Oil Market Report: 13 July 2011

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Highlights

  • The IEA announced on 23 June a coordinated release of 60 mb of strategic stocks for an initial 30 days, in response to the ongoing Libyan crisis. The Libya collective action aimed to provide a bridge between rising oil demand in 3Q11 and extra supplies made available by major OPEC producers.
  • Crude oil prices were volatile in June, after an initial bearish impact from the collective action was tempered by non-OPEC supply outages. Early indications are that the stock release has helped realign sweet-sour price spreads, distorted by lost Libyan barrels, and flattened earlier Brent backwardation. Brent and WTI were last trading at $116/bbl and $95/bbl.
  • Global oil demand in 2012 is expected to rise by 1.5 mb/d year-on-year to 91.0 mb/d. Growth is driven entirely by non-OECD countries, with OECD demand declining slightly. The global estimate for 2011 is raised by 0.2 mb/d to 89.5 mb/d (+1.2 mb/d year-on-year), with upward non-OECD baseline revisions outweighing downward adjustments in the OECD on persistent high prices and weaker economic activity.
  • Global refinery throughputs are set to increase by 2.3 mb/d to 75.9 mb/d from 2Q11 to 3Q11, on lower maintenance and as refiners strive to meet seasonally higher demand. The sharp rise follows an exceptionally weak 2Q11, when runs were curtailed by extensive turnarounds, Libyan crude and refining outages, earthquake damage in Japan and poor margins.
  • Global oil supply in June increased by 1.2 mb/d from May, to average 88.3 mb/d, with OPEC crude rising by 0.8 mb/d to 30 mb/d as Saudi Arabia boosted supply. Non-OPEC supply is now seen averaging a lower 53.1 mb/d in 2011, on prolonged production outages, before rising to 54 mb/d in 2012. The 'call on OPEC crude and stock change' now rises by 1.3 mb/d in 3Q11 to 31.3 mb/d. It averages 30.7 mb/d for 2012, +0.1 mb/d versus 2011.
  • OECD industry stocks rose by 23.9 mb to 2 680 mb or 58.6 days of forward demand cover in May. Preliminary June data point to a decline in both onshore OECD industry stocks and short-term oil floating storage. This takes end-June onshore stocks close to five-year average levels, after many months of substantial overhang versus historical levels.

Providing liquidity to a tighter market

This month provides a first detailed look at OMR projections for 2012, while also incorporating consolidated annual 2009/2010 oil data for non-OECD and OECD countries, respectively. With higher underlying non-OECD demand (but persistent weakness in the OECD), and a string of 2011 supply-side outages, over and above the one in Libya, the market ledger this month looks slightly tighter than a month ago. Our balances for first-half 2011 show demand continuing to run ahead of supply, if a little less rapidly than in 2H10. Of course, upward price momentum has also come from the absence of 1.5 mb/d of light/sweet Libyan crude. The 'call on OPEC crude and stock change' is now 31.3 mb/d for 3Q11 (a significant, if as-yet unquantifiable, portion of this will come from the IEA's Libya collective action). The 'call' then fluctuates between 29.8-31.4 mb/d through end-2012. Major producers have recognised that demand for their oil is rising, with the seasonal uptick in 3Q11 refinery runs, and more generally as economic growth and short-term fuel substitution keep global and emerging market demand growth robust. We welcome rising OPEC volumes seen in June (30.03 mb/d output), but the market needs still more oil for 3Q.



This backdrop is simply a more vivid version of the one underpinning the IEA action, which commenced on 23 June. Member governments agreed to release 60 mb of strategic stocks for an initial 30 days, amid an ongoing disruption to light-sweet Libyan oil supplies, the anticipated rise in 3Q11 refiner and end-user demand and a likely hiatus before incremental OPEC barrels reach the market. Much ink has been spilt subsequently suggesting that the IEA action comes three months too late, depletes emergency stockpiles and has failed to reduce rampant crude and motor fuel prices. However, we feel compelled to point out that critics cannot have their cake and eat it too.

Market intervention in late-February, when the Libyan crisis broke and prices surged by at least $10/bbl, would have been tempting, were price control really the prime motivation. But the presence of a supply disruption, and sharply higher prices is not, by itself, justification for a collective action. Market context is also important. Refiner crude demand was falling seasonally in March and April, but rising sharply in June and moving higher still in July and August, despite modest refining margins. Early-year industry stocks looked comfortable back in March, and there was a presumption then that other OPEC producers would immediately step in to boost supply to replace Libyan outages. In contrast, the absence up until June of major OPEC increases implied a real possibility that commercial stocks could fall to the bottom of their seasonal range, risking a renewed, damaging and sustained surge in international prices in 3Q11. The IEA therefore decided to act to address this supply-side issue, even though prices were then trending lower.

Moreover, the collective action is about providing short-term physical liquidity to the market: a combination of draws in strategic stocks of light-sweet crude and products and the added flexibility of reduced mandatory obligations for refiners. So far, the action involves just over 1% of total IEA inventory - hardly a depletion of reserves for future emergencies. That said, oil made available by the collective action will continue to have a physical impact through July and August. Market appetite for the oil made available so far has been greater than during the Katrina action of 2005. In particular, the US SPR release will likely result in the re-routing of alternative light-sweet crude supplies into Europe and Asia. Member governments have flexibility on the timing and pace for any stock replenishment and look likely to exercise that. Indeed, all 12 IEA countries involved still have emergency reserves well above 90 days of net imports.

Marker crude prices fell by $5/bbl immediately after the action was announced. Since then Brent futures have oscillated between $105-$119/bbl, and WTI between $91-$99/bbl. At writing, flat prices of $116/bbl (Brent) and $95/bbl (WTI) are close to those seen immediately prior to the action, but will doubtless fluctuate further in the weeks ahead. However, it is blinkered to focus on specific price levels, which were never the rationale for the action. Narrower sweet-sour spreads, modestly stronger refining margins and an easing of the steep backwardation evident before the release on the other hand all suggest a more benevolent market reaction. We acknowledge that the impact of the collective action will only be truly evident in hindsight. However, recognising the flexibility and market liquidity it has already provided, we take a resolutely positive view so far.

Demand

Summary

  • Global oil demand is forecast to rise by 1.6% (+1.5 mb/d year-on-year) to 91.0 mb/d in 2012. This is based on IMF economic assumptions (World Economic Outlook Update, June 2011), with global real GDP growth reaching 4.4% in 2012, compared to 4.2% in 2011. It also assumes that Brent oil prices will average $108 in nominal terms, and that oil intensity will decline by 2.6%. Oil demand growth in 2012 is expected to be driven entirely by non-OECD countries while the OECD declines. In terms of product categories, middle distillates, gasoline and LPG are expected to grow fastest.
  • Global oil product demand growth for 2011 is reduced to 1.2 mb/d on persistent high prices and somewhat weaker IMF economic prospects for advanced economies. Demand, which averaged 88.3 mb/d in 2010 (+3.3% or +2.8 mb/d year-on-year and 320 kb/d above our last report with the incorporation of official annual revisions for OECD and non-OECD countries), is expected to reach 89.5 mb/d in 2011 (+1.4% or +1.2 mb/d year-on-year and 250 kb/d higher versus earlier projections).
  • OECD oil demand is projected at 45.7 mb/d in 2012 (-0.3% or -120 kb/d versus 2011). Despite expectations of relatively strong GDP growth in 2012 (+2.6%), increased vehicle efficiency and a persistent decline in oil-fuelled heating and power generation amid high oil prices will outweigh increases in economic activity. Downside risks will stem from the increasingly fragile financial situation in Europe and the general sustainability of the economic recovery across all three regions. However, upside demand risks may arise due to increasing uncertainty over Japan's power sector, with the potential for greater-than-anticipated oil and gas substitution in place of nuclear generation.


  • Non-OECD oil demand should reach 45.3 mb/d in 2012 (+3.6% or +1.6 mb/d year-on-year). Given GDP growth of 6.5%, this forecast is consistent with observed historical income elasticity, though it suggests a less intensive use of oil than during the government-stimulus-backed years of 2009-2010. Non-OECD Asia, the Middle East and Latin America will account for most of oil demand growth in 2012. The latter two regions look to expand faster than in 2011, while non-OECD Asian growth is slower due to more moderate expansion from China. Nevertheless, China's growth (+480 kb/d, versus +630 kb/d in 2011) should account for a sizeable portion (30%) of global demand growth.

Global Overview

This report includes the most recent IMF economic forecasts (World Economic Outlook Update, June 2011) and presents our first detailed assessment of global demand prospects for 2012. Our recently released Medium-Term Oil & Gas Markets 2011 (MTOGM) provided an initial glimpse of the annual trend, whereas this analysis provides an update and rolls out a more complete quarterly profile.

The economic outlook has changed little since the Fund's previous forecast in April 2011, with global GDP growth adjusted only 0.1% lower in 2011 and unchanged for 2012. The economic assessment has grown more cautious, however, with slowing 1H11 industrial activity in the US, increased financial risk in the euro area and rising inflation, which is prompting monetary tightening in some key emerging markets. Part of this economic pause is arguably related to a temporary disruption of global supply chains following the March earthquake and tsunami in Japan. As such, after slowing in 2Q11, economic growth should strengthen in the second half of the year. Growth is expected to be driven largely by emerging economies, with increased economic downside risks in the OECD.

Indeed, oil demand growth in 2012 is expected to be driven entirely by non-OECD countries (+3.6% or +1.6 mb/d), while the OECD gently declines (-0.3% or -0.1 mb/d). Non-OECD Asia, Latin America and the Middle East will account for virtually all of global growth in 2012, with China generating 30%, though the overall non-OECD growth rate is slightly slower versus 2011. Structural declines borne out through improved efficiency will continue in the OECD, though stronger economic growth versus 2011, particularly in the US and Japan, will provide an offsetting demand support. Global product demand in 2012 will be led by middle distillates, gasoline and LPG.

Aside from economic growth, downside pressures from higher-than-expected oil prices also represent a risk to the forecast. While we assume a nominal Brent price of $108/bbl and no significant changes to emerging market price subsidy regimes in 2012, a higher price profile would weaken demand growth, in particular through exacerbated declines in the OECD. Indeed, the most recent demand data for 2011 - albeit preliminary - indicate that a combination of high oil prices (some $10/bbl above our current annual assumption) and slower economic growth have sapped oil demand growth since the beginning of the year. Total OECD demand contracted by 1.9% year-on-year in May and non-OECD demand growth stood at 4.8%. Nevertheless, this represents an uptick from April, when the OECD declined by 2.7% and the non-OECD grew by only 3.5%. As such, should price pressures ease and stronger economic growth materialise, as assumed by this forecast, declines in global demand growth would level off, with potentially subdued increases over the next 18 months.



Demand in 3Q11 is forecast to rise 1.3% (+1.2 mb/d) year-on-year to 90.3 mb/d. Moreover, the quarter-on-quarter increment (+2.2 mb/d), led by the OECD (+1.8 mb/d), looks strong when compared to an especially weak 2Q11. This global increase is higher than the 10-year average change from second to third quarter (+1.2 mb/d, excluding 2008). Part of this higher-than-normal jump reflects implicitly stronger economic growth prospects for 3Q11 relative to 2Q11, particularly in the US and Japan, where reconstruction activity from March's devastating earthquake and tsunami is evident. This support augments anticipated seasonal rises in heating oil purchases in Europe as well as summer transport fuel increases across a number of OECD markets. However, it also benefits from more structural increases in oil-fired power generation anticipated during the summer, particularly in Japan, China and Saudi Arabia. Moreover, with uncertainty over viable (Japan) and economic (China) generation capacity, greater-than-expected oil-based generation represents an upside risk to the forecast during this year and next.



Finally, this month's issue also includes baseline revisions across all OECD regions, with most countries, except the US, having submitted their official estimates for 2010 oil demand and, in some cases, revised previous years as well. Overall, total OECD demand has been increased by 60 kb/d in 2010, with this adjustment largely carried forward. On the non-OECD side, the incorporation of additional official estimates for 2009, notably for Russia and several Middle East countries, has revised up non-OECD oil demand by 230 kb/d for that year, with the adjustment, again, largely carried forward.

OECD

According to preliminary data, OECD inland deliveries (oil products supplied by refineries, pipelines and terminals) contracted by 1.9% year-on-year in May. Demand declined by 3.0% in the OECD Pacific, with weak deliveries of LPG, jet fuel/kerosene, residual fuel oil and 'other products'. In OECD North America (which includes US Territories), demand fell by 2.6%, largely on depressed gasoline, LPG and 'other products' deliveries. The decline in OECD Europe demand was marginal with a rebound in diesel and naphtha deliveries largely offsetting declines in gasoline and heating oil.



Downward revisions to April preliminary data were large (-610 kb/d) and concentrated in North America and the Pacific. In the former, revisions stemmed from lower deliveries for all products except residual fuel oil, with diesel revised down 460 kb/d. In the latter, a downward revision to 'other products' led the adjustment. Revisions to OECD Europe, by contrast, were positive due to naphtha and heating oil. In all, OECD demand growth stood at -2.7% for April, versus -1.2% previously. Total OECD oil product demand is raised by 60 kb/d to 46.2 mb/d in 2010 following the incorporation of official annual submissions across most countries except for the US. Growth, at +1.2% or +560 kb/d year-on-year, remains unchanged given a similar adjustment for 2009. The prognosis for 2011, by contrast, has been trimmed by 110 kb/d to 45.8 mb/d (-0.8% or -390 kb/d versus the previous year), largely on weaker prospects for North America. In 2012, OECD demand is expected to shrink by 0.3% (-120 kb/d) to 45.7 mb/d.



North America

Preliminary data show oil product demand in North America (including US territories) falling by 2.6% year-on-year in May, following a 1.6% decrease in April, due to high prices and slowing economic activity. Indeed, the IMF's latest assessment has revised down North American GDP growth for 2011 and 2012 by 0.2% to 2.7% and 2.8%, respectively. Much of this adjustment comes from the US, where downward revisions to April monthly data were heavy and May/June preliminary data have been weak. Economic growth and oil demand look to improve somewhat from 3Q11 onwards, though the sustainability of the recovery remains an uncertainty, particularly with the US labour market remaining weak. Overall, North American demand is set to fall 0.9% (-210 kb/d) to 23.6 mb/d in 2011 and remain flat for 2012.

April revisions were steep (-745 kb/d) and occurred across all product categories except residual fuel oil. Diesel (-340 kb/d) and LPG (-110 kb/d) adjustments in the US were particularly large, suggesting slowing industrial activity. The volatile pattern of unadjusted weekly to monthly revisions in the US remains a significant forecasting hazard. Over the past six months, revisions to gasoline have been consistently negative. However, other products have been more unpredictable, with total product demand revisions alternating between positive and negative.



With this caveat in mind, our adjusted preliminary weekly data for the United States (excluding territories) indicate that inland deliveries - a proxy of oil product demand - declined by 2.4% year-on-year in June, following a 2.6% decrease in May, with losses in all products except fuel oil and LPG. Despite declining by 2.8% year-on-year, gasoline demand continued to rise month-on-month, suggesting the makings of a normal (albeit weak) summer driving season. Diesel, by contrast, showed greater signs of a summer stall, with demand down both on an annual and monthly basis. Activity has slowed, but rail/road freight and manufacturing orders continue to expand year-on-year. Moreover, supply chains are recovering as Japan recovers from its March earthquake and tsunami. As such, we still expect diesel demand to expand seasonally, rising 60 kb/d from 2Q11 to 3Q11.

Overall, US total product demand should decline by 0.9% (-170 kb/d) in 2011 to 19.1 mb/d. In 2012, with GDP growth expected at 2.7% (somewhat higher than 2011's 2.5%), oil demand is expected to remain relatively unchanged on average. Increases in LPG, diesel and jet fuel/kerosene (driven by economic activity and favourable gas liquids pricing for petrochemicals) should roughly balance declines in gasoline, heating oil and residual fuel oil (borne out by increased vehicle efficiency and fuel switching towards natural gas).



In Mexico, oil demand fell by 5.1% in May, led by declines in residual fuel oil (-23.6%) and other products (-10.4%). Mexico's economy has likely temporarily slowed in conjunction with reduced activity in the US. Yet our growth assumptions still indicate strong GDP expansion of 4.7% and 4.0% for 2011 and 2012, respectively. After falling by 1.4% (-30 kb/d) in 2011 to 2.0 mb/d, Mexican oil demand is expected to remain unchanged on average for 2012.



Europe

Preliminary inland data indicate that oil product demand in Europe remained essentially unchanged in May versus 2010, with stronger deliveries of diesel and naphtha offsetting declines in heating oil and gasoline. The contraction in heating oil demand likely signifies both structural decline and delays in consumer tank refilling owing to prevailing high prices. The increase in naphtha demand stems almost entirely from Germany, while diesel strength was due to higher readings across a range of countries. However, this apparent rebound in transport demand may stem partially from fewer holidays versus the prior year.

Revisions to preliminary April demand data were positive (+230 kb/d), with stronger-than expected readings for naphtha and heating oil more than offsetting weaker deliveries of jet fuel/kerosene and diesel. With annual official submissions, total oil product demand in OECD Europe was revised up by 130 kb/d to 14.6 mb/d in 2010, with declines (-0.6% or -80 kb/d compared with the previous year) reduced given a smaller baseline revision to 2009.



The outlook for OECD Europe demand in 2011 is raised by 160 kb/d to 14.4 mb/d (-1.1% or -160 kb/d versus 2010) with a more robust economic growth assumption of 2.4%. In 2012, OECD Europe demand is expected to decline by 0.4% (-60 kb/d) to remain near 14.4 mb/d, with falls in most product categories outweighing growth in distillates. Economic growth, at only 2.0% for 2012, remains a downside risk, particularly with increased austerity measures and heightened financial risk from peripheral countries.

In May, according to preliminary data, oil product deliveries in Germany increased by 4.9% year-on-year following a 1.8% rise in April. Demand growth was robust in naphtha (+30.0%) amid strong industrial production, and in diesel (+7.4%). However, the presence of two additional working days versus May 2010, due to the holiday calendar, may partly explain the jump in usage in the face of higher oil prices. Higher economic growth - revised up by 0.7% to 3.2% for 2011 - was also supportive. Nevertheless, German demand is expected to decline by 0.2% in 2011. With slowing GDP growth, at 2.0%, in 2012, demand is forecast to fall by 0.5% (-10 kb/d) to 2.5 mb/d.



Total oil demand readings were mixed in other major European markets in May. In France (-0.3% year-on-year), diesel demand growth (+7.0%) was strong, again due to more working days, but may also reflect upwardly revised economic growth. By contrast, heating oil deliveries remained weak (-35.2%), with warm weather and consumers delaying tank filling in the face of high prices. In Turkey (+6.7%) diesel demand has surged on the back of strong economic growth - GDP growth for 2011 was revised up by 4.1% to 8.7%. Overheating concerns remain and economic growth is expected to slow to 2.5% in 2012. Nevertheless, with annual increments expected at 2.5% (+20 kb/d) in both 2011 and 2012, Turkey represents Europe's strongest oil demand growth engine. Elsewhere, May featured falling demand in the UK (-3.5%), Italy (-1.4%) and Spain (-2.8%) where high oil prices and weaker economic prospects are taking their toll on consumption.



Pacific

Preliminary data indicate that oil product demand in the Pacific fell by 3.0% year-on-year in May. Weaker economic activity in the aftermath of Japan's devastating earthquake and tsunami has played a significant role, with all product categories declining except for diesel and residual fuel oil. The latest IMF assessment suggests that after declining on average by 1.4% during 2Q11-3Q11, Japan's economy will rebound in 4Q11, growing by 0.8% year-on-year. This represents a lower annual GDP profile than in previous assessments, with 2011 growth cut from +1.4% to -0.7%. Our forecast for 2011 sees demand declining to 4.4 mb/d (-0.2% or -10 kb/d year-on-year), as reductions linked to the earthquake and tsunami are largely offset by boosts from reconstruction activity and oil burning for power generation. With GDP growth expected at 2.9% in 2012, Japanese oil demand is expected to resume its structural decline, falling 1.5% (-60 kb/d) to below 4.4 mb/d.



However, reconstruction and oil burning for electricity may provide upside demand support during 2H11 and potentially beyond. Japan's oil demand is expected to grow by 0.4 mb/d from 2Q11 to 3Q11, led by diesel, gasoline, fuel oil and 'other products' (which include crude for power generation). However, deliveries of crude oil and fuel oil may yet surprise to the upside given potential struggles in meeting peak summer power demand. Oil consumption by utilities has so far not shown a dramatic uptick, with levels through June running only 50-100 kb/d higher than last year. Yet the restart timing of undamaged nuclear power plants that undertook maintenance shutdowns following the earthquake in March is increasingly uncertain. Moreover, in the event that extra thermal generation capacity is needed to compensate, it is unclear to what extent additional power needs will be met by LNG, oil or both. With already warmer-than-normal June weather and authorities prescribing an array of power saving measures for the summer, it is possible that crude and fuel oil purchases may strengthen by more than anticipated to meet peak demand.



Meanwhile, in Korea, oil product demand fell by 6.4% in May, with declines across all categories bar naphtha. With economic growth revised up slightly to 4.5% for 2011, it appears that a combination of interfuel substitution in power generation and high oil prices have sapped oil demand growth, particularly in LPG and fuel oil. Nevertheless, demand for diesel and gasoline appeared to accelerate in June, ahead of an announced price rise by refiners from 8 July. For 2011, Korean total product demand is expected to fall by 1.7% (-40 kb/d) to 2.2 mb/d. In 2012, demand declines slightly by 0.1% (remaining near 2.2 mb/d), with falls in heating oil and fuel oil outweighing an expected rise in diesel and LPG.

Overall, Pacific demand in 2011 is expected to decline by 0.2% (-20 kb/d) to 7.8 mb/d. Relatively stronger demand growth in Australia and New Zealand should partly offset declines in Japan and Korea this year and next. Despite regional economic growth at 3.3% in 2012, OECD Pacific demand is expected to decline by 0.7% (-60 kb/d) as increases in reconstruction-linked diesel demand in Japan are outweighed by falls in gasoline and residual fuel oil. However, should power sector issues persist in Japan, with significant nuclear capacity remaining offline, regional oil demand could yet surprise to the upside.



Non-OECD

Preliminary data indicate that non-OECD oil demand growth picked up in May (+4.8% or +2.0 mb/d year-on-year) versus April. Total May demand is estimated at 43.9 mb/d, while April levels were revised up by 285 kb/d, both on baseline changes and revisions to preliminary readings, to 43.2 mb/d (+3.5% or +1.5 mb/d year-on-year).





Growth across most product categories was strong in May, with naphtha (+7.2% year-on-year), gasoil (+6.6%) and LPG (+5.0%) posting the largest relative gains. Gasoil continued to lead in absolute terms (+840 kb/d, over 40% of total non-OECD growth), growing more than twice as much as gasoline, its nearest rival (+360 kb/d). The FSU (+8.0% year-on-year), buoyed by Russia, Asia (+5.7%), driven by China, and the Middle East (+4.2%), boosted by Saudi Arabia, provided the strongest regional growth.

Non-OECD demand has been revised up by 250 kb/d on average over 2009-2010, following updates to 2009 data from Russia and a few Middle East countries (Qatar, Israel, United Arab Emirates). Demand has been raised for 2011 (+360 kb/d) on stronger-than expected readings in the FSU, Asia and the Middle East. Growth for 2011 is now seen at 1.6 mb/d (+3.8%) and demand is seen averaging 43.7 mb/d. In 2012 demand is also expected to rise by 1.6 mb/d (+3.6%), climbing to 45.3 mb/d.



China

China's apparent oil demand growth accelerated slightly in May (+8.1% year-on-year), following an increase of 'only' 7.7% in April. Naphtha (+15.8%), gasoil (+11.2%) and motor gasoline (+8.7%) were particularly strong in May. The incorporation of revised refinery throughputs resulted in minor changes to intra-year demand back to 2005, but annual demand remains largely unchanged.

Concerns persist over the ability of Chinese utilities to meet power demand over the summer. Despite an electricity tariff hike in April, the China Electricity Council has reported that generators were still running at a loss in May (due to relatively higher coal prices) and that a capacity shortage of 30 GW may emerge during the summer months. A 1 June increase of electricity tariffs for non-residential users plus recent heavy rains, boosting hydroelectric power, may provide some buffer to generation capacity.



Nevertheless, it is unclear whether the pricing policy will be evenly enforced by local authorities - the National Development and Reform Commission has indicated that preferential electricity prices for industrial users have come about in some areas - and widespread use of diesel generators may emerge. Our forecast sees Chinese gasoil demand hitting its summer high point of 3.5 mb/d in June, some 90 kb/d above May levels, but the potential upside for summer months could be as much as 300 kb/d if 4Q10 experience, when coal-fired generation was severely restricted, is any guide.

Expectations for 2011 economic and oil demand growth have changed little since our last report with GDP expanding by 9.6% and apparent demand growing by 6.9% (+630 kb/d) to 9.7 mb/d. In 2012, with similar economic growth (+9.5%), oil demand is expected to rise by 5.0% (+480 kb/d) to 10.2 mb/d. Product demand increases will be led by gasoil, gasoline and 'other products'. While the former two categories are seen growing less than in 2011, the results are consistent with envisaged reductions in oil intensity over time. Still, the relationship between income and oil demand in China is notoriously difficult to gauge, with implied income elasticity fluctuating greatly over the past decade. Moreover, a prolongation of power sector problems could add upside to gasoil demand.



Other Non-OECD

Indian demand rose by 5.7% year-on-year in May, following slower growth of 3.3% in April, with LPG (+12.8%), gasoil (+10.2%) and gasoline (+7.8%) posting the strongest gains. In June, authorities raised domestic prices for gasoil, LPG and kerosene (by 9%, 14% and 20%, respectively), the first such pricing adjustment in a year. The government also reduced tariffs on imported diesel and gasoline to 2.5% from 7.5% in an effort to provide offsetting relief from the move, which will likely stoke higher inflation in the short term. While the price increases should help offset revenue losses by refiners who have faced rising crude prices, the prices of the affected products remain regulated and the price hikes are likely not enough to significantly dent oil demand growth in the short term.



As such, our forecast for Indian oil demand in 2011 continues to be driven primarily by expectations of strong economic growth (+8.2%). Total product demand is seen rising by 3.7% (+125 kb/d) to 3.5 mb/d. In 2012, GDP growth slows slightly, to 7.8%. Yet, oil demand growth is seen maintaining its pace, expanding by 3.8% (+130 kb/d) to 3.6 mb/d, led by gasoil, LPG and gasoline.

In Russia, May total product demand soared by 9.7% year-on-year, with gasoil (+17.8%) and gasoline (+12.1%) posting large gains. With retail prices recently lowered, at the government's behest, gasoline shortages have emerged, even with the imposition of sizeable export duties, which look likely to continue in the short term. Annual government submissions have yielded upward revisions to LPG (+175 kb/d) and residual fuel oil (+50 kb/d) for 2009-2010, which have been largely carried forward. Based on GDP growth of 4.8%, Russian total product demand is expected to rise by 2.7% (+90 kb/d) in 2011 to 3.4 mb/d. With economic growth at 4.5%, 2012 oil demand is seen increasing by 1.6% (+50 kb/d), but still near 3.4 mb/d.



In Brazil, oil demand grew by only 0.5% year-on-year in April, led by jet fuel/kerosene (+11.9%) and gasoil (+2.6%). Gasoline declined by 0.2% as ethanol consumption fell. Still, seasonally higher ethanol production and vehicle data showing a 27% year-on-year increase in May sales suggests potentially more supportive demand ahead. Brazil's economy is expected to grow by 4.1% in 2011 and 3.6% in 2012. However, growth was revised down in both years on average by 0.4% and high inflation continues to be a concern. In 2011, oil product demand is projected to grow by 2.6% to 2.8 mb/d while 2012 should see growth of 2.9% (+80 kb/d) to 2.9 mb/d, led by middle distillates and gasoline.



Saudi Arabia's Power Generation from Crude

A recent, yet overlooked, global demand issue relates to oil-fired power generation in several large countries. The most obvious example is Japan, following the shut-in of a majority of the country's nuclear reactors in the wake of March's earthquake and tsunami. However, oil-fired generation outside of the OECD represents a major demand driver, reflecting strong emerging market economic performance and rising electricity needs amid shortages of alternative supplies such as hydropower or natural gas.

Whereas the fuels of choice are typically residual fuel oil - for large-scale plants  - and gasoil  - better suited for small-scale generators as, for example, in China - the direct burning of medium/heavy, sweet crudes is increasingly favoured in some countries. On the one hand, direct crude burn pollutes less than high-sulphur residual fuel oil; on the other hand, this is a convenient outlet for large oil producers eager to maintain production in periods of weak global demand, as in the recent Great Recession in 2009.

Saudi Arabia is typical of this trend. Direct crude burn (based on implied numbers from JODI data), averaged less than 200 kb/d for most of the 2000s, but more than doubled in 2009 (450 kb/d), coinciding with the collapse of global oil demand. Yet, despite the economic rebound, direct crude burn has continued to rise steadily and is on track to reach a new historical record in 2011 (600 kb/d), potentially capping future Saudi crude exports, despite rising production. Meanwhile, residual fuel oil demand has fallen sharply, by roughly a third, to 250-300 kb/d.



This new pattern of direct crude burning has implications for global demand seasonality. Indeed, the difference between peak and trough Saudi direct crude demand has increased sharply, from about 180 kb/d over 2002-2008 to roughly 660 kb/d since 2009. Treating direct crude burn as a component of 'other products' demand, as this report does, compounds the traditional OECD-driven, third-quarter global product demand swing - and wreaks havoc with 'historical average seasonality' used by many analysts as a guide for demand projections. More generally, as previous issues of this report have already highlighted, a new, non-OECD-driven global seasonality is emerging but is not yet in place. Evidence of such a shift continues to build - namely, a surge in Chinese gasoil use in 4Q10, on the back of restrictions on coal-fired power generation, which boosted global demand sharply during a quarter when non-OECD demand normally eases.



Supply

Summary

  • Global oil supply rose by 1.2 mb/d to 88.3 mb/d in June on a hefty 0.8 mb/d increase in OPEC crude output and with non-OPEC production up by 0.4 mb/d. Year-on-year, global oil production was 1.3 mb/d higher, split between OPEC NGLs and OPEC crude.
  • OPEC crude oil supply in June surged to 30.03 mb/d, up by nearly 850 kb/d, due to a sharp rise in supply from Saudi Arabia. Current group production, however, remains well short of the 31.3 mb/d 'call on OPEC crude and stock change' projected for 3Q11 and the 30.6 mb/d envisaged for 4Q11.
  • For 2012, the 'call' is pegged at 30.7 mb/d on average, up 100 kb/d from average 2011 levels. Libya's civil war, underway since late February, has radically altered the near-term outlook for OPEC's crude oil production capacity through the first half of 2012, which thereafter posts a marked recovery. Indeed, from 1Q12 to 4Q12, capacity is expected to expand by nearly 1.3 mb/d, amid assumed Libyan recovery and expansions from Angola, Iraq and the UAE.
  • Non-OPEC oil supply rose by 0.4 mb/d to 52.5 mb/d in June, on a seasonal rise in biofuels output and following maintenance in the North Sea. Production for 2011 is revised down by 0.2 mb/d on baseline adjustments to non-OECD volumes, as well as prolonged production outages in a series of countries, and is now seen averaging 53.1 mb/d. In 2012, non-OPEC supply is projected to rise to 54.0 mb/d, driven by higher output in non-crude liquids, as well as higher conventional crude supply from Canada, Brazil, Australia, China and others.


All world oil supply data for June discussed in this report are IEA estimates. Estimates for OPEC countries, Alaska, Peru and Russia are supported by preliminary June 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 May 2011, 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 ?200 kb/d for non-OPEC as a whole, with downward adjustments focused in the OECD.

The non-OPEC and OPEC NGL supply sections this month focus on the roll out of our detailed 2012 forecast, with discussion of key trends in production. However, to avoid duplication, several of the themes underpinning this analysis are elaborated upon in the MTOGM 2011 Edition, released on 16 June 2011. Readers should consult the MTOGM for more detailed discussion of factors affecting supply in 2012 and beyond.

OPEC Crude Oil Supply

OPEC crude oil supply in June surged to 30.03 mb/d, up by nearly 850 kb/d from May due to a sharp rise in production from Saudi Arabia. Five months into Libya's protracted civil war, fellow OPEC members now appear to be moving to replace lost supplies from the war-torn country.

OPEC-11 supplies, which exclude Iraq because it does not have an official output target, rose by around 800 kb/d, to 27.31 mb/d. OPEC's 8 June Vienna gathering collapsed in disarray because the majority of members rejected proposals put forward by Saudi Arabia and other Gulf members to collectively agree to increase output to make up for lost Libyan production. That said, more than half of the 11 producing countries with output targets appeared to have raised production in June. Saudi Arabia, however, provided the lion's share, accounting for almost 90% of incremental June supplies.



The unexpected acrimony that emerged among members at the June conference, largely along the lines of those with and without spare production capacity, may have temporarily altered the group's dynamics going forward. Indeed, the unusual occurrence of price hawk Iran holding the presidency for the first time in more than 35 years, was reportedly behind the meeting ending without even an official communiqué. A proposal put forward at last month's OPEC ministerial conference by the group's current President, Iran's acting oil minister Mohammad Aliabadi, to hold a meeting in Tehran in September to review the market, was roundly rejected by key Gulf members. The end of Iran's term this year may make for more harmonious gatherings once again going forward, with the next formal Ministerial meeting scheduled for 14 December 2011 in Vienna. Internal OPEC politics aside, production is now 5.19 mb/d above a long-outdated official output target of 24.845 mb/d, agreed in late 2008.

Current crude oil production of just over 30 mb/d, however, is still well short of the 31.3 mb/d 'call on OPEC crude and stock change' projected for 3Q11, and the 30.6 mb/d envisaged for 4Q11. The steep 1.3 mb/d quarterly increase in the 'call' between 2Q and 3Q eases for 3Q and 4Q, but is still 600 kb/d above June production levels. The 'call' for 2011 has been raised by 0.4 mb/d to 30.6 mb/d due to higher forecast demand and lower non-OPEC supply. For 2012, the 'call' is pegged at 30.7 mb/d on average, up 100 kb/d from average 2011 levels.

Higher current production has correspondingly reduced OPEC spare capacity to an estimated 3.2 mb/d in June. Indeed, the group's spare capacity is expected to remain limited while Libyan supplies are constrained. Libyan production is reportedly running at minimal levels, below 100 kb/d, but expansion of the northern no-fly zone to include the eastern oilfields under the control of the new National Transitional Council, if it occurs, could enable a restart of production in 2H11. Indeed, we estimate Libyan production may be restored to 200 kb/d by end-2011 and gradually increase to an average 700 kb/d by 2012. Between 2011 and 2012 total OPEC production capacity is expected to post modest increases, with the recovery in Libyan production offset by natural decline rates and a dearth of new projects (see 'OPEC Crude Production Capacity Remains Constrained Through 2012').

Saudi Arabia's output increased substantially in June, up by an estimated 700 kb/d to 9.7 mb/d. OMR data suggest that is the highest monthly level since February 2006. The incremental output appears to be

split evenly between exports and for domestic use at refineries and direct crude burn at power and desalination plants.

After completing maintenance work in May, refinery throughput rates are estimated to have increased by approximately 250 kb/d in June, to 1.71 mb/d, largely reflecting higher runs at the Rabigh refinery. A smaller portion of the incremental crude supply was likely directed for direct burn, which we estimate up by 80 kb/d to around 780 kb/d in June compared with just under 700 kb/d in May. The month-on-month increase reflects increased demand for power generation and water desalination plants during the peak summer season. Direct crude burning in Saudi Arabia has been rising steadily since 2004 and is on track to reach all-time highs in 2011 (see Demand section, 'Saudi Arabia's Power from Crude').

Market reports and preliminary tanker data over the course of June indicated Saudi supplies were only up marginally, but latest shipping data suggest the kingdom's crude exports may have increased by at least 350 kb/d month-on-month. It is unclear whether the entirety of higher June exports will go to customers or are earmarked for storage facilities, with China being mooted as a possible location. However, a number of Asian buyers have already bought additional supplies for July and August, which are expected to underpin increased refinery throughput rates. Sources from the market and within the Kingdom earlier suggested that July production might rise to as much as 10 mb/d.



Iraqi crude supply is at the highest level in a decade (since November 2001) thanks to higher production from the northern Kurdish region. Iraqi production in June rose by 40 kb/d to 2.72 mb/d. Total exports rose about 50 kb/d to 2.27 mb/d, with higher northern exports (537 kb/d) largely accounting for the increase. Exports from the south averaged 1.73 mb/d, nearly unchanged from May. Tanker brokers report southern export facilities are hitting maximum capacity levels, with storage tanks now holding more than 4 mb of crude as a result of the logjam.

Production from the Tawke field averaged 70 kb/d and the Taq Taq field was estimated at 80-90 kb/d. Combined with smaller fields in the region, crude output from the Kurdish region was up by around 30 kb/d, to 175 kb/d in June. Volumes are expected to reach more than 250 kb/d in July. Around 40% of the Kurdish output is processed at local refineries and much of the rest exported through the Ceyhan pipeline. Meanwhile, China's CNPC and Zhenhua started production at the 60 kb/d al-Ahdab field on 21 June.

The UAE increased production by 80 kb/d to 2.5 mb/d. Output from the Upper Zakum field was curbed in May, but state-owned Adnoc reported production restored in June. UAE production in July, however, looks set to decline after Adnoc told customers that contract supplies of Murban crude would be cut by 10%. Kuwait boosted production by 50 kb/d to 2.49 mb/d in June and plans to offer more barrels to term buyers, mostly in Asia, in July and August. However, it appears state-owned KPC is bumping up near capacity of 2.54 mb/d. Meanwhile, Iranian supply was down 50 kb/d to 3.65 mb/d from an upwardly revised 3.7 mb/d for May. Iranian crude oil held in floating storage edged lower in June, with market players reporting that several cargoes were sold into Europe.

The protracted civil war in Libya continues to stymie production, with most reports suggesting output was just 80 kb/d in June. Oil facilities along the coast continue to be targeted by government forces, with the refinery in Misrata the latest casualty. Rebel leaders recently reported damage to oil infrastructure had been extensive but declined to name the facilities attacked for security reasons.

Angolan output fell a further 70 kb/d to 1.5 mb/d in June and is now at the lowest level since December 2006. Maintenance and repair work on the problematic water injection system at the deepwater Greater Plutonio complex continued in June. Operator BP said in early July it was slowly being brought back online. Technical problems at the Mondo and Saxi-Batuque operations also curbed production by a combined 50-60 kb/d in June. Latest loading programmes indicated production should recover in August, with exports slated to increase by 140 kb/d to 1.64 mb/d.

Angolan output is now running 400 kb/d below its peak of 1.9 mb/d in February 2010. This year production has averaged 1.58 mb/d compared with 1.73 mb/d in 2010. Start-up by year-end of new projects will help reverse the country's decline, adding 370 kb/d to nameplate capacity (see 'OPEC Crude Production Capacity Remains Constrained Through 2012').

Nigerian crude output fell by 70 kb/d to 2.28 mb/d due to problems with the country's Bonny production stream. Sabotage caused a fire and leaks at the Trans-Niger pipeline in mid-June, forcing operator Shell to declare force majeure on loadings of Bonny crude for both June and July. Continued sabotage and pipeline thefts have limited further recovery potential for Nigerian production this year, which is up on average by 110 kb/d in the January-June period compared to 2010 levels.

OPEC Crude Production Capacity Remains Constrained Through 2012

Libya's civil war, which erupted in mid-February, has radically altered the near-term outlook for OPEC's crude oil production capacity through the first half of 2012 but thereafter capacity should post a marked recovery. At first glance, it appears the group's capacity is slated to increase by only 155 kb/d to 34.44 mb/d between 2011-2012. However, the yearly averages mask a sharp recovery seen by end-2012. Indeed, from 1Q12 to 4Q12, capacity is expected to expand by a full 1.3 mb/d, with Libya showing a significant recovery, followed by respectable increases by Iraq, the UAE, Angola and Algeria.

After posting a sharp 1.1 mb/d drop in crude capacity in 1Q11, OPEC's capacity low point is expected to be hit in 1Q12, in large part reflecting the ongoing decline in Iranian production. Iran's crude oil production capacity is set to fall by around 150 kb/d, to 3.55 mb/d by 2012, due to the country's increasing isolation following stiffer international sanctions implemented in mid-2010, as well as its generally unfavourable investment terms. Even China is now showing tepid interest in the country, and Iranian officials recently said they will cancel Iran's South Pars Phase-11 gas field project if state CNPC continues to delay the project.

OPEC is expected to struggle to maintain capacity until Libyan supplies start to recover in 2H12. However, Libyan capacity is not expected to reach pre-crisis production levels until end-2013 (see 'MTOGM, 16 June 2011, 'Libya Faces Long Haul to Restore Production Capacity').

Aside from Libya, just three other OPEC members are on course to post significant capacity gains by 2012. Iraqi capacity is slated to rise steadily, from 2.71 mb/d in 1Q11 to 3.06 mb/d by 4Q12. Logistical constraints curb southern exports until 2H12, which in turn may force companies to contain their production expansion plans. However, recent increases in production from the Kurdish region hold the promise of significantly increasing production capacity and with it an upward revision to our forecast by end-2011.

The UAE is next in the queue in volume terms, with capacity expected to increase by around 175 kb/d to 2.92 mb/d from 3Q11 to 4Q12. The Emirates are slated to bring online five different expansion projects with nameplate capacity of 420 kb/d over the 2011-12 period. However, since the MTOGM report was completed there have been fairly significant management changes at the oil ministry and state oil companies, reportedly due to persistent development delays, so timelines may be pushed back beyond our original forecast.

Angolan projects, however, appear to be well on schedule, with capacity set to rise by a net 160 kb/d to 2.11 mb/d between 3Q11 and 4Q12. The 220 kb/d Pazflor project and the 150 kb/d PSVM will be online by end-2011.



The 2012 Outlook for Non-OPEC Supply

Overview

Non-OPEC supply is expected to grow a robust 0.9 mb/d in 2012, to 54.0 mb/d, as previewed in the recently published Medium-Term Oil & Gas Markets 2011 report (MTOGM). Growth for 2010-2011 is trimmed slightly, to 0.5 mb/d, following baseline revisions to 2010, as well as new and prolonged production shut-ins for a long list of countries in mid-2011. A return to near 1 mb/d annual growth would put 2012 back on a par with supply increments seen in 2009-2010, as well as the 2000-2004 period, and can be seen as the result of sustained upstream investment on the back of high oil prices and success at slowing decline rates at mature assets.



The inclusion of finalised annual supply data for another 23 non-OECD countries results in a lower 2009 baseline of 51.5 mb/d (-50 kb/d compared to the previous report), while 2010 average output is adjusted down by -85 kb/d to 52.6 mb/d. Revisions are spread across the board, but notable adjustments include Egyptian, Vietnamese, Malaysian and Uzbekistani NGL production. For 2011, revisions are mostly carried through, to which is added the impact of ongoing and new short-term supply outages in a string of countries. In addition to those already highlighted in recent reports (Argentina, Canada, Norway, Sudan, the UK and Yemen), strikes, seasonal maintenance and technical problems are currently also affecting output in Australia, Brazil, Kazakhstan, Malaysia and Vietnam. In sum, these are estimated to curb 0.7 mb/d from 2Q11 and 3Q11 non-OPEC supply. New shut-ins, coupled with the baseline changes and recent production data, result in the overall 2011 non-OPEC supply estimate being lowered by 0.2 mb/d to 53.1 mb/d.



Underlying strength in non-OPEC supply means that 2012 output is projected to grow by 0.9 mb/d to 54.0 mb/d, on the assumption that the above-mentioned outages are short-term in nature and will be resolved before the end of the year. Incremental supply will in large part come from non-crude output, including Canadian oil sands-derived liquids, biofuels, NGLs and refinery processing gains. Brazil, Canada, Australia, Colombia, China and Yemen each add over 50 kb/d of total new supply (albeit, Yemen only as it recovers from shut-in 2011 volumes). Oman, the US, Russia and Ghana add 30-50 kb/d each. The most pronounced annual declines in oil production are projected for Mexico, Indonesia, Malaysia and Sudan, which see output fall by 30-60 kb/d. By contrast, Norway and the UK are expected to see marginal growth (of around +25 kb/d each), as production recovers at key fields that experienced significant problems in 2011, e.g. the Gullfaks complex and Buzzard, and some new capacity start-ups.



OECD

OECD total oil supply is expected to rise by 0.3 mb/d, to 19.2 mb/d in 2012, with growth in North America of 0.2 mb/d (Canada and the US, but not Mexico) and 0.1 mb/d in the Pacific (Australia) contributing the lion's share. OECD Europe should see a minor rise (+15 kb/d), unusually, as the North Sea recovers from pronounced outages in 2011, and capacity is added at some smaller projects. This would be the first annual increment since 2000.



Oil production in the US is projected to rise by around 50 kb/d in 2012, to 7.9 mb/d. Growth stems from the Other Lower-48 and, to a lesser extent, from Texas and the Gulf of Mexico. Oil production in California and Alaska, as well as NGLs output, should decline. Onshore growth is driven by increasing volumes of light tight oil, often referred to as shale oil, produced in unconventional formations and a key source of future liquids growth in the US (see After the Shale Gas Revolution, Now It's Oil's Turn in the recent MTOGM for more detail). Output in the Gulf of Mexico remains affected by drilling delays at many fields and new developments, though this is more than offset by the ramp-up of production at two new complexes, Chinook/Cascade and Great White/Silvertip/Tobago. The 2011 hurricane season has started, with the first storms hitting the region. This year's storm season is expected to be heavier-than-average, and the forecast includes the usual adjustment based on the five-year average shut-in production volumes, which stand at an average -115 kb/d for the third and fourth quarters of both 2011 and 2012.

Canada's oil production is set to rise by 170 kb/d, to 3.6 mb/d in 2012, as bitumen and mined, upgraded synthetic crude from oil sands increase by 90 kb/d and 75 kb/d respectively, in addition to incremental NGLs supply of 45 kb/d. Other conventional crude declines marginally. Oil sands-driven growth is expected to see Canada remain non-OPEC's largest source of incremental supply in the medium term.

In Mexico, oil production is projected to decline by 60 kb/d to 2.9 mb/d in 2012, as output from the mature Cantarell field continues to slide - albeit more slowly than in the 2005-2010 period - and Ku-Maloob-Zaap (KMZ) volumes hit a plateau of around 850 kb/d. Additions at some smaller fields fail to offset this decline. This projection contrasts with state oil company Pemex's own view that oil production will stabilise around current volumes in the short-term and increase to 3 mb/d by 2015. In the absence of major new projects at the development stage, it is difficult to see how this target will be reached.

Norway will see oil production increase by 25 kb/d, to 2.2 mb/d in 2012, with new oil from Yme and Skarv from the latter half of 2011. Norway's Oil Ministry recently published an energy white paper, outlining its plan to slow structural decline in oil production by encouraging wider use of enhanced oil recovery techniques and the development of new, northern areas. It also hopes to speed up permitting and development time for fast-track projects and bring down upstream costs vis-à-vis other North Sea producing areas. Partners ConocoPhillips and Total have just officially launched the kind of programme the ministry is envisaging. For US$11.5 billion, they hope to extend the working life of Ekofisk, Norway's oldest producing field, and neighbouring Eldfisk, by another 40 years, squeezing out another 470 mboe.



Similarly, the UK is projected to experience a brief hiatus in oil production decline, with output rising by 20 kb/d to 1.3 mb/d in 2012. This is largely due to an assumed return to normal output levels around 200 kb/d at the country's largest field, Buzzard, which in the course of installation of a fourth platform has experienced protracted outages in recent months. We assume normal output levels at Buzzard will be reached in the course of August 2011. Following an upstream tax rise announced earlier this year amid protest by industry, the government in July unveiled proposals for a broadening of exceptions to the rule for various 'marginal', i.e. small, challenging or remote, fields. Statoil, which had previously threatened to put its Bressay and Mariner field developments on hold, promptly announced they had been reactivated. Even prior to the recent announcement, equity partner Maersk had given its go-ahead for the development of the 60 kb/d Golden Eagle field, to start production in 2014.

The OECD Pacific will see total oil supply increase by 0.1 mb/d, to reach 0.7 mb/d in 2012. This is due to a projected rise in Australia's oil production by 115 kb/d, to 620 kb/d, which sees incremental output at the Van Gogh and Pyrenees fields, recovery at Cossack, which saw its floating production, storage and offloading (FPSO) vessel exchanged in 2011, and new oil from the Kitan and Montara/Skua developments, which are expected to start production in late 2011 and early 2012 respectively.

Non-OECD

Oil production in the Former Soviet Union (FSU) is projected to rise by just 45 kb/d, to 13.7 mb/d, in 2012, with limited new upstream projects only just offsetting mature field decline. Russia is expected to see a continuation of 2011's trends, with output rising slowly at Rosneft, TNK-BP and in NGLs, but dipping for Lukoil, Surgutneftegaz and other companies. Rosneft's large Vankor field is scheduled to hit 400 kb/d in the course of 2012. Overall production growth will slow to only 30 kb/d, with output rising to 10.6 mb/d in 2012. This compares with a rise of 100 kb/d in 2011 and 240 kb/d in 2010. Recent positive noises about changes to the tax regime could encourage more investment and ultimately higher production growth.



Kazakhstan, while still on track to see production increase in the medium-term, is projected to see a small dip in output in 2012, falling by 20 kb/d to 1.6 mb/d. Looking further ahead, the start-up of the super-giant Kashagan field may be postponed yet again. Officially, the consortium developing the field is bound to pump first oil by late 2013 or face penalties, but apparent disagreements both within the consortium and between the consortium and authorities, may now see first oil delayed into 2014. The field was originally designed to start production in 2005, but delays and rampant cost inflation have caused chronic project slippage.

Some consortium partners are now reportedly looking to exit the project, and while some national oil companies might take their position, this could lead to more contractual delays. The start-up date of the second phase of the project is now effectively on hold and is only likely after 2020. Some surmise that the entire second phase could now be at risk, as the chronic delays mean that consortium partners may not be able to see significant returns before their leases expire. Rather than let this happen, it seems most likely that the state would step in and find new developers. This forecast currently assumes that small volumes of Kashagan oil will be pumped in late-2013, but that first-phase capacity of 370 kb/d will only be reached by early 2016.

Total non-OECD Asia-Pacific oil production will remain flat in 2012, with some growth in China and India offset by declining production in Indonesia and Malaysia. China's oil production is projected to rise by 70 kb/d to 4.3 mb/d in 2012, with increases in Changqing, Yanchang and in offshore fields. India is expected to experience growth in oil production of 20 kb/d on rising output from its Mangala-Bhagyam-Aishwariya complex in Rajasthan, though at the time of writing, there were indications that start-up at the 50 kb/d Bhagyam field would be delayed into late 2011. Malaysia is currently experiencing problems at its offshore Kikeh field, where production has been curbed to around half its capacity of 100 kb/d for several months. That and steady decline elsewhere mean that Malaysia's oil production could fall by 33 kb/d to 585 kb/d in 2012, albeit 2013 should see production rise again, as the Gumusut and Malikai developments start up. In the absence of any significant rise in output at its Banyu Urip field, where production remains stalled at around 20 kb/d, Indonesia is projected to see supply decline by 50 kb/d, to 865 kb/d in 2012.



Latin America is the region with strongest growth in output in 2012, with supplies rising by 270 kb/d to 4.6 mb/d. Brazil is the main contributor, expected to see total oil production increase by 175 kb/d to 2.4 mb/d as output rises from new offshore developments, including volumes from pre-salt strata. Despite there being a long list of new upstream projects, some concerns remain about spiralling costs and the ability of the domestic supply and service industry to satisfy an ambitious project schedule with mandatory local content. State oil company Petrobras recently delayed again the publication of its much-anticipated 2011-2015 plan, allegedly on wrangling over costs, especially for ambitious downstream projects and resulting government fears of higher fuel prices and inflation. Colombia is the region's other key source of growth. Production there is projected to rise by 85 kb/d, to just over 1.0 mb/d in 2012, on rising output in the Llanos region. In Argentina, strikes that had been hitting oil production in the Santa Cruz region, reportedly fizzled out in late June. Production in April, May and June is estimated to have been curbed by around 100 kb/d. Projections for 2012 see production flat from 2011, at 675 kb/d.



In the Middle East, oil production is set to rise by 75 kb/d, to 1.8 mb/d, in 2012, as output in crisis-stricken Yemen is assumed to recover, and on rising volumes in Oman. In Yemen, around 120 kb/d is expected to remain shut-in during 3Q11, only recovering towards the end of the year - assuming repairs to a key crude pipeline can be made if the political situation improves. As a result, annual production is expected to rise by 55 kb/d to 250 kb/d in 2012. In Syria, production appears currently unaffected by the deteriorating political situation, despite news reports indicating lower expected exports in July. Oil production remains in decline and is expected to fall by 25 kb/d to 345 kb/d in 2012. In Oman, production is expected to rise by 50 kb/d to 970 kb/d in 2012 due to various enhanced oil recovery (EOR) projects and some new, small field developments.

Africa's oil production is set to increase by 30 kb/d, to 2.6 mb/d in 2012, as production rises in newcomers Ghana (+30 kb/d) and Uganda (+10 kb/d), as well as marginally in Congo (+20 kb/d) and Equatorial Guinea (+10 kb/d). By contrast, oil production in Sudan (now split into northern and southern halves; but for the meantime still listed as one in our databases) and Egypt should decline marginally.

FSU Exports

FSU net oil exports reached 9.50 mb/d in May, a 550 kb/d fall from April's exceptionally high level of 10.05 mb/d. Crude exports plummeted by 530 kb/d to 6.38 mb/d as volumes declined across all seaborne and pipeline routes as the economics of exporting crude deteriorated over the month. This was attributed to fluctuations in the Urals reference prices used to calculate the Russian crude export tax. In May this was based on the average price of Urals between 15 March and 14 April, and amounted to $453.7/mt, a $30/mt increase over the April level. However, in early May Urals fell sharply by $12/bbl, remaining well below March-April levels for the duration of the month. Therefore, many producers preferred to hold over shipments until economics improved. As such, exports are expected to pick-up again in June. On a regional basis, cargoes sent via Baltic ports plummeted by 200 kb/d after Primorsk and Gdansk volumes declined by 100 kb/d each. Shipments from Black Sea ports fell by 100 kb/d after declines from the Ukrainian ports of Odessa and Feodosiya combined with a 70 kb/d dip in CPC flows. Volumes sent to Kozmino and China through the ESPO remained close to capacity at a combined 600 kb/d.



Since Russian product export taxes are also based on the lagged price of Urals, the above factors conspired to erode economics and thus product exports fell by 40 kb/d. Gasoil was hit hardest, decreasing by 60 kb/d with increased supplies into the domestic market.

Starting in this issue, we have changed our data sources and have therefore revised our entire FSU export data series historically. This change has resulted in an average downward revision of 10 kb/d to net FSU exports for the January 2009-March 2011 period. Within the regional breakout, Arctic/Far East crude has been increased by on average 260 kb/d on the increased visibility of exports from Arctic ports and flows moving through the Kenkiyak-Alashankou pipeline from Kazakhstan to China. Additionally, we have reclassified vacuum gasoil from gasoil into fuel oil, based on its likely use as a refinery feedstock, with volumes averaging 260 kb/d from 2009 onwards.

OECD Stocks

Summary

  • OECD industry stocks rose for a second consecutive month, gaining 23.9 mb in May, to 2 680 mb or 58.6 days of forward demand cover. The bulk of the increase stemmed from product restocking, while April inventory is revised down by 11 mb. Despite the May stockbuild, the surplus to the five-year average narrowed from 16.4 mb in April to 10.3 mb in May.
  • June preliminary data indicate a 2.9 mb decline in OECD commercial inventories. Crude oil fell by 6.6 mb as draws in the US outweighed European restocking. Refined product holdings rose by 7.1 mb, led by a seasonal build in 'other products'. This contrasts with an average five-year increase of 2.6 mb.
  • Short-term oil floating storage fell to 54.4 mb in June, from 56.1 mb in May. Crude floating storage declined by 2.1 mb to 40.6 mb, led by the offloading of Iranian crude in the Middle East Gulf, while seaborne product storage rose by 0.4 mb to 13.8 mb on increases in the Asia-Pacific.
  • On 23 June, the IEA announced a coordinated release of 60 mb of oil in response to ongoing supply disruptions in Libya and an anticipated increase in oil demand in 3Q11. Government stocks account for 40 mb, while lowered stockholding obligations on industry will provide operators with additional flexibility amounting to a further 20 mb. 


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

OECD industry stocks rose for a second consecutive month, gaining by 23.9 mb in May, to 2 680 mb or 58.6 days. This was in line both with the last report's preliminary expectations, and with a 30.0 mb five-year average build. Crude and 'other oils' grew only slightly, by 2.1 mb, while the bulk of the stock increase (21.8 mb) stemmed from product restocking. 'Other products' built by 12.5 mb, in line with seasonal trends, while a 3.8 mb gain in distillates is much lower than a 15.1 mb average increase over the past five years. However, gasoline inventories rose counter-seasonally by 7.6 mb, as refinery output in the US outweighed product demand.



OECD forward demand cover remained below year-ago levels at 58.6 days in May, down from 59.2 days in April; nevertheless, stock cover still stood 2.1 days above the five-year average. April OECD inventories built by 23.2 mb, slower than a previously reported 34.5 mb increase, as stock levels were revised down by 11.3 mb upon receipt of more complete monthly data. Downward adjustments were largely centred in crude and gasoline. Moreover, monthly conversion factors for Canadian data were reconciled with those for annual data.



Despite the seasonal monthly stockbuild, the surplus of OECD industry stock levels to the five-year average narrowed from 16.4 mb in April to 10.3 mb in May. The overhang remained centred on US crude and European distillates. However, crude oil stock levels in Europe changed dramatically following a 1 mb/d drop in crude imports, resulting from the halt to Libyan exports and production outages in the North Sea. Crude stocks now look to have plunged sharply by 20.5 mb from January to May and have transformed a 2.3 mb surplus to the five-year average evident at the beginning of 2011 into a 29.9 mb deficit.



Preliminary Euroilstock data for June indicate a 6.0 mb build in European crude stocks, but this was outweighed by draws elsewhere. Overall, OECD total oil inventories dropped by 2.9 mb in June. Short-term oil floating storage also fell in June to 54.4 mb, from 56.1 mb in May. Crude oil held offshore on vessels declined by 2.1 mb, as the offloading of Iranian crude oil in the Middle East Gulf offset additions in the US Gulf. Products floating storage increased by a marginal 0.4 mb, following additions to products held in the Asia-Pacific. Further product offloading in the Mediterranean and the release of a vessel held off West Africa provided partial offset.

The IEA's Libya Collective Action Explained

On 23 June at 3 pm Paris time, the IEA announced a release of 60 mb of oil as a response to the ongoing supply disruption of Libyan light sweet crude, an anticipated oil demand increase in 3Q11, and to act as a bridge to incremental supplies from major producers. Although the IEA's Libya Collective Action was agreed upon by all 28 member countries, the action is undertaken by 12 member countries, specifically those with strategic stocks and a share of more than 1% in the total oil consumption of all IEA countries.

The release has been carried out according to standard practices in each of the 12 countries; their procedures are regularly reviewed and rehearsed. Five countries (Belgium, Germany, Korea, the Netherlands and the US) are releasing stocks from public reserves via tender, auction or direct sale. Eight countries (Belgium, France, Italy, Japan, Poland, Spain, Turkey and the UK) lowered the emergency reserves obligation on market operators (Belgium is using both public and industry stocks in this action). The release from public stocks accounts for nearly 40 mb, and obligated industry stocks around 20 mb.

At the end of June the US offered 30.2 mb of light sweet SPR crude via auction. Of 90 bids received, 28 bids were accepted, totalling over 30.6 mb. Uptake of the 2011 tender has been greater than that for the IEA's Katrina Collective Action of 2005. At that time 30 mb were also offered for tender, with only 11 mb sold, in addition to 11.4 mb taken up just prior to the Katrina Action via a US SPR loan program.

In Germany, 4.2 mb, evenly split between crude and products, were tendered in early July. Of this, 66% was taken up; 1.62 mb of crude oil, 0.5 mb of gasoline and 0.65 mb of diesel. During the Katrina Action in 2005, the market took up 25% of the offers (3.63 mb offered; 0.96 mb bought). In Belgium, Korea and the Netherlands, at writing, all stocks offered appear likely to be taken up by the market.

In countries with mandatory industry stocks, governments require importers, refiners, product suppliers or wholesalers to hold a minimum number of days of stocks. Generally, the days of stocks are based on a percentage of the previous year's sales, consumption or imports. In a collective action, a uniform reduction in the stockholding obligation for all operators is the preferred approach in most of these countries. When the industry obligation specifies oil products (gasoline, diesel/gasoil, kerosene, fuel oil), the lowered obligation is usually also product-specific, as shown in the table below.



Operators generally have the flexibility to meet their product obligation at least partly with crude oil, according to product yields. Hence, when the obligation is relaxed, it is up to the company to decide whether to lower product stocks or crude oil stocks, or a combination of both, according to its own needs and market circumstances. While relaxing the stock obligation on operators might be a less visible response, or be seen as a more diluted measure, since no formally announced sales or physical movements may occur, it is no less effective. The lowered obligations give operators the opportunity to make additional oil available over the coming months, and they will use this greater flexibility according to market circumstances.

OMR analysis focuses on developments in industry stocks in OECD countries, with Table 5 showing the levels of both government-controlled (public) and industry stocks. The industry stocks category consists of operational stocks, mandatory industry holdings (obligated by governments for emergency use) and the portion of industry stocks estimated as technically unavailable (pipeline fill or tank bottoms). OECD industry oil stocks stood at 2 656 mb in April, with IEA member countries holding 2 607 mb. Around 25% of these IEA industry stocks were held under a government obligation. IEA governments controlled 1 559 mb of oil stocks in April and total IEA oil stocks (industry and government-controlled) stood at 4 166 mb, while total OECD oil stocks reached 4 215 mb. To date, the IEA's Libya Collective Action therefore involves just over 1% of total IEA inventory or just over 2.5% of mandatory held stocks by government and industry.

The stockholding regimes of IEA member countries are explained in the IEA publication "Oil Supply Security, Emergency Response of IEA Countries 2007", free for download from the IEA website (http://www.iea.org/publications/free_new_Desc.asp?PUBS_ID=1981). This publication gives an overview of stockholding systems in all IEA member countries. As the emergency policies of IEA countries are reviewed on a regular basis, new country chapters are added to the website, as soon as a review is concluded; currently 15 updated chapters can be downloaded. Seven IEA countries have their emergency stocks concentrated in public reserves, eight countries have their emergency reserves solely with industry and 11 countries have a mixed system of public reserves and industry obligations (Canada and Australia do not have mandatory stockholding systems).

Analysis of Recent OECD Industry Stock Changes

OECD North America

Industry stocks in OECD North America rose seasonally by 19.2 mb to 1 328 mb in May. The second consecutive monthly increase followed a 12.2 mb build in April. However, unlike in April when the build was driven by rising crude and 'other oils' stocks, the inventory gain in May was led by counter-seasonally rising gasoline stocks, resulting from stronger refinery output ahead of the driving season. Nevertheless, a seasonal restocking of 'other products' in the US also contributed.



EIA weekly data point to a 3.0 mb increase in US industry stocks in June, driven by further seasonal increases in 'other products'. Propane inventories rose by 7.4 mb in June. Middle distillates gained 4.0 mb, led by sharp increases in jet fuel and heating oil stocks, while diesel declined. Lower refinery yield of gasoline in June resulted in a 1.3 mb drop in inventories. Overall, however, June product stocks rose by 16.3 mb.



US crude oil inventories declined by 11.8 mb to near year-ago levels in June. Stronger crude runs on the US Gulf and East Coasts led the stockdraw, but crude inventories in the congested Midcontinent also fell due to pipeline problems at the beginning of the month. Moreover, stocks held in Cushing, the delivery point for NYMEX WTI futures, declined by 2.2 mb to 37 mb in June, 4.8 mb below the record high of 41.9 mb reached in April.

OECD Europe

Industry oil inventories in OECD Europe rose by 7.1 mb to 945 mb in May, stronger than the 2.9 mb five-year average stockbuild for the month. However, the stronger-than-seasonal stock increase came after three months of sharp draws, which have depleted European oil inventories by almost 50 mb since January. Crude oil stocks now stand 20.5 mb below January levels after the loss of Libyan supplies and production outages in the North Sea.



2Q11 refinery maintenance in Europe helped to ease the shortage, at the expense of curtailing both onshore and offshore product stocks. Product inventories on land were down by 23.5 mb from January, largely on gasoline and distillates draws. At the same time, products held in floating storage offshore Europe (largely distillates) also diminished and there are currently no reports of vessels storing crude in the region.

Rising May onshore stocks suggest that some countries managed to secure alternative supplies for their seasonal increase in crude throughputs, either from the FSU, West Africa or from Middle Eastern producers. Nevertheless, end-May European stocks stood 23.4 mb below the five-year average levels near the bottom of the range, kept afloat only by the overhang in middle distillates. Middle distillates also underpinned the overall May stockbuild, as holdings rose by 5.1 mb. Crude stocks rebounded by 1.6 mb, and sub-0.5 mb gains occurred also in gasoline, 'other products' and 'other oil' categories. German end-user heating oil stock data for end-May were delayed, but consumer stocks stood at 47% of capacity in April, and consumers likely postponed significant restocking due to relatively high prices.



Preliminary June data from Euroilstock point to a 0.6 mb stockbuild in the EU-15 and Norway, as gains in crude oil holdings balanced product draws. Crude oil stocks rose by 6.0 mb, sharply building in the UK, Austria, Germany and France. Products declined by 5.3 mb, led by falling gasoline and distillate inventories in Germany, the Netherlands and the UK. Meanwhile, refined oil product inventories held in Northwest European independent storage rose marginally, as rising gasoline and naphtha stocks outweighed draws in jet fuel, gasoil and fuel oil.

OECD Pacific

Industry oil inventories in the OECD Pacific declined by 2.3 mb to 408 mb in May. The draw strongly contrasted with a 10.3 mb seasonal five-year average build, but it came after a sharp 25.5 mb Japanese post-quake and tsunami restocking in April. Following the March disaster, the Japanese government relaxed the stockholding obligation on industry from 70 days to 45 days of domestic consumption equivalent. The relaxation expired on 21 May and Japanese refiners also reinstated product exports to Singapore while waiting for domestic demand to pick up.



Meanwhile, Korean refiners absorbed some redirected crude cargoes in April, boosted refinery runs and exported the products to fill the gap in regional supplies. However, as the temporary surge in crude imports faded in May, elevated refinery runs drew 5.2 mb of Korean crude stocks in May. Overall, Pacific crude stocks declined by 4.4 mb in May, partly balanced by a 3.3 mb increase in middle distillates.

Weekly data from the Petroleum Association of Japan (PAJ) suggest a 6.6 mb draw in Japanese industry inventories in June. As refiners ramped up runs, crude oil stocks declined by 0.8 mb and 'other oils' fell by a further 2.0 mb. Japanese product exports to Singapore rebounded to pre-disaster levels and product stocks also fell by 3.8 mb, led by declines in middle distillates and 'other products'.

Recent Developments in China and Singapore Stocks

Chinese commercial oil inventories fell by an equivalent of 3.6 mb (data are reported in terms of percentage stock change), to just below 350 mb in May, according to China Oil, Gas and Petrochemicals (China OGP). Commercial crude oil inventories decreased by 3.5% (-7.4 mb) from April, as already-high refinery runs rose again, in order to maintain domestic supplies amid concerns that power shortages will hike diesel demand again. Meanwhile product stocks climbed by 2.6% (+3.7 mb) month-on-month, driven by gains in all categories. Gasoline stocks rose by 1.0% (+0.6 mb), diesel by 3.0% (+2.2 mb), and kerosene by 8.0% (+0.9 mb).



Refined oil product inventories in Singapore rose by 1.0 mb in June. Middle distillate stocks gained 1.2 mb as jet fuel and gasoil imports from Japan returned to February levels and provided partial relief following lower deliveries from China due to concerns over power shortages. Light distillate stocks, including naphtha and gasoline, declined by 0.4 mb on stronger regional exports to cover for refinery maintenance. Gasoline stocks dropped to the five-year average from their April record highs. Fuel oil inventories rose by 0.2 mb, as western arbitrage arrivals offset strong bunker fuel demand.



Prices

Summary

  • Crude oil prices were volatile over the course of June in response to conflicting market drivers, with benchmark crudes trading in a wide $9-15/bbl range. The initial bearish impact on prompt prices from the IEA's Libya collective action was tempered by significant supply outages among non-OPEC producers, especially the North Sea, with prices retracing their losses by early July. Oil sold under the IEA action will filter into consuming markets in July and August. The more immediate impact may prove to be the realignment of sweet/sour crude price spreads, earlier distorted by the loss of lighter Libyan crude, and a flattening of erstwhile backwardation. Benchmarks Brent and WTI were last trading around $116/bbl and $95/bbl.
  • Weaker crude prices in June generally supported product crack spreads, but light ends saw differentials decline and stay weak. Middle distillates crack spreads improved slightly while the largest improvement was at the bottom of the barrel, with fuel oil discounts narrowing in June. Refining margins were down in June month-on-month, but generally stronger after the IEA collective action.
  • Well before the IEA stock release pressured prices lower, managed money traders were cutting their net long exposures in light, sweet crude oil contracts, off by 40% since mid-April to 21 June 2011. However, in the last week of June, long positions increased again, in part on renewed expectations of stronger demand coupled with constrained supplies.
  • Despite higher production from OPEC's Middle East producers, benchmark crude tanker rates remained depressed throughout June. The Middle East Gulf - Japan VLCC rate has remained close to, or below, break-even levels for much of the past three months due to a combination of high bunker fuel prices, sluggish demand and swelling tonnage.


Market Overview

Oil market sentiment rapidly shifted from fears of shortfalls of light, sweet crude to the possibility of oversupply after the 23 June IEA collective action. Prices initially fell by $3-5/bbl, but within days retraced their losses amid stronger economic news and what now look like misplaced fears that the temporary IEA measure might discourage OPEC producers from increasing output as planned during the peak summer demand period. Chronic production outages in the North Sea, coupled with seasonal field maintenance, also added upward momentum, with mounting concern that supply will be eclipsed by seasonally stronger demand in 3Q11. However, in recent days prices turned lower again on renewed concerns about the Eurozone debt crisis and fears recent economic developments may undermine oil demand growth. At writing, prices for benchmark Brent and WTI futures were trading around $116/bbl and $95/bbl.

With extra supply from the IEA's collective action likely to take time to filter onto the market the Brent market quickly shrugged off the IEA stock release and refocused its attention on the chronic monthly supply shortfalls of North Sea Forties and other grades evident since February. Problems at the key Buzzard field, part of the Forties complex, have led to a significant loss of supply over the past five months. Indeed, current estimates for lost production from Buzzard top 12 mb from February to June. Seasonal scheduled maintenance will further reduce North Sea supplies in July and August. Buzzard is the largest field in the UK with production of around 200 kb/d. North Sea Forties is a key blend used for setting the Dated Brent price.

In addition to reduced North Sea crude production, supply outages elsewhere in non-OPEC countries, which include Yemen, Canada and Argentina, were estimated at just shy of 700 kb/d in 2Q11 and are forecast to post a similar loss for 3Q11 (see Non-OPEC Supply).

Despite market scepticism that OPEC would follow through on delivering more barrels to the market in the wake of the IEA release, our latest estimates suggest that OPEC supply was up by nearly 850 kb/d, to 30.03 mb/d in June, with Saudi Arabia accounting for 85% of the group's increase (see OPEC Supply). Seasonally stronger oil demand in 3Q11 is expected to increase the 'call on OPEC crude and stock change' by a steep 1.3 mb/d from 2Q11 levels. The end of large-scale maintenance programmes at refineries in Europe, Asia and the US is also leading to brisk demand for crude.

While refiners opted not to take up Saudi Arabia's offer of extra barrels, including new hybrid crudes similar to lost Libyan supplies, for the April-June period, there are indications that buyers are showing more interest for July and August, especially in Asia. However, others say August prices set by Saudi Aramco are too expensive, which may discourage increased liftings.



While benchmark crude prices were largely back to where they were before the IEA's collective decision to release stocks, the action has led to a narrowing of the sweet-sour crude price spreads, which ballooned to peak levels following the onset of civil war in Libya. The release of light-sweet SPR crude in the US is seen as diverting alternative supplies into Europe and Asia, helping to nullify the impact of lost Libyan barrels.

In addition, the extra crude supply added downward pressure on prompt month contracts. The forward price curve for M1-M12 Brent contract briefly moved out of backwardation immediately following the IEA's announcement. Before that, the Brent M1-M12 spread averaged around $3.25/bbl in June but post-IEA action it tumbled into contango at -$0.40/bbl on average for the last week of June. Worries over 2H11 supply and demand fundamentals, however, once again pushed Brent M1-M12 into relatively shallow backwardation, at around $0.80/bbl in the first week of July. Markets have been closely tracking supply and demand data in recent weeks, with the tenuous links with the S&P 500 and other economic and financial market data seemingly less important for now.





Futures Markets

Managed money traders have been cutting their net long exposures in light, sweet crude oil contracts since mid-April on both CME and ICE Exchanges. Money managers cut net-long positions in NYMEX WTI crude oil by 40%, from 267 539 contracts in early April to 162 190 contracts on 21 June, just before the IEA announced its 60 mb stock release. They continued to reduce their net long position following the release. However, in the last week of June, they increased their long position by 9 637 to 159 641 contracts in New York. In the meantime, managed money traders also reduced net long exposure in WTI contracts traded in London from almost 50 000 to 12 330 from April to the week following the release. Money managers increased their long positions by 3 768 to 16 098 contracts in the week of 5 July.

Producers decreased their net shorts position during the month of June; they held 25.5% of the short and 14.5% of the long contracts in CME WTI futures-only contracts. Swap dealers, who accounted for 33.5% and 32.7% of the open interest on the long side and short side, respectively, reinforced a recent trend of dwindling net short by adding 20 774 gross long contracts. On the other hand, both producers and swap dealers remained net short in London ICE WTI contracts.



Open interest in WTI contracts on the New York CME and London ICE exchanges changed very little in June. While open interest in New York increased in June in futures-only contracts and declined in futures and futures-equivalent options, at the same time, open interest in London ICE WTI contracts declined in both futures-only and combined contracts to 0.46 million and 0.5 million contracts, respectively.



Meanwhile, ICE Europe started publishing its weekly Commitments of Traders report for Brent crude oil and gasoil on 20 June, 2011. While somewhat limited in coverage, this new step by ICE Europe toward increased transparency is welcome. The report resembles the CFTC's disaggregated Commitments of Traders Report and goes back to the start of June 2011. The report shows that money managers reduced their net long position by 39% from 63 427 to 38 530 contracts from 7 June, 2011 to 28 June, 2011. However, they increased their net long futures exposure by 24 164 to 62 694 contract from 28 June to 5 July, 2011 on expectations of stronger demand coupled with constrained supplies.

Index investors reduced their exposure in commodities in May 2011. They withdrew $9.5 billion from the WTI Light Sweet Crude Oil market in May 2011 — a fall to 669 000 contracts from an all-time high of 694 000 futures-equivalent contracts in March, or $68.90 billion in notional value.

The CFTC also started publishing two new reports on trading activity of large traders. Although it has indicated that the purpose of these two new reports is to promote transparency in the market place, the current reports fail to meet market expectation for more disaggregated data on individual contracts. The new Large Trader Net Position Changes report provides daily average net position change and the daily average volume of traders in 35 physical and financial derivatives markets. The Trading Account Net Position Changes data, on the other hand, provides the average daily net position change at the trading-account level, for a given week. The current report reveals that most of the volume in crude oil market is due to activity by day traders rather than long-term bets on oil prices.

At the same time, and as expected, the CFTC announced that it will miss the 21 July deadline for the implementation of the Dodd-Frank Act. Due to extraordinary comments it has received for the proposed rules, officials now believe that they will be ready for implementation by year-end. However, some market participants think that longer delays are possible.

Is WTI Weakness Purely Physical?

Prices for crude oil benchmarks WTI and Brent have historically been related. In general WTI light sweet crude oil sold at a 5% premium to Brent crude oil between 1994 and 2010. However, this relationship between WTI and Brent crude oil totally collapsed in 2011. Brent crude oil sold at an average premium of $13/bbl in 1H11, or 13%, reaching $23/bbl in mid-June.

That Brent might sell at a premium over WTI is not a new phenomenon. However, the magnitude as well as the duration of the current episode raises questions about the causes of this new 'reality' and whether the weakening of WTI and strengthening of Brent prices are temporary or permanent phenomena.

This report has long noted the combination of rising Canadian and onshore US crude supplies into Cushing, sluggish US demand recovery after the recession and bottlenecks facing the shipment of crude from Cushing to the Gulf Coast refining hub. This has led to a record increase in stock levels in Cushing, thereby depressing WTI crude prices, especially in the front end of the futures curve. At the same time, lower supplies from the North Sea, the loss of Libyan crude and rising demand from large emerging market economies, especially in China, have exerted upward pressure on the price of Brent crude oil. In addition,  given its ready access to seaborne markets, Brent crude  has gained more acceptance as a global oil benchmark.

Some argue that physical supply and demand cannot explain the magnitude and the duration of divergence between Brent and WTI crude oil prices due to a simple economic principle: arbitrage. The arbitrage principle suggests that if goods are close subsitutes and easily transported, then they should sell for a similar price. Since the transportation costs from Cushing to the Gulf of Mexico is not more than $10/bbl, and carry from the Gulf of Mexico to Europe costs an additional $3-4/bbl, a spread above $15/bbl should not be sustainable. The suggested conclusion is that, aside from physical demand and supply considerations, financial factors might have played some role in widening the spread between Brent and WTI crude oil prices.

There are basically two arguments as to how financial markets could play a role in widening the spread. In the first place, it is argued that, amid anticipation of rules on hard position limits by the CFTC, some speculators and commodity index dealers may have migrated from New York (Nymex) to London (ICE) in order to avoid such position limits. However, open interest data published by CFTC and ICE Europe do not support this hypothesis. Open interest in CME NYMEX WTI contracts has risen by 3.5% since January. Open interest in both ICE WTI and Brent contracts declined by 20% and 7% in the same period, respectively. Although data on speculators' positions on Brent crude oil became available too recently (June 2011) to allow for comparisions, evidence from the ICE WTI contract suggests that the overall positions of speculators and swap dealers declined between January and July.

The second hypothesis is related to changes in the structure of the forward curve for Brent and WTI crudes. Up until December 2010, both WTI and Brent were in deep contango. However, starting last December, the Brent forward curve displayed a steep backwardation, while the WTI curve has stayed in contango. One of the components of the returns in total-return commodity index investments is the roll yield, which is generated by the rolling of expiring nearby futures into the first-deferred contracts. Depending on whether the forward curve is in contango (when longer-dated futures prices are higher than nearby contracts) or, in backwardation (when nearby prices are higher than longer-dated futures prices), the roll yield is either negative (in contango) or positive (in backwardation). All other things equal, and assuming flexibility to switch positions across Brent and WTI, investment by commodity index traders in Brent contracts relative to WTI futures contracts should be expected to have increased since December due to a more positive roll yield in Brent. This shift should also be reinforced by the increase in the share of Brent and decline in the share of WTI crude oil in commodity indices. However, empirical evidence on the role of commodity index traders on prices is mixed; therefore further study is needed to assess the role of index funds on widening the spread.

At the same time,  many market observers disagree  with the notion that massive WTI-Brent spread necessarily imply a violation of the arbitrage principle. In the first place, those commentators argue that Brent and WTI,

although close substitutes, cannot be directly interchangeable due to different gravity and sulphur content, not to mention restrictions on US crude exports. Second, there is not enough capacity to move oil from Cushing to the Gulf Coast. This last fact suggests that, until we see improvements in the transportation infrastructure from the Midwest to the Gulf, which might be available from 2013 onwards, WTI may continue to trade at well below its historical relative value. Pronounced WTI discounts may primarily be a physical phenomenon after all.  

Spot Crude Oil Prices

Spot crude oil prices were volatile over the course of June in response to conflicting market drivers, with benchmark crudes trading in a wide $9-15/bbl range at times. Spot prices trended higher in early June as concern mounted over the loss of Libyan and North Sea output at a time when refiners were starting to return from seasonal turnarounds and heading into the relatively stronger third quarter demand period. Later in the month, euro zone debt worries and fears of oversupply following the IEA's Libya Collective Action market pressured prices lower. By early July, however, prices again moved up on supply outages in the North Sea, as well as in Yemen, Canada, and Argentina. Indeed, total non-OPEC supply outages totalled nearly 700 kb/d in 2Q11 and similar shut-in volumes are forecast for 3Q11 (see Non-OPEC Supply).

Prices ended lower on average in June, with WTI posting the largest monthly decrease, off $5/bbl to an average $96.21/bbl. Highly-prized light, sweet Malaysian Tapis crude fell by $2.12/bbl, to $119.32/bbl. By contrast, North Sea Dated Brent and Dubai were off a much smaller $0.50-0.60/bbl on average in June, to $114.04/bbl and $107.77/bbl, respectively.



Traditional price spreads went awry as traders digested the impact of the IEA stock release on global, and especially regional, markets. In the US, the successful sale of just over 30 mb of light, sweet crude from the SPR triggered downward pressure on LLS as well as sharp swings in some domestic crude spreads. Pre-SPR sale, the LLS-WTI price spread averaged $17.80/bbl but then quickly narrowed to $14.50/bbl by the last week in June. The unexpected injection of more US domestic light-sweet crude also led to a weakening of African grades as sellers turned to Europe and Asia to offload supplies. 



Moreover, pricier Dated Brent crude initially led to a record widening of its premium over WTI, to $23.71/bbl on 13 June, but post-SPR sale the spread narrowed again to around $15/bbl. However, renewed concern about lower North Sea output saw the spread widen once more on 8 July to $21.50/bbl (see 'Is WTI Weakness Purely Physical?').

With the US awash with light, sweet crude—or soon to be so in July and August following the SPR sale—African grades are now moving to Europe instead. US buying interest in relatively more expensive light crudes was already curtailed in June as more sophisticated refineries capable of running sour, heavier grades came back online.

Adding further complexity, despite inflated prices for Brent, prices for competing European and African crudes weakened, which also helped narrow the sweet-sour spread. The influx of competing grades also added downward pressure on Azeri crude— hitherto a preferred replacement for lost Libyan grades. A smaller Russian export programme for July, however, helped narrow price differentials to Brent in the Mediterranean.



The Brent/Dubai spread, a barometer of the premium for light sweet grades over heavy sour supplies and a benchmark for moving Atlantic basin crudes eastward, widened on average in June, to -$6.27/bbl compared with -$6.18/bbl in May. However, this masked the overall narrowing trend after the stock release. The Brent/Dubai spread reached a monthly high of -$9.27/bbl on June 14 and then plummeted to a low of -$1.60/bbl on 23 June . By end June, the spread was running at -$4-5/bbl but widened again to over -$7/bbl in early July on expectations of increased Mideast supplies.



Spot Product Prices

A weaker light end of the barrel saw product cracks falling in June, whereas middle distillates crack spreads gained slightly. The largest improvement was at the bottom of the barrel with fuel oil discounts narrowing in June, albeit they widened again at the beginning of July. Falling crude prices throughout June generally supported product crack spreads, but a sharp increase in crude prices in the beginning of July again pressured product crack spreads lower.



Gasoline crack spreads fell month-on-month in all main regions from the elevated, if volatile levels seen in May. On the US Gulf, crack spreads for Mars fell from an average of $20.2/bbl in May, moving mostly in a $10-14/bbl range in June, and within a higher $25-30/bbl range at the East Coast for WTI. Cracks were, however, supported by a closed arbitrage from Europe and high exports to Latin America. European gasoline crack spreads on the other hand continued to fall in early June due to increased refinery runs and the closed arbitrage, resulting in higher stocks. Nonetheless, gasoline crack spreads improved from around mid-month as product prices lagged a decrease in crude prices. A larger-than-expected draw in US gasoline stocks at end-month gave further support to the gasoline crack spreads in all major regions.

After posting a record-low discount mid-month, naphtha crack spreads improved in second-half of June. Crack spreads have been depressed due to weaker petrochemical demand in addition to low gasoline blending demand, but have now improved again with seasonally stronger gasoline markets.



Middle distillate crack spreads improved month-on-month in all regions, with the largest increase seen in the US, where the heating oil crack spread (vs. WTI) in June increased by $5.5/bbl vs. May. High export demand and the fear of a tightening market ahead were among factors pushing the distillate cracks higher in the US. In Europe, seasonally higher demand for diesel supported prices, together with strong desulphurisation demand, whereas Asian distillate cracks improved on the expectations of high Chinese diesel demand this summer.

Low-sulphur fuel oil crack spreads saw large improvements month-on-month in all regions, supported by high Asian demand. The Singapore LSWR (vs. Dubai) spread was pushed into positive territory in June, averaging $1.2/bbl vs. a discount of $4.2/bbl in May. Also high-sulphur fuel oil crack spreads improved, but the gains were more muted than for low-sulphur fuel oils as refineries have been running more heavy and sour crudes lately.



Refining Margins

Refining margins declined month-on-month in June in all regions except China and simple refineries in Singapore. Weak middle distillates crack spreads and high fuel oil discounts in the beginning of the month weighed on margins, together with weak gasoline crack spreads in Europe.



Although margins were weaker month-on-month, in general they strengthened towards month-end as most product cracks improved on higher demand and somewhat lower stock levels, in particular for gasoline. Moving into July, margins fell again as product prices lagged behind an increase in crude prices. Refining margins in Europe were still at depressed levels and fell further month-on-month in June, but trended upwards in the second half of the month. Urals hydroskimming margins were unchanged month-on-month as the fuel oil discount narrowed but the average calculated loss was still above $5/bbl. In the Mediterranean, notional Es Sider hydroskimming margins showed a small improvement as the market now looks less tight for light, sweet crudes as well as the narrowing discounts for fuel oils.



US Gulf refining margins all fell in June, losing $1.00-2.60/bbl compared with May, with the exception of LLS cracking margins, which were unchanged month-on-month after crude economics improved on the narrowing premiums for light sweet crudes in the second half of the month. The main reason for the fall was weaker gasoline product cracks in June compared with the very high gasoline prices seen in early May. Also on the US West Coast, refining margins fell on average in June. Kern cracking margins improved, however, as the high fuel oil yields from this crude helped increase refined value.

In Asia, refining margins at simple refineries improved slightly on average in June, whereas margins at more complex units weakened. Narrowing fuel oil discounts supported the hydroskimming margins, together with a lower premium for Tapis towards the end of the month. Weaker gasoline crack spreads in June compared with May are among the factors behind the decrease in hydrocracking margins. In China, calculated refining margins mostly improved in June supported by a strong LSWR price.

End-User Product Prices in June

End-user prices in selected IEA countries declined in May and June, after rising the previous five months. In part, retail prices were affected by relatively lower crude oil prices, but also by a more 'stable' US dollar during 2Q11. May and June saw a reversal in the depreciation of the US dollar compared to previous months. This helps explain the change of trend in end-user prices, in US dollars ex-tax, during the period.



Gasoline prices fell by 1.1% in May and by 3.9% in June, nonetheless they are now 39% above year ago levels.  Diesel prices decreased by 2.7% and 1.7% in May and June, respectively, while the annual increase is a hefty 41.3%. With respect to the remaining surveyed products, heating oil contracted by 0.9% and low-sulphur fuel oil (LSFO) increased by 1.6% in June. On a yearly basis, heating oil rose by 41.2% and LSFO by 50%.

The strongest decline in gasoline and diesel prices occurred in the US, down by 7.2% and 3.9%, respectively. The Euro-zone also saw diminishing prices for gasoline especially in Germany (4.9%) and France (3.4%), while diesel had a sizable decrease only in Italy (1.5%). Heating oil end-user prices fell in all surveyed countries, but plummeted in Canada by 3.8% in June. LSFO prices saw mixed movements across countries, gaining value in France (2.5%) and Germany (3.4%), but falling in Spain (1.1%) and Japan (2.10%). 

Freight

Benchmark crude tanker rates remained depressed throughout June due to soft fundamentals and despite signs of rising OPEC supply. The Middle East Gulf - Japan VLCC rate has remained at close to, or below, break-even levels for much of the past three months due to a combination of relatively high bunker fuel prices, sluggish demand and swelling tonnage. Some upward momentum was generated in June on the back of increased demand, although the swollen fleet easily absorbed this and consequently rates soon fell back down to below their early-month levels by month-end. Rates on the North Sea - Northwest Europe Aframax route have remained stagnant since early-May, hovering close to $6/mt. With the upward momentum from May's firming dissipating, rates on the Suezmax West Africa - US Atlantic coast voyage languished below $12/mt for much of June on low enquiries and plentiful vessel availability. Reports suggest that most owners are trying to buttress rates above break-even levels by slow steaming, which has the benefit of reducing bunker fuel consumption and tying up vessels for longer. Unless there is an uptick in tanker demand in 2H11 this trend is likely to continue.



In contrast to stagnant crude tanker markets, rates for product tankers have been relatively volatile over the past couple of months. After sustained firming for much of 2011 to reach a post-2008 record level of $32/mt in early-May, rates on the benchmark UK - Atlantic Coast route plummeted back to $18/mt by early-June. This crash was provoked by waning US demand for imported gasoline after US refinery output ramped up in response to a rapidly improving gasoline crack. It was further precipitated by swelling tonnage previously attracted into the market. Rates recovered some ground by late June, but again fell back in early-July. The high US gasoline crack was also behind the fall in the Caribbean - US Atlantic Coast rates over the same period. The only route that has remained relatively stable throughout the past couple of months is Southeast Asia - Japan; after firming by approximately $3/mt in early-April rates have generally held their gains, trending close to $17/mt.

Short-term floating storage of crude and products stood at 54.4 mb at end-June, a fall of 1.7 mb from May as crude fell by 2.1 mb offsetting a 0.4 mb rise in products. The fall in crude was led by a 4.4 mb fall in Iranian storage, and indeed these volumes located in the Middle East Gulf have now fallen by a significant 8.8 mb since end-April and are now approximately half of their record high reached in May 2010. Elsewhere, crude built by 2.3 mb in the US Gulf. When long-term floating storage is also taken into account, volumes have receded back in line with the 5-year average and are now 44 mb below last year's level. Products built by 2.4 mb in Asia-Pacific, which offset falls in the Mediterranean (0.7 mb) and West Africa (1.3 mb). The storage fleet now numbers 36 vessels, having come down by eight, largely Aframax and Panamax sized vessels since end-April as a result of products coming ashore.

Refining

Summary

  • Global refinery throughputs are forecast to increase by 2.3 mb/d from 2Q11 to 3Q11, to reach 75.9 mb/d to meet seasonally higher oil product demand. Refinery maintenance falls sharply from May onwards, and slightly better margins evident in recent weeks could support runs further. Annual growth in throughput has, however, slowed in line with demand patterns, from 2.2 mb/d on average in the previous four quarters to -50 kb/d in 2Q11 and 480 kb/d in 3Q11.
  • 2Q11 global refinery runs are estimated to have averaged 73.6 mb/d, down 945 kb/d from 1Q11 and slipping below year-ago levels on a quarterly basis for the first time since 4Q09. The loss of Libyan crude supplies and refining capacity as well as lower runs in Japan due to earthquake damage amplified normal seasonal maintenance shutdowns. Poor margins further cut runs in some regions.
  • OECD crude runs increased marginally in May, to 35.28 mb/d, from 35.21 mb/d in April, the season's low point. Improved utilisation rates in Europe and slightly stronger North American throughputs were mostly offset by lower Pacific runs, as refiners there extended maintenance shutdowns. OECD runs are estimated sharply higher from June onwards, reaching a high of 37.5 mb/d in August, as both US and Japanese refiners complete scheduled turnarounds, while European runs are seen climbing on seasonally stronger demand and slightly improved economics.
  • OECD refinery yields increased for gasoline and 'other products', and fell for all other product categories in April. OECD gasoline yields increased 0.36 percentage points (pp) mostly due to a higher share in Europe. Yields are, however, still below the five-year range. OECD gasoil/diesel yields have been trending downward so far this year, and fell further by 0.6 pp in April. Declines in both OECD North America and Europe offset an increase in the Pacific.


Global Refinery Overview

Global refinery crude throughput estimates for 2Q11 are unchanged overall from last month's report, at 73.6 mb/d. Lower submissions by OECD Europe for April and May were offset by higher-than-expected runs in the OECD Pacific and several non-OECD countries. The exceptionally weak 2Q11 levels, which were almost 1 mb/d lower than 1Q11, and below year-earlier levels for the first time since 4Q09, resulted from a variety of factors. In addition to the traditional 2Q seasonal peak in refinery maintenance and lull in oil product demand, the earthquake that hit Japan in March of this year and the Libya crisis significantly affected global refinery operations. While Japanese crude throughputs surprised to the upside in June, recovering to last year's level earlier than expected, two refineries remain closed due to damage sustained in the disaster. The Libyan crisis not only cut off crude supplies to regular customers in Europe and elsewhere, it also saw the country's own refining industry grind to an almost complete halt, creating serious product supply shortages. Furthermore, the normal ramp-up in US runs was delayed this year, and throughputs only caught up to year-earlier levels by late May. Operational problems and shutdowns related to power outages and flooding on the Gulf Coast were partly responsible.



As a result of the exceptionally weak 2Q11 throughputs, global refinery runs are expected to see a sharper increase in 3Q than normally. We have revised down 3Q11 estimates by 240 kb/d since last month's report, mainly on a weaker outlook for OECD Europe and North America, but nevertheless see a quarterly increase of close to 2.3 mb/d. This compares to normal 2Q/3Q increases ranging from 1.1 mb/d to 1.7 mb/d; 3Q11 runs are now estimated at 75.9 mb/d, 480 kb/d above the same quarter in 2010.

Higher 3Q throughputs may be easier to sustain now that evidence has begun to emerge of incremental supplies from major OPEC producers, even though pricing terms so far look less than aggressive. Refiners should also find a rather more liquid market in light sweet crude following the IEA collective action announced on 23 June. Lower obligations on stock holding, moreover, allow for some extra operational flexibility.



OECD Refinery Throughput

Preliminary data show that OECD crude throughputs nudged higher in May to average 35.3 mb/d, 70 mb/d more than in April but a full 1.0 mb/d below the same month last year. Exceptionally weak runs in Japan, whose refining industry was devastated by an earthquake and tsunami in late March, and sharply lower runs year-on-year in the US were the key factors behind the slowdown. Total OECD runs were in line with our previous forecast overall, as disappointing European throughputs were offset by higher-than-expected run rates in South Korea. While European runs were some 200 kb/d lower than expected in May (and revised 280 kb/d lower for April), they nevertheless rebounded by 360 kb/d month-on-month to equal last year's levels. 



Preliminary data show that OECD runs rose sharply in June, potentially by as much as 1.0 mb/d. US refiners increased crude processed by more than 500 kb/d to regain year-earlier levels mid-month, while Japanese runs rebounded earlier than expected from maintenance lows. While no data was available for European runs for June at the time of writing, these are forecast to have risen by a further 360 kb/d in the month to meet seasonally higher demand. In 3Q11, OECD runs are expected to remain higher overall, despite dipping again in September, after the peak driving season is over and autumn turnarounds commence.



US refinery runs finally recovered to year-earlier levels in mid-June, averaging 15.2 mb/d for the month, some 500 kb/d above May and 870 kb/d above April's monthly low (compared with revised monthly data). Early month, the most significant increase came from refiners in the Midwest (PADD 2), which ramped up runs to their highest level ever (3.59 mb/d in the week ending 17 June). Runs fell sharply in the last week, however, as Lima refining shut a crude unit at its 155 kb/d Ohio refinery and ConocoPhillips' 306 kb/d Wood River refinery had to run at reduced rates due to a 25 June power disruption. PADD 5 runs also gained some 200 kb/d from the previous month, as BP's Cherry Point and Conoco's Wilmington plants returned after scheduled maintenance.



In PADD 1, on the US East Coast, PBF reported flaring related to start-up operations in early June of its 180 kb/d Delaware City refinery. The plant had been closed since November 2009, when previous owner Valero shut it due to poor margins. Refiners on the US Gulf saw smaller gains month-on-month, although increased steadily through early July, and reduced their deficit to year-earlier levels from 530 kb/d in April, and 180 kb/d in May, to only 10 kb/d on average in June.



The submissions of official monthly data for April and preliminary data for May led to downward revisions of 280 kb/d and 210 kb/d, respectively, for total OECD European crude runs. April's revision was almost entirely due to reduced runs in the Netherlands, which fell to 0.8 mb/d, the lowest levels since 1990. The 280 kb/d monthly decline came as BP's Rotterdam and Shell's Pernis refineries both underwent work, while ExxonMobil had to shut its Rotterdam plant for some days due to a fire. April now appears as the lowest point of the season, despite maintenance work estimated to have peaked in March, due to weak margins and some supply difficulties due to the Libyan outage.

May data, while lower than expected, still showed a monthly increase of 360 kb/d from April's low. While a large part of the increase followed a rebound in Dutch operations, French refinery runs also showed some improvement. Belgium's refinery operations in May were hampered by the prolonged maintenance at Total's Antwerp refinery. The plant is the company's largest and most complex, and Europe's second largest by size. The extent of the work at the 360 kb/d refinery is not known, but we assume one of the plant's two CDUs was offline for all of May and a few days in June.

Repsol's 220 kb/d Bilbao refinery in Spain halted operations in June due to a strike. The expansion of the company's Cartagena refinery to double production capacity to 220 kb/d is scheduled for completion in 4Q2011. The upgrade will also significantly cut Spain's import needs of diesel and kerosene, as 50% of the output of the expanded plant will be middle distillates and especially diesel. Company officials have also stated that after the upgrade the refinery will be able to process up to 76% of cheaper heavy crudes, up from 4% at present. In the UK, reports were that Total had successfully restarted a 110 kb/d crude unit at its Lindsey refinery in early July. The unit had been closed since June 2010 due to damage sustained in a fire.



OECD Pacific refinery crude runs have been revised higher for both May and June since last month's report, by 200 kb/d and 150 kb/d respectively. In May, preliminary monthly data for South Korea were again stronger than anticipated, at 2.5 mb/d. Both runs and product exports declined slightly month-on-month in May, by 1.1% and 2.5% respectively, according to data released by state-run Korea National Oil Corporation. A partial shutdown of GS Caltex's heavy oil upgrading units in June reduced diesel output and led the company to ask for an emergency supply of 870 kb from the government's strategic stocks. Caltex was forced to shut a 60 kb/d vacuum residue hydrocracker for an estimated two weeks in June as well as a 70 kb/d desulphurisation units for a few days, impacting upon diesel supplies at a time of rising demand (ahead of a planned price increase in July).



Weekly data from the Petroleum Association of Japan (PAJ) show that Japanese refinery throughputs rebounded from seasonal lows earlier than expected and had surpassed 3 mb/d in the week ending 18 June. As a result, June totals were revised up by more than 200 kb/d compared to our previous expectations. JX Nippon successfully restarted the 190 kb/d crude distillation unit at its 250 kb/d Kashima refinery on 4 June and the 63 kb/d condensate splitter by mid-month, despite the continued closure of the VLCC berth at the refinery. The company was allowed to use 1.9 mb of strategic stocks stored at the plant, while allocating the same volume of crude stored at its Kire crude import terminal in the south of the country. JX has announced it plans to operate the plant at 60% utilisation until autumn when it expects damaged facilities, including the VLCC berth, to be restored. Two refineries, with a combined capacity of 365 kb/d, remain closed due to damage sustained during the earthquake and tsunami.

Refinery Capacity Investments Back with a Boom in 2012

After a lull in global refinery capacity additions in 2011, 2012 is expected to see a slew of refinery projects completed, with possibly as much as 2.4 mb/d of crude distillation capacity being added globally. The largest share of investments are still coming from non-OECD Asia, led by China in particular, which is seen adding almost 600 kb/d, or 25% of the total. Interestingly, however, after three years of net capacity reductions in the OECD, 2012 reverses this trend with significant expansions coming on-line in North America in particular.

As outlined in the 2011 Medium Term Oil and Gas Markets report, 2011 provided some respite for the global refinery industry, with only 400 kb/d of distillation capacity added globally. Compared with demand growth currently pegged at 1.2 mb/d for the year, surplus capacity should shrink, providing a somewhat better margin environment for the industry as a whole. Net decline in the OECD, where more than 500 kb/d of capacity was permanently shut in 2011 (-430 kb/d net reduction), offset additions in the non-OECD of some 840 kb/d.

Non-OECD additions in 2011 were dominated by India, which alone accounted for some 400 kb/d. The expected commissioning of Bharat Oman's 120 kb/d Bina refinery and HPCL/Mittal's 180 kb/d Bathinda plant in 3Q11, augmented by an 80 kb/d expansion of Essar's Vadinar refinery in 4Q11 are among key projects. After several years of impressive capacity growth in China, only smaller expansion projects reach completion in 2011. The participation of China National Petroleum Corp. (CNPC) in overseas markets paid off for Chad, however, which started up its first refinery in July 2011, a 20 kb/d plant outside N'Djamena. 



In 2012, however, the IEA expects a massive 2.4 mb/d of crude distillation capacity to be added worldwide. China features again on top of the list, with almost 600 kb/d of net additions expected on line. Key projects include CNPC's 200 kb/d Pengzhou and Yinchuan projects and Sinopec's Beihai, Jinling and Shijiazhuang expansions. India is expected to add a further 240 kb/d, while the expansion of Pakistan's Karachi refinery could add 130 kb/d (if recent financing problems are resolved). While the IEA sees other projects in Iran being challenged by international sanctions and financing problems, we expect the expansion of Iran's Arak refinery from 170 kb/d to 250 kb/d to be completed in 2012. The 100 kb/d expansion of Sudan's Khartoum refinery, also financed by China's CNPC, is expected to be completed next year, albeit questions hang over crude supply from newly independent Southern Sudan.

North American capacity could rise by more than 0.5 mb/d next year, as Mexico's much delayed Minatitlan expansion (150 kb/d) is expected to come on line, and Motiva's Port Arthur refinery on the US Gulf Coast is expanded by a massive 325 kb/d to become the largest refinery in the US and one of the top 10 in the world. Few refinery closures are scheduled for next year, and so far the IEA is including only Shell's Harburg refinery in Germany and its Clyde refinery in Australia.

Non-OECD Refinery Throughput

Non-OECD refinery runs are forecast to rise from 38.0 mb/d in 2Q11 to 38.9 mb/d on average in 3Q11, mainly on higher Middle Eastern, Other Asian and Russian throughputs. The inclusion of some consolidated historical data for a number of countries has lowered the 2006-2009 estimates by 100 kb/d on average with adjustments partly carried through the forecast. Spring maintenance in main non-OECD countries and outages seen in 2Q11, led to a dip in runs from 38.8 mb/d in January to only 37.4 mb/d in April. The completion of work and the commissioning of some new capacity are expected to take runs back to 38.9 mb/d in July and August when seasonal summer demand is at its highest.



Chinese refinery runs for May averaged 9.1 mb/d, 55 kb/d higher than our previous forecast. Throughputs are expected to decline slightly over June and July, as several refineries undertake maintenance. Refiners cut crude imports in May by some 200 kb/d from April in anticipation of lower run rates. Crude imports in June fell 5.5% month on month, to 4.8 mb/d. The government abolished import duties on jet fuel and gasoil and import duties on gasoline were lowered from 5% to 1%, while fuel oil import duties were cut from 6% to 1% from 1 July on concerns over potential supply shortages in the summer.



Indian crude throughputs are estimated to have averaged 4.0 mb/d in May, largely unchanged from April but some 160 kb/d above a year earlier. The Indian Prime Minister officially opened the 120 kb/d Bina refinery in May. Although the refinery is not included in May Ministry data, operations should start soon. The Ministry said in a statement in July that India's state refiners are now losing 2.4 billion rupees ($54.3 million) a day on sales of diesel, kerosene and cooking gas at regulated prices, less than half the 4.9 billion rupees they were losing daily before prices were raised late June. India's state refiners are compensated for some of their losses through cash subsidies or bonds from the government, and through discounts on their crude purchases from India's upstream players.

Indonesia's April throughputs were very weak, at around 600 kb/d, compared to levels of 800 kb/d normally (and 80 kb/d lower than our estimate). The explosion and fire at the Cilacap refinery on 2 April, thought to have been operating at 350 kb/d before the blast, forced the plant to shut for some 10 days. Pakistan reportedly had to boost imports of gasoline in June after three of the country's five refineries closed. Attock's Morgah plant had to shut, as did National Refinery Limited's Karachi refinery and Byco's Balochistan plant. It is not clear how many days the shutdowns lasted. In Vietnam, the country's sole Dung Quat refinery will remain closed for two months starting in mid-July, according to the operator. Vietnam has stopped reporting monthly data to JODI since October 2010.

Middle Eastern crude throughput estimates are largely unchanged from previous reports, despite the incorporation of some annual data and an upward adjustment to UAE runs, which previously included only Abu Dhabi crude and some condensates. Regional runs are now seen rising from 5.6 mb/d in May to 6.0 mb/d in June and 6.2 mb/d in July, on higher Saudi Arabian and Kuwaiti runs. The restart of the 400 kb/d PetroRabigh in Saudi Arabia, after a six-week full shutdown in June is underpinning the sharp increase in Saudi domestic crude demand, and together with seasonal increases in crude oil direct burn (see Saudi Arabia's Power from Crude in the demand section), is absorbing a significant part of recent Saudi production increases. Kuwait's 190 kb/d Shuaiba refinery was ramping up production in May, after a month-long maintenance shutdown. In Yemen, the 130 kb/d Aden refinery restarted on 20 June after receiving a donation of Arab Light crude from Saudi Arabia. The refinery had to close, as output of Yemeni Light Marib crude was shuttered after an attack on the main pipeline in March.



FSU refinery crude runs estimates for 2Q11 and 3Q11 are largely unchanged since last month's report, at 6.3 mb/d and 6.5 mb/d respectively. Russian crude runs were nevertheless some 170 kb/d higher than expected in May, at 5.1 mb/d, up from 4.94 mb/d in April and 4.78 mb/d in May last year. Revisions to historical estimates based on annual data were minimal, taking 2009 estimates only 25 kb/d lower.



In Africa, regional runs are still low following the near complete shut down of refinery operations in Libya due to lack of crude or damage to facilities. According to news reports, Libya's 120 kb/d Azzawiya refinery near Tripoli had to halt operations in mid-June as rebels cut off the crude supply pipeline to the plant. Also the 20 kb/d Tobruk refinery sustained damage and had to halt operations for an estimated two weeks in June, cutting off gasoline supplies to rebel forces fighting the Gaddafi regime. The country's largest refinery in Ras Lanuf has been shut since late February. It looks likely that all of the country's refineries are out of operation at the moment. Chad's first refinery, a Chinese-funded plant outside of N'Djamena, started operating in late June. The plant has an initial capacity of 20 kb/d, but could be expanded to 50 or 60 kb/d at a later stage.

OECD Refinery Yields

OECD refinery yields increased for gasoline and other products, and fell for all other product categories in April. OECD gasoline yields increased by 0.4 percentage points (pp), mostly on account of higher European gasoline yields. Yields are however still below the five-year range. In OECD North America, yields were almost unchanged vs. March, and are now slightly above last year's level. OECD Pacific yields increased somewhat as well, and in April stood at the five-year average. OECD gasoil/diesel yields have been trending downward so far this year, and fell further by 0.6 pp in April. Declines in both OECD North America and Europe offset an increase in the Pacific. OECD gross refinery output in April fell by 440 kb/d compared with March, and was almost 2 mb/d lower than the five-year average amid exceptionally low runs in both OECD North America and Europe.



In OECD North America, gasoline yields increased slightly, ramping up for the summer driving season, whereas gasoil/diesel yields declined by 1.0 pp, partly reflecting weaker product cracks for middle distillates. Refineries in OECD Europe increased gasoline yields in April at the expense of both naphtha and gasoil/diesel. Gasoline yields are however low both compared to last year's level and the five-year average, standing 0.3 pp and 0.8 pp below, respectively. Naphtha yields fell in line with seasonal trends. In the OECD Pacific, gasoil/diesel yields increased by 0.6 pp in April, as demand was strong and a tightening market pushed product cracks higher.