Oil Market Report: 18 January 2011

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Highlights

  • Marker crudes approached $100/bbl in early January, prompting concerns over the impact of high prices on the global economic recovery. December futures prices rose for the fourth month running, trading in a range of $88-$92/bbl. Robust economic growth in Asia, especially China, coupled with stronger-than-expected oil demand in the OECD has pushed crude above the $70-$80/bbl range seen for much of 2010.
  • Global oil product demand for 2010 and 2011 is revised up by an average of 320 kb/d on higher-than-expected submissions, reflecting buoyant global economic growth and cold northern hemisphere weather. Global oil demand, assessed at 87.7 mb/d in 2010 (+2.7 mb/d year-on-year), rises by 1.4 mb/d to 89.1 mb/d in 2011.
  • Global oil supply fell by 0.3 mb/d to 88.1 mb/d in December, as non-OPEC output was reduced, on short-lived outages. An Alaskan pipeline leak and a fire at a Canadian oil sands upgrader also cut January output. Overall, 2010 and 2011 non-OPEC estimates are unchanged at 52.8 mb/d and 53.4 mb/d, respectively. OPEC NGLs contribute 5.3 mb/d in 2010 and 5.8 mb/d in 2011.
  • OPEC supply gained 250 kb/d to reach 29.58 mb/d in December, continuing a rising trend evident since the spring. In light of stronger demand estimates for 2H10, output in 3Q10 and 4Q10 has been lagging the underlying 'call', which is revised up to 29.9 mb/d for 2011. OPEC effective spare capacity has nudged below 5 mb/d for the first time in two years.
  • November OECD industry stocks declined by 8.3 mb to 2 742 mb, or 58.7 days, led by draws of 'other products', middle distillates and residual fuel oil. Preliminary December data indicate OECD industry stocks dropped by a sizeable 33.1 mb and oil in floating storage also fell.
  • 4Q10 and 1Q11 global refinery throughputs have been revised up sharply to average 74.5 mb/d and 74.9 mb/d respectively, in response to stronger than expected global demand on cold weather and better economic performance, compounded by a rapid return from maintenance in the US and Europe. Both 4Q10 and 1Q11 show annual growth above 2 mb/d.

There may be trouble ahead

Markets continued to tighten in 4Q10, with preliminary data showing demand running ahead of supply to the tune of 0.7 mb/d. The implied global stock draw in the second half of last year averaged around 1 mb/d. Marker crude prices have gained over 25% since September and at writing Brent is flirting with $100/bbl. The most visible portion of inventories - OECD company stocks - looks relatively comfortable, at over 58.7 days of cover. But stock overhang is largely restricted to North American crude (hence the relative weakness of WTI), with other components looking better balanced. Lower floating storage and a flatter price strip speak of recovering oil demand and tighter prompt markets. Severe northern hemisphere weather and a slightly healthier outlook for the OECD economies have encouraged OPEC producers to leak more crude onto the market. Meanwhile 2011 demand growth is expected to shift back to the developing countries, with global growth easing from 2010's giddy 2.7 mb/d to nearer 1.4 mb/d in 2011 - still robust by any measure. 

Recent price strength, notably for international benchmark Brent (light, sweet Asian Tapis already topped $100/bbl), has seen rising open interest on crude futures, and total commodity financial assets under management that have pushed above early-2008 levels. But with futures and derivatives ultimately taking their cue from both today's apparent, and tomorrow's expected, fundamentals, we note that most prognoses, not just our own, see demand growth easing in 2011. Rising upstream spending is helping non-OPEC supply and OPEC gas liquids meet most of the increase. Meanwhile, company stocks, OPEC spare capacity, and ultimately IEA government strategic inventory, provide a cushion against unexpected events in either supply or demand. Many market watchers already see a market prone to downward correction, suggesting the dalliance with three-figure oil should ultimately prove to be fleeting. But will that prove to be the case?

Not least for the avoidance of collateral economic damage, we hope that it does. Recent price levels already pose a real economic risk - something of deep concern to producers and consumers alike. Average prices near $80/bbl in 2010 represented a nominal 'oil burden' (global oil expenditures divided by global GDP) of 4.1%. Were $100/bbl oil to become entrenched in 2011, that would risk pushing the figure through 5% (even without adjusting GDP growth to below currently expected levels). True, this is a deliberately simplistic barometer of the impact of higher oil prices, but equivalent levels of oil burden in the past have clearly been associated with economic problems. Ultimately, oil producers, financial investors and consumers (notably import-dependent developing countries) all suffer under such a scenario. It may have been said in these pages before, but to those who have recently enjoyed extolling the virtues of three-figure oil: be careful what you wish for, lest it come true.

Demand

Summary

  • Forecast global oil product demand for 2010 and 2011 is revised up by 320 kb/d, on average, given higher-than-expected submissions in all OECD regions and in key non-OECD areas (Asia, FSU and the Middle East), which appear to be partly related to more buoyant-than-anticipated global economic growth (this report's underlying economic assumptions will be revised based on the forthcoming IMF update). Global oil demand is now assessed at 87.7 mb/d in 2010 (+3.2% or +2.7 mb/d year-on-year), and is projected to rise to 89.1 mb/d in 2011 (+1.6% or +1.4 mb/d year-on-year).
  • Projected OECD oil demand for 2010 and 2011 is adjusted up by 200 kb/d, on average, on stronger-than-expected data submissions in all regions. A firmer economic recovery, more than the frigid weather conditions that prevailed in the northern hemisphere in late 2010, likely explains the latest readings' strength, since OECD heating oil demand, albeit higher on a yearly basis, remains well below its five-year average. Total OECD demand, now estimated at 46.1 mb/d in 2010 (+1.5% or +0.7 mb/d year-on-year), is seen declining slightly in 2011 (-0.4% or -0.2 mb/d versus the previous year).


  • Estimated non-OECD oil demand for 2010 and 2011 is raised by 120 kb/d, on average, on higher readings in Asia (China, Malaysia and Thailand), the FSU (Russia) and the Middle East (Saudi Arabia). Chinese demand reached a new record high in November (10.2 mb/d), largely on rising gasoil use, accounting for roughly half of Asia's increase and for almost a third of total non-OECD growth. Total non-OECD demand, estimated at 41.6 mb/d in 2010 (+5.3% or +2.1 mb/d year-on-year), is now projected to reach 43.2 mb/d in 2011 (+3.8% or +1.6 mb/d versus the previous year). These prognoses, however, may change depending on the evolution of China's gasoil shortages and as the effects of Iran's dramatic subsidy removal become clearer.

Global Overview

Although 2010 has drawn to a close, the magnitude of that year's oil demand rebound is only now becoming clearer. After an extraordinary weather-driven surge in 3Q10, preliminary data for October and November indicate that growth in 4Q10 also remained buoyant. This led to a large revision to that quarter's estimates (+0.7 mb/d in the OECD and +0.4 mb/d in the non-OECD), lifting our global oil demand assessment to 87.7 mb/d, the highest level on record (and +280 kb/d versus our last report). Growth, at +2.7 mb/d year-on-year or +3.2%, although a shade below that registered in 2004 (+3.0 mb/d), is one of the highest in the last three decades, albeit relative to an exceptionally low base.

Interestingly, such demand strength appears to be more related to a buoyant economic recovery than to the frigid weather conditions that prevailed in most of the northern hemisphere in late 2010. Indeed, heating oil demand in the OECD, albeit higher on a yearly basis, remains well below its five-year average. This supports our contention that heating oil use in the OECD is structurally declining, given ongoing efficiency gains and displacement by ample supplies of natural gas and other sources. In mid-December, for example, gas prices in the US briefly doubled to almost within striking distance of heating oil prices (to roughly $12/mmbtu versus $16/mmbtu for heating oil), yet they halved again by end-month.



Although other temporary factors have been at play - most notably China's policy-induced surge in gasoil use - the latest demand readings suggest that the global economy probably grew at a much faster tempo than anticipated in late 2010, notably in the OECD. Yet whether such a pace of expansion will continue in 2011 is open to debate, as counter-cyclical factors such as government stimuli and business restocking are likely to be much less prominent. Moreover, the Eurozone turmoil continues, while the US economy, albeit more resilient than expected, still faces significant imbalances and is not growing fast enough to curb high unemployment. Elsewhere, inflation is creeping up, particularly in large non-OECD economies, mostly on the back of rising commodity prices and exchange-rate rigidities. This could herald fiscal and monetary tightening, particularly in Asia, and hence lead to a marked economic slowdown in that area.

As such, and assuming that winter temperatures will track their ten-year average, the 4Q10 adjustment has only been partly carried forward to 1Q11 and beyond. Overall, we foresee global oil demand expanding by 1.4 mb/d or 1.6% year-on-year in 2011 and 360 kb/d higher versus our last report - almost half of last year's growth level but nonetheless significant - driven entirely by the non-OECD. Indeed, we project that OECD demand, which in 2010 expanded by an estimated 0.7 mb/d on the back of a strong rebound in North America, will reverse to its underlying, structural decline in 2011.



OECD

According to preliminary data, OECD inland deliveries (oil products supplied by refineries, pipelines and terminals) rose by 2.6% year-on-year in November. Growth was particularly strong in OECD Pacific (+3.8%) and OECD Europe (+3.4%), partly driven by heating fuels on the back of an unseasonal cold spell but also by buoyant deliveries of industrial and transportation fuels, which suggest that the economic recovery has been more pronounced than expected earlier. In OECD North America (which includes US Territories), the story is similar, even though oil demand growth was lower (+1.7%) than in the other two regions.



Revisions to preliminary data were relatively limited (+130 kb/d in October), indicating that total OECD demand grew by 0.4% year-on-year during that month (versus +0.1% as suggested by preliminary data). The largest adjustments pertained to Europe (+200 kb/d), providing further indications of healthier-than-expected demand, particularly in the biggest countries. By contrast, North American demand was revised down (-130 kb/d), as monthly US readings diverged once again from weekly preliminary estimates, notably with regards to gasoil. In the Pacific, meanwhile, overall revisions were relatively small (+60 kb/d), almost entirely concentrated in Japan.



Based on the latest submitted data, OECD oil product demand is now estimated at 46.1 mb/d in 2010 (+1.5% or +670 kb/d year-on-year and +170 kb/d versus our last report). Despite this more buoyant assessment, we still project a decline in OECD demand to 45.9 mb/d in 2011 (-0.4% or -170 kb/d versus the previous year and 230 kb/d higher when compared to our last report), assuming that winter temperatures revert to their ten-year average. Yet, paradoxically, this assumption could prove to be over-optimistic: following the unusual freezing conditions that prevailed in November and December, temperatures have been remarkably mild so far in January, particularly in Europe.

North America

Preliminary data show oil product demand in North America (including US territories) rising by 1.7% year-on-year in November, following a 1.5% increase in October. On their own, the October and November readings would signal a slowdown in oil demand growth, particularly since growth rates for gasoline and diesel moderated versus the prior six months. Nevertheless, sharply colder weather (with higher heating-degree days or HDDs relative to both the previous year and the ten-year average), stronger economic indicators and buoyant US weekly data in December all point to a more robust demand picture heading into 2011. As such, we have raised our outlook for 1Q11, with smaller adjustments filtering through the remainder of the year.





October data were revised down by 130 kb/d, led by lower diesel readings (-250 kb/d) in the US and Canada, which offset higher LPG and jet/kerosene data. Weekly-to-monthly revisions in the US for October were slightly negative, in contrast to positive adjustments in the previous two months. Still, 4Q10 on the whole has been revised up by 220 kb/d on the basis of higher-than-expected Mexican preliminary readings for November and significantly higher US weekly demand data in December. North American demand is now estimated at 23.9 mb/d in 2010 (+2.6% or +610 kb/d versus 2009 and 60 kb/d higher than in our last report). Demand in 2011 is seen rising slightly to 23.9 mb/d (+0.1% or +25 kb/d year-on-year and 60 kb/d higher than previously expected).

Adjusted preliminary weekly data for the United States (excluding territories) in December indicate that inland deliveries - a proxy of oil product demand - grew by 3.7% in December, following a 1.2% year-on-year rise in November. December data featured a sharp year-on-year increase in the volatile 'other products' category (+25.9%), underscoring the uncertain nature of overall demand strength. The month was characterised by sharply colder weather in the Northeast, which boosted heating oil and propane demand. In addition, refiner incentives to accelerate deliveries out of storage for end of year tax purposes were another supportive demand factor.

The strength of transportation fuel readings continues to spark a lively debate. Preliminary data suggest that US gasoline grew by 2.7% year-on-year in December, despite retail gasoline prices averaging $3.00/gallon - almost 40 cents higher than the prior year. Other indicators, however, muddy the picture. For example, data from the MasterCard SpendingPulse survey, which estimates US weekly sales through activity in its payments network, suggests gasoline demand has consistently declined on an annual basis since September. Moreover, MasterCard's absolute levels of demand have differed from EIA weekly data by as much as 450 kb/d during that period.



Similarly, real personal consumption expenditures on gasoline through November, reported by the Bureau of Economic Analysis (BEA), suggest that gasoline consumption (on a twelve-month rolling average basis) has largely stagnated since the autumn of 2009. This would imply minimal year-on-year growth, as well as demand levels well below other estimates. By contrast, the Federal Highway Administration's estimates of vehicle-miles travelled (VMTs) provide a more supportive view - albeit with a two-month lag. Year-on-year VMT growth topped 1.9% in October and the twelve-month rolling average has increased consistently since May.

Mexican oil demand grew by 2.0% year-on-year in November, supported by stronger transport fuel readings. Diesel and gasoline demand grew strongly (+7.3% and +3.9% year-on-year, respectively). Despite continued reduced domestic airline capacity, as noted in last month's report, jet fuel/kerosene demand was down by only 2.0% versus a 12.8% decline in October, suggesting the partial reinstatement of traffic lost from the Mexicana airline bankruptcy.



Europe

Preliminary inland data indicate that oil product demand growth in Europe averaged 3.4% year-on-year in November. Demand was largely boosted by strong distillate deliveries, which account for over 40% of the total, with diesel and heating oil rising by +2.6% and +22.6%, respectively. The diesel readings suggest that the overall European economy has probably fared much better than anticipated, despite the ongoing financial turmoil that has affected some peripheral countries. In fact, industrial production in the Eurozone was much stronger than expected in November (+7.4% year-on-year, against consensus expectations of +6.0%), largely driven by Germany, which also posted its highest GDP growth since reunification - German GDP expanded by 3.6%, according to preliminary data, after slumping by 4.7% in 2009.

The heating oil data, on the other hand, are reflective of unusually cold temperatures, with HDDs markedly above both the ten-year average and the previous year. However, as this report has previously pointed out, heating oil use is structurally declining - because of both efficiency gains and interfuel substitution - thus limiting the effects of such unseasonal cold spells. Not only does heating oil demand remain well below the five-year average (albeit slightly above last year's levels), but distillate stocks also reportedly built.



Interestingly, 75% of October's revisions to preliminary demand data (+200 kb/d) were concentrated in the light and middle portion of the barrel, notably LPG/naphtha, providing further evidence of sustained petrochemical and industrial activity. Overall, demand rose by 0.3% in October, rather than declining by 1.1% as suggested by preliminary readings. Oil product demand in OECD Europe is now estimated at 14.4 mb/d in 2010 (-0.5% or -70 kb/d compared with the previous year and 50 kb/d higher than previously expected). In 2011, demand is expected to decline by roughly the same magnitude to 14.3 mb/d (-0.5% or -80 kb/d versus 2010, and 70 kb/d higher versus last month's report).

Oil product deliveries in Germany rose by 10.1% in November, according to preliminary data, driven by strong distillate demand. Diesel use jumped by 9.8%, while heating oil deliveries surged by 77.5% year-on-year, with consumer stocks standing at 61% of capacity, only slightly below both October levels (63%) and the five-year average.



Similar conditions prevailed in France, Italy and even Spain (according to preliminary November data), as well as in the UK (October data), with relatively buoyant deliveries of diesel and heating oil, highlighting both a stronger-than-expected economic rebound and colder temperatures. France, though, features a unique pattern with regards to extreme weather conditions: since heating facilities are increasingly electric, the country is obliged to resort to oil-based power generation to meet peak demand - typically resulting in residual fuel oil spikes (+21.3% year-on-year in November).



Pacific

Preliminary data show that oil product demand in the Pacific rose by 3.8% year-on-year in November, with all product categories bar residual fuel oil posting gains. As elsewhere in the OECD, these readings point to stronger-than-anticipated economic activity, in addition to colder-than-normal weather (with HDDs above both the ten-year average and the previous year, boosting kerosene use, the fuel of choice for heating in the region). Such economic resilience was particularly marked in Korea, where oil product demand surged by 6.5%, with the all-important naphtha category (over 40% of total demand) rising by 5.8%. In addition, transportation fuel readings were noticeably strong (with gasoline rising by 11.8% and diesel by 10.0%).





Japan also posted strong oil demand growth (+2.5%), a trend that may have continued in December following lower nuclear plant utilisation rates (52.1%, compared with 67.5% a year earlier). According to news reports, TEPCO - the country's largest power company - sharply boosted oil use for power generation given maintenance and unexpected outages at two of its nuclear facilities. December readings may therefore indicate strong demand for both residual fuel oil and crude for direct burning (the latter is included in the 'other products' category).

Revisions to OECD Pacific preliminary October data, meanwhile, were relatively minor (+60 kb/d) and mostly concentrated in Japan's 'other products'. Nonetheless, total OECD Pacific demand, estimated at 7.8 mb/d in 2010 (+1.6% or +120 kb/d year-on-year and 60 kb/d higher than previously expected), is expected to revert to its structural decline trend in 2011, falling to 7.7 mb/d (-1.5% or -120 kb/d versus 2010, and 100 kb/d higher versus last month's report).

Non-OECD

Preliminary demand data show that non-OECD oil demand growth accelerated again in November (+6.0% year-on-year), suggesting that economic growth is racing ahead. Growth was buoyant across all product categories, and continued to be led in absolute terms by gasoil, which surged by almost 800 kb/d, equivalent to roughly a third of the total demand increase, although naphtha posted the highest percentage increase. Meanwhile, gasoline demand - the second largest product category - also registered buoyant growth.



On a regional basis, oil demand growth in Asia - an astonishing +1.6 mb/d or +8.3% year-on-year - continues to dwarf that of all other non-OECD regions. As in previous months, China was the single largest contributor to growth, largely (but not exclusively) because of its policy-driven gasoil surge, accounting for roughly half of Asia's increase and for almost a third of non-OECD growth.



Stronger-than-expected readings in China, Russia and Saudi Arabia have resulted in a large 4Q10 revision (+440 kb/d), partly carried forward into the next four quarters. Non-OECD demand is now estimated at 41.6 mb/d in 2010 (+5.3% or +2.1 mb/d year-on-year and 110 kb/d higher than previously anticipated). In 2011, assuming somewhat tighter macroeconomic policies in several key countries facing increasing inflationary threats, demand growth is expected to moderate to +3.8% or +1.6 mb/d versus the previous year, reaching 43.2 mb/d (+130 kb/d when compared to our last report).

China

China's preliminary data show that apparent oil demand growth accelerated to +15.1% year-on-year in November, with all product categories posting strong gains. Total demand has thus reached new historical highs (10.2 mb/d), surpassing for the first time the symbolic 10 mb/d threshold. The country's demand surge is largely related to rising gasoil consumption (+12.2% year-on-year), which accounts for roughly a third of total demand.

As noted previously in this report, the soaring use of gasoil has been driven by extensive use of small-scale electricity generators. Government-mandated closures of coal-fired plants, aimed at complying with the emissions and energy efficiency targets of the 11th Five-Year Plan (2006-2010), resulted in power shortages across the country. This coincided with the harvesting and fishing season, when gasoil use normally rises, and led in turn to widespread gasoil shortages, which the government has tried to solve through several measures. It raised again 'guidance' retail prices for both gasoline and gasoil by roughly 4% in late December, despite mounting inflationary concerns (inflation in November reached 5.1%, well above the 3% official target). This, it was hoped, would strengthen domestic refining margins and encourage refiners to boost gasoil production, and hopefully curb demand at the margin as well - although the price rise was arguably too low to have any discernible demand effect (in fact, prior to the hike, many service stations around the country had reportedly been selling diesel fuel at prices above official caps). The government has also directed state-owned companies to both curb gasoil exports and hike imports (yet China, contrary to some claims, remained a net gasoil exporter in November).



Two other sources of supply have also emerged, perhaps explaining why gasoil stocks rose slightly in November (+0.8% month-on-month). First, as highlighted last month, the gasoil shortages have boosted net imports of residual fuel oil, probably because independent 'teapot' refineries have found it profitable to refine it and produce off-spec gasoil, despite high fuel oil import taxes (a methodological note: fuel oil used as feedstock is removed from our estimates of apparent demand in order to avoid double-counting, which some observers wrongly contend we do). Second, imports of so-called 'power kerosene' - a blend of kerosene and gasoil, which is also used as feedstock - have reportedly risen, notably into the southern Guangzhou province. Power kerosene is not - yet - subject to import constraints, contrary to gasoil, which can only be brought into the country by government-approved companies, and jet fuel/kerosene, which can only be imported by the state-owned China National Aviation Fuel Group. Should this blend be accounted for as kerosene in official trade statistics, it may explain why apparent demand for jet fuel/kerosene skyrocketed by 36.9% in November - although rising air travel related to the Asian Games (also held in Guangzhou) may too have played a role.

Looking forward, most observers expect gasoil shortages to ease, perhaps by January, since the government has officially declared that its emissions and efficiency targets have been fully met. If so, gasoil demand should ease in the months ahead. Gasoil use may have been lifted by as much as 200 kb/d in 4Q10 because of power generation needs, over twice as much as our initial estimates.



Other Non-OECD

Indian oil product sales - a proxy of oil demand - rose by 1.3% year-on-year in November, according to preliminary data, with all product categories bar residual fuel oil and 'other products' posting gains. Gasoline sales were particularly buoyant (+16.7%), supported by healthy vehicle sales (+22%) and the start of the traditional festival season. Such strength, however, may also partly reflect some stocking in anticipation of a price increase, as retail gasoline prices have in principle been deregulated since last June - although the government, through its state-owned oil companies, effectively continues to have the final say over the magnitude of price changes (as such, domestic prices still remain below international prices). End-user prices indeed rose by 5.6% in December and again by 4.5% in mid-January, but gasoline demand is largely price inelastic and is mainly driven by economic growth, which could well have exceeded 9% in 2010.





Meanwhile, gasoil demand rose by 3.8%, on the back of sustained industrial and farming activity (even though heavy rains limited the usage of irrigation pumps). This product, which accounts for over a third of total demand, was also due to be deregulated, at least partially, by end-2010. However, a meeting of the Empowered Group of Ministers, led by the Finance Minister and convened for late December to decide on this issue, has reportedly been postponed indefinitely, most likely because of the detrimental impact of any gasoil price rise upon inflation, already spurred by mounting food prices. Given the fact that international oil prices have continued to rise, the deregulation of gasoil prices may slip further - even though the subsidy burden, mostly absorbed by state-owned companies, will continue to rise.

Following average year-on-year growth of 6.8% over the first three quarters of 2010, Brazilian oil demand growth possibly weakened somewhat in 4Q10. Economic activity has slowed in recent months, while inflation has risen to almost 6%, raising the spectre of reduced public spending or further interest-rate hikes. Total product demand in October, at 2.7 mb/d, expanded by just 0.2% versus the prior year, with gasoline posting a 1.9% fall. Gasoil demand growth, albeit strong (+2.9%), contrasted sharply with the pace observed in the previous month (+9.6%), while residual fuel oil also posted a deeper decline in October (-8.6%) versus September (-1.3%), seemingly due to higher use of natural gas and gasoil for power generation. By contrast, only jet fuel/kerosene continued to grow rapidly (+12.9%). Looking ahead, with demand reaching 2.8 mb/d in 2011, growth should be slightly lower (+110 kb/d or +4.1% year-on-year) than in 2010 (+140 kb/d or +5.6%).



In Argentina, reduced natural gas availability and power sector shortfalls have supported gasoil demand during the austral summer. Air conditioning needs have prompted the rollout of 10-20 MW gasoil generators and the subsequent importation of additional gasoil cargoes. In November, both gasoil and fuel oil use grew strongly (+9.0% and +94.1% year-on-year, respectively), representing a combined increase of 55 kb/d versus November 2009. Despite slowing industrial indicators, Argentina's fiscal position has benefitted from a record soybean harvest, potentially setting the stage for increased government spending in 2011 (an election year). Yet, after growing by 75 kb/d (+12.0%) in 2010, we expect oil demand to increase by a more moderate 25 kb/d (+3.2%) in 2011. Still, worsening power generation problems are an upside risk.

Meanwhile, in Bolivia, the difficulty of fuel subsidy removal amid rising oil prices was painfully illustrated last month. On 26 December, the government announced that gasoline and diesel prices would rise by 73% and 83%, respectively, in order to ease the nation's subsidy bill ($380 million in 2010) and curb smuggling to higher-priced neighbouring markets. However, the introduction of conciliatory measures, such as freezing the price of LPG and natural gas for vehicles, increasing both public-sector pay and the minimum wage, and putting price ceilings on services ranging from water to bus transportation, did little to quell the ensuing nationwide protests. Ultimately, the government bowed to popular pressure and rescinded the subsidy removal five days after its initial announcement. Nevertheless, with indications that the 2011 subsidy bill may rise to as much as $660 million, some market analysts believe the price reform, may be attempted again - but in a more gradual, negotiated manner.

After much hesitation, on 19 December the Iranian government finally implemented the oil product subsidy-removal legislation approved by parliament in January. Originally due to be put in place in September, the new law aims to curb the country's subsidy bill, estimated at around $100 billion per year. The ensuing price hike, albeit anticipated, was hefty: gasoline prices under quota (60 litres/month) rose by 300%, while those for gasoil shot up by 800%. Meanwhile, above-quota prices rose by 75% and 100%, respectively. By deploying security forces on a large scale and announcing the changes just a few hours before they took place, the government managed to avoid the riots that followed the introduction of a rationing scheme in mid-2007. In addition, it temporarily increased the gasoline quota by 50 additional litres/month (which are priced at $0.10/litre) until next March, and began releasing targeted cash handouts ($40 per month) that were deposited in special accounts to some 61 million Iranians, out of a population of 73 million.

According to some reports, gasoline demand - which had been on a declining trend since May - fell by about 16% in the days immediately after the announcement, while gasoil demand, which had continued to rise until October (the last data point available), plummeted by as much as 73%, partly because of a brief strike by Iranian truckers. By the end of December, though, the average fall appeared to have been somewhat lower (5% for gasoline and 20% for gasoil). However, estimating the long-term impact of the new Iranian pricing scheme is difficult at this point. Some analysts argue that gasoline demand (which powers most private cars) should fall only slightly, since most Iranians have no alternative means of transportation. Some others contend that the $40 monthly payment should almost offset the extra cost for the average driver.

By contrast, other observers suggest that high gasoline prices will prompt the conversion of many vehicles to natural gas (an operation that is itself subsidised), even though there are questions regarding the sustained availability of gas. Still others note that the price hike will also certainly curb the hitherto highly profitable smuggling to neighbouring countries, thus removing a significant source of demand (controls at the border with Afghanistan, for example, have reportedly been tightened to prevent unauthorised fuel exports).

Ultimately, though, the likely spike in inflation (to perhaps as much as 70% in 2011) will arguably exceed the amount of the cash handouts. Real household expenditures, including energy and transportation, especially among the rural poor, will probably fall sharply. Although the government has insisted that the cost of public transportation in the country's major urban areas will not rise, fares for widely used taxis are likely to surge. In addition, domestic industry, already hard hit by international sanctions, is likely to suffer more, further depressing the economy and hitting oil demand. As much as we have attempted to factor in what, in our view, is likely to be a sustained fall in both gasoline and gasoil demand, our prognosis for Iranian oil demand, currently expected to rise to 1.9 mb/d in 2011 (+4.0% year-on-year), may eventually be revised as the effects of the price rise become clearer over the next few months.

Supply

Summary

  • Global oil production fell by 0.3 mb/d in December, to 88.1 mb/d, as non-OPEC supply decreased largely due to weather-related and technical outages. Year-on-year, global supply is 2.1 mb/d higher, shared evenly between non-OPEC, OPEC crude and OPEC NGL production.
  • Non-OPEC supply was down by 0.5 mb/d in December from November, to 53.0 mb/d, largely on outages in Argentina, Australia, Azerbaijan, Norway and Russia, which curbed 0.3 mb/d of output. Some of these were rapidly resolved, but a pipeline leak in Alaska and a fire at a Canadian oil sands upgrader kept January total shut-in volumes at the same level. Overall, 2010 and 2011 non-OPEC estimates remain unchanged at 52.8 mb/d and 53.4 mb/d, respectively.
  • OPEC supply gained 250 kb/d to reach 29.58 mb/d in December, continuing a rising trend evident since the spring. In light of stronger demand now apparent for second-half 2010, both the group's unchanged production targets and actual output levels in 3Q10 and 4Q10 have been lagging the underlying 'call on OPEC crude and stock change'. OPEC effective spare capacity has nudged below 5 mb/d for the first time in two years.
  • Higher demand estimates have led to an upward revision in the 'call on OPEC crude and stocks' for 1Q11 of 0.7 mb/d, to an estimated 29.8 mb/d. The 2011 'call' now averages 29.9 mb/d, around 0.4 mb/d higher than previously and a rise of 0.3 mb/d from 2010.
  • A high-level panel investigating the blowout at BP's Macondo oil well and subsequent huge oil spill in the US Gulf last year found no justification for a blanket ban on deepwater drilling. The panel's report did however recommend a range of measures designed to prevent another such accident, finding that the causes were systemic, even though it put much of the blame on a 'failure of management' at BP, Transocean and Halliburton. Regulatory structures were also criticised.


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

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

OPEC Crude Oil Supply

OPEC crude oil supply ended the year at the highest level since December 2008, when the producer group last agreed to cut output targets. December supply rose by around 250 kb/d, to 29.58 mb/d, with crude oil production by OPEC-11 averaging 27.15 mb/d, up 240 kb/d from the previous month. The group is now producing about 2.3 mb/d above its notional 24.845 mb/d output target.

The steady increase in prices over the past few months appears to have prompted a number of producers to increase supplies to capture higher revenues and/or to moderate price increases. Saudi Arabia, Iraq, Kuwait, the UAE, Nigeria, Ecuador and Venezuela all increased supplies in December. Only Angola saw output slip last month, apparently due to continued technical problems at some fields.

OPEC's crude production rose steadily throughout the year, with preliminary 2010 output averaging 29.22 mb/d. That is an increase of 528 kb/d over 2009 levels of 28.69 mb/d but still some 2 mb/d below 2008 levels. Nigeria and Saudi Arabia provided the lion's share of the higher output, up a combined 490 kb/d. Supplies from Iran, Iraq and Ecuador were marginally lower.



As expected, OPEC ministers left production targets unchanged at their 11 December meeting in Quito and agreed to meet again in Vienna on 2 June 2011. However, with prices nudging beyond $95/bbl and with the global oil burden (nominal expenditures as a percentage of nominal GDP) reaching levels that in the past have coincided with weakening economic activity, there appears to be tacit recognition by some producers of a need to adjust actual production levels to try to take some of the steam out of the market. The consensus view on oil demand showing record growth in 2010, followed by slowing but still robust growth in 2011 would seem to justify that flexible policy. Our own estimates for the 'call on OPEC crude and stock change' have been revised up by 0.7 mb/d for 1Q11 and by 0.4 mb/d for 2010 (largely on demand upgrades), to average 29.9 mb/d.

In Quito, Saudi Oil Minister Ali Naimi refuted earlier suggestions that the Kingdom now sees $70-90/bbl as necessary, and reiterated $70-80/bbl was the preferred target, echoing statements from a year previously when he described a range of $70-80/bbl as "a perfect price for the world." Oil prices have been well above these levels in recent months, with WTI futures averaging just over $89/bbl in December and trading above $92/bbl in early January. Brent futures posted even sharper gains, to $92.25/bbl in December and above $98/bbl in January.

With the next scheduled gathering still six months away, some veteran OPEC analysts believe the group's leading members will quietly increase production. Indeed, it appears Saudi Arabia has been making more crude available to the market in the past six months, judging by export data from independent tanker trackers. Having reviewed export data from a number of sources, we have revised our production estimates for Saudi Arabia higher by an average 135 kb/d for 2010. The most significant upward revisions pertained to 2H10, up by just under 200 kb/d to an average of 8.5 mb/d.

IEA estimates of Saudi production have historically been slightly higher than data submitted to the Joint Organisations Data Initiative (JODI) but the disparity has become especially sharp following this month's revisions. In particular, crude export data submitted to JODI by Saudi Arabia show a sharp downturn this year compared with independent trackers' assessments showing a steady upturn in exports of crude and NGLs. However, definitional issues likely also cloud the picture.

In December, Saudi output was assessed at 8.6 mb/d, up 100 kb/d from a revised November estimate of 8.5 mb/d. Preliminary market data indicate that the Kingdom is on track to increase production again in January. In addition, Saudi Aramco lowered prices for a number of key grades for February, making sales more attractive. Following in Aramco's footsteps, other Gulf member countries have reduced prices for next month's liftings, including Iraq, Kuwait, and the UAE.

Kuwait and the UAE both increased supplies in December by 30 kb/d, to 2.32 mb/d. For the year, UAE output rose by 1.6% to 2.31 mb/d on average while Kuwait posted a smaller 1.1% increase to 2.28 mb/d. Judging by the current list of projects in the pipeline, the UAE is on course to significantly increase nameplate capacity above neighbouring Kuwait in the next few years. The UAE's production capacity is forecast to increase from 2.7 mb/d in 2010 to 3.0 mb/d in 2013 as a number of projects come online, including expansion of Umm Shaif, both the Lower and Upper Zakum fields plus other enhanced recovery projects onshore. By contrast, protracted political wrangling in Kuwait is behind the anticipated decline in productive capacity, from 2.59 mb/d in 2010, falling to 2.51 mb/d in 2012 before inching higher to 2.54 mb/d in 2013.

Iraqi supplies in December were up a marginal 15 kb/d, to 2.44 mb/d from a revised 2.42 mb/d the previous month. OMR Iraqi production estimates are based on export volumes plus crude runs for domestic use at refineries and power plants, less reinjected oil and spiked fuel oil. Exports averaged 1.92 mb/d for December compared with 1.90 mb/d in November. Exports of Basrah crude from the southern ports were down by just under 20 kb/d, to 1.5 mb/d due to weather-related loading disruptions. Exports of Kirkuk, largely from the Turkish port of Ceyhan rose by an estimated 43 kb/d, to 423 kb/d in December.

For 2010, Iraqi exports declined on average by just under 20 kb/d, to 1.89 mb/d compared with 1.91 mb/d in 2009. Increased exports of Basrah crude in the south of around 34 kb/d, to 1.48 mb/d, partially offset lower shipments of Kirkuk crude from the northern region, down 54 kb/d to around 400 kb/d.

The government's plans to increase output failed to materialise in 2010, with production actually declining year-on-year, off by around 70 kb/d to 2.36 mb/d. However, 2011 holds the promise of an increase in production to 2.7 mb/d by 4Q11. IOCs appear to be making headway in expanding output via remedial work and debottlenecking at fields already producing, such as at the BP-CNPC Rumaila project and ENI's Zubair development. IOCs are reporting that they have reached contractual levels of increasing output by 10%, which enables them to start recovering costs.

The long-awaited formation of a new government in Iraq last month should also help improve the operating environment for IOCs, with challenging logistical and capital-intensive infrastructure funding a key priority, according to new Oil Minister Abdul Kareem Luaibi Former Oil Minister Hussein al-Shahristani has been elevated to a new position that effectively controls the strategic vision for the country's oil sector. Still uncertain is the fate of the fields controlled by the Kurdistan Regional Government (KRG). After ramping up production at the Tawke and Taq Taq fields in mid-2009, a dispute over payments to operating companies and the broader question of whether the government in Baghdad or the one in Erbil will control production in the region forced the shut-in of around 90 kb/d of production and left further production increases in limbo. As part of the new 2011 budget, the ministry has pencilled in increases of production from the region of 150 kb/d, but there are many thorny political issues that need to be overcome to reach this goal.

Iran's oil production in December is assessed at 3.68 mb/d, unchanged from the previous month. For the full year, Iranian supplies declined by 0.9%, to an average 3.71 mb/d. The year 2010 proved to be an annus horribilis for Iran's oil production outlook, as escalating tensions between Tehran and the international community over the country's nuclear enrichment plans culminated in the implementation of the most severe global sanctions to date. The immediate impact of the new sanctions has been the disruption of normal crude flows due to banking and other credit-related problems. European refiners slowed Iranian imports in the latter half of the year, and now Iranian exports of some 400 kb/d are in jeopardy due to stricter banking regulations being enforced by India.

In the medium term, sanctions have exacerbated the downward trend in the country's production profile as foreign operators withdraw from projects, and expectations of steeper field decline rates now that much-needed access to technology and equipment has been effectively cut off. Our latest medium-term update projects a decline in Iranian crude capacity to just 3.10 mb/d by 2015.

Nigeria accounted for about 40% of higher OPEC production in December, with supplies up 100 kb/d, to 2.28 mb/d. Repairs to damaged infrastructure led to higher output of Qua Iboe crude and prompted Shell to lift the force majeure on Bonny Light that had been in place since November. However, militants in the volatile Niger Delta region attacked critical pipeline infrastructure in late December, forcing the state oil company to shut down three of the country's four refineries.

Last year, the success of the government's ceasefire accord underpinned the 14% jump in production levels, to an average 2.08 mb/d. Nigerian production will likely remain volatile near term ahead of April presidential elections.

Angolan output slipped to 1.62 mb/d last month, down by 40 kb/d from November levels. An array of technical problems at the country's complex deep-water fields is behind the steady decline in supply over the year. Greater Plutonio has been producing well below 200 kb/d capacity this year due to chronic problems with its water injection system. As a result, Angolan production was nearly unchanged from 2009 levels at 1.77 mb/d in 2010.

Production from OPEC's South American members in December edged up by a slight 10 kb/d, with Venezuelan supplies rising to 2.2 mb/d and Ecuador to 480 kb/d. In 2010, Venezuela output ebbed and flowed in line with operational problems at the country's four heavy crude oil upgraders but overall gained around 75 kb/d year-on-year, to 2.23 mb/d. Ecuador intensified its efforts to nationalise its oil industry last year, with output slipping 1% to 465 kb/d.

OPEC's loftier production levels in December have led to a downward revision in our estimate for the group's effective spare capacity. At the same time, assessed production capacity levels in a number of countries edged lower in the new year, especially in Algeria, Iran and Angola. As a result, OPEC's current effective spare capacity has fallen below 5 mb/d for the first time in two years. Effective spare capacity, which excludes notional spare capacity in Iraq, Nigeria and Venezuela, is estimated at 4.9 mb/d compared to 5.56 mb/d in November.

Higher OPEC production of some 250 kb/d in December accounts for roughly 40% of the 660 kb/d decline. A hiatus in new capacity additions combined with natural decline rates are behind lower production capacity estimates for Algeria, Iran and Angola, which combined equate to just under 370 kb/d of adjustment in 1Q11. Overall OPEC installed capacity is seen declining in 2011 compared with 2010, from 35.5 mb/d to 35.2 mb/d, then slowly recovering in 2012 and reaching 36.9 mb/d by 2015.



Non-OPEC Overview

Non-OPEC oil supply fell by 0.5 mb/d to 53.0 mb/d in December, with around half of the drop stemming from a range of production outages in Argentina, Australia, Azerbaijan, Norway and Russia. Several of these were resolved by January, but were then replaced by output shut-ins in Alaska due to a pipeline leak and in Canada, after a fire at an oil sands upgrader. January is expected to see 0.3 mb/d of oil production curbed as a result, and Canadian shut-ins are expected to tail off in March and April. In contrast, reported data for October through December brought relatively minor revisions to preliminary estimates, but showed higher recent production in the US, Canada and China. Estimated 2010 production is therefore left unchanged at 52.8 mb/d.





Projected 2011 non-OPEC supply is also left unchanged, at 53.4 mb/d, with higher estimated Chinese oil production of nearly 0.1 mb/d offset by marginally lower output in the OECD Pacific, the FSU, Latin America and global biofuels. As such, incremental 2011 supply in non-OPEC countries remains unchanged from last month's report at 0.6 mb/d, following 2010's estimated 1.1 mb/d increment, the highest annual growth since 2002.



Higher prices are encouraging investment and helping to sustain supply growth. A survey published by Barclays Capital in December indicated that 2011 upstream investment is expected to grow by 11% year-on-year, to just under $500 billion. Rigs drilling for oil in December 2010 were up by 40% year-on-year, according to Baker Hughes, largely driven by increased activity in the US and Canada, where the combined rig count has doubled year-on-year (in the US, not least due to many smaller rigs working on shale oil formations). Key sources of incremental oil production in 2011 include China (+185 kb/d), global biofuels (+180 kb/d), Brazil (+160 kb/d), the FSU (+160 kb/d), Colombia (+120 kb/d), Ghana (+85 kb/d), India (+60 kb/d) and Oman (+45 kb/d). Production is expected to fall in North America (-215 kb/d, shared equally among the US, Canada and Mexico), Malaysia (-60 kb/d) and, to a lesser extent than in previous years, the North Sea (-75 kb/d).



Global Biofuels

Global biofuels production is revised down by 25 kb/d in 4Q10 and by 15 kb/d for 2011 as a whole (the latter to 1.8 mb/d), largely due to lower expected Brazilian ethanol output. In Brazil, dry weather in the Centre-South resulted in lower November cane production versus the prior year and high sugar prices have encouraged some switching from ethanol to sugar production. Expectations for 2011 ethanol production in Brazil are trimmed by 15 kb/d to 510 kb/d versus an estimated 465 kb/d in 2010.

Meanwhile, US ethanol production reached 885 kb/d in October, with weekly data suggesting production exceeding 900 kb/d at times in December. US ethanol and biodiesel producers both benefitted from the government's renewal of blenders' tax credits of 45 cents/gallon and $1/gallon, respectively, in late December. The credits were left unchanged from previous levels and the biodiesel credit was applied retroactively to the beginning of 2010. Nevertheless, the credits were extended only through end-2011, leaving concerns over the industry's medium-term economics. We see US ethanol production averaging 900 kb/d in 2011, up from 860 kb/d in 2010.

OECD

North America

US - December Alaska actual, others estimated:  December US oil production dipped by 0.1 mb/d to 7.9 mb/d, even while preliminary weekly data prompted an upward revision of 0.1 mb/d to the month. A leak forced the closure of a key export pipeline and around 600 kb/d of crude production from Alaska on 8 January. The shut-down of the Trans-Alaska Pipeline System (TAPS), which links North Slope production with the Valdez export terminal in the south, forced a halt to production in the north, although crude continued to be loaded at the terminal, reducing stock holdings there. Alaska produced an average 610 kb/d in 2010, most of which is North Slope crude.



At the time of writing, the pipeline had been restarted, at a reduced rate of 300-400 kb/d, even though the leak had not yet been fully repaired. This was in order to prevent crude and water within from freezing. Plans were for a short section of the pipeline to be circumvented with a bypass. Assuming production is offline for a week, average January Alaskan production is estimated to be 140 kb/d lower than in December. Total 2010 oil production in the US is left virtually unchanged, at 7.8 mb/d, and is estimated to fall to 7.7 mb/d in 2011.

Report Finds No Need for Deepwater Drilling Ban, but Recommends Tighter Rules

On 11 January, the first of several investigations into the causes of the Macondo oil spill last year published its findings. The National Commission on the BP Deepwater Horizon Oil Spill and Offshore Drilling (www.oilspillcommission.gov) cited a 'failure of management' by BP and service companies Transocean and Halliburton as leading to the well blowout, the sinking of the Deepwater Horizon drilling rig and the subsequent spill of 5 mb of oil into the Gulf of Mexico. It was judged to be a systemic failing and thus seen as a far wider problem than simple negligence by individuals or one company. In addition, regulatory oversight, safety standards and oil spill response practices failed to keep pace with the push into deeper and increasingly challenging offshore areas.

However, arguing that the expected US energy needs will continue to rely upon oil for the foreseeable future, and that for energy security reasons a substantial proportion of this should stem from domestic sources, the Commission saw no need for a blanket ban on deepwater oil drilling. Rather, it recommended a much-improved safety culture, based on wide-ranging reforms of both industry and the regulatory regime. Specifically, the Commission recommended that:

  • Besides boosting the capability of the existing regulator, a new, politically independent safety body should be created along the lines of the nuclear industry's Institute for Nuclear Power Operations.
  • The liability cap for companies implicated in offshore disasters should be raised by an unspecified amount (it currently stands at $75 million), although the Commission shied away from earlier proposals for unlimited liability, which might have led to an exodus of smaller operators from the Gulf.
  • Regulators should comply with a new 60-day review period for applications to drill, a compromise between the existing 30-day limit and a new 90-day limit sought by the Department of the Interior.
  • New regulations should be underpinned by a risk-based approach placing responsibility on companies to prove that they have evaluated all risks and are as up-to-date as possible with best drilling, safety and response practices. This would put the US in line with the approach long taken by other countries with substantial offshore production, notably the UK and Norway.

The report encountered widely different responses on its release and will be reviewed by Congress before its recommendations are passed into law, although some of its proposals may be implemented by executive order. In all likelihood, legislators and authorities will also wait to review the publication of other investigations into the disaster, notably those of the US Coast Guard/Bureau of Ocean Energy Management and the Chemical Safety Board.

What seems clear is that reforms widely accepted as necessary for reasons of safety and environmental protection will nonetheless add to offshore project costs and lead times.

Canada - Newfoundland November actual, others October actual:  In December, total Canadian oil supply dipped marginally to 3.4 mb/d, as constraints on pipelines into the US forced some minor shut-ins. Preliminary October data were 200 kb/d higher than expected, with stronger output in conventional crude, bitumen and NGL production. However, on 6 January, a fire at CNRL's Horizon oil sands upgrader forced a complete halt to operations, including related bitumen production. The upgrader converts heavy, viscous bitumen into synthetic crude oil, which can be processed in regular oil refineries. With a capacity of 110 kb/d, Horizon produced an average 90 kb/d of synthetic crude oil in 2010.

On past experience, fire damage at upgraders can take several months to repair, but preliminary investigations reportedly indicate that around half of the plant's coking capacity is unaffected and could be brought back online soon. We assume a gradual return to around 50% production levels by February and March, followed by the return of the remaining capacity in April. CNRL hopes to complete some seasonal maintenance now, rather than in the summer, which should largely compensate for the outage in terms of total expected 2011 production.

Higher 4Q10 output raises average 2010 total Canadian oil production marginally, to 3.34 mb/d. Output in 2011 is estimated at a slightly lower 3.27 mb/d, with declining conventional oil and NGL production more than offsetting increased oil sands output (though subsequent years will see the opposite, as substantial new oil sands production capacity comes online).



Mexico - November actual:  Mexican oil production in November dipped slightly below 2.9 mb/d on lower-than-expected output numbers. Production at key fields Ku-Maloob-Zaap (KMZ) and Cantarell fell by 40 kb/d and 20 kb/d respectively month-on-month, to 800 kb/d and 435 kb/d. As a consequence, yearly production estimates were nudged down, with 2010 now expected to average 2.95 mb/d, and 2011 estimated at 2.88 mb/d, as the country's mature base continues to decline.

North Sea

Norway - October actual, November provisional:  December total oil production in Norway was steady at 2.15 mb/d. High temperatures at a gas turbine forced the shut-in of the Kristin and Tyrihans fields from early December until the end of the month, curbing total supply by 80 kb/d for the month. On 11 January, a gas leak briefly shut in the Snorre A platform and neighbouring Vigdis field. Both regained full production within 24 hours however. Overall, 2010 and 2011 production estimates are unchanged, averaging 2.15 mb/d in both years. In contrast with average annual decline of 150 kb/d in 2010 and 2009, 2011 is expected to see flat aggregate production, with 180 kb/d of new field production coming onstream, and lighter maintenance expected than in 2010.



UK - October actual:  UK total oil production was broadly steady at 1.35 mb/d in 4Q10, and 2010 production is estimated to average 1.37 mb/d, declining to 1.32 mb/d in 2011.

The UK's Parliamentary Energy & Climate Change Committee, weighing supply security considerations, concluded in January that there was insufficient evidence of risk of a Macondo-style blowout in UK waters to justify a deepwater drilling moratorium, but tightened regulations requiring insurance and oil-spill response systems.

Pacific

Australia - October actual:  Australian total oil supply fell to around 480 kb/d in December and January, as severe offshore storms briefly forced a halt to nearly half the country's output capacity (recent catastrophic flooding in Queensland did not materially affect oil production). An estimated 50 kb/d was curbed for each month. The Cossack oil field will be taken offline for an estimated 90 days in February to April, while its FPSO unit is exchanged. This is estimated to cut output by around 35 kb/d for that period. In sum, 2010 and 2011 Australian oil production is adjusted down by 10 kb/d and 20 kb/d, to 515 kb/d and 545 kb/d respectively. 2011 production will receive a boost from the ramp-up of the Pyrenees oil field and the delayed start at Montara.

Former Soviet Union (FSU)

Russia - November actual, December provisional:  Russian oil production dipped by 55 kb/d to just below 10.5 mb/d in December, partly due to the impact of harsh winter weather, although outages are not assumed to last long. Nonetheless, Russian oil supply in 2010 rose by 240 kb/d to average 10.45 mb/d, its highest annual post-Soviet level.

However, downward-adjusted company guidance stemming from uncertainty over tax breaks has prompted a revision of 35 kb/d to the 2011 forecast; production is now expected to average 10.53 mb/d. In particular, state-controlled Rosneft said its new Vankor field will see average production rise to only 300 kb/d in 2011, rather than the previously reported 340 kb/d, as export tax breaks are due to expire in May. In December, the Duma voted to hike the Mineral Extraction Tax (MET) amid conflicting imperatives to boost revenues but maintain hydrocarbon activities. The uncertain tax situation remains key to assessing the likely trajectory of Russian oil production.

Azerbaijan - October actual:  October oil production in Azerbaijan was revised down by 60 kb/d to 1.06 mb/d. In addition, December saw the Chirag platform at the Azeri-Chirag-Guneshli (ACG) complex, shut-in for around 10 days in mid-month, curbing 35 kb/d from output. National production is expected to rise from 1.06 mb/d in 2010 to 1.09 mb/d in 2011.



Kazakhstan - October actual:  Kazakhstani oil production rose 130 kb/d to 1.63 mb/d in October, after seasonal maintenance had curbed operations at the Karachaganak field in September. All told, 2010 production is expected to average 1.64 mb/d, rising to 1.69 mb/d in 2011.

In December, the go-ahead was given for the expansion of the Caspian Pipeline Consortium (CPC) pipeline, which feeds Kazakhstani crude to an export terminal near Novorossiysk on the Russian Black Sea coast. Capacity will be more than doubled to 1.35 mb/d by 2015, which will mainly be used to accommodate rising production from the Tengiz and Karachaganak fields and eventually also some of the initial volumes from the huge Kashagan field, from which we expect to see first output in late 2013. The CPC expansion should help to solve the expected export capacity crunch, though only partly so, as Kashagan output gradually increases to an expected 350 kb/d by end-2015 and potentially much more thereafter. Talks on the other main proposed export solution, the Kazakhstan Caspian Transportation System (KCTS), which would involve using tankers to transport crude across the Caspian Sea and into new-build export infrastructure on the western shores of the Caspian, remain stalled.



FSU net oil exports continued their upward momentum in November, increasing by 200 kb/d from October to 9.5 mb/d. In contrast to previous months, product exports drove the hike, increasing by 190 kb/d to 3.1 mb/d, while crude shipments inched up by 10 kb/d to 6.5 mb/d. Seaborne shipments of FSU crude remained constant at 5.0 mb/d, with small increases in Black Sea and Ceyhan cargoes offsetting minor declines in the Baltic, Arctic and Far East regions. Flows through the Druzhba pipeline increased by 50 kb/d, balancing falls elsewhere. It should be noted that although the ESPO spur to China began line fill of around 70 kb/d in November, these volumes have not been considered as exports.

November's product exports were the highest since July 2010 as fuel oil, gasoil and 'other products' increased by 90 kb/d, 70 kb/d and 30 kb/d, respectively. These hikes resulted from increased refinery runs (+200 kb/d) and exporters increasing shipments ahead of the December rise in export duties. Over the short term, a surplus of Russian fuel oil is expected to be shipped abroad, as domestic demand wanes due to a number of power stations, notably in the Arctic and Far East, switching from fuel oil to cheaper natural gas. However, looking towards the medium term, shipments of fuel oil could actually fall in response to an equalised product export duty (see OMR dated 10 December 2010) and Russian refinery investment in upgrading to increase middle distillate output at the expense of heavy products.

Recent reports have indicated that there are still creases to be ironed out in the customs union agreement between Russia and Belarus. Deliveries of Russian crude to Belarusian refineries are reported to have halted on 1 January after producers raised their prices in response to the removal of export duties. At present shipments to Europe are not adversely affected. Offsetting incremental supplies are now reaching Belarus, piped northwards from the Black Sea port of Odessa via Brody. A recent long-term deal has now been signed where oil will be supplied by Azerbaijan on behalf of Venezuela.

Other Non-OPEC

China - November actual:  November oil supply in China is revised up by 100 kb/d to 4.3 mb/d, a new record high, on stronger-than-expected offshore output. This results in higher estimated 2010 production of 4.1 mb/d and is largely carried into 2011, now adjusted higher to 4.3 mb/d. Since first publishing detailed supply estimates for 2011 (estimated at 3.9 mb/d in the OMR of 13 July 2010), successive upward revisions, partly due to baseline revisions, but also stronger expected growth, have resulted in China now being one of the largest contributors to short-term non-OPEC supply growth.



India - November actual:  Indian oil production in November is revised up by 50 kb/d to 930 kb/d, also a new record-high level, as output at the Mangala complex in Rajasthan ramps up more rapidly than expected. Combined production from Mangala, soon to be augmented by output from the Aishwariya field and later from the Bhagyama field, is expected to reach a total production capacity of around 240 kb/d by the end of 2012. India's total oil supply is estimated to average 865 kb/d in 2010, rising to 925 kb/d in 2011.

Sudan:  On 9 January, a referendum on a possible secession from the north was held in southern Sudan. Most observers expect southerners to vote in favour of secession, which could pave the way for the peaceful creation of a new sovereign state in July this year. The outcome is yet to be announced, however, and there is still the possibility of disruptions due to an outbreak of violence.

Moreover, the crucial issue of how to share oil revenues is far from resolved. The majority of oil production - around 75-80% - is located in the south, while export infrastructure and refineries are in the north. According to news reports, production of Dar Blend, which represents around half the country's total output, was nearly shut-in in December, due to fears for oil workers' safety, though this was avoided after political intervention. Sudan's total oil production is estimated at 0.5 mb/d in 2010, and assumed to remain at this level in 2011. Sustaining these production levels clearly depends on continued investment and the evolving political situation.

Ghana:  December saw the start-up of the first phase of the large Jubilee oil field, heralding Ghana's emergence as a significant sub-Saharan oil producer. In a first phase, Jubilee is expected to ramp-up production volumes to 120 kb/d by 3Q11. However, delays in finalising an oil law, which would determine the state's share of oil revenues, is causing uncertainty over a possible second phase. We estimate that 2011 oil production should average 90 kb/d, rising from 7 kb/d in 2010.

OECD Stocks

Summary

  • OECD industry stocks declined by 8.3 mb to 2 742 mb in November, broadly in line with the five-year average 10.9 mb stock-draw for this month. The fall was led by draws of 'other products', middle distillates and residual fuel oil, while gasoline inventories rose.
  • November OECD forward demand cover fell to 58.7 days, from 59.1 days in October. A draw in 'other product' stocks combined with rising three-month average forward demand for total oil products drove the overall decrease, but lower fuel oil and middle distillates holdings also contributed.
  • Preliminary December data indicate OECD industry oil stocks plummeted by 33.1 mb. This second consecutive monthly decline was led by steep draws in US crude and 'other products'. Overall, OECD crude inventories contracted by 18.7 mb, while products fell by 11.8 mb.
  • Short-term oil floating storage fell to 56 mb in December, from 64 mb at end-November. Crude floating storage contracted by 2 mb to 36 mb due to offloading in the Asia-Pacific. Product floating storage declined by 7 mb to 20 mb on draws in Northwest Europe and West Africa.


OECD Inventories at End-November and Revisions to Preliminary Data

OECD industry oil inventories stood at 2 742 mb at the end of November, or 58.7 days of forward demand cover. A large draw in North American 'other product' stocks contributed to an 8.3 mb monthly drop in the total OECD holdings, taking stocks to 3.2 mb below the previous year's levels, but still near the top of the five-year range. By comparison, stocks drew by 10.9 mb on average in November over the past five years.



Declining inventories contributed to a drawdown in the OECD stock overhang, which remains primarily in North America, although the region reduced its surplus to the five-year average to 64.4 mb, from 97.8 mb in August. European inventories look better balanced at 7.0 mb above historical averages, while relative tightness in the Pacific diminished from -32.3 mb in September to only -7.6 mb in November.

Crude oil inventories declined by a marginal 0.9 mb in November, but the overall figure masks offsetting movements within the regions. North American refineries increased their crude runs after heavy turnarounds in prior months, drawing 10.5 mb of regional crude stocks, while European crude stocks fell by 1.4 mb on trade flows. An 11.0 mb build in Pacific stocks provided some cushion despite an uptick in regional throughputs.



Stronger demand for power generation, especially in Europe, reduced residual fuel oil holdings by 2.8 mb, whereas 'other product' stocks fell by a steep 9.1 mb in North America. After counter-seasonal builds over the summer and draws in the autumn, gasoline converged to the five-year trend and built by 5.2 mb. Meanwhile, the October halt in refinery operations in France triggered higher distillate exports to Europe, raising regional holdings by 3.5 mb, but total OECD middle distillate inventories fell by 1.9 mb in November. A spell of colder weather at end-November and in December further pressured heating fuel inventories, but OECD countries seemed well supplied ahead of winter, as middle distillates stood 29.4 mb above the five-average levels at the end of the November.

French preliminary inventory levels at end-October, submitted in a detailed breakdown by French authorities a month earlier than usual, were revised up only marginally, by 0.8 mb, with the largest upward adjustment of 0.9 mb to gasoline. October total OECD stocks were revised up by 5.1 mb, implying a sharper 6.3 mb build than the preliminary 0.7 mb gain reported previously.



Preliminary December data point to similar trends in stocks to those seen in November, albeit magnified. Inventories in the US, Japan and Europe fell by 33.1 mb on the month, in line with a typical 40.1 mb seasonal draw. Steep draws in US crude and 'other products' drove the decline, with crude oil stocks down by 18.7 mb, 'other products' by 20.2 mb and fuel oil by 2.3 mb. Gasoline and distillate builds, supported by higher refinery output and by offloading of product floating storage, tempered the overall stock-draw.

Diminishing profitability of floating storage helped to drain offshore oil inventories as the contango structure in the oil price forward curve flattened. Consequently, short-term crude oil floating storage has declined by almost 60 mb from its peak in May to 36 mb at end-December, although levels are still elevated by a reported 20 mb of Iranian heavy crude held in the Middle East Gulf. Similarly, product floating storage has shrunk by more than 75 mb from a peak a year ago, to 20 mb in December.

Analysis of Recent OECD Industry Stock Changes

OECD North America

Industry stocks in North America fell by 20.7 mb in November to 1 367 mb, the largest decline since December 2009 and sharper than the five-year average 7.8 mb stock-draw. Crude inventories decreased by 10.5 mb as imports contracted at the time when US refiners increased throughputs after heavy turnarounds during the previous month. Albeit falling from their highest levels since April 2009, crude stocks still maintained a 42 mb surplus to the five-year average. Meanwhile, product inventories dropped by 11.3 mb on falling 'other products' and middle distillates, with a weaker-than-seasonal gasoline build providing only limited upside support.



US weekly data point to a 39.3 mb draw in US industry stocks in December. Crude oil inventories plummeted further by an additional 22.6 mb. However, the decline was centred in the US Gulf Coast region, where levels finally fell below the five-year average after almost two years in surplus. While companies deferred tanker imports to reduce end-year tax liabilities, a further increase in refinery runs and marginally higher exports also contributed to the decline.



In contrast to US Gulf Coast, the US Midcontinent remains awash in crude stocks, having built following a temporary 300 kb/d increase in imports of Canadian crude during 2Q10 to stand almost 25 mb above the five-year average levels. Crude stocks held in Cushing, Oklahoma, the delivery point for NYMEX WTI futures, rose by 2.7 mb to 37.5 mb, approaching July record levels of 37.8 mb. In addition to the stock overhang in the US Midcontinent, the build in Cushing further pressured WTI prices relative to Brent in December and early January.



December draws in the 'other product' category, especially propane used for heating, drove a 13.0 mb decline in US product inventories. Gasoline stocks rose by 6.5 mb amid stronger demand, while distillates increased by 3.2 mb. Cold December weather drew heating oil stocks 6.9 mb lower, but diesel stocks rose by 10.1 mb on higher refinery output and imports.

OECD Europe

Commercial oil inventories in Europe rose by 3.5 mb to 955 mb in November, in line with a typical 7.6 mb seasonal build. Gains in middle distillates and gasoline drove product holdings up by 5.0 mb, while a 1.8 mb draw in residual fuel oil stocks provided partial offset. Crude oil stocks fell by 1.4 mb concealing offsetting trends in Northwest European and Mediterranean countries. As expected, French crude stocks rose in November, after a backlog of tankers awaiting to offload on the south coast of France gradually cleared during the month. Further increases came from the Netherlands and Germany, but lower imports reduced stock levels in Greece, Italy and Spain, while export-driven draws in the UK and Norway also ensured an overall drop for November.



Middle distillate stocks rose by 3.5 mb in November supported by higher imports and refinery output as refineries in France, idled during a month-long industrial action in October, returned to operation. However, an uptick in Spanish exports partly constrained the distillate build. Meanwhile, higher end-user heating oil prices discouraged consumers from further restocking and they instead drew their accumulated inventories. As such, German end-user heating oil stocks fell to 61% of capacity in November, from 63% in October.



Preliminary data from Euroilstock indicate a 3.3 mb gain in December inventories in the EU-15 plus Norway. By comparison, December oil stocks on average rose by 10.7 mb in the past five years, entirely driven by product gains. This year, products built in line with the seasonal trends by 7.5 mb, outweighing a 4.2 mb drop in crude oil stocks. In spite of stronger demand supported by cold weather and holiday travel, distillate stocks built by 7.1 mb, mainly in France and Spain, augmented by imports from the Asia-Pacific and by products from floating storage. Northwest European offshore product stocks declined by 6 mb in December, but some 8 mb remain stored at sea. In addition rising gasoline, gasoil and fuel oil inventories lifted refined oil product stock levels held in independent storage in Northwest Europe in December.

OECD Pacific

In November, industry stocks in the OECD Pacific rose counter-seasonally by 8.9 mb to 419 mb, driven by a sharp build in crude oil. By contrast, over the past five years stocks declined by 10.7 mb on average, led by 7.9 mb product draws on top of a 2.0 mb crude draw. This year, crude oil stocks surged by 11 mb as both Japanese and Korean inventory levels rose. Product draws were more muted at around 2.4 mb, as higher crude runs were supported by stronger demand for heating fuel. This was combined with elevated product exports to the Asia-Pacific, notably middle distillates and fuel oil from Europe.



Japanese oil industry stocks rose by 2.9 mb in December, according to preliminary weekly data from the Petroleum Association of Japan (PAJ). Despite a further monthly increase in refinery runs, crude oil inventories gained 8.0 mb on higher imports. Meanwhile, a decline in kerosene stocks used as heating fuel in winter led to a 6.2 mb draw in products, but naphtha and gasoline decreases also contributed.



Recent Developments in Singapore and China Stocks

According to China Oil, Gas & Petrochemicals (China OGP), Chinese commercial oil inventories drew by 0.8 mb in November. High refinery runs drove a third consecutive monthly draw in crude oil stocks (3.2% or 6.6 mb), even though crude imports rebounded to near record levels. In an attempt to keep the market well supplied amid domestic diesel shortages, China boosted product output and increased diesel imports in November. Consequently, gasoil stocks edged 0.8% (0.4 mb) higher in November after collapsing by more than 45% since February 2010. The country has also remained a net diesel exporter since the start of 2009. In addition, gasoline inventories gained 8.7% (4.6 mb) and kerosene stocks built by 7.0% (0.8 mb), and thus brought total product stock levels higher by around 5% (5.8 mb).



Refined product inventories in Singapore fell by 5.8 mb in December on declines in all product categories. Strong exports to China and arbitrage cargoes to Europe drew gasoil inventories by 2.9 mb. Gasoline stocks declined by 1.1 mb amid stronger regional demand, while fuel oil dropped by 1.8 mb despite Western arbitrage arrivals.



Prices

Summary

  • Marker crude prices were trading near $100/bbl in early January, prompting concerns over the impact on the global economic recovery. Futures prices rose for the fourth month running in December, trading in a higher range of $88-$92/bbl. Robust economic growth in Asia, and especially China, coupled with stronger-than-expected oil demand in OECD countries, has pushed crude above the $70-$80/bbl range it held for much of 2010.
  • While oil prices in the US, Europe and Asia all trended higher in December, market vagaries led to divergent regional developments. In the US, crude prices affected by weakness in prompt WTI, with swelling stocks at Cushing pressuring the front end of the futures curve. By contrast, Brent moved into backwardation, in part due to slightly fewer cargoes of some North Sea grades. Futures prices were last trading at around $91.00/bbl for WTI and $98.00/bbl for Brent.
  • Spot product prices were higher across all major regions in December, although increases for the light ends and middle distillates far outpaced those of fuel oil. However, crack spreads were mixed by product and region. Cold weather boosted heating oil cracks in the US but largely failed to lift European markets. Refining margins were mixed on a regional basis, with the US and Europe generally weaker in December, while Asia strengthened.
  • Crude oil tanker rates experienced an improvement throughout the first three weeks of December amid a rush to fix cargoes before the Christmas holidays, but by early January, rates had receded sharply. Buoyant Asian demand and exceptionally high eastbound Middle East liftings pushed the benchmark Middle East Gulf - Japan route to a peak.


Market Overview

Marker crude prices were trading near $100/bbl in early January, setting off alarm bells among economists worried about the impact on the global economic recovery. Futures prices rose for the fourth month running in December, trading in a higher range of $88-$92/bbl. Robust economic growth in Asia, stronger-than-expected oil demand in OECD countries and a steady drawdown in global stocks, especially those held in floating storage, are behind the four-month rally in prices that saw crude break above the $70-$80/bbl range it held for much of the last year.

In December, oil prices were boosted further as northern hemisphere temperatures plummeted and snow blanketed the US and Europe. Benchmark crudes in December were up by around $5-6/bbl, with WTI averaging $89.23/bbl and Brent a higher $92.25/bbbl. WTI futures surged to a 2010 high on 23 December, closing at $91.50/bbl, the highest closing level since October 2008. WTI averaged $79.61/bbl in 2010, up 28% year-on-year and second only to 2008's record $99.75/bbl. Brent averaged $80.34/bbl in 2010, up nearly 28% on the year.

While oil prices in the US, Europe and Asia all trended higher in December market vagaries led to divergent regional developments. In the US, prices continued to be constrained by weakness in prompt WTI, with swelling stocks at Cushing pressuring the front end of the futures curve. North Sea Brent crude moved into backwardation in mid-December, with the M1-M2—while relatively small—averaging around $0.10/bbl since mid-December. The prompt month strength is due in part to lower supplies of some North Sea grades such as Forties.



A flattening of the WTI forward price curve in early December continued over the month, with the WTI M1-M12 spread narrowing to around $2.40/bbl on average in December compared with $3.50/bbl in November, $4.55/bbl in October and $7.10/bbl in September. By the first week of January, the M1-M12 spread was widening again—largely due to prompt month weakness—running about $4.75/bbl. The relatively tighter North Sea market saw the ICE Brent M1-M12 spread contract even sharper than WTI last month, averaging just $0.41 cents/bbl in December compared with $2.31/bbl in November and $3.49/bbl in October. By early January it had widened to $0.87/bbl.

OPEC's decision to keep production levels steady at its 11 December meeting in Quito also helped fuel the bullish market sentiment. Predictions that the New Year will bring a return to $100/bbl have been down played by some OPEC ministers, who argued that speculators were to blame for the latest run-up in oil prices. In Quito, the Saudi Arabian Oil Minister refuted earlier suggestions that the Kingdom sees $70-90/bbl as the new price level, and reiterated $70-80/bbl as a preferred level. Indeed, it appears Saudi Arabia has been making more crude available to the market in the past six months.



Institutional Investors Embrace Commodities as New Asset Class

Investor interest in commodities, including oil, has risen dramatically over the last decade and commodities have become a new asset class in institutional investors' portfolio. Partly, this development is due to diversification benefits. In addition, the development of new investment vehicles, such as exchange traded funds, has allowed individual investors to get exposure to movements in commodity prices. Due to the storage and trading costs associated with direct physical investment in commodities, the main vehicle used by investors to gain exposure is via commodity indices (baskets of short maturity commodity futures contracts that are periodically rolled over as they approach expiry), exchange traded funds or other structured products. These instruments provide generally long-only exposure to commodities.

The main goal of commodity index funds is to track the movement of commodity prices. There are several major commodity indices as well as sub-indices. Standard and Poors' GSCI (formerly the Goldman Sachs Commodity Index) is the oldest and most widely tracked index in the market. The S&P GCSI, first created in 1991, covers 24 commodities but is heavily tilted toward energy because its weights reflect world production figures. For example, in 2010, energy markets accounted for almost 72% of its weight.

Investors are exposed to three sources of returns in total-return commodity index investments. The first type is the yield on the underlying commodity futures. The second type is the roll return, which is generated from the rolling of nearby futures into first deferred contracts. A forward curve  in contango (when longer-dated futures prices are higher than nearby contracts) generates negative roll yields, while backwardation (when nearby prices are higher than longer-dated futures prices) provides positive roll yields. The third type is the Treasury-bill return, which is the return on collateral. Historically, the roll return has constituted the largest contributor in total returns. However, it has been negative since 2005 for the S&P GSCI Total Return Index, due to the contango market evident in crude oil futures markets.

Institutional investors generally gain exposure to commodity prices through their investment in a fund that tracks a popular commodity index. The fund managers themselves either directly offset their resulting short positions by going long in futures markets or by entering swap agreements with a swap dealer. In turn, swap dealers in the OTC market generally go long or short in the futures market to offset their net long (or short) position. Of course, the client base of swap dealers also includes traditional hedgers.

The size of commodity index investment has been difficult to measure due to netting issues, as well as inadequate reporting requirements in the US and other countries. Although the US CFTC releases several different aggregated data on swap dealers and commodity index traders positions, these data do not provide accurate information on the extent of commodity index investment. One such report is the CFTC's commodity index trader report ('COT Supplemental'), which provides information on weekly index traders' positions in selected agricultural markets. Unfortunately, the reported position typically over-estimates the size of commodity index investment. This is because the CFTC, which by special call had identified some traders as index traders ('CITs'), classifies all those traders' positions as index-related, regardless of trading activities. 

For this reason, studies using COT Supplemental reports are subject to a bias in assessing index trading activity. A second and more realistic data set, called 'index investment data,' is published monthly by the CFTC. It specifically identifies commodity index investment activities on exchange and over-the counter market of these same traders. However, this data set likely underestimates the size of index investment due to exclusion of some index traders.

A third source, index investment data collected by Barclays Capital for US and non US assets under management, provides a comprehensive indication on the size of the market. The Barclays data indicate that commodity index investment has increased from $55 billion in late 2004 to $354 billion in November 2010.

The coincident influx of money into commodity indices and rising commodity prices, especially after 2003, has led to claims that commodity index traders are one of the major causes of the increase in the prices, especially for oil. Indeed, some argue that index traders' strategic allocation changed the way in which commodity prices behave. However, others argue that the increase in commodity index investment is due to the first sustained demand driven price shock of the last 20 years, which started in 2004. Expectations of continued strong economic growth in Asia and other emerging economies might explain both the resurgence of commodity prices and the increased appetite for commodities by investors. In addition, some argue that activities of long-only commodity index investment might help to reduce the cost of hedging since commodity index traders are essentially willing to take the opposite position from short hedgers at lower prices than traditional speculators. This debate is sure to continue.

Futures Markets

Crude futures markets saw an inflow of funds in December. Open interest in WTI contracts increased in December in both futures-only and futures and futures-equivalent options to 1.471 million and 2.564 million contracts, respectively. Producers decreased their net short position during the month of December; they held 27.4% of the short and 17.4% of the long contracts in WTI futures-only contracts. Swap dealers, who accounted for 29.5% and 32.3% of the open interest on the long side and short side, respectively, remained net short.



Managed money traders' net long exposure declined by close to 9% in December to 176 000 futures contracts.  In line with the decline in their net long position, the market share of managed money traders has fallen from 29.9% to 28.3% on the long side and has increased from 15.9% to 16.4% on the short side. Other non-commercials, who accounted for 18.6% of open interest on the long side and 20.4% on the short side, remained net short in the market. 



The CFTC issued its long-delayed proposal on position limits across commodity futures and swap markets on 13 January 2011. According to the proposed rules, position limits will apply to contracts in 28 commodities, including four energy contracts. The rules call for position limits on spot month contracts at 25% of deliverable supply. The rules also limit non-spot month and all-months-combined positions to 10% of open interest for the first 25 000 contracts owned by a trader and 2.5% thereafter. Bona fide hedging positions will not be counted towards the limits.

Meanwhile, the European Commission released its consultation document, which also focuses on position reporting and position limits. The proposal brings a 'position reporting requirement' by category of traders for their trades on all EU-organised trading facilities. For position limits, the consultation document suggests the need to consider hard position limits on front month contracts but position management systems for all other contracts, similar to position accountability levels in US exchanges, which will authorise regulators to demand traders to reduce their position if needed.

US WTI Price Structure Collapsing Under Weight of Surplus Inventories

Prices of benchmark US West Texas Intermediate (WTI) are once again under pressure from burgeoning stocks at the land-locked Cushing, Oklahoma storage depot, the delivery point for the NYMEX light, sweet crude oil contract. Swelling stocks at Cushing are severely depressing the front end of the futures curve as well as the discount to the Atlantic basin's other benchmark crude, Brent. WTI's discount to Brent averaged $2.28/bbl in December compared to $1.13/bbl in November, but by the first week in January the differential had ballooned to just under $5/bbl and reached $8/bbl at one point.

Crude stocks held in Cushing, Oklahoma are approaching July record levels of 37.8 mb (see Stocks). Rising imports of Canadian crude into the region combined with extensive refinery turnarounds in the Midcontinent during September through November are partly to blame for the stockbuild. Moreover, increased nameplate storage capacity at Cushing is having the unintended consequence of providing more downward pressure on WTI as the persistent contango continues to encourage storage amid growing tank availability.

The disparity between WTI and Brent has also been exacerbated by the latter's relative strength. Indeed, the Brent M1-M2 futures contract made a respectable move into backwardation in mid-December. Brent's backwardation - while relatively small - averaged around $0.10/bbl since mid-December. The prompt month strength is in part due to lower supplies of some North Sea grades such as Forties.



While lower supplies from the North Sea appear to have been the flash point for the ICE Brent contract to move into backwardation, a gradual shift of funds by investors away from the WTI contract and across the Atlantic to Brent may also have played a role. Aside from the well-documented price swings that have marked the landlocked WTI for the past few years, Brent is gaining more acceptance as the global benchmark given its prominent role as a price link to European, Asian, and Middle East crudes as well as the new Russian ESPO crude. Some market participants have also commented that Brent may currently be gaining favour because its price structure is less influenced by long-only fund investors.

Spot Crude Oil Prices

Spot prices for benchmark crudes were up $5-6/bbl in December. Dated Brent posted the largest increase, up by $6.03/bbl to an average $91.36/bbl, in large part due to reduced North Sea supplies. Strong Asian demand for heavier Mideast crudes saw Dubai spot prices up by $5.40/bbl to $89.05/bbl last month. US WTI posted the smallest increase under the weight of high stocks, especially in the Midwest and at Cushing, rising by $4.87/bbl to $89.08/bbl.

WTI has remained weak relative not only to Brent but also to other domestic crudes (see 'US WTI Price Structure Collapsing Under Weight of Surplus Inventories'). WTI's discount to Light Louisiana Sweet (LLS) widened to almost $7.00/bbl by early January compared with $5.25/bbl in December and $4/bbl in November.



The closure on 8 January due to a leak of the Trans Alaska Pipeline, which links North Slope production on the northern coast with the Valdez export terminal in the south, strengthened other west coast crudes as well as alternative grades, including Russian ESPO crude.



In Asia, strong petrochemical demand has boosted prices of light grades, with Malaysian Tapis fetching just over $100/bbl for the week ended 15 January. Vietnam's Bach Ho and Minas were trading just under $100/bbl over the same period.

ESPO Blend's Star Shines Bright in Asia-Pacific Markets

Russia's new ESPO Blend has been a rising star in Asia-Pacific markets throughout 2010 and the distillate-rich crude is likely to shine even more brightly in the new year following the commissioning of a new spur line to China and against the backdrop of strong demand for diesel and gas oil.

The start of exports in early 2010 through the East Siberia Pacific Ocean (ESPO) pipeline, running from Taishet to Skovorodino and railed via its outlet at Kozmino on the Sea of Japan, marked the beginning of a new chapter in Russia's ambitious attempts to diversify its exports and boost its presence in competitive Pacific Basin markets. Initially ESPO blend crude was bought solely by Russian trading companies, notably Gunvor, before being exported for trial runs in South Korean and Japanese refineries. By the end of 1Q10, foreign companies began taking ESPO crude so that by December regular ESPO purchasers included Chevron, Exxon, BP, Total and Shell. On a geographical basis, ESPO has been shipped to Japan, South Korea, China, Thailand, Singapore, the Philippines, Indonesia, Taiwan, Vietnam and as far afield as the US West Coast.

ESPO Blend's popularity among Asian and US West Coast refiners is underscored by the rising premium to Dubai crude over the past six months, which posted another record in December. The ESPO-Dubai premium averaged $3.10/bbl last month compared to $1.90/bbl in November, $1.05/bbl in October, $0.64/bbl in September and $0.19/bbl in August.

In Japan, ESPO has quickly gained a foothold at the expense of Middle Eastern grades, buoyed by the shorter transit times, lower freight rates, and lesser restrictions on usage than Middle Eastern crudes. It also enjoys a stable composition (37.4° API and 0.54% sulphur) and a high diesel yield. Japanese imports of Russian crude averaged around 250 kb/d from January to October 2010, 95 kb/d (+60%) above the same period in 2009. On the same basis, Japanese imports of Middle Eastern grades fell by around 75 kb/d.

This month marks a new chapter in ESPO with the opening of the 300 kb/d pipeline spur from Skovorodino to Daqing, China which began flowing at midnight on 1st January. It is anticipated that this route will flow at capacity and replace the 200 kb/d of Russian crude previously railed to China. Although Chinese refining capacity could undoubtedly absorb both the railed and piped crude, railed exports are likely to cease. Rosneft, which previously supplied these exports and will supply the ESPO spur, cannot do both without diverting more of its westward flows which it is believed unwilling to do. Of greater importance in the short-term is the question of whether exports from Kozmino will fall considerably as ESPO crude is diverted to China. Initial port loading schedules suggest that this will not be the case. Kozmino has recently been operating above its 300 kb/d nameplate capacity (320 kb/d in November and up to 370 kb/d in June), and 1Q11 loading schedules indicate that liftings will only fall back to 300 kb/d.

Construction is now well under way on the ESPO-2 pipeline which will link Skovorodino and Kozmino (currently linked by rail). This leg is due to be completed in 2013 and could eventually increase the capacity of the pipeline to a reported 1.6 mb/d. Providing crude is available, such an infrastructure would undoubtedly permit the world's current largest producer to make further inroads into the Pacific Basin and move towards making ESPO an Asian benchmark grade.

India stepped in to the spot market in early January to replace around 400 kb/d of crude normally imported from Iran. Indian refiners halted imports of Iran crude after the Reserve Bank of India (RBI) barred payments through its facilities in order to comply with international sanctions. India's Mangalore Refinery and Petrochemicals Ltd (MRPL), which imports about 60% of its crude from Iran, entered into the spot market for the first time in six months.

Spot Product Prices

Spot product prices were higher across all major regions in December, though increases for the light ends and middle distillates far outpaced those of fuel oil. However, crack spreads were mixed by product and region. Cold weather boosted heating oil cracks in the US but failed to lift European markets. Heating oil crack spreads in New York rose by $1.38/bbl to $14.47/bbl on average in December. In Europe, gasoil cracks in the Mediterranean were up $0.63/bbl to $11.96/bbl but down about $1/bbl to $9.85/bbl in Northwest Europe on ample supplies.



In Asia, gasoil cracks were up on colder weather in some countries, but mostly due to China's surging demand for diesel and gasoil in the wake of more stringent government regulations to meet emissions reductions. China will continue limiting diesel exports in January but the recent shortage of distillates has eased on record refinery production and a surge in imports in the past two months.

Equally robust naphtha markets continued to strengthen in December on stronger petrochemical demand. Crack spreads in Europe jumped 75-85% in December, averaging $3.23/bbl in the Mediterranean last month compared with $1.73/bbl in November. In Northwest Europe, cracks were up to $1.73/bbl versus just under a $1/bbl in November.



In Asia, naphtha cracks rose to $4.78/bbl versus $3.61/bbl in November and $2.75/bbl in October. Middle East naphtha markets were also strong, with crack spreads averaging $2.86/bbl in December versus $1.65/bbl the previous month. Part of the strength was due to anticipation of reduced supplies from Saudi Aramco in 1H2011 due to planned maintenance at two of its refineries.

Fuel oil cracks continued to deteriorate sharply last month, in part pressured lower by high throughput rates needed to produce middle distillates. Low-sulphur fuel crack spreads in December weakened the most in Northwest Europe, off $4.67/bbl to -$14.44/bbl compared with a decline of around $2.95/bbl in Singapore, to -$10.25/bbl.  Heavy fuel oil differentials followed similar trends, off around $4.00/bbl to -$15.77/bbl in NWE and by $2.63/bbl to -$9.44/bbl in Singapore.



Refining Margins

Margins for December were mixed on a regional basis, with Europe and the US Gulf Coast weaker, and the US West Coast and Asia stronger. In general, margins fell at less complex refineries as the fuel oil product crack decreased steeply in December.

In Northwest Europe margins were lower with the exception of Urals cracking margins. The main reason for the weaker margins was falling product cracks due to weaker product prices and relatively stronger crude prices, despite increased demand for gasoil and diesel due to cold weather. The Urals cracking margin improved due to a widening price discount. In the Mediterranean, margins at cracking units improved whereas hydroskimming margins fell. Cracking margins were supported by relatively weak Urals feedstock combined with strength in the gasoline market in both early- and end-December, whereas the drop in hydroskimming margins was related to the increased fuel oil discount as supplies were ample. The Urals hydroskimming margin was, at a calculated loss of $7.14 /bbl, in fact at a record low in December.





Refining margins at the US Gulf Coast moved sideways month-on-month, except for Mars cracking and Maya coking margins, which on average lost $0.99/bbl and gained $0.80/bbl, respectively. The Mars cracking margin continued its weakening trend and has shown losses since September. This month it was particularly weakened by relative strength in Mars prices themselves. On the other hand, the Maya coking margin maintained its strength, showing an average profit of $4.75/bbl in December, with relatively weak Maya having sustained margins close to these levels since early-spring 2010. At the US West Coast, margins all strengthened in December, especially the Kern coking margin, which increased by $2.30/bbl from November. This was mainly as a result of a steeper Kern crude discount.

In Singapore, margins improved from low November levels as product prices were strong both for light and middle distillates. However, the Dubai hydroskimming margin fell to new lows with an average loss of $3.00/bbl in December, the lowest since April. The main reason was weaker product cracks, especially for fuel oil and also a stronger Dubai price. China refining margins also improved, benefitting from stronger product cracks especially for middle distillates on the back of strong regional demand for diesel. Also here the Dubai hydroskimming margin dropped as Dubai was relatively stronger priced.

End-User Product Prices in December

In December, IEA region end-user prices rose by 3.6% in US dollars, ex-tax. Disaggregating the fuels the average IEA prices for gasoline rose by 3.5%, while diesel followed at 2.9%. Meanwhile, heating oil and low-sulphur fuel oil increased by 4.6% and 3.5%, respectively, during the period. Excluding relatively weaker-performing Japanese prices, heating oil prices gained on average by 5.3% from previous month levels. 

This can be explained by the below normal temperatures observed in the UK, Northwest Europe and the US Northeast. Compared to December 2009 average price levels in surveyed IEA-member countries saw a 15.9% hike year-on-year. The big price gains were automotive diesel (20.3%) and heating oil (19.5%). Gasoline observed a more modest, but still significant, increment of 16.4%. Prices for low-sulphur fuel oil posted the smallest increases, up an average 7.5% within the survey countries. Notably, Canada saw gasoline prices rise by a steep 25.8% y-o-y increase and the UK heating oil price increase by 33.9% y-o-y. In the Northern Hemisphere, heating oil and low-sulphur fuel oil end-user prices observed a seasonal recovery from the relatively weaker levels seen in November.

Freight

Crude oil tanker rates experienced an improvement throughout the first three weeks of December amid a rush of fixtures ahead of the Christmas holidays, but by early January rates had receded sharply. Buoyant Asian demand and exceptionally high eastbound Middle East liftings pushed the benchmark Middle East Gulf - Japan route to a peak of $13.13/mt on 23 December, which then retreated to $11.10/mt by 7 January.



The West Africa - US Atlantic Coast Suezmax route experienced a dramatic post-Christmas crash, descending from $17.75/mt on 22 December to under $11/mt two weeks later. A likely driver was the tax-incentivised de-stocking by US refiners, which could reduce US imports over the coming weeks. Even the introduction of ice-class requirements at the Baltic Sea port of Primorsk could not prevent the Aframax North Sea - NW Europe rates from crashing to a low of $5.60/mt from an early-December high of $10.51/mt.

Product tanker rates presented a mixed picture in December but the overall trend of pre-Christmas firming, followed by softening, prevailed. The only benchmark route that gained over the month was the 30 kt Southeast Asia - Japan route, likely in response to localised supply tightness resulting from surging imports of gasoil into China. The transatlantic UK - US Atlantic Coast route experienced an impressive crash from $24.54/mt on 9 December to a low of $16.36/mt on 7 January, and again this likely resulted from US tax-incentivised destocking, reducing US product import requirements.

Short-term crude and products in floating storage fell by 8.1 mb to 56.3 mb at end-December. Crude fell by a modest 1.6 mb while products declined by 6.5 mb. The decrease in crude was concentrated in the Asia Pacific region (-1.4 mb). Despite mid-December reports of soaring Iranian floating storage following the withdrawal of the payment mechanism between India and Iran, it appears that sales soon restarted, since by end-month it stood at 21.5 mb (-0.2 mb). The fall in products was concentrated in Northwest

Europe (-5.5 mb) where products went ashore in response to the flattening ICE gasoil contango following cold weather.

The storage fleet now numbers 43 vessels, a decline of 103 from a year ago, further underlining the pressures of a bloated fleet on freight rates. With owners not inclined to lay up their ships, and a raft of new builds entering the market, unless the floating storage play takes off again it is difficult to foresee a sustained recovery of freight rates in 2011.

Refining

Summary

  • Global refinery throughputs have been revised up sharply for 4Q10, to average 74.5 mb/d, or 2 mb/d above a year earlier. Exceptionally strong demand growth due both to cold weather in the US and Europe and stronger economic activity, notably in the OECD, as well as robust demand in China, were compounded by a sharp exit from turnarounds by refiners in the US and Europe.
  • 1Q11 global refinery runs are estimated to average 74.9 mb/d, with annual growth remaining above 2 mb/d. As the maintenance schedule for 1Q11 so far looks particularly light and demand growth is set to slow, refiners will likely again face lower margins and increased economic run cuts in coming months.
  • OECD crude runs rebounded sharply in November to average 36.5 mb/d, or 1.8 mb/d above October lows. Runs rose in all regions, although European rates showed the most striking recovery, not only from a month earlier, but also from the same month last year, when regional runs were 850 kb/d lower. Preliminary data show OECD runs rising further in December, with the North America adding close to 1 mb/d after maintenance completion.
  • October OECD yields increased for gasoline and gasoil at the expense of all other products. OECD gross output fell by 2.2 mb/d from September to a five-year low due to maintenance, poor refining margins and the French refinery strike.


Global Refinery Throughput

Global refinery throughputs have been revised sharply higher for 4Q10, to average 74.5 mb/d, or 720 kb/d higher than in our last report. Exceptionally cold winter weather in the Northern Hemisphere and seemingly robust economic activity boosted oil demand and OECD runs in particular, and the ramp-up of refinery runs from outages and maintenance in October/November was much sharper than expected. US runs rose by 630 kb/d in December from November. The rebound in European runs from the record lows seen in October, when close to the entire French sector was shut due to strikes, was also sharper than expected. Runs recovered, not only from October, but were also almost 0.9 mb/d above 2009's depressed levels. Preliminary indications are that European runs were sustained at these levels in December, in part due to cold weather and modestly improved economics.

In the non-OECD, estimates have also been lifted for 4Q10 and 1Q11 based on recently released data. Chinese runs reached record highs again in November, at 9.0 mb/d, as refiners ramped up rates to meet surging domestic diesel demand. Chinese apparent demand grew at 15.1% annually in November, as increased use of diesel generators amplified strong growth in other products. Indian runs were also stronger than expected in November, suggesting the impact of maintenance at Reliance's Jamnagar refinery was less than anticipated. Russian refinery production raced ahead, as increased crude supplies and favourable export taxes for products compared to crude translated into higher runs. FSU product exports increased sharply, to 3.1 mb/d, or 200 kb/d above October. Looking ahead, 1Q11 global runs have also been lifted, but by less than in 4Q10. The restart of Valero's Aruba refinery in early January, after an 18-month hiatus, will further add to product supplies in coming months. An assumed return to normal temperatures in the US and Europe, and a slowdown in global economic growth are expected to tame oil demand growth, and consequently throughput growth, compared with recent high levels.



OECD Refinery Throughput

OECD crude refinery throughputs were stronger than expected in November, adding 1.8 mb/d from October's lows, to average 36.5 mb/d. Runs rose in all regions, though most sharply in Europe where French refiners returned to operations after the strike in October. Total European crude inputs averaged 12.7 mb/d in the month, a full 1.1 mb/d above a month earlier. Runs also rose in Japan and the US, as maintenance drew to a close.



Preliminary data for December were also stronger than expected, lifting total OECD runs a further 950 kb/d to average 37.5 mb/d. US runs in particular recorded sharp increases, as strong winter demand and better product cracks coincided with refiners exiting turnarounds. Preliminary data from Euroilstock indicate that European refiners also sustained runs at near-November levels, again supported by record cold weather and improved cracking margins. Assuming weather returns to normal during the remainder of the northern hemisphere winter, a slowdown in demand growth should again put pressure on OECD refiners. Surging distillate stocks in the US and in Northwest Europe in December suggest the correction in runs from autumn lows might have been too strong, although the preliminary nature of December data may ultimately result in a different picture. Furthermore, the light maintenance schedule apparent for 1Q11 suggests OECD refiners might again instigate economic run cuts.



North American crude runs averaged 17.0 mb/d in November, up 245 kb/d from October's low point but in line with last year's level. Heavy autumn maintenance in all countries dragged runs lower, while poor cracking margins also contributed. US runs were revised up by 130 kb/d from preliminary estimates to average 14.3 mb/d, 455 kb/d above a year earlier. The monthly increase of some 300 kb/d from October was spread across all PADDs, but in volumetric terms was largest on the Gulf Coast.



At 14.9 mb/d, US refinery crude throughputs posted an unexpectedly large rise in December. Total crude runs were 630 kb/d higher than in November, and almost 1 mb/d higher than December 2009. The increase in total refinery inputs was even steeper, climbing some 300 kb/d above the five-year average, to 15.5 mb/d in December. US margins looked stronger in December, with gasoline cracks at their widest since May and heating oil prices boosted by cold weather related demand. Preliminary weekly data show total US deliveries reaching 20 mb/d for the first time since February 2008, led by gasoline and jet fuel/kerosene sales. Refiners on the US Gulf Coast ramped up runs to 7.6 mb/d on average in December, 320 kb/d higher than a month earlier. Runs on the East Coast also rebounded as maintenance at ConocoPhillips' Bayway refinery and Hess' Port Reading plant was completed.



In Canada, runs were curtailed by October/November maintenance at the country's largest refinery, Irving's 300 kb/d St John plant, compounding the effects of the closure of Shell's Montreal refinery from September. Weekly data from the National Energy Board show that Canadian crude throughputs recovered in December, averaging 1.8 mb/d, or 120 kb/d above November runs. Mexican refinery runs fell sharply in November, to only 990 kb/d, 90 kb/d below October and 330 kb/d below a year earlier. The Salina Cruz refinery started maintenance in mid-October, and the work was finished in the first week of December. The drop in runs coincided with sharply higher crude exports.

North American runs are expected to decline from December's high levels during 1Q11 as spring maintenance gets underway. There is so far little information available on company turnaround schedules, but we assume seasonal patterns. North American spring turnarounds normally start in January and peaks in March before concluding ahead of summer and the US driving season. Following two years of weak demand, and high outages, it is possible that refiners have lower shutdown requirements this year. If that is indeed the case, we believe voluntary run cuts will have to increase.

OECD European crude throughputs rebounded sharply in November, to 12.7 mb/d, or 1.1 mb/d above strike-reduced and record-low October levels. Regional runs were almost 600 kb/d higher than the previous estimate and in line with the (relatively) high rates seen over the summer. Refiners ramped up production to replenish depleted inventories resulting from the protracted French strike and planned autumn maintenance. Preliminary Euroilstock data for December show Europe-16 refinery crude intake remaining relatively high, at only 70 kb/d lower than November. Cold weather and improving cracking margins in both Northwest Europe and the Mediterranean likely supported runs, although hydroskimming margins remained firmly negative in both regions, given fuel oil's weakness.

Despite a very light regional maintenance schedule for 1Q11, at least in terms of announcements and known plans, we expect European runs to fall off from recent relatively high levels. European maintenance normally peaks in February-March, but for this year we only have the shutdown of Italy's ERG refinery in Sicily and ExxonMobil's Fos-sur-Mer refineries on record as undertaking major turnarounds in January-February. The high shutdown levels in 2009-2010 could mean that maintenance requirements are lower this year, though in part the low levels are surely reflective of less forthcoming information from companies in this very competitive business environment. Furthermore, assuming a return to normal winter weather (indeed temperatures have climbed substantially from the extreme cold seen in December), demand growth is set to slow and put pressure on refiners to again cut runs. Record-high gasoil inventories in NWE independent storage at the start of 2011 suggest that the high run rates and increased imports in November/December over-compensated for any demand-induced tightening. 1Q11 European runs are therefore seen at best steady from 4Q11, averaging 12.3 mb/d.



Restructuring of the European Refining Sector Continues

The European refining industry is continuing to see major changes due to structurally declining demand, stark competition for export markets from new capacity in emerging countries and resulting poor margins. Since the beginning of 2009, six refineries have announced they will halt operations completely and several are looking for investors or buyers to avoid shutdown and closure. The latest announcement came on 12 January, when Shell announced it plans to convert its 110 kb/d Harburg refinery in Germany to an oil terminal by early 2012. Shell had been trying to sell the plant for nearly two years, and had been in discussion with Indian Essar amongst others, but failed to conclude a sale for the ageing refinery.

The fate of Harburg is not unique. Petroplus announced at the end of last year that it would convert its French Reichstett refinery to a terminal, as did Tamoil regarding its Cremona unit in northern Italy. Petroplus already converted its Teesside refinery in the UK to a terminal in 2009, and Total has closed Dunkirk and will reduce capacity at its Gonfreville plant. ConocoPhillips' 260 kb/d Wilhelmshaven refinery, which has been idle since May 2010, will be converted to an oil terminal if attempts to find a buyer fail. In non-OECD Europe, OMV will close its 70 kb/d Romanian Pitesti refinery.



On 10 January, China's state-owned PetroChina and UK-based Ineos signed an agreement to form an oil refining and trading joint venture, marking China's first move into the European refining sector. The deal encompasses Ineos's two European refineries: the Grangemouth refinery in Scotland and the Lavera refinery in Southern France, both with processing capacity of around 210 kb/d. The cooperation includes the sharing of refining and petrochemical technology and expertise between the respective businesses.



Russian oil giant Rosneft made a similar move in October, when it bought PDVSA's 50% stake in Germany's Ruhr Oel. The company is now a 50/50 downstream joint venture between BP and Rosneft, with stakes in four German refineries, including Gelsenkirchen (100%), Schwedt (37.5%), Bayernoil (25%) and Miro (24%). The four plants have a combined capacity of 1.04 mb/d, of which 460 kb/d can be attributed to Ruhr Oel. There are now 13 refineries in Europe with Russian interest. While on the one hand the influx of capital from cash-rich overseas interests is good for local employment and for the potential upgrading of mature European capacity, it does little to address a continent-wide problem of surplus refining capacity overall.

OECD Pacific crude runs were mostly in line with forecast for November and December, at 6.8 mb/d and 7.0 mb/d respectively (+70 kb/d and 10 kb/d compared to last month's report). Runs were 440 kb/d and 255 kb/d above a year earlier respectively, with South Korean runs, in particular, strong compared to the previous year. These have been supported by high product exports, up by some 15.2% year-on-year in November according to government data. Annual increases in exports were recorded to Japan, China and Singapore, primarily kerosene, jet and gasoil. Industry surveys show South Korean refiners planning to hold runs steady at above 2.5 mb/d in December and January, supported by a recovering economy and healthy refining margins.



In Australia, the severe floods currently plaguing Queensland forced major refiner Caltex to shut its 100 kb/d Lytton refinery outside of Brisbane in early January. At the time of writing, the 100 kb/d Bulwer Island refinery was operating normally and Caltex was planning to begin the restart of the Lytton plant. The return to full operating levels will depend in part on the resumption of operations of the Port of Brisbane.

Japanese crude throughputs reached 3.7 mb/d in December, slightly higher than the previous year and up 130 kb/d on November. Major Japanese refiners reported significantly improved profitability of their refining operations in the first half of the current fiscal year (2010-11), though upcoming higher taxes on oil products could again curb company profits (whether shouldered by the companies or passed on to consumers and resulting in lower demand). The government is increasing taxes on various fuels to generate an additional $3 billion in tax revenue to help fund measures to curb greenhouse gas emissions. METI said it will gradually hike its taxes on fossil fuel use starting on 1 October 2011.

Non-OECD Refinery Throughput

Non-OECD refinery throughput estimates have been lifted by 130 kb/d and 180 kb/d respectively for 4Q10 and 1Q11, respectively, following recent exceptionally high operating rates in a number of countries. Most notably, China reported crude runs yet again at record highs following a surge in domestic diesel demand and ensuing product shortages. Other Asian refiners also profited from stronger product demand and improved margins by increasing runs. FSU crude throughputs were boosted by export tax incentives, while it seems Middle Eastern refiners maintained high runs towards the end of the year ahead of planned maintenance in 1Q11. In all, non-OECD crude runs are estimated at 38.3 mb/d in both 4Q10 and 1Q11.



Chinese refinery crude runs averaged 9.0 mb/d in November, 200 kb/d up on October and 840 kb/d above a year earlier. The new record came as refiners operated at full capacity amid domestic diesel shortages. The shortages seem to have dissipated and runs likely eased somewhat in December, with industry surveys showing major refiners planned to cut operating rates and undertake some delayed maintenance. We currently have December runs pegged at 8.7 mb/d, down 220 kb/d from November. On the other hand, the decision to increase fuel prices as of 22 December by 4%, the fourth price increase this year, probably sustained runs at levels higher than otherwise, due to improved margins.

Elsewhere in Asia, runs were also stronger in November, and approached the record highs of June. At 8.9 mb/d, regional throughputs were 80 kb/d higher than a year earlier. Asian refiners increased runs due to higher demand and widening margins. In Singapore, gasoil and jet margins reached a two-year high in mid-December, while fuel oil prices were $10/bbl below crude, the steepest discount since March 2009. Regional oil demand is hitting new highs, with sales in China up 10% in November from a year ago (led by diesel). Strong petrochemical demand in Asia is driving naphtha demand higher. Year-on-year growth was however checked by lower Indian runs, which were reduced due to maintenance at Reliance's older domestic plant. Reliance had shut a crude unit at the 660 kb/d plant from the last week of October to 17 November. The maintenance impact was nevertheless smaller than we had anticipated, and Indian runs for November have been revised up by 150 kb/d from the previous forecast. According to Platt's survey of Indian exports, refined product exports rose to a high of more than 1 mb/d in December, from a low of 660 kb/d in November.



FSU crude runs were stronger than expected in November, and contributed to an upward revision of 50 kb/d for 4Q10 regional throughputs. Russian crude runs averaged 5.1 mb/d that month, up 130 kb/d from a month earlier and 240 kb/d higher than November 2009 as refiners returned from maintenance and took advantage of export duties favouring products over crude. FSU product rose by 200 kb/d in November, to 3.1 mb/d, the highest level since July 2010. The largest monthly increases in runs came from the Nizhnekamsk refinery and Rosneft's Syrzan refinery, which both ramped up runs after completing scheduled maintenance. Kazakhstani crude runs also increased in November, by 13% from a month earlier, to 250 kb/d, as maintenance at PetroKazakhstans' Shymkent plant was winding down.



Latin American crude runs have been revised down slightly for 4Q10 given lower Brazilian operations, but lifted for 1Q11 following the restart of Valero's Aruba refinery in early January. The 235 kb/d plant, which has been closed since summer 2009, is expected to be fully operational by the second half of January, resuming oil product and feedstock exports to the US, the Caribbean, Latin America and Europe. By shipping vacuum gasoil, heavy distillate fuel oil and intermediate feedstocks to its US Gulf Coast plants, the company is planning to minimise US production shortfalls during planned maintenance in 1Q11. However, the refinery cannot produce diesel or heating oil meeting US product specifications.

Brazilian crude runs were 80 kb/d lower than expected in October, averaging 1.8 mb/d. In light of the recent reduced operating rates, we have also adjusted the Brazilian forecast slightly, in part offsetting the increase from Aruba. Elsewhere, PDVSA again postponed the restart of its 330 kb/d Curaçao refinery in December. The refinery, which has remained idle since March 2010 due to power supply problems, was supposedly to restart operations in mid-December. The postponement was reportedly due to problems with the fuel catalytic cracking unit. It is not yet clear whether the restart, this time scheduled for 26 December, was successful and we continue to exclude the refinery from our estimates until its true status becomes clear.



Middle Eastern crude throughputs are projected to average 6.1 mb/d in 4Q10 before falling to 6.0 mb/d in 1Q11, and to only 5.7 mb/d in April 2011. Refinery maintenance in Saudi Arabia, Kuwait and Bahrain will reduce regional product supplies, prompting regional actors to increase spot purchases to meet local demand. According to industry sources, Saudi Aramco has scheduled to shut a 150 kb/d crude unit at its Jubail refinery for a 45-day maintenance programme starting from February and the entire 425 kb/d Rabigh refinery from late April to end-May. State-run Bahrain Petroleum Company plans a major turnaround between mid-February until early April, and Kuwait National Petroleum's ageing 200 kb/d Shuaiba refinery will also shut for full maintenance in April, lasting 30 days. Amplifying local light product supply tightness, Adnoc will shut one of its two 140 kb/d condensate splitters (not included in OMR crude throughput estimates).



OECD Refinery Yields

October OECD yields increased for gasoline and gasoil at the expense of all other products. OECD gross output fell by 2.2 mb/d from September to a five-year low due to maintenance, poor refining margins and the French refinery strike.



Gasoline yields increased in all OECD regions, and in both OECD North America and Pacific, yields were in the upper half of the five-year range. In OECD Europe, yields increased from the low levels seen earlier this year, and were in line with last year's level, close to the five-year average. The high gasoline yields were supported by stronger margins due to tight product supply especially in Europe as most French refineries were shut due to strike action. The stronger gasoline prices in Europe even created opportunities for westward arbitrage from Asia.



OECD gasoil/diesel yields rose further in October. OECD Pacific posted the largest gain, where yields were up by 0.59 percentage points (pp). In OECD Europe, yields were at about the same level as in September, supported by strong German heating oil demand and healthy product cracks. In OECD North America, high demand from Latin America has encouraged refineries to produce more gasoil/diesel, and exports from OECD North-America have increased steadily since April, standing in October almost 330 kb/d above the five-year range. OECD fuel oil yields fell again in October, after a small rise in September. The fuel oil yields fell in all OECD regions, and were below both the five-year range and last year's level in all regions, reflecting lower demand and poor margins.