surge in Japan-driven 'other products', implied in preliminary data, was revised down sharply (-155 kb/d), with demand now more in line with natural gas use and rising utilisation rates in nuclear power plants. OECD Pacific demand thus barely increased in May (+0.4%), much less than anticipated by preliminary figures (+2.3% year-on-year). Total oil product demand in 2010 is revised down by 25 kb/d to 7.6 mb/d (-0.9% or -70 kb/d year-on-year), and is projected to decline further in 2011 to 7.5 mb/d (-1.2% or -90 kb/d compared with the previous year and 15 kb/d less than last month's report).



Is A New Seasonality Emerging?

Global oil product demand traditionally peaks in the first quarter, as winter temperatures in the northern hemisphere are coldest and heating needs increase. Demand then typically declines to its lowest in the second quarter - that is, until recently. Indeed, a new seasonal trend may have emerged since 2009. The 1Q-2Q gap fell sharply that year, reversed markedly in 2010 and could remain marginal in 2011.





This unusual pattern reflects the world's new oil demand dynamics. Indeed, as much as 2Q oil demand falls quarter-on-quarter in the OECD, it normally rises in the non-OECD. In many developing countries, economic activity tends to slow down sharply in the first quarter following the New Year's celebrations - most notably in China, where the Lunar Year holidays occur in January/February - before rebounding in the second quarter. Given that non-OECD demand is now driving global growth, it is also starting to alter the world's oil demand seasonality, which until now followed the mould of OECD demand.

Aside from 2009 and 2010, which were distorted by the recession (since demand in the OECD plummeted, while it surged in the non-OECD), 2Q global demand is likely to even out gradually relative to the first quarter. Eventually, as non-OECD oil demand overtakes OECD consumption over the next few years, the first quarter may come to feature the lowest demand level within any given year. In fact, a glimpse of the future has already been provided by preliminary 2Q10 demand readings. At 86.6 mb/d, demand is some 600 kb/d higher quarter-on-quarter, as buoyant non-OECD demand largely offset the OECD seasonal fall, which was tempered by the economic recovery (and, as such, was relatively limited compared with previous years). Even allowing for potential downward revisions given a sizable 'miscellaneous to balance' factor (which could signal lower demand than available preliminary data indicate), 2Q10 demand is unlikely to fall below 1Q10 levels. More significantly, perhaps, this emerging seasonality will likely raise new refining and logistical challenges in the years ahead.

Non-OECD

China

Preliminary data indicate that China's apparent oil demand (refinery output plus net oil product imports) rose by 9.9% year-on-year in June. Despite concerns that demand for plastics may turn out to be below expectations in 2H10 if global economic activity slows down, the country's apparent demand for naphtha remains extremely buoyant (+45.9%), with growth well ahead of jet fuel/kerosene (+13.7%), gasoil (+8.3%), 'other products' (+7.7%) and gasoline (+5.3%).

Still, China's oil demand growth has seemingly trended down over the past several months. June's year-on-year growth, at +870 kb/d, albeit higher than in May (+730 kb/d) was almost half that recorded in January (+1.7 mb/d, the highest ever). Assuming a mild slowdown in 2H10 as the stimulus programme is unwound and export markets soften somewhat, monthly year-on-year growth should moderate to some +400 kb/d on average over the reminder of the year and into the next. As such, yearly total oil demand growth is expected to halve from +9.0% in 2010 to +4.6% in 2011.



Other Non-OECD

India's oil product sales - a proxy of demand - rose by +2.2% year-on-year in June, supported by continued strong readings for LPG, gasoline and gasoil (+7.9%, +12.7% and +7.2%, respectively).

At first glance, the strength in transportation fuels may have been due partly to destocking in anticipation of the price hike that occurred late in the month, but underlying demand appears buoyant (car sales rose by 30% year-on-year in June). Farming and industrial activity also contributed to support gasoil demand. By contrast, demand for jet fuel/kerosene contracted by 2.6%, possibly as a result of the price rise. Meanwhile, naphtha demand, which had briefly spiked in May following the start-up of Indian Oil's naphtha cracker in Haryana, resumed its decline (-11.5%) on the back of continued natural gas substitution.



In Argentina, residential usage of natural gas has spiked on below-freezing temperatures in July, reducing availability for industry and power generation. The government has responded by allocating funds to utilities in order to import diesel and fuel oil, as well as additional piped natural gas and LNG. Indeed, to meet peak demand, Argentina remains largely dependent on gas from Bolivia, which suffers from chronic supply-side underinvestment, and on LNG. Moreover, end-user prices are subsidised, with gas selling for about $1/Mbtu less than import costs. Controversy has surfaced over the importation of fuel oil from Venezuela, with former Argentine energy officials alleging the payment of excessively high prices to PDVSA given quality differentials between the domestic and imported product. Meanwhile, the cold weather and gas restrictions have reportedly reduced Argentina's petrochemical operating rates to 30-40% of capacity.



Overall, the country's oil demand estimates for 2010 and 2011 have been revised up by 10 kb/d, with the incorporation of higher GDP expectations, as well as an upward revision to winter prognoses with regards to diesel and fuel oil consumption, which outweigh a reduction in expected petrochemical demand. The magnitude of the weather effect remains uncertain at this point, however. As such, the persistence of severe conditions and the anticipated inclusion of July government data in next month's report suggests upside risk to diesel and fuel oil, while petrochemical demand readings may come out lower than forecast.

Russian oil demand has rebounded spectacularly from the depths it reached in 2009. According to preliminary June data, total demand rose by a hefty +12.8% year-on-year, with products such as jet fuel/kerosene and gasoil surging by +25.4% and +13.6%, respectively. This reflects the recovery of the Russian economy, which sank by 7.9% in 2009. With GDP expected to rise by 4.3% this year, oil demand is set to average almost 3.0 mb/d (+6.0% or +170 kb/d versus 2009). However, although economic activity is projected to remain strong in 2011 (+4.1%), the pace of oil demand growth should moderate, rising by +2.2% or +70 kb/d, partly amid more plentiful availability of domestic natural gas.



Supply

Summary

  • Global oil supply rose by 850 kb/d to 87.2 mb/d in July, with OPEC crude, OPEC NGLs and total non-OPEC supply each around 0.2-0.4 mb/d higher than in June. Compared to July 2009, global oil production is 1.8 mb/d higher, with year-on-year gains shared between the three components.
  • Non-OPEC oil supply rose by 0.4 mb/d to 52.7 mb/d in July, as seasonal maintenance in Norway ended. The 2010 and 2011 forecasts are revised up by 0.2 mb/d and 0.1 mb/d respectively following a baseline adjustment to the US and higher-than-anticipated 2Q10 Chinese oil production. 2010 output is now expected to average 52.6 mb/d, rising to 52.9 mb/d in 2011.
  • BP has succeeded in its effort to stabilise the leaking Macondo well in the US Gulf of Mexico and may intercept the damaged bore with a relief well in coming days, thus potentially enabling a permanent sealing by the end of August. The flow of oil from the well was already stopped on 15 July. A new report estimates that the total volume of oil spilled since late April is 4.9 mb, of which 0.8 mb was siphoned off. This would make the spill the second-largest in history. We now identify 60 kb/d of potential lost output due to associated new project delays in 2010, rising to 100 kb/d in 2011.
  • OPEC crude oil supplies edged higher in July, largely due to increased output from Nigeria and the UAE. Total OPEC output rose by 220 kb/d to 29.2 mb/d. OPEC-11 supplies, which exclude Iraq, rose by 190 kb/d, to 26.8 mb/d in July, reducing compliance with output targets to just 53% last month versus 58% in June.
  • The 'call on OPEC crude and stock change' was reduced by 100 kb/d for both this year and 2011, to 28.8 mb/d and 29.1 mb/d respectively, due to a slightly higher forecast for non-OPEC supplies.


All world oil supply data 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 supplies edged higher in July, largely due to increased output from Nigeria and the UAE. Total OPEC output rose by 220 kb/d to 29.2 mb/d. OPEC output for June was revised up by 80 kb/d, to just under 29.0 mb/d.  Production by OPEC-11, which excludes Iraq, rose by 190 kb/d, to 26.8 mb/d in July, reducing compliance with output targets to just 53% last month versus 58% in June. The group is now pumping 1.97 mb/d above the 24.845 mb/d collective target. OPEC ministers are scheduled to next meet on 14 October.



OPEC's Gulf producers typically ramp up output during the summer months to meet increased power needs for regional air-conditioning and desalination. Unusually hot weather this summer, combined with a structural expansion of infrastructure in many of the Gulf countries, has likely boosted power needs more than in previous years. As summer demand winds down, production may well drift lower in September, judging by announced customer allocations by some smaller OPEC members.

Saudi Arabia's oil production was up slightly in July, by 30 kb/d to 8.27 mb/d. The higher output is reportedly due to increased demand for direct crude burn at power plants during the peak summer cooling period. Saudi Arabia's crude burn for power generation is expected to average around 700 kb/d over the summer months, though some reports suggest this figure could be closer to 1 mb/d. Latest data from JODI show implied crude oil direct burn running at 590 kb/d in May and 685 kb/d in June.

Iranian crude oil production edged lower in July, down 70 kb/d to 3.65 mb/d, according to tanker data. Estimates for Iranian crude and condensate held in floating storage vary for July, with reports showing volumes declining by between 4 mb and 12 mb in July.

Iraqi production was higher in July, up 30 kb/d to 2.38 mb/d. June production was revised higher by 45 kb/d, to 2.35 mb/d. Total exports were unchanged at 1.83 mb/d in July, with shipments of Basrah crude at 1.45 mb/d and exports of Kirkuk crude oil from the Turkish Mediterranean port of Ceyhan steady at 375 kb/d. A further 10 kb/d is exported to Jordan by truck. The political impasse in forming a new government following the March elections has also delayed any progress on negotiations between Baghdad and the Kurdish Regional Government (KRG) over crude oil exports from the Kurdish region. Government and company officials have said that production from the Taq Taq and Tawke fields has been around 20 kb/d since exports last September were halted following a payment dispute with Baghdad, with all of the output going for local refinery use. However, unconfirmed reports have emerged that as much as 100 kb/d of crude production from the Kurdish region is being sold to neighbouring countries. Officials deny the allegations.

The UAE cranked up production in July by 70 kb/d, to 2.36 mb/d, in part reflected by higher export allocations for the month as well as to supply increased local summer demand. However, state-owned ADNOC lowered customer allocations sharply for both August and September. ADNOC plans to supply Murban crude at 20% below contract levels in September compared with 10% below contract volumes in August, and curbs of just 3% in July.



Angolan crude oil production in July slipped to the lowest level in more than a year on continued technical problems at key fields and scheduled maintenance work. Production is estimated at 1.74 mb/d, down 40 kb/d from June and 210 kb/d lower than the record high of 1.95 mb/d reached in February. Output in August and September could fall even more following the forced shut-in of capacity at Total's Girassol operations. Total declared force majeure on 13 July for Girassol crude oil loadings after a technical problem forced it to cut production. Continued maintenance work at the Palanca fields, repair work on the Nembe system and technical problems with the water injections system at the Greater Plutonio fields also reduced July production.

Nigerian crude oil production in July increased by 180 kb/d, to 2.1 mb/d, on higher Qua Iboe, Escravos and EA production as previously shut-in crude streams were brought back on line. The 100 kb/d EA offshore field operated by Shell resumed full production in July. Output of Qua Iboe and Forcados also appear set to rise based on export allocations for August. However, Total said Amenam flows would be reduced in August due to technical problems, down by 30 kb/d from a more normal 120 kb/d.

Nigeria's new oil minister Diezani Allison-Madueke, said the government is pushing hard to finalise the country's controversial Petroleum Industry Bill (PIB) by end-August. The minister said that the terms for foreign investors had improved following further talks with the operating companies. Shell, the country's largest operator, and other IOCs have been lobbying hard for changes to the original PIB. With elections now set for January 2011 and the government keen to show progress in stabilising the oil sector, time is running out to finalise the legislation, and it is unclear if the new deadline will be met given the slow progress on the bill to date.

Libyan production was unchanged in July but June levels were revised up by 20 kb/d, to 1.58 mb/d. Since the beginning of the year, Libya has eased up on its compliance with output targets, averaging just 48% in July versus 71% in January.

Market Shrugs Off Tanker Attack in Strait of Hormuz

The market took in its stride an attack on 28 July on a crude oil tanker in the strategic Strait of Hormuz, since traffic through the key channel was unaffected. There was minimal damage to the vessel, which was towed to the UAE port of Fujairah, one of the world's largest bunkering centres, for now-completed repairs. The double-hulled VLCC was carrying 2 mb of crude oil from Abu Dhabi to Japan. Such an event would normally raise the spectre of security of oil supplies from the region, but market reaction was muted given there was no disruption in the shipping lane and damage to the tanker was minimal.

The Strait, a narrow waterway located between Oman and Iran, is a critical transit route for some 40% of global seaborne oil shipments, or around 17 mb/d of oil, including exports from OPEC producers Saudi Arabia, Kuwait, Iraq, Qatar, Iran and the UAE. Indeed, 90% of Middle East crude oil exports flow through the waterway. In the past few years sales to Asia have steadily increased, with data for June showing approximately 85% of Japan's oil imports and just under 50% of China's imports coming via the straits. In addition, 2 mb/d of refined products and some 60 mt of Qatari LNG annually transit the Strait.

The cause of the explosion on the Japanese-owned 'M Star' tanker was somewhat of a mystery initially and it was feared by some observers to be possibly linked to the escalating tensions over Iran's nuclear enrichment programme. Iran has repeatedly threatened to disrupt tanker movements through the passageway in retaliation for sanctions by the United Nations, the US and European countries. New EU sanctions against Iran went into force on 27 July. The latest round of sanctions specifically targets the country's oil and gas sector as well as gasoline imports but does not include crude exports. Already, Iranian imports of gasoline have been disrupted by the new sanctions regime (see OMR, 13 July 2010, 'New Sanctions Target Iran's Energy Sector').

However, on 6 August UAE officials said the explosion was caused by a "terrorist attack" judging by explosive residue found on the hull.  A group linked to al-Qaeda had previously claimed responsibility.

US and Arab Gulf naval forces jointly patrol the Strait, as well as the surrounding waters of the Arabian Sea and Gulf of Oman in order to safeguard the flow of oil from the region given the strategic importance of the Strait. US Central Command is charged with fulfilling American responsibilities in the region, with the Navy's Fifth Fleet patrolling the Gulf from its base in Bahrain. During the 1980-88 Iran-Iraq war the two countries targeted each other's oil tankers, and numerous other foreign-flagged vessels were caught in the cross-fire. The start-up of coordinated naval patrols since then has minimised the risk of attacks. Somali pirates attacking ships as far north as the Gulf of Oman have posed the biggest problems in recent years.

Non-OPEC Overview

Non-OPEC supply for 2010 and 2011 is revised up by 0.2 mb/d and 0.1 mb/d respectively, to 52.6 mb/d and 52.9 mb/d, largely on stronger 2Q10 Chinese production and a baseline adjustment to the US following the release of finalised 2009 data. The 2010 forecast is also boosted by higher expected Kazakhstani and Russian output, but in 2011 this is offset by forecast weaker Azerbaijani supply. Annual growth is now forecast at 0.9 mb/d in 2010, followed by a weaker 0.3 mb/d in 2011, both driven by incremental supply in the FSU, Latin America and in global biofuels. Non-OPEC supply for 2009 is adjusted up by 0.1 mb/d to 51.7 mb/d due to higher US output.

The prevailing assumption of stronger-than-average storm activity in the Atlantic is borne out so far, with three named storms to date. At the time of writing, Tropical Storm Colin had just fizzled out off the US East Coast, leaving US Gulf of Mexico (GoM) oil installations untouched. Hurricane Alex and Tropical Storm Bonnie had previously forced the precautionary shut-in of large volumes of oil and gas production in the US Gulf, albeit briefly and without causing any damage. However, these passing storms resulted in an estimated loss of 27 kb/d and 105 kb/d of GoM oil production for June and July respectively.



Bonnie also delayed work on plugging the leaking Macondo well, though BP now appears to have had a breakthrough in terms of a permanent solution. Following the halt to spillage in mid-July due to the placing of a new containment dome on top of the leaking well, recent days have seen apparent success in stabilising pressure by means of pumping drilling mud into the well from above ('top kill'). The company is currently cementing the wellhead after which it hopes to permanently seal the well by intercepting it with two relief wells close by. This would put an end to what is now thought to be the largest oil spill in US waters and the second-largest in history (see Macondo: The Beginning of the End?).



A new drilling moratorium (valid until 30 November 2010) was put in place on 12 July, following the striking down of a previous one by a federal court. New legal challenges are being mounted and much uncertainty surrounds the evolution of regulatory requirements pertaining to deepwater drilling, by necessity making the impact on US oil supply unclear. Nonetheless, greater detail on the impact of drilling restrictions in the Gulf has led us to hike our estimate of potentially 'lost' oil production to 60 kb/d in 2010, rising to 100 kb/d in 2011. However, a baseline revision to 2009 data and expected growth in some onshore crude, as well as NGLs and other hydrocarbons, keep our US oil supply forecast for 2009-2011 flat at 7.45 mb/d for the time being. Much also depends on how the hurricane season develops. Potentially severe storm impact provides a risk to the downside, while the opposite would result in an upward revision of 240 kb/d to 2H10 output due to the elimination of our existing hurricane adjustment.



OECD

North America

US - July Alaska actual, others estimated: Finalised US oil production data for 2009 (from the EIA's Petroleum Supply Annual) brings a baseline upward revision of 65 kb/d, which is carried through our forecast. Hurricane Alex and Tropical Storm Bonnie briefly forced the precautionary shut-in of 20% and 50% of Gulf of Mexico oil production respectively, but caused no damage to oil infrastructure. This resulted in estimated lost production of 27 kb/d and 105 kb/d for June and July respectively. A June storm impact on GoM oil production is relatively unusual, while the July outages exceeded our previous adjustment of 45 kb/d for that month, based on the five-year rolling average. Meanwhile, despite lower-than-forecast July output in Alaska, May and preliminary June and July oil production for the whole of the US was higher than expected, contributing to the overall upward revision. In the US GoM, Marathon started production at its Droshky field in mid-July, which is expected to reach a peak capacity of 45 kb/d by the end of the year. Total US production is now forecast to stay flat at 7.45 mb/d in 2009-2011.



Macondo: The Beginning of the End?

At the time of writing, BP had succeeded in cementing the leaking Macondo well in the Gulf of Mexico, following the injection of heavy drilling mud to stabilise pressure (so-called 'top kill'). In coming days, relief wells are due to intercept the original bore some 4 000 metres below the seabed, enabling a stabilisation from below ('bottom kill') and the permanent plugging of the well, possibly by the end of August. In mid-July, BP already succeeded in halting the flow of oil by means of a new containment cap.

Updated estimates by a government task force indicate that a total of 4.9 mb of crude oil leaked from the damaged well, which puts the volume at the higher end of the previously estimated range and makes the spill the second-largest ever, greater than the 3.3 mb spilled in the 1979 Ixtoc I disaster in Mexico, but behind the 8-10 mb deliberately released into the Middle East Gulf by Iraqi forces during the 1991 Gulf War. The report estimates that 800 kb or 17% were siphoned off by BP and another 8% burned or skimmed.

On 12 July, the Obama administration put in place a new moratorium on offshore drilling, this time eliminating the shallow/deepwater distinction, but disallowing drilling with rigs that use subsea blowout preventers (effectively ones operating in deeper water). Again, this moratorium targets the drilling of new producing and exploratory wells, but allows workovers of existing wells. A previous, very similar, moratorium had been struck down by a federal court. The new moratorium, also valid until 30 November, is again being challenged, most vocally by companies and workers in the Gulf of Mexico's offshore oil industry. The government maintains that the moratorium is a prudent measure until ongoing investigations have clearly determined what the causes of the accident were. In the meantime, uncertainty about temporary and future drilling regulations have slashed regional rig counts to a quarter of pre-accident levels.



We now identify an estimated 60 kb/d of crude oil production potentially lost in our prevailing 2010 Gulf of Mexico output estimate, rising to 100 kb/d in 2011. The core of this volume is based on the assumption that a handful of identified projects will be delayed by 6-12 months. We will adapt these calculations when more details on individual project slippage become available and as more clarity on the duration and precise effect of the current moratorium and future drilling regulations emerge. Having said that, relative to total offshore GoM production, the impact is still relatively small and the moratorium explicitly does not target currently-producing fields (though as evident in the table, some existing fields are nonetheless affected). Marathon made headlines when it commenced production at its new 45 kb/d Droshky field in the GoM in mid-July. In other countries with significant offshore production, despite a review of existing procedures and regulations, we do not so far identify any impact on production. Previously, we had estimated that a year's delay to new upstream projects in Angola, Brazil and Nigeria could potentially curb 500-600 kb/d of crude oil by 2015.

In the US Congress, moves to pass new legislation affecting offshore operations rumble on, though now look unlikely to pass until after the summer recess, and even then may stumble over widely polarised views ahead of mid-term elections. But proposed elements include the lifting of the existing $75 million cap on liability, a ban on companies with poor safety records from operating in federal waters and the less controversial split-up of the previous regulator, the Minerals Management Service (MMS), into three new bodies, thus separating the roles of licensing, taxation and regulatory oversight - already a key shortcoming identified by most observers. The regulatory response to Macondo depends largely on whether operational negligence or broader systemic failures were the cause. Either way, resulting legislation will need to balance project oversight, enforcement and operating standards on the one hand with continued deepwater access and supply security on the other.

Canada - May actual: Oil production in Canada dipped to 3.2 mb/d in May on lower bitumen output, and is set to decline slightly more in coming months on seasonal maintenance offshore Newfoundland and in oil sands-related production. March data were revised up by 250 kb/d on higher bitumen and mined synthetic crude, as well as NGL output, while April came in only marginally higher. As a result, 2010 production was adjusted slightly higher, at 3.3 mb/d, to remain flat in 2011.

Mexico - June actual: Mexican total oil supply fell by 45 kb/d to 2.9 mb/d in June, as output in the key Cantarell and Ku-Maloob-Zaap (KMZ) complexes dipped. Nonetheless, total production in June was marginally higher year-on-year after recent months have seen decline at Cantarell in particular slow somewhat. But Pemex officials have now stated that KMZ, since early 2009 Mexico's largest producing complex of fields, has now also peaked. June production fell to 800 kb/d, after five months around 835 kb/d. Pemex says it expects KMZ to continue producing at around current levels for three years. Chicontepec, the onshore structure on which high hopes had been pinned as a compensation for declining output at Cantarell and KMZ, reportedly lingers at just over 40 kb/d. Total Mexican oil supply is forecast to decline from 2.9 mb/d in 2010 to 2.8 mb/d in 2011.

North Sea

Norway - May actual, June provisional: As anticipated, crude and NGL production in Norway fell by 350 kb/d to 1.9 mb/d in June due to seasonal maintenance and problems at the Gullfaks complex. This brings output to its lowest level in 20 years, according to the Norwegian Petroleum Directorate (NPD). Maintenance is particularly heavy at the Ekofisk complex, estimated to have curbed output by around 150 kb/d. The Draugen, Snorre, Snohvit and Vale fields were also affected by maintenance. Meanwhile, problems at the Gullfaks C platform shut in production for the entire month, after lower output in May. Production restarted in mid-July. On 1 August, the Morvin field started producing, with an expected peak capacity of 20 kb/d. Total Norwegian oil supply is forecast to fall from 2.2 mb/d in 2010 to 2.1 mb/d in 2011.



UK - May actual: Oil output in the UK averaged 1.5 mb/d in May, down slightly from April, which was unrevised from last month's report. Seasonal maintenance is only expected to truly kick in during August, when production is set to dip to 1.3 mb/d. In late June, Apache started producing oil at its new Maule field, which is expected to have a peak capacity of 12 kb/d. Problems with a valve in the Forties pipeline system cut output at the Scott platform in mid-July, and are anticipated to last into August. Total UK oil production is forecast to fall from 1.5 mb/d in 2010 to 1.3 mb/d in 2011.

Former Soviet Union (FSU)

Russia - June actual, July provisional: Russian crude oil production notched up a new post-Soviet high of just over 9.8 mb/d in July, and including NGLs, came in at 10.4 mb/d. June production was revised up a marginal 25 kb/d, largely on higher gas liquids output. Higher crude output levels came from rising production at Vankor (estimated at 270 kb/d in July), but also from steady production at older assets such as those operated by Yuganskneftegaz. August should see oil production dip again marginally, as seasonal maintenance curbs output at the Chayvo field, part of the Sakhalin 1 project. September will see the Odoptu field start production, adding around 30 kb/d to production at Sakhalin 1.

Much speculation surrounds the planned auction of the Trebs and Titov fields, some of the largest remaining undeveloped onshore assets and situated in Timan Pechora. But besides a question mark over its price, uncertainties remain concerning access to the field, how it would be linked into existing infrastructure and whether it might attract tax exemptions. In addition to the planned phasing-out of crude export duties for selected fields (see FSU: Taxing Times Ahead in the 13 July 2010 report), changes to the mineral extraction tax (MET) are mooted, with a likely exception for small fields. Fiscal uncertainty, it would seem, remains just as much a determinant of further development of Russian oil reserves as international crude price levels and upstream development costs. Following forecast growth of 250 kb/d to 10.45 mb/d in 2010, Russian oil supply is forecast to grow by 50 kb/d to 10.5 mb/d in 2011.



Kazakhstan - June actual: June oil production in Kazakhstan was reported 50 kb/d lower than expected, on heavy maintenance at the Tengiz field. On the assumption that work had started earlier than anticipated, an earlier expected end to maintenance prompts an upward adjustment to July and August estimates. Overall, 2010 and 2011 supply levels have been hiked by 25 kb/d to 1.7 mb/d.

Azerbaijan - March actual: In Azerbaijan, final March and preliminary April/May data were nudged higher, raising estimated 2010 oil supply to 1.1 mb/d. However, Azeri-Chirag-Guneshli (ACG) prospects for 2011 were trimmed by 50 kb/d on so far sluggish progress at ramping up production at the large offshore complex. Total Azerbaijani supply is now forecast to rise from 1.1 mb/d in 2010 to 1.2 mb/d in 2011.

June FSU net exports fell by 560 kb/d to 9.6 mb/d from the record level set in May as increased eastward exports (+70 kb/d), notably through the ESPO line, failed to offset month-on-month declines elsewhere. Crude exports fell by 230 kb/d and products decreased by a sharp 340 kb/d. The Black Sea (-120 kb/d) led the fall in crude exports after unfavourable port economics diverted crude elsewhere. Russia and Kazakhstan exported no crude through Ukraine in June after a rise in tariffs and the continuing reversal of the Dnepr pipeline to take imports from Odessa inland. Reports suggest that compared to 2009, the cost of exporting crude through the Ukrainian port of Pivdenne has risen by 33% and 66% for cargoes originating from Nizhnevartovsk and Samara, respectively. This compares with 12-16% rises elsewhere in the FSU. Volumes exported through the Baltic fell by 80 kb/d as maintenance on the Baltic Pipeline System depressed volumes transported via Primorsk. Product exports fell seasonally to 3.0 mb/d, their lowest level since October 2009. Shipments of products fell as exporters held back their cargoes in anticipation of improved economics following a July cut in export taxes.



Over the summer, crude exports are likely to rise slightly in the short term following a July export duty cut, however this is set to be increased again in August. Additionally, the problems in the Black Sea are anticipated to persist, with Kazakhstani volumes expected to be diverted north to Gdansk. Concerning long-term infrastructure developments, eastward exports will rise following the June completion of the Chinese leg of the ESPO pipeline. Deliveries are expected to begin in 1Q11 with a contracted 300 kb/d to be supplied to CNPC by Rosneft. Concerning products, Gunvor's flagship Ust-Luga products terminal is now tentatively expected to open in 3Q10. This terminal is expected to divert Russian volumes which would otherwise have been shipped through ports in the Baltic States.

Other Non-OPEC

China - June actual: Following last month's sizeable baseline revision of +110 kb/d on higher, finalised annual data due to previously-undercounted output from smaller producers, Chinese oil supply was again adjusted up on a stronger-than-expected performance in May and June (+160 kb/d on average). Oil production increased to nearly 4.2 mb/d in June on rising output from new offshore fields and from the onshore Changqing area. Chinese oil supply first crossed the 4.0 mb/d threshold in early 2010. In contrast to demand and stocks data, Chinese production data is considered reasonably comprehensive.

In a partial offset to the stronger 2Q10 levels, prospects for output at the offshore Jidong Nanpu field were downgraded again (from an assumed capacity of 125 kb/d to 50 kb/d by end-2011) on reports that production ramp-up has been far slower than originally expected. Initially touted as a field with at least 200-300 kb/d potential, more recent reports have indicated that reserves may not be as large as anticipated. 2010 and 2011 production estimates for China as a whole are revised up by 85 kb/d and 140 kb/d respectively, with output expected to remain flat at 4.1 mb/d, following a 0.2 mb/d surge from 3.9 mb/d in 2009.

Malaysia - June actual: Malaysian oil production dipped to 705 kb/d in June. Output is expected to fall further when seasonal maintenance cuts into the Tapis stream in August. In addition, in mid-July, problems shut down the East Belumut field (with an estimated capacity of around 20 kb/d), and repairs are expected to last eight weeks. Total oil supply in 2010 is forecast to average 705 kb/d, falling to 670 kb/d in 2011.



India - May actual: Oil production in India was reported at 825 kb/d in May, only marginally lower than April. Output is expected to pick up in coming months, as the new Mangala field in Rajasthan reportedly crossed the 100 kb/d mark in June, now that a dedicated heated pipeline supplying regional refineries is up and running. Mangala's estimated 150 kb/d peak capacity will be boosted by tie-ins Aishwariya (in 2011) and Bhagyama (in 2012). India's total oil supply is forecast to rise from 865 kb/d in 2010 to just under 900 kb/d in 2011.

OECD Stocks

Summary

  • OECD industry inventories declined by 0.8 mb to 2 760 mb in June, contrasting with the strong 28.0 mb build of the previous month. Gains in North American distillates and 'other oils', and Pacific 'other products' partially balanced a draw in European crude stocks.
  • OECD stock cover edged 0.1 days higher, to 61.0 days, at end-June. North American cover rose by 1.2 days due to seasonal demand decrease ahead and higher inventories, while a sharp stock draw and stronger demand in Europe provided some downward offset.
  • Preliminary data indicate total OECD industry oil stocks rose by 21.5 mb in July. By comparison, the five-year average is a 31.7 mb stockbuild. Crude oil increased by 0.9 mb from the previous month, while products built by 20.6 mb.
  • Oil held in short-term floating storage fell to 93 mb at end-July, from 115 mb in June. Crude floating storage declined to 59 mb from 85 mb on large draws in Asia-Pacific, the US Gulf, West Africa and the ME Gulf. This was partly offset by a product build in Europe. Overall, product floating storage rose to 34 mb in July from 30 mb in June.


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

Commercial oil inventories in OECD member countries edged 0.8 mb lower in June, reaching 2 760 mb. This month's modest decline, in contrast with the five-year average stock draw of 8.1 mb, did little to avert a sharp 2Q10 stockbuild. Inventories grew by 78 mb in 2Q10, unusually driven by 'other oils', which include NGLs and feedstocks, and by 'other products'. By comparison, five-year data show an average second-quarter build of 48 mb, although this is distorted by a very low 2Q09.



In June, crude oil stocks fell by 12.5 mb, almost twice the five-year average draw of 6.4 mb. Stock levels in Europe declined sharply (-17.7 mb), led by Norway and Germany. 'Other oils', including NGLs, surged by 6.3 mb, while product inventories added a further 5.4 mb on a stronger-than-normal build in 'other products' in the Pacific. Motor gasoline fell across all regions, while another sizeable gain in US middle distillates outweighed draws in Europe and the Pacific. A distillate draw in the Pacific widened the deficit to the five-year average levels to 5.8 mb. Overall, Pacific oil stocks are 13 mb below the average levels over the past five years, but the OECD inventory surplus is still high at 103.4 mb.



May inventory readings were revised slightly higher by 3.9 mb, implying a stronger monthly stockbuild (+28.0 mb) than reported previously. The magnitude and direction of the North American 'other products' revision is atypical (+16.3 mb), contrasting with the average 3.2 mb downward revision in May over the past five years. Revised assessment for Pacific crude holdings (-8.4 mb) provided some offset.



Preliminary data point to another strong stockbuild (+21.5 mb) in July, driven by rising US inventories. US weekly data indicate a 23.5 mb gain, with crude and product stocks reaching their highest levels over the past 20 years. Petroleum Association of Japan (PAJ) weekly data show a 3.1 mb addition to Japanese crude stocks, with jet fuel and kerosene also contributing to an overall build. An offsetting decrease came from Europe, where inventories fell by 6.0 mb in July, according to Euroilstock.

Analysis of Recent OECD Industry Stock Changes

OECD North America

Industry stocks in North America rose by 17.7 mb to 1 377 mb in June. The build, almost double the five-year average, was concentrated in US middle distillates and 'other oils', while Mexican crude oil also contributed. Mexican gasoline inventories dipped in June, on reduced refinery output and lower imports, on which the country is increasingly dependent.



According to US weekly data, total oil inventories rose for the fifth consecutive month by 23.5 mb in July, reaching their highest levels since 1990. The stockbuild was driven by a large increase in products, mostly middle distillates, 'other oils', propane and, unusually, gasoline. Distillate inventories surged by 10.0 mb and approached record October 2009 levels. Motor gasoline usually draws on average by 4.2 mb in July, but US weekly data point to an unseasonal 3.7 mb build, largely occurring on the US Gulf Coast.



The US Gulf Coast witnessed also a brief reshuffle of oil inventories due to Tropical Storm Bonnie. Weekly data show a high level of imports and a sharp crude stockbuild in the third week of July as most of the crude held in floating storage came ashore, and a subsequent release of stocks the following week. Overall, crude oil inventories fell by 0.9 mb in July, but stocks held in Cushing, Oklahoma, grew by 2.0 mb to 37.8 mb.

OECD Europe

In June, European commercial oil inventories stood at 976.5 mb, down seasonally by 21.1 mb from May. The largest draws occurred in Norway and Germany. In Norway, crude oil inventories held in loading terminals dropped by 10 mb. German oil stocks drew across all categories by 6.9 mb, with crude oil down sharply. German motor gasoline inventories surged to 11.9 mb in January in anticipation of refinery maintenance during the following two months. However, stocks have subsequently fallen further, potentially to as low as 6.7 mb in June, although this data point remains provisional. Meanwhile, German end-user heating oil stocks increased from 50% to 53% of capacity in June.

Preliminary July data from Euroilstock point to a 6.0 mb draw in both crude oil and product inventories in the EU-15 plus Norway. Stronger summer gasoline demand pushed motor fuel inventories lower by 3.0 mb, while crude oil and middle distillate stocks declined by 1.3 mb and 1.4 mb, respectively. Oil products held in independent storage in Northwest Europe fell in July, driven mainly by fuel oil exports to Asia. Gasoline, naphtha and jet fuel stocks also edged lower. However, contrary to other product categories, gasoil inventories rose following elevated imports of middle distillates from Asia.



OECD Pacific

Industry inventories in the OECD Pacific rose by 2.6 mb to over 406 mb in June. Crude oil stocks edged 1.9 mb higher, while a strong build came from 'other products' (+5.0 mb), split equally between Japan and Korea. Draws in main products (gasoline, distillates and fuel oil) provided some offset. Unlike 2Q09, when a large draw in 'other products' and other oils (NGLs & feedstocks) resulted in a counter-seasonal quarterly decrease in overall stock levels, this year's second-quarter build was concentrated in these categories. Gains in 2Q10 pushed oil stocks up by 20.2 mb, breaking through the bottom of the five-year range. Nonetheless, as of end-June, they still maintained a 13 mb deficit to five-year average levels.



Preliminary weekly data from the Petroleum Association of Japan (PAJ) indicate a seasonal 4.0 mb stockbuild in July. By comparison, the five-year average is a 5.8 mb gain driven by middle distillates. However, much of the increase this year stemmed from crude oil (+3.1 mb) despite an uptick in crude runs as refineries emerged from seasonal maintenance. Jet fuel and kerosene rose by a combined 2.3 mb, but draws in motor gasoline and fuel oil provided some offset.



Recent Developments in China and Singapore Stocks

Chinese crude oil inventories increased by 9.5 mb in June, to 211 mb, according to China Oil, Gas and Petrochemicals (China OGP). The build stemmed from surging crude imports on the back of high refining runs. On the product side, gasoline and kerosene stocks built by a combined 1.6 mb, reaching 55.3 mb and 14.3 mb, respectively. Meanwhile, gasoil inventories declined by 4.0 mb, to 66.4 mb, on stronger exports to Asian countries, including Singapore. In Singapore, middle distillate stocks approached December 2009 record levels of nearly 16 mb, growing by a further 0.6 mb in July, after soaring by almost 4 mb in June due to high imports.



However, Chinese product exports dropped in July following a pipeline explosion at the port of Dalian and a subsequent fire and oil leak. The port is the largest Chinese export outlet for oil products and the second largest import terminal for crude oil in China. During a 10-day closure of the port the nearby WEPEC and Dalian refineries were short of crude and trimmed runs. As such, both gasoil and gasoline exports were affected and data from International Enterprise indicate a monthly 1.2 mb drop in gasoline stocks held in Singapore. Singapore fuel oil inventories also edged lower on stronger bunker fuel demand.



Prices

Summary

  • Benchmark crude oil futures trended higher throughout July, supported by stronger equity markets as well as the threat of supply disruptions from hurricane activity in the Gulf of Mexico. Despite the steady increase, month-on-month prices ended mixed in July, with WTI up by around $1/bbl, to an average $76.38/bbl, while Brent futures were down by $0.30 /bbl, to $75.36/bbl.
  • Market fundamentals remained comfortable overall but Tropical Storm Bonnie and field maintenance work in the North Sea added some upward pressure to markets. By early August, oil prices shot to three-month highs over $82/bbl, up $4/bbl from end-July levels as equity markets rallied and the US dollar weakened. The upturn proved fleeting, however, as a dismal jobs report in the US triggered a sell-off in equity markets. Both WTI and Brent were recently trading around $80/bbl.
  • Spot prices for refined products were mostly lower in July, with fuel oil the exception owing to peak summer demand for power generation. However, crack spreads in July trended lower in the US and Europe while differentials for gasoil/diesel and fuel oil improved in Singapore.
  • VLCC rates on the benchmark Middle East Gulf - Japan route collapsed to $9/mt in July, their lowest levels since November 2009, given massive vessel oversupply in markets East of Suez. Meanwhile, floating storage of crude and products declined by a sharp 24.7 mb on eroding economics. Crude drew by 25.6 mb while products increased by 0.9 mb.


Market Overview

Benchmark crude oil futures trended higher throughout July, supported by stronger financial markets and either scheduled or unplanned supply disruptions in the US Gulf of Mexico, China and the North Sea. Despite the steady increase, however, month-on-month prices were mixed in July, with WTI up by almost $1/bbl, to an average $76.38/bbl while Brent futures were down by 30 cents/bbl, to $75.36/bbl.

By early August, oil prices shot up to three-month highs over $82/bbl, up $4/bbl from end-July levels. A strong recovery in equity markets on the back of positive second-quarter earnings and a sharp downturn in the US dollar were reportedly behind the rebound. The upturn proved brief, however, with prices knocked off their perch again after a dismal US jobs report triggered a sell-off in equity markets. Both WTI and Brent were last trading around $80/bbl.

While financial markets and macroeconomic factors are currently the driving force behind stronger oil prices, mounting concerns about the pace of the global economic recovery in the second half of the year appear to be tempering the upward price momentum. Analysts have long forecast that economic growth in the second half of 2010 would be slower than the first half of the year as governments unwind stimulus spending and tighten fiscal terms, especially in China. Traders are closely watching the extent to which both OECD and non-OECD governments plan to withdraw stimulus measures and implement austerity measures. Some economists have also not ruled out a double-dip recession, which would have a significant impact on oil demand forecasts.  Our base case scenario for global oil demand now envisages 86.8 mb/d in 2H10 but, should the economy falter, our lower GDP scenario sees demand some 600 kb/d lower, at 86.2 mb/d.

The uncertain outlook for oil prices is underscored by the flattening of the forward price curve on the NYMEX. The 36-month price spread has narrowed to $7.45/bbl in July from $10.30/bbl in June and $12.70/bbl in May. The flattening of the outer months' price curve seems to suggest the market is less bullish about price strength in the longer term.



Countering macroeconomic worries, a steady stream of forecasts warning that this year's hurricane season could be the worst in many years has likely kept a prop under markets. Indeed, Hurricane Alex and Tropical Storm Bonnie added some upward pressure to US prices in July, but WTI futures eased as the storms waned and with stocks at the pivotal Cushing storage centre still hovering at high levels. Indeed, US stocks of both crude and refined products combined increased in July to the highest level in almost 20 years.

In addition to planned field maintenance work in the North Sea, technical problems briefly disrupted output at a key field feeding the Forties system. In China, an explosion at the pivotal port at Dalian forced crude supplies to be diverted elsewhere while repairs are made. Nonetheless, the market impact from scheduled and unplanned supply outages in July was offset by ample crude on offer in key markets, especially Middle East grades.

Traders also attributed some price strength to the 28 July attack on a tanker in the strategic Strait of Hormuz waterway between Oman and Iran. The Strait is a critical transit route for around 20% of global oil supplies or around 17 mb/d (see Supply, 'Market Shrugs Off Tanker Attack in Strait of Hormuz'). The market ultimately dismissed the explosion aboard the Japanese-owned tanker, since traffic through the key port was unaffected, damage to the vessel minimal and, in the end, it appeared to be an isolated terrorist incident by a lone suicide bomber.



Futures Markets

A summer lull in crude oil futures trading on the NYMEX saw July open interest at the lowest level since end-December, partly due to a seasonal slowdown in activity and because the narrow $70-80/bbl trading range, shrinking contango and flattening forward curves leave little room for profit taking. Indeed, the price structure along the forward curve flattened throughout July.

The near-term contango between the front month contract and forward markets continued to narrow in July with a drawdown in floating storage in the US Gulf and hurricane worries supporting prompt prices. The WTI M1-M2 contango narrowed from around $1/bbl in June to just 43 cents/bbl in July.  Further out, WTI M1-M12 price spreads narrowed to $4.50/bbl in July, compared with $6.10/bbl in June and $8.60/bbl in May. By early August, the spread was running about $4/bbl.



Open interest in NYMEX WTI futures was down slightly in July by 3%, to 1.24 million contracts. Underscoring shifting market sentiment in recent months, money managers steadily decreased their net long positions by two thirds in early June from a 2010 peak of 187 000 contracts at the beginning of April. However, since early July they have been rebuilding long positions, to 134 000 contracts as latest data through 3 August show.

As prices steadily increased by more than $7/bbl from July to early August, money managers increased their net long holdings by 79 000 lots over the month, switching their bets from shorts to longs. While producers trimmed their net short positions by only 12 000 contracts, swap dealers and other participants balanced the market by increasing their short holdings. Meanwhile, RBOB gasoline open interest rose by 7% to 248 000 contracts. With a $5.60/bbl increase in RBOB futures, money managers halved their short holdings and sharply increased long positions.



Meanwhile, the US moved one step closer to overhaul of the financial regulatory framework on 21 July after President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act. US regulators will draft new rules setting restrictions on, among others, the oil trading community. The bill requires over-the-counter (OTC) trades to be standardised and moved to exchanges and has also granted the US Commodity Futures Trading Commission (CFTC) the authority to set position limits on futures contracts.

The US was joined in its efforts by the EU and other G-20 member countries in a move to prevent 'regulatory arbitrage' (the shift of trades to other countries with less strict laws). The European Commission plans to present its proposal on regulation of the OTC markets in September 2010. (For more information on the global financial regulatory overhaul see 'Financial Market Regulation' in the June Medium-Term Oil and Gas Markets 2010 and 'Unintended Consequences of New Market Regulation' in the 13 July 2010 OMR.)

Spot Crude Oil Prices

Spot crude oil prices strengthened in July for both Atlantic basin benchmark crudes. WTI gained about $1/bbl, to $76.30/bbl and Dated Brent rose by around 80 cents/bbl to $75.64/bbl. By contrast, Dubai was down by a sharp $1.50/bbl, to $72.50/bbl on ample supplies of Mideast crudes. Indeed OPEC ramped up production in July by 220 kb/d, to 29.2 mb/d.

Spot WTI owed some of its strength in July to Hurricane Alex and Tropical Storm Bonnie. Against the backdrop of ongoing and ultimately successful efforts to plug the Macondo well, market attention focused on the potential for a further major disruption to Gulf of Mexico supplies.

Indeed, a steady stream of forecasts for a very active hurricane season this year appears to be putting something of a floor under prices. Meteorologists are predicting as many as 8-12 hurricanes this season, in part due to a combination of dissipation of the El Niño weather system in the central Pacific region and warmer weather in the Atlantic basin. That compares with a total of three hurricanes in the Atlantic last year, including just one affecting the Gulf of Mexico.

In July, the production shut-in from Tropical Storm Bonnie topped 825 kb/d at one point in the month as operators took extra precautions in the wake of the Macondo explosion. The US Minerals Management Service, recently renamed Bureau of Ocean Energy Management, Regulation and Enforcement (BOEMRE), reported just over 100 kb/d was shut-in on average in July as a precaution ahead of the weather front, though the storms passed through the region without inflicting damage to oil infrastructure. While the hurricane season runs from July through November, the heaviest period is typically in August and September.



The shut-down of a major crude oil pipeline running between the US Midcontinent and Canada also supported prices by end July/early August. The Enbridge-operated 190 kb/d 6B crude pipeline was closed on 26 July due to a rupture, which has affected crude flows to a half dozen refineries in the landlocked region (see Refining). No date has been set for restart.

WTI held onto its premium over Brent in July, averaging $0.68/bbl versus $0.44/bbl in June and a discount of $1.54/bbl in May. However, the premium slowly eroded throughout July - from about $1.20/bbl at the start of the month and finishing at just $0.21/bbl by end-July. Indeed, Brent regained a premium, trading at around $0.85/bbl over WTI on average in the first week of August.

Tighter supplies of North Sea grades due to seasonal maintenance work not only strengthened Brent relative to WTI but also inverted the forward curve. Brent prompt prices moved above forward prices for the first time in two years in mid-July before reverting back to contango in early August.  North Sea field maintenance work in August is expected to reduce Forties production by 150 kb/d while Norway's output is forecast to decline by 105 kb/d for the month.



Lower volumes of North Sea crudes were also behind the widening of Brent differentials to European and African crudes. After narrowing to around 50 cents/bbl in June, the Urals-Brent differential in the Med widened again in July, to an average discount of $1.84/bbl. By early August, Urals was trading at a steep $3.18/bbl below Brent. Nigerian grades, which normally fetch a premium to Brent given their higher light product yield, were trading at a discount by end-July and early August given lofty Brent levels.

Middle East spot crude prices in Asia were markedly weaker than in Atlantic basin markets in July. Ample supply of Mideast and African grades, as well as Russian ESPO crude, weighed on spot prices. Underscoring the weakness, the price discount of Dubai against Brent moved from $85 cents/bbl on average in June versus $3.15/bbl in July. By early August the discount was around $5.25/bbl. 

In line with weaker spot markets, Saudi Aramco lowered official selling prices for September to Asian customers, with the deepest cuts in medium and heavy grades given surplus supplies of Middle East crude and steadily increasing Russian ESPO crude on offer in the region. Other Middle East producers lowered prices for September on the back of weak physical markets.



An explosion and pipeline fire at China's Dalian port also added to surplus supplies in the region with many contracted cargoes dispersed to other ports for offloading. The port is slowly resuming operation following installation of a temporary replacement pipeline at its largest oil berth. However, no date has been announced for when the main oil berth at Xingang will reopen for very large crude carriers (VLCCs). The explosion also halted supplies to some of the regional refineries, including the country's largest export refinery, the West Pacific Petrochemical Corp plant (WEPEC).



Spot Product Prices

Spot prices for refined products in all major markets were mostly lower in July, with fuel oil the exception owing to peak summer demand for power generation and continued strong bunker demand. Crack spreads in July trended lower in the US and Europe while differentials for gasoil/diesel and fuel oil improved in Singapore.

Despite typically stronger demand during the summer driving season in the US, gasoline crack spreads edged lower in July—averaging just under $12/bbl in NY Harbor last month compared with $13.50/bbl in June and over $16/bbl in May. In Europe, gasoline cracks were mixed, with differentials to Brent in Northwest Europe down by about $2/bbl to $8.36/bbl while Urals cracks in the Med remained largely unchanged at around $8.40/bbl on average in July.



In Asia, gasoline crack spreads improved on increased export demand, with differentials to Dubai rising to just under $10/bbl in July compared with $9.28/bbl in June in Singapore and up by a smaller $0.12/bbl on average, to $9.51/bbl, in Japan. The stronger gasoline crack spreads partly reflect weaker spot Dubai crude prices in July. In addition, the pipeline explosion at China's Dalian port on 16 July sharply reduced gasoline exports.

New sanctions, especially those implemented by the EU in July, are already having an impact on Iranian gasoline imports. Volumes reportedly have been reduced by half in July from May levels and spot barrels sold into Iran are fetching a premium of 25% over market levels.



Gasoil cracks were largely lower in the US and Europe but stronger in Asia. Atlantic basin crack spreads edged lower in July on increased refinery output and despite increased exports to Latin America.  In the US Gulf Coast market, exceptionally high refinery throughput rates pressured crack spreads, with differentials to Mars down by about $2/bbl on average for the month, to $7.90/bbl while cracks for Light Louisiana Sweet fell to $3.29/bbl from $5.47/bbl in June. In New York Harbor diesel cracks declined to $9.15/bbl in July from $11.60 in June and just under $14/bbl in May.

Higher than normal US exports of diesel to Latin American countries such as Chile, Mexico, Colombia and Argentina have been partially offset by lower shipments to Europe. One reason for the higher exports to Latin America is due to changes in quality specifications while planned and unplanned refinery maintenance work in the region also contributed to higher imports from the US. Both Mexico and Colombia reduced sulphur specifications this year but lack desulphurisation capacity to meet the new specs.



Fuel oil crack spreads for low-sulphur material largely improved in all major regions in July while high-sulphur cracks were mixed. Both fuels remained in negative territory, bar low-sulphur fuel oil in Singapore.  Increased use at power plants on stronger cooling demand during the summer season helped fuel the recovery in July but by early August cracks started weakening again on increased supplies.

In Europe, an improved arbitrage to Asia helped support crack spreads and offset the impact of higher Russian fuel oil exports to the region. Low-sulphur fuel oil cracks in the Med eased to -$2.83/bbl on average in July compared with -$6/bbl in June. In Northwest Europe cracks averaged -$4/bbl last month compared with -$5.31/bbl in June.

In Singapore, differentials for cracked LSWR fuel oil swung from a loss of -$6.94/bbl in June to +$0.91/bbl in Singapore last month, in part due to increased demand for power generation. Again, part of the improvement is due to the weaker Dubai spot price. Crack spreads for high-sulphur fuel oil also posted a strong rebound in the Asia-Pacific region. HSFO differentials to Dubai in Singapore averaged -$3.13/bbl in July compared to -$4.78/bbl the previous month. In Japan HSFO cracks averaged -$1.99/bbl in July versus -$4.15/bbl in June.



Refining Margins

Refining margins fell across all regions in July as product prices failed to capture increases seen in crude markets. The declines were particularly large in Northwest Europe, prompting talk of renewed economic run cuts. European refinery runs rebounded sharply in June as refiners exited maintenance and took advantage of relatively favourable economic conditions. The increased supplies were met by lacklustre demand and limited export opportunities, however, again putting downward pressure on margins.



On the US Gulf Coast, margins all fell in July, except for Bonny cracking, and all cracking margins were negative on a full cost basis in the month. While coking margins also fell, they remained in positive territory. US West Coast margins generally fell by less, as reduced runs and stronger gasoline prices evident since May continued to play a role. Californian Carbob prices are currently the strongest in the US, with cargoes delivered at Los Angeles trading at an average $9.00/bbl premium to New York Harbor RBOB and $9.20/bbl premium to Gulf Coast RBOB.

Singapore margins were mixed, with Dubai margins increasing (even turning positive for hydrocracking) given Dubai's relative weakness compared to other crude grades.





End-User Product Prices in July

Following two months of falls, prices in July rose across the IEA regions by an average 2.8% in US dollars, ex-tax. However, the influence of the weakening US dollar was partly responsible since, when examining prices on a national currency, ex-tax basis, prices fell by an average 0.6%. On a US dollars ex-tax basis, increases were reported across all surveyed products led by heating oil and low-sulphur fuel oil, up 2.6% and 5.0%, respectively. This was in contrast to earlier gains in 2010, which were led by transportation fuels.

Gasoline prices fell across the Eurozone and Japan and rose in the US and Canada. In July regular gasoline prices averaged $2.73/gallon in the US, ¥136/litre in Japan and £1.17/litre in the UK. In the Eurozone prices ranged from €1.40/litre in Germany to €1.15/litre in Spain. Diesel prices fell across all surveyed countries except Canada. Retail prices averaged $2.91/gallon in the US, ¥115/litre in Japan and £1.20/litre in the UK whilst in continental Europe prices ranged from €1.07 in Spain to €1.22 in Italy.

Freight

VLCC rates on the benchmark Middle East Gulf - Japan route collapsed to $9/mt in July, their lowest levels since November 2009, given massive oversupply in markets East of Suez. Operating vessels within the region rose to a record 93, as a release of VLCCs from floating storage added to the surplus. Rates on the Suezmax West Africa - US Atlantic coast route fared slightly better, slumping from $12/mt to $9/mt by mid-month but then peaking impressively on scarce tonnage as charterers rushed mid-month to fix cargoes for delivery by month-end.



The clean tanker market fared a little better with one notable exception: rates on the UK - US Atlantic coast market fell rapidly to below $20/mt as transatlantic trade waned with few reported fixings and a ready supply of vessels. Rates on the Aframax Middle East Gulf - Japan route spiked as high demand and low tonnage pushed rates up to $26/mt from an early-month low of $20/mt.

Looking forward, the oversupply in East of Suez markets is likely to persist, although any increase in perceived terrorist activity in the Straits of Hormuz could shore-up rates (Supply, 'Market Shrugs Off Tanker Attack in Strait of Hormuz'). In the Atlantic Basin some short-term support could come from any hurricane-related damage to oil infrastructure and resulting increase in imports. The US National Hurricane Centre has predicted this year could be the busiest since 2005.

Floating storage of crude and products fell by a sharp 24.7 mb in July on a narrowing contango. Crude drew by 25.6 mb and products increased by 0.9 mb. Crude is now only being stored at sea in the Middle East (46.6 mb), Asia-Pacific (3.2 mb) and the US Gulf (9.4 mb). Middle East volumes fell by 4 mb after Iran offloaded some cargoes mid-month in the Red Sea port of Ain Sukhna. However, tankers returned to Iran, were reloaded with unsold crude and then headed back to the Red Sea to await buyers.

Storage in the US Gulf fell by 5.2 mb with volumes likely stockpiled onshore in anticipation of an active hurricane season. As volumes decreased, so did VLCCs deployed for storage with 11 vessels released, leaving 29 VLCCs in the storage fleet, the lowest level since December 2008.

Refining

Summary

  • Global refinery crude throughputs have been revised up by 425 kb/d for 2Q10 following an apparent recovery in European crude runs. Preliminary data for June show European throughputs up almost 1.0 mb/d from May, and 740 kb/d above year-ago levels. At 73.9 mb/d, 2Q10 global runs are now 1.8 mb/d above 2Q09, with annual increases underpinned by capacity increases in China and a recovery in US refinery activity.
  • 3Q10 global crude runs are estimated at 74.7 mb/d, 70 kb/d higher than our last estimate and 1.1 mb/d above 3Q09. Runs are expected to remain strong in North America, in part supported by continued refinery outages in the Caribbean and Latin America. Continued capacity expansions will likely support Chinese throughputs at strong levels in 3Q10, although the rate of growth is seen slowing to 0.7 mb/d year-on-year, from a quarterly average of 1.3 mb/d since 4Q09.
  • OECD refinery crude runs averaged 37.1 mb/d in June, 1.2 mb/d higher than a year earlier and 780 kb/d up on May. The month-on-month increase stems exclusively from OECD Europe, which recorded runs almost 1.0 mb/d higher than a month earlier. A sharp exit from turnarounds was augmented by relatively healthy margins and the commissioning of some new distillation capacity. Refinery profitability has since deteriorated, prompting talk of renewed run cuts in the region.
  • May OECD refinery yields rose for gasoil/diesel (+0.3%) and 'other products' (+0.4%) but fell for products at the top and bottom of the barrel. OECD refinery gross output continued its upward momentum, increasing in May by 100 kb/d to a level above a year ago for the first time in 2010.


Global Refinery Throughput

Estimated global refinery throughputs averaged 73.9 mb/d in 2Q10, 1.8 mb/d higher than a year earlier and 1.1 mb/d above 1Q10. The global figure has been revised up by a sharp 425 kb/d since last month's report, following an impressive apparent recovery in European refinery runs in June. Preliminary data point to a 1.0 mb/d monthly increase in European runs, reaching their highest level since December 2008. Turnaround completion, augmented by relatively healthy margins, supported the increase. It remains to be seen however, whether the extent of the rebound is confirmed by official data released next month, and whether refiners can sustain these steeper throughput levels. Profit margins deteriorated over July and August, as increased supplies met still lacklustre regional demand, and product prices failed to keep pace with the rally seen in crude towards the end of July. As products were added to inventories, on land and in floating storage, talk of renewed run cuts emerged in the region.

Although unchanged from last month's report, year-on-year growth in 2Q10 stems mostly from China (+1.1 mb/d) and the US (+0.6 mb/d). Increased distillation capacity in China underpins the record throughput levels there, while North America saw a sharp recovery in April as refiners exited maintenance and Marathon's Garyville expansion was commissioned. Runs in the OECD Pacific, the FSU and Other Asia also recorded year-on-year growth in 2Q10. Offsetting some of the gains, Latin American runs were severely curtailed by outages and refinery closures in the quarter, while European runs remained firmly below year-earlier levels on a quarterly basis despite the June rebound.

3Q10 global crude throughputs are currently estimated at 74.7 mb/d, with quarterly increases in the OECD Pacific, the Middle East, the FSU, Latin America and Europe. North American run rates depend in part on the impact of the current hurricane season, but also on the extent of the recovery in both economic growth and oil demand in coming months. Latin American runs are expected to remain constrained into 3Q10, as operational problems at PDVSA's Curaçao refinery linger. However, independent US refiner Valero is talking about restarting its 235 kb/d Aruba refinery after completing maintenance in September, potentially adding to regional product supplies.



OECD Refinery Throughput

OECD crude throughputs averaged 37.1 mb/d in June, an increase of 780 kb/d from May and 1.2 mb/d higher than a year earlier. Surprisingly high runs in Europe accounted for all of the monthly increase. Peak maintenance in the Pacific offset some of the build, while North American runs were steady. Relatively strong margins in Europe, coinciding with turnaround completion at several refineries and the commissioning of some new capacity, all contributed to the sharply higher runs. Profitability has since slumped, however, prompting talk of renewed run cuts in Europe and likely lower runs in July and August.

2Q10 OECD refinery crude runs are now estimated at 36.7 mb/d, 700 kb/d higher than the low point reached a year earlier and 400 kb/d higher than the previous forecast. The recovery in operating levels stems from North America and to a lesser extent the Pacific. Despite the apparent sharp recovery in European runs in June, 2Q10 operating levels remain well below 2Q09, at 12.3 mb/d.



Looking ahead, 3Q10 OECD throughputs have also been revised up by 540 kb/d, to 37.0 mb/d. Stronger than expected runs in the US in July account for much of the upward shift, and the apparent recovery in European runs has led us to adjust the prognosis for this region higher as well. It remains to be seen whether official data confirm the extent of the European rebound, and whether refiners can sustain high operating levels. The recent collapse in European refinery margins seems to indicate that the increase in runs was too sharp, however, so for now we keep European runs around 12.5 mb/d in coming months.



North American crude runs averaged 18.1 mb/d in June, unchanged from a month earlier and previous estimates. Preliminary weekly data for both the US and Canada point to higher runs in July, however, bringing the regional total up by 380 kb/d month-on-month. The US Gulf Coast registered the largest increase, and runs reached their highest level since July 2007 at the end of July. For the month, Gulf Coast throughputs averaged 7.8 mb/d, 220 kb/d higher than in June, despite a fall in margins. Crude runs in the Midwest also sustained recent high levels around 3.5 mb/d in July, as planned and unplanned shutdowns were insignificant.

US throughputs have in part found support from increased export opportunities of middle distillates to Latin America. Indeed, Latin America has replaced Europe as an outlet for surplus US supplies in recent months, with the latter only accounting for 12% of US exports in the first five months of 2010, compared to 46% in the same period of 2009. Strong demand in both Mexico and Colombia have boosted import requirements from these countries, while constrained supplies from Chile, Ecuador, Venezuela, Aruba and the Netherlands Antilles have further reduced regional availabilities.

US margins (both on the Gulf and West Coasts) were generally weaker in July. With the end of the driving season in sight, and product stocks above seasonal norms, throughputs are expected to recede from recent highs in coming weeks and into September and October. As noted in earlier reports, a key uncertainty to the forecast is the extent of hurricane shut-ins on the US Coast this year, which for now is assumed to match the five-year average (of 980 kb/d in September).

The shutdown of Enbridge's 190 kb/d 6B crude pipeline, following a leak on 26 July, is expected to have limited impact on throughputs at affected refineries. The pipeline runs from Indiana to Sarnia, Ontario, and supplies refineries in Ohio, Michigan, Pennsylvania and southern Ontario. Although a few refineries, including United Refining's Warren (70 kb/d capacity), BP/Husky's Toledo (127.5 kb/d) and Sunoco's Toledo (160 kb/d) have reported reduced runs as a result of the incident, most of the refineries normally served by the pipeline have been able to source crude from elsewhere. Other lines feeding the affected refineries include:

  • Enbridge's 490 kb/d Line 5 from Superior, Wisconsin, and 240 kb/d Line 9 from Montreal;
  • Enbridge's 190 kb/d Spearhead pipeline from Canada to Cushing, Oklahoma;
  • TransCanada's 435 kb/d Keystone pipeline from Alberta to Patoka, Illinois, which was inaugurated in late June; and
  • The 240 kb/d, Sunoco-run, Mid-Valley pipeline from Texas to Toledo, Ohio.

US independent refinery Western Refining started shutting its 65 kb/d Yorktown refinery in Virginia in August. The company cited a poor outlook for East Coast margins for the rest of this year, despite improved economics in 2Q10, as the reason for the closure, which will take six weeks to complete. The company shut its 17 kb/d Bloomfield refinery in New Mexico last year.



Preliminary data indicate that European runs rose sharply in June, to their highest level since December 2008, from an upwardly revised May base. Final May data have been revised up by 175 kb/d, following higher official data from Austria, Italy and the Netherlands. Regional throughputs averaged 13.0 mb/d in June, an increase of 985 kb/d from May and 740 kb/d higher than June 2009. Month-on-month increases were recorded in Spain (+300 kb/d), Italy (+240 kb/d), Netherlands (+90 kb/d), Germany (+85 kb/d) and Greece (+50 kb/d). The increase in runs, if confirmed by official data, is in part explained by the completion of maintenance in several countries. Regional shutdowns (including permanently shut Dunkirk and Teesside) are thought to have fallen from a seasonal high of 1.6 mb/d in May, to just over 1.0 mb/d in June. Runs were further augmented by improved refining margins, as well as by the commissioning of new capacity in Greece and Spain at the end of 2Q10.

Since June, however, European refining margins have slumped, prompting talk of renewed economic run cuts. The declines were particularly sharp in Northwest Europe, where Brent cracking margins fell from an average $3.29/bbl in June to only $0.78/bbl in July (and as low as -$1.06/bbl in early August). Regional product prices failed to keep pace with the rally in crude prices since mid-July as increased refinery supplies were met with weak demand. Although the duration of the recovery in European runs remains to be seen, we have raised the regional outlook somewhat since last month's report. 3Q10 European crude runs are now projected at 12.5 mb/d, 125 kb/d higher than in last month's report.



Expansions in European Refining Capacity Despite Industry Woes

As outlined in the Medium Term Oil & Gas Markets 2010 report, while European refiners in general have been cancelling expansion projects and are looking to shut capacity, a few projects remain active. These include the recent commissioning of a new Crude Distillation Unit (CDU) at Motor Oil Hellas, Corinth Refineries SA, Aghii Thoedori refinery in Greece. The expansion raises CDU capacity at the refinery by 60 kb/d, to 160 kb/d in total and Greek refinery runs are already reported higher, at 455 kb/d in June, up from 405 kb/d in May and 340 kb/d in April.

Surprisingly strong refinery runs in Spain in June (+300 kb/d m-o-m) could also stem from increased capacity. Cepsa's La Rábida refinery is currently expanding both distillation and upgrading capacity. According to the company website, the refinery completed the installation of a hydrocracker towards the end of 2Q10. The refinery's CDU capacity is also being augmented by 75 kb/d to 175 kb/d this year, though it is not clear if the new crude distillation capacity has also been commissioned and underpins the recent increase in throughput levels. According to official statements following a fatal fire at the plant in early August, overall capacity was the same as in recent months; therefore, further growth could still be to come.

The expansion of Repsol's Cartagena refinery will add further to Spain's distillation capacity next year. The project, currently estimated at a cost of €3.2 billion, will double the refinery's capacity to 220 kb/d as well as adding significant upgrading capacity. In addition to atmospheric and vacuum distillation units, a hydrocracker, coker and desulphurisation units will be added, making it one of the most complex refineries in the region.

OECD Pacific runs were 6.1 mb/d in June, slightly higher than the previous year and our earlier estimate. Regional throughputs were nevertheless 185 kb/d lower than in May, as seasonal declines in Japan largely offset increases elsewhere. South Korean refinery runs averaged 2.4 mb/d in June, an increase of around 120 kb/d from both a month earlier and from June 2009. Weekly data from the Petroleum Association of Japan show Japanese crude throughputs gaining 380 kb/d in July, 100 kb/d less than our previous forecast. Japanese runs are expected to continue to increase in August as maintenance hits a seasonal low, before falling off again in September and October with renewed scheduled work. Regional maintenance falls sharply from 1.3/1.1 mb/d in May/June, to 685 kb/d in July and 330 kb/d in August.



Non-OECD Refinery Throughput

2Q10 non-OECD refinery throughputs have been left unchanged since our last report, as slightly higher runs in Africa, and to a lesser extent China, were offset by lower runs elsewhere. At an estimated 37.3 mb/d, runs are 1.1 mb/d above year-earlier levels and 310 kb/d higher than in 1Q10. Throughputs are seen increasing further in 3Q10, adding close to 0.4 mb/d from current levels to reach 37.7 mb/d. A partial recovery in Latin American throughputs, as well as seasonally higher runs in the Middle East and the FSU, largely underpin the increase. Annual growth however remains rooted in China, which alone accounts for 700 kb/d of increased throughputs, more than the total non-OECD increment.



According to the National Bureau of Statistics, Chinese crude throughputs averaged 8.6 mb/d in June, up 140 kb/d from May and 830 kb/d higher than a year earlier. Official data from the country's General Administration of Customs show that China imported a record 5.44 mb/d of crude in June, 270 kb/d higher than the previous record set two months earlier, and 34.1% higher than the same month in 2009. Despite the higher runs, preliminary data indicate that product exports were lower in June, both compared to the previous month and a year earlier.

Crude deliveries to China's Dalian port in the northeast were temporarily suspended in July after an explosion on 16 July damaged the main pipeline feeding the port. Yet, the installation of a temporary crude pipeline allowed the port to resume limited operations shortly thereafter. Dalian has two refineries: Petrochina operates a 410 kb/d refinery in the area while the West Pacific Petrochemical Corp (WEPEC) operates a 200 kb/d plant. Both companies reportedly scaled back crude runs following the port closure, but the reduced runs are thought to have been short-lived.

In Other Asia, Indian crude throughputs, excluding Reliance's new export refinery, which is not included in government statistics, slowed to 2.9% year-on-year growth in June, down from 7.7% a month earlier. Several plants were undertaking maintenance, including HPCL's Visag refinery, which has extended its shutdown until mid-August (from a planned re-start in mid-July). The refinery is currently in the process of upgrading units to increase heavy oil processing capacity. Including assumed throughputs of 600 kb/d for Reliance's new refinery, total runs are estimated at 3.9 mb/d in June, 190 kb/d higher than a year earlier.

In Taiwan, an explosion at Formosa's 540 kb/d Mailiao refinery at the end of July forced the company to shut the entire plant for three days before the first of the plant's three crude distillation units (CDUs) could be restarted. The second 180 kb/d CDU was reportedly restarted a week later, but the most recent industry estimates reckon the last tower, which was damaged in the fire, could be out of commission for two to three months. Following the incident, the company has delayed planned maintenance from end-August until a later, yet unspecified, date, to ensure steady production.

In Pakistan, the severe floods currently plaguing the country have forced the complete closure of PARCO's 100 kb/d refinery at Mahmood Kot near Multan. The refinery, which is the country's largest, accounts for 35% of the country's total refining capacity. According to PARCO's managing director, it would take seven days to re-commission the refinery, unless more severe damage is caused by the floodwater, currently kept away from the installation by temporary embankments set up by the army. The closure could result in oil product shortages in several regions, following the complete suspension of deliveries to different parts of the country.



Refinery runs in the Middle East are kept unchanged from last month's report, averaging 5.9 mb/d in 2Q10 and 6.1 mb/d in 3Q10. Saudi crude throughputs rebounded sharply in May, as maintenance at Aramco/Exxon's 400 kb/d Yanbu refinery was completed. A technical problem at Saudi Arabia's 400 kb/d PetroRabigh plant in early August partially halted production, reportedly forcing the Kingdom to import around five cargoes of gasoline. Maintenance could take two weeks, according to some sources. Also in Saudi Arabia, in late July, Saudi Aramco awarded seven major engineering, procurement and construction packages for the planned 400 kb/d export refinery at Yanbu, in the Kingdom's Western province. Aramco has so far not found a replacement for ConocoPhillips, who pulled out of the JV project in April of this year, but the company seems to be proceeding alone for the time being. MTOGM 2010 had tentatively excluded the Yanbu plant from capacity estimates due to the absence of firm JV partners.

Latin American crude runs have again been revised lower for the coming months, as the Curaçao refinery will likely remain closed for some time. We had previously assumed that the 320 kb/d refinery, operated by Venezuela's PDVSA, would restart in July, but in early August the plant remained shut. In an attempt to pressure management to solve the power problems, which have paralysed the refinery since March, workers at the idle plant went on strike in early August. Until these problems are addressed, we assume the refinery will remain closed. Leading independent US refiner Valero Energy seems set to restart its 235 kb/d Aruba refinery possibly as early as September if economic conditions allow it. The refinery, which has been closed since July 2009 due to poor economics and a tax-settlement disagreement with the Aruban Government (now solved), is currently undergoing a 90-day maintenance programme with the aim of a restart later this year. In this forecast, we assume the Aruba refinery will restart operations in October, and reach pre-shutdown levels of 170 kb/d by November.

African throughputs have been lifted by 115 kb/d for 2Q10, to 2.3 mb/d, following the submission of JODI data for a number of countries. Monthly JODI data point to stronger runs for both South Africa and Egypt in April and May, and higher Libyan runs in June. According to a representative for Nigerian state-owned NNPC, the company has apparently been able to tackle power problems at its main 210 kb/d Port Harcourt refinery, while also increasing runs at the country's other two refineries at Warri and Kaduna. Nigeria has increasingly relied on product imports to meet domestic demand as the country's refinery activity has been hampered by power supply and crude delivery problems. While NNPC has not reported any monthly data since February, the most recent JODI data put June throughputs at only 90 kb/d, or 20% of capacity. We await confirmation from national data, on whether the reported improvement in power supply translated into higher supplies.



Refinery runs in the FSU averaged 6.3 mb/d in June, up 180 kb/d from May, due in most part to higher runs in Russia (+160 kb/d m-o-m). Ukrainian throughputs were constrained in June, as TNK-BP's 320 kb/d Lisichansk plant was shut for 6 weeks for maintenance. The refinery was upgraded earlier this year to enable the plant to produce fuels that comply with Euro 4 fuel engine emission standards. Kazakhstani refinery activity was slightly higher in June than a month earlier, with runs averaging 280 kb/d. According to preliminary reports, Russian crude runs rose a further 130 kb/d in July, to average 5.1 mb/d, the highest level in at least eight years.

OECD Refinery Yields

May OECD refinery yields rose for gasoil/diesel (+0.3%) and 'other products' (+0.4%) but fell for naphtha (-0.2%), gasoline (-0.02%), jet fuel/kerosene (-0.2%) and fuel oil (-0.3%). OECD refinery gross output continued its upward momentum, increasing by 100 kb/d to a level above a year ago for the first time in 2010. Although naphtha yields fell seasonally to 4.7%, they consolidated their recovery by holding 0.2% above the 2009 level. The picture was more complicated for jet fuel/kerosene; yields dipped seasonally whilst remaining above 2009 and within the five-year range, but the differential to the average widened to 0.2%.



North American gasoline yields fell by 0.4% to dip below the five-year average whilst in Europe and the Pacific they rose by 0.3%. This latter region is outperforming the rest of the OECD, evidenced by 2010 gasoline yields consistently holding above the five-year range and approximately 2% higher than the five-year average.  The same picture is evident for Pacific gasoline gross output, which remained slightly higher year-on-year despite high refinery maintenance. At the same time, exports of gasoline from the region have risen by an average 50 kb/d during 2010. Data therefore suggest that the region's refineries are re-orientating themselves to serve the expanding Asian gasoline market.



OECD gasoil/diesel yields increased above their five-year average for the first time in 2010 as yields in North America increased by 0.6% to come back into line with the five-year average and offset falls in Europe (-0.2%) and the Pacific (-0.1%). In Europe, yields stand comfortably above the five-year average at 38.8% but refinery gross output remains depressed, 300 kb/d lower than last year's level.



OECD fuel oil yields remain below both the five-year average and 2009 levels as they fell by a seasonal 0.3% in May. All OECD regions exhibited the same downward movement with North America, Europe and the Pacific falling by 0.2%, 0.4% and 0.6%, respectively. The trend away from fuel oil production was also highlighted by refinery gross output also remaining depressed, approximately 800 kb/d below the five-year average.