Oil Market Report: 10 August 2011

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Highlights

  • Marker crude prices have lost $12-$15/bbl since early-August amid growing concerns over government debt and the likely impact on the global economy. At writing, Brent and WTI futures stood at $103/bbl and $80/bbl respectively. This follows July's relative calm, when crude rose by $1-$3/bbl, accompanied by modest gains in refining margins.
  • Global 2011 oil demand is trimmed by 0.1 mb/d on weaker baseline and 2Q11 data, high prices and slowing economic growth. The 2012 outlook is raised by 0.1 mb/d due to oil-fired power needs in Japan. Demand averages 89.5 mb/d in 2011 (+1.4% or 1.2 mb/d y-o-y) and 91.1 mb/d in 2012 (+1.8% or 1.6 mb/d). A lower GDP case would cut 0.3 mb/d and 1.3 mb/d respectively from 2011 and 2012 demand.
  • World oil supply in July rose by 0.6 mb/d from June, to 88.7 mb/d, with non-OPEC production up by 0.4 mb/d. Rising Canadian production offset lower UK production. Non-OPEC supply is now seen averaging a lower 53 mb/d in 2011 on prolonged production outages, rising to 54 mb/d in 2012.
  • OPEC crude supply in July averaged 30.05 mb/d, up by 0.1 mb/d from June. Output has regained levels close to those seen before the Libyan crisis, although OPEC spare capacity now stands at only 3.3 mb/d. Output still lags a 'call on OPEC crude and stock change' that averages 31 mb/d in 2H11 and 30.8 mb/d for 2012.
  • June OECD industry oil inventories fell counter-seasonally by 11.8 mb to 2 678 mb, or 58.4 days of forward demand. The surplus to the five-year average narrowed significantly, from 18.2 mb in May to 4.7 mb in June. Preliminary July data suggest an 18.5 mb gain in onshore OECD inventories, but floating storage fell.
  • Global refinery crude runs for 2Q2011 have been raised by 0.1 mb/d since last month, as surging Russian June throughputs offset weaker-than-expected Chinese runs. 3Q11 estimates are unchanged, up 2.2 mb/d from 2Q11, at 75.9 mb/d, as stronger expected OECD runs counteract a weaker picture for non-OECD Asia.

Summer on the big dipper

Crude oil prices have plunged for the third time in three months, reviving all the old clichés about roller-coaster volatility. In passing, we note that just as a certain asymmetry in pump prices is often remarked upon, so too policy makers seem rather less concerned with price volatility when it is to the downside (although arguably there are bigger problems to worry about with financial meltdown on the horizon). Brent and WTI futures at the time of writing are flirting with lows near $100/bbl and $80/bbl respectively. Brent at $125/bbl back in late-April seems a long time ago. Concerns over debt levels in Europe and the US, and signs of slowing economic growth in China and India have spooked the market and raised fears in some quarters of a double-dip recession. From an oil market standpoint, perceived wisdom is that this must inevitably mean weaker oil demand to come. With extra crude volumes now hitting the market after OPEC boosted supply and the IEA released emergency stocks, this has been sufficient to sharply weaken prices. Lower energy input costs are well and good, but not if they are achieved at the cost of another economic crisis. Arguably, political paralysis has played a greater role in the current situation than has the financial sector. Either way, earlier bullish oil market prognoses are being hastily re-examined.

Our own base case demand trend remains remarkably unscathed, partly since our view of 2011 demand growth was already below that of some of our peers. That said, our global 2011/2012 GDP growth assumption in excess of 4% might seem optimistic in the present climate. Downward adjustments to recent US and Chinese demand data carry forward through 2012. But there are inter-fuel substitution offsets, notably in Japan. Our analysis suggests Japanese nuclear outages will see oil-burn for power generation in 2011 and 2012 around 250 kb/d higher than normal, and higher than first thought when the Fukushima disaster struck in March. However, recognising emerging economic storm clouds, we also run a lower, 3% global GDP growth scenario, which more than halves base case 2012 oil demand growth to only 0.6 mb/d. Such an outcome could conceivably push the 'call on OPEC crude and stock change' below 30 mb/d, all other things being equal.

Of course, only in forecasters' imaginations are all things ever equal. The unforeseeable 1.5 mb/d Libyan supply disruption rumbles on. Non-OPEC supply remains prone to unexpected outages. OECD industry stocks, despite a potential top-up in August from rising OPEC supply, SPR oil and renewed market contango, now look tighter at around five-year averages, and could go lower still if the near-700 kb/d of current non-OPEC outages proves deeper or more prolonged than we assume here. Aside from UK field problems, political instability in a number of MENA and sub-Saharan African oil producers also risks curtailing supply further in the next 18 months. And although higher prompt OPEC supply is welcome in the face of seasonally rising demand, it has inevitably curbed OPEC spare capacity, down now to 3.3 mb/d, fairly meagre in comparison to the totality of currently perceived supply-side risks.

The above caveats to currently bearish market sentiment explain why we will continue closely monitoring the market this summer, with emergency data reporting by IEA member governments ongoing in August and September. The IEA did not extend the original 60 mb collective action during its 30-day review in late-July, with most SPR barrels from the initial phase still reaching the market in August. But nor was the action formally terminated. By September, market direction may be clearer if the economic outlook itself has become more clear-cut. The so-far benign Atlantic hurricane season has largely spared US Gulf and Mexican energy infrastructure. Then again, August has a habit of springing both geopolitical and meteorological surprises, so the big dipper ride may still have further to run. 

Demand

Summary

  • Forecast global oil demand is trimmed by 60 kb/d for 2011 and raised by 70 kb/d for 2012. Adjustments to this year's forecast stem largely from lower-than-expected 2Q11 and 3Q11 demand readings amid the sustained pressure of high oil prices and increased evidence of economic slow-down. Higher expectations for oil-fired power generation in Japan, however, provide a boost to 4Q11 and 2012 demand. Overall, global oil demand is expected to average 89.5 mb/d in 2011 (+1.4% or +1.2 mb/d year-on-year), rising to 91.1 mb/d in 2012 (+1.8% or +1.6 mb/d year-on-year).


  • Projected decline in OECD oil demand moderates by 40 kb/d for 2011 and by 80 kb/d for 2012 to -340 kb/d and -40 kb/d, respectively. Increased requirements for oil-fired generation in Japan amid widespread nuclear outages outweigh downward revisions to US demand. With the incorporation of annual data from the US, OECD demand for 2010 is revised down by 50 kb/d to 46.2 mb/d. OECD demand is now seen at 45.8 mb/d for both 2011 and 2012.
  • Forecast non-OECD demand growth for 2011 is reduced by 50 kb/d to 1.5 mb/d, largely on weaker 2Q11 readings in China and Latin America, which outweigh stronger-than-expected data from the FSU and the Middle East. Nevertheless, the consumption picture remains strong, with demand estimated at 43.7 mb/d (+3.7%) in 2011, rising to 45.3 mb/d (+3.8% or +1.6 mb/d) in 2012.
  • An economic sensitivity analysis, with GDP growth one-third lower than in the base case, would cut 0.3 mb/d from expected 2011 oil demand and 1.3 mb/d from the 2012 projection, effectively curbing global annual demand growth to 0.9 mb/d and 0.6 mb/d, respectively.

Global Overview

Sustained high oil prices and slowing economic growth have dramatically curbed global oil demand growth in recent months. In April and May, annual increases are assessed at +0.2% and +1.7%, respectively, with June growth, albeit based on preliminary data, coming in at zero. Manufacturing indicators have eased as industries have reversed some of the strong stock building that characterised the recovery in 2010, though partly due to the disruption of supply chains following Japan's earthquake and tsunami in March. Yet, larger cyclical and structural issues persist. In addition to the pressure of high oil prices, an overhang of sovereign debt and an uncertain fiscal picture in the developed world have, so far, sapped consumer confidence and prompted rigorous economic tightening. Moreover, emerging markets have begun decelerating as the lagged effects of monetary tightening in the hope of cooling inflation take hold.

We have revised down 2011 global oil demand by 60 kb/d, with weaker readings in the US and China driving the adjustment. With 2010 revised down by 50 kb/d, amid baseline data revisions to the US, global growth remains at 1.2 mb/d. Still, 2H11 growth rates, averaging 1.1% year-on-year, look relatively tepid. By contrast, the outlook for 2012 has strengthened, with demand revised up by 70 kb/d and growth now expected at 1.6 mb/d.



Given an increase in the fragility of the global economic and oil demand picture, it is worth examining the reasons for such growth. First, we continue to incorporate global GDP growth of 4.2% and 4.4% for 2011 and 2012, respectively, based on assumptions from the International Monetary Fund published in mid-June. While offering the advantages of being relatively transparent and comprehensive, these assumptions may ultimately prove too optimistic. As such, we have also run a sensitivity analysis employing lower GDP assumptions (see Downside Economic Risks Could Prompt Lower Oil Demand).

Downside Economic Risks Could Prompt Lower Oil Demand

In the wake of recent market turmoil and souring economic indicators, the potential has grown for lower-than-assumed economic growth and oil demand. Similar to the sensitivity analysis done in Medium-Term Oil and Gas Markets 2011 and in previous issues of this report, we have tested the effects on global demand should GDP growth come in around one-third lower than our base case. Economic impacts are assumed spread evenly between the OECD and non-OECD countries, but our oil price assumptions remain unchanged versus the base case.

Assuming GDP growth one-third lower than in our base case and given a half year of estimated demand data for 2011, global oil demand would be reduced by 0.3 mb/d for 2011 and by 1.3 mb/d for 2012. Because of greater income elasticity of demand, the impact of lower GDP is greatest in the non-OECD countries. Offsetting support for OECD demand would still come from our re-assessment of Japanese power needs, which imply a slightly slower pace of oil intensity reduction. Nevertheless, under a lower GDP case, global oil demand would grow by a lesser 0.9 mb/d in 2011 and by 0.6 mb/d in 2012, versus the 1.2 mb/d and 1.6 mb/d, respectively, envisaged in our base case.

Second, while demand weakness in the US now looks more entrenched, the future implications of a sharp June slowdown in Chinese demand growth are less certain. Finally, other areas provide demand offsets. Robust recent monthly data for Russia have augmented our forecast there. More notably, a reassessment of the increasingly problematic nuclear power situation in Japan has prompted significant upward revisions to oil burning in power generation there, particularly in 4Q11 and through 2012.



OECD

According to preliminary data, OECD inland deliveries (oil products supplied by refineries, pipelines and terminals) contracted by 2.2% year-on-year in June, with all regions posting losses. The heaviest declines were borne by OECD North America, where gasoline, jet fuel/kerosene and heating oil were weak. The patterns for OECD Europe and the OECD Pacific were similar. However, demand in the latter region benefitted from relatively stronger residual fuel oil and 'other products', boosted by increased use in power generation.



Revisions to May preliminary data were positive (+280 kb/d), but concentrated in the relatively volatile categories of LPG in North America and 'other products' in Europe. This moderated total OECD demand decline from -1.9% year-on-year to -1.1%. Most product categories posted annual declines, except for diesel (+4.8%), 'other products' (+2.1%) and LPG (+0.8%).



Total OECD oil product demand is revised down by 50 kb/d in 2010, but still remains at 46.2 mb/d (+1.1% or +510 kb/d year-on-year), following upward adjustments to 2010 US demand data. The prognosis for 2011 has been trimmed marginally by 10 kb/d to 45.8 mb/d (-0.7% or -340 kb/d versus the previous year), while the 2012 outlook has been raised by 80 kb/d to 45.8 mb/d (-0.1% or -40 kb/d year-on-year), largely due to stronger expectations for Japanese power sector oil use.

North America

Preliminary data show oil product demand in North America (including US territories) falling by 2.6% year-on-year in June, following a 2.3% decline in May. Serious concerns have emerged over the health of the US economy, with a downward revision to first quarter GDP growth, second quarter GDP growth (at a +1.3% annual rate) coming in less than market expectations and fuel prices remaining high. With downward baseline revisions for 2010 and July preliminary data pointing to continued weakness, our prognosis for North American demand has been cut by 70 kb/d for 2011 and 55 kb/d for 2012. Demand is now expected to fall by 225 kb/d (-0.9%) to 23.5 mb/d in 2011 and stay relatively unchanged at that level for 2012.



May revisions were light overall (+20 kb/d), though the headline number masked more significant underlying changes. LPG (+340 kb/d) saw a significant upgrade, which more than offset downward adjustments to residual fuel oil (-100 kb/d), diesel (-60 kb/d) and gasoline (-50 kb/d). With the feed-through of updated monthly-to-annual adjustment factors for the US, January-April data were revised as well, though the net overall change was close to zero. Such adjustments derived from an annual update to US baseline data, which saw 2010 revised down by 50 kb/d, with an upward adjustment to LPG (+60 kb/d) overshadowed by a decrease in gasoline (-60 kb/d) and other product categories. Notably, even with US growth for 2010 now pegged at 410 kb/d, gasoline demand - once the engine of both US and global demand growth - remained stagnant on an annual basis.



Adjusted preliminary weekly data for the United States (excluding territories) indicate that inland deliveries - a proxy of oil product demand - declined by 2.5% year-on-year in July, following a 2.8% fall in June. Deciphering the gasoline picture remains problematic given the volatility of weekly data. On the one hand, June data suggest a seasonal upswing in gasoline demand, with year-on-year declines of only 1.5%. On the other hand, July readings signal a counter-seasonal fall, with annual declines widening to 3.8%. Meanwhile, the latest available vehicle miles travelled data, as of May, indicate a year-on-year fall of 1.9%. While the precise path of the US summer driving season remains inconclusive for now, larger persistent declines on an annual basis have prompted gasoline demand downward revisions of 50 kb/d this year and 20 kb/d in 2012.

In Mexico, oil demand fell by 2.3% in June, with weakness in gasoline (-0.9%) persisting. Jet fuel/kerosene (-5.1%) and residual fuel oil (-15.4%) also posted declines. Nevertheless, diesel has grown consistently, rising by 6.0% year-on-year in June. The overall outlook for 2011 (-1.7%) and 2012 (+0.2%) is largely unchanged, but a more bearish outlook for its trading partners to the north may foreshadow forecast downside.

Europe

Preliminary inland data indicate that oil product demand growth in Europe declined by 2.0% year-on-year in June, on the back of weak deliveries of heating oil and falling gasoline. The contraction in heating oil demand likely continues to signal both structural decline and delays in consumer tank refilling in the face of high prices. Strong LPG (+6.4%) and naphtha (+3.5%), provided some offset to demand declines.



Revisions to preliminary May demand data were positive, at +160 kb/d, with stronger-than expected readings for 'other products', heating oil and diesel offsetting weaker deliveries of naphtha, gasoline and jet fuel/kerosene. Overall, our OECD Europe forecast is largely unchanged, with demand declining by 160 kb/d (-1.1%) to 14.4 mb/d in 2011 and by 80 kb/d (-0.5%) in 2012.



In June, according to preliminary data, oil product deliveries in Germany posted a decline of 3.9% year-on-year. Demand fell across all product categories but naphtha and 'other products'. Declines in diesel (-4.5%) and heating oil (-28.7%) were particularly strong. Total oil demand also fell in other major European markets in June. Demand fell by 6.3% in France, with declines in all products, except for naphtha. Spain posted a decrease of 4.9% year-on-year, with all categories falling except for jet fuel/kerosene. Meanwhile, year-on-year growth was tepid in Italy (+0.6%) and in Turkey (+0.5%), where the economy is growing relatively fast compared to European counterparts.

Pacific

Preliminary data indicate that oil product demand in the Pacific fell by 1.5% year-on-year in June. All product categories posted falls, except for diesel, residual fuel oil and 'other products', which are likely linked to Japan's post-earthquake reconstruction and increased fuel burning needs for power generation. Revisions to May preliminary data, at +100 kb/d, were led by 'other products', diesel and heating oil. Despite evidence of economic weakness and high prices weighing upon regional demand, our assessment is revised up by 60 kb/d to 7.9 mb/d (+0.5% or 40 kb/d) for 2011 and by 140 kb/d to 7.9 mb/d for 2012 (+0.3% or 20 kb/d) due to increased Japanese oil-fired power generation needs.



In Japan, oil demand declined by 2.1% year-on-year in June. Jet fuel/kerosene (-22.0%), LPG (-6.7%) and gasoline (-1.7%) all fell. Nevertheless, with diesel (+2.0%), residual fuel oil (+17.5%) and 'other products' (+14.1%), which include direct crude burn, all posting gains, the picture is consistent with post-earthquake reconstruction and power generation needs providing some offset to economic and price induced demand declines. Moreover, that offset is set to rise over the next year - even as overall power generation demand declines - as remaining nuclear power plants go into maintenance amid an increasingly uncertain restart timeframe (see Nuclear Outages See Japan's Power System Turn to Thermal). As such, we have revised up Japanese total oil demand by 50 kb/d in 2011 and 140 kb/d in 2012. Demand in 2011 is expected to grow 50 kb/d (+1.0%) to 4.5 mb/d, while 2012 demand should increase 20 kb/d (+0.4%) but stay near 4.5 mb/d.



Meanwhile, in Korea the demand outlook is slightly weaker. June oil demand fell 2.4% year-on-year, with declines in all product categories except naphtha and 'other products' under the pressure of high prices and relatively muted oil-fired power generation needs. Purchases ahead of an anticipated July price rise by refiners may have provided an offsetting boost to diesel and gasoline demand. Nevertheless, the two categories still posted declines of 1.7% and 3.4%, respectively.

Nuclear Outages See Japan's Power Sector Turn to Thermal

Since our initial analysis following Japan's earthquake and tsunami (see Adjusting our Demand Projection for Japan, OMR dated 12 April 2011), the power sector outlook looks increasingly tenuous. Our previous forecast assumed the loss of 10 GW of nuclear capacity (60 TWh of annual generation), requiring an average 170 kb/d of additional oil-fired demand, concentrated in the Northeast, versus 'normal' circumstances (combined crude and fuel oil generation demand was about 200 kb/d in 2010). With lower than expected nuclear capacity going forward and outages affecting the entire country, we now estimate this increment at 230 kb/d this year and 270 kb/d for next. Based on this analysis and reported monthly data, we have raised forecasted fuel oil and 'other products' demand (including crude burn) by 35 kb/d for 2011, and by 75 kb/d for 2012. Still, these adjustments depend on tentative variables, notably the duration of the nuclear shortfalls and the allocation of thermal generation sources.

Of Japan's 54 nuclear reactors, which normally account for 27% of electricity demand, currently only 16 are online. In addition to those damaged in the earthquake, plants that have gone offline for normal maintenance face uncertain restart times due to public safety pressures, the need for plants to undergo still-undefined stress tests and pending local government approvals. So far, no plant has returned from a shutdown. Without a change in policy or maintenance schedules, all 54 reactors will be offline by May 2012.

Similar to work done by Japan's Institute of Energy Economics (IEEJ), and in conjunction with the IEA's Gas, Coal and Power (GCP) Division, we have analysed two scenarios of nuclear outages going forward, acknowledging that a range of possibilities exist. In the base case, once restarts are allowed, reactors taken offline for annual maintenance would return to duty after an average period of six months (versus three normally). Nuclear power generation would thus decline steadily through 2011 to a nadir of 3.5 TWh/month in February 2012 before recovering to 15 TWh/month - a level still below 'normal' levels - by October 2012.

Demand saving measures could partially offset such a supply loss. The government has requested industrial users to scale back peak demand by 15% and a conservation campaign aims to reduce demand among smaller users. Indeed, we envisage annual power demand decreasing by 4.5% in 2011. However, with the loss of so much baseload generation, the system would need to rely upon substantial contributions from other, primarily thermal, sources. While photovoltaic (PV) solar power deployment could potentially add a degree of non-thermal supply, the extent to which this may occur remains tentative and is not factored into the forecast.



Rather, Japan's 47.5 GW oil and 65.3 GW gas fired generation fleet are likely to make up for the shortfall. Coal (at 41 GW of capacity) will also play a key role, but given already high operating rates, its upside is more limited. We assume that oil (roughly 50% fuel oil, 50% crude oil) and LNG will meet incremental power needs according to a split of 60/40 in 2011 and 50/50 in 2012. These ratios may ultimately differ from the actual buying patterns of Japanese utilities. For now, they represent a 'best guess' based on fuel consumption data since March and greater short-term supply constraints in LNG importation. Operating constraints on the oil side may yet upset this picture, though. Oil-fired plants tend to be older and less efficient than gas counterparts and may face problems running for extended periods at maximum rates. 

These assumptions suggest an additional annual 230 kb/d of oil and 10 bcm of LNG demand in 2011 and an extra 270 kb/d and 18 bcm in 2012 versus an outlook of normal nuclear generation. During periods of peak outages this winter, incremental oil needs could rise to 460 kb/d. Yet, we must also acknowledge a worst case scenario in which no nuclear plants restart in the next 18 months. Under such conditions, 2012 requirements for additional oil and gas would stand at 460 kb/d and 30 bcm, respectively. With respect to LNG, while the base case would tighten markets to a manageable extent, the 'no nuclear restart' scenario would create significant supply tensions, given the global addition of only two LNG plants (13.6 bcm capacity) next year.

Non-OECD

Preliminary demand data indicate that non-OECD oil demand growth in June (+2.4% or +1.0 mb/d year-on-year) slowed to its weakest pace since May 2009, largely due to China. Total June demand is estimated at 44.0 mb/d, while May levels have been revised down by 25 kb/d to 43.8 mb/d (+4.8% or +2.0 mb/d).



Growth in all product categories slowed in June, particularly in gasoil (+3.8%), naphtha (-0.4%) and gasoline (+1.8%). At the regional level, the largest change occurred in Asia, where falling Chinese demand dragged down June growth to 0.8%. Nevertheless, the FSU (+9.9%), Middle East (+3.3%) and Latin America (+3.2%) continued to show relatively strong expansions.





Revisions to baseline data were minor, with 2010 revised down 10 kb/d. Non-OECD annual growth is now assessed at +3.7% (+1.5 mb/d) for 2011, with demand reaching 43.7 mb/d, and at +3.8% (+1.6 mb/d) for 2012, as demand climbs to 45.3 mb/d.

China

For the first time since March 2009, China's monthly apparent demand (calculated as refinery output plus net product imports) contracted on an annual basis, falling by 1.5% in June as refinery runs eased some 400 kb/d from May levels. The slowdown was sharp in gasoil, where growth fell from +11.5% in May to only +1.3%, suggesting that widespread diesel usage has not emerged in the face of potential power sector supply constraints. The decline also coincided with evidence that China's economy is also slowing down - though still positive, manufacturing growth has stalled in recent months - and that higher end-user prices are weighing upon demand. As such, we have revised down 2011 demand by 80 kb/d, with 2012 now seen 50 kb/d lower than previously.



Nevertheless, apparent weakness in Chinese demand of such a magnitude deserves caution. June was marked by heavy rains, which curtailed agricultural and industrial activity. Moreover, there was some evidence of product destocking (as calculated in this report, apparent demand implicitly masks stock changes), which would have weighed upon readings. In addition, while coal prices have eased, hydropower has increased and the high price of diesel may be prompting industrial users to forego, rather than substitute, for any electricity shortages, the demand risk for gasoil likely still lies to the upside. Nevertheless, as this report has previously argued, as Chinese authorities try to engineer an economic soft landing, the oil demand outlook this year and next should be one of moderating growth.



Other Non-OECD

Indian demand rose by 1.8% in June, a notably lower growth rate than during the previous six months, which averaged +4.2%. The Indian economy has shown signs of slowing, with manufacturing growth easing and the government revising down its own forecast of GDP growth for fiscal 2011 from 9.0% to 8.2% (the latter value consistent with our own assumption). Slowdowns have occurred mostly sharply in gasoline (+0.6%), naphtha (-0.4%) and gasoil (+2.2%). Still, some of this weakness stems from a comparison to a stronger-than-normal June 2010, where demand rose ahead of an anticipated increase in fuel prices. As such, revisions to the forecast are light, with 2011 growth trimmed slightly to 3.6%.







In Russia, product demand continued to soar on an annual basis, growing by 12.7% in June. Product strength was evident across most categories as gasoil rose by 29.1% year-on-year while gasoline increased by 8.3%. A cap on retail fuel prices at the government's behest has created fuel shortages in recent months. Russian authorities recently announced intentions to create a strategic products reserve of 2 million tonnes to counter such shortages, with filling to be completed by November. Given the hasty timeline and fuzzy logistical details, the viability of such a project remains uncertain. Nevertheless, estimates suggest the potential for 15-20 mb of stockpiling in gasoil, gasoline and jet fuel/kerosene in the next few months, which would also coincide with a period of seasonally higher demand.



In Brazil, oil demand grew by 2.8% in May, led by strength in jet fuel/kerosene (+11.5%), gasoil (+7.7%) and LPG (+4.6%). Gasoline demand grew by only 0.9%; still, domestic supply constraints in both gasoline and ethanol have prompted increased imports, which, anecdotally, appear poised to rise in the months ahead as well as next year. The government recently considered reducing ethanol content in the gasoline pool below 25%, but decided to hold off on an adjustment for now. Meanwhile, high inflation and persistent monetary tightening by the central bank represent a downside risk to the economy. Our forecast remains largely unchanged, however, with demand growth of 2.6% and 2.8% expected this year and next, respectively.



Argentina's total oil demand grew by 2.2% in June, led by LPG (+33.8%), gasoline (+18.0%) and gasoil (+3.7%). Transport fuels have benefitted from positive economic activity and consumer confidence, both observable in recent strong vehicle sales. By contrast, jet fuel/kerosene dropped by 18.2% year-on-year, largely due to the disruption of air traffic caused by a volcanic eruption in June. Finally, the opening of a 2.9 bcm/year LNG terminal at Puerto Escobar near Buenos Aires, which doubles Argentina's import capacity, will likely enhance inter-fuel substitution capabilities going forward, with residual fuel oil demand likely to moderate during peak power seasons.



Supply

Summary

  • Global oil supply rose by 0.6 mb/d to 88.7 mb/d in July, largely on stronger non-OPEC output. Compared to July 2010, global oil production was up by 1 mb/d, around half of which stemmed from higher OPEC NGLs production, and another third from increased OPEC crude output.
  • Non-OPEC supply rose by 0.4 mb/d to 52.7 mb/d in July, as output recovered from maintenance and other outages. Inclusion of finalised 2010 US data and other revisions result in 2011 production now being assessed 0.1 mb/d lower, at 53 mb/d. 2012 estimates are revised down by a similar volume, but supply is nonetheless expected to grow to 54 mb/d on higher output, mainly from Australia, Brazil, Canada, Colombia and global biofuels.
  • Total non-OPEC outages curb at least 0.7 mb/d in 3Q11, of which around one-third is due to normal levels of seasonal maintenance in the North Sea. The hurricane season in the US Gulf of Mexico has started, and is reflected via a five-year average adjustment of -0.1 mb/d in 3Q and 4Q10. Unplanned outages in the North Sea, alongside curtailed output in Argentina, Canada, Malaysia and Yemen add to the shut-ins. In 4Q11, we foresee a reduction in overall levels of outages to slightly over -0.2 mb/d.
  • OPEC crude oil supply in July reached 30.05 mb/d, up by 115 kb/d month-on-month, thanks to a concerted effort led by Saudi Arabia to increase output to replace lost Libyan supplies. Indeed, Saudi Arabia lifted its production to the highest level in three decades. OPEC NGLs inched higher in July, up 100 kb/d to 5.9 mb/d.
  • Despite the group's higher output levels, July production is still some 1.1 mb/d below the 31.2 mb/d 'call on OPEC crude and stock change' forecast for 3Q11 and 550 kb/d below the 30.7 mb/d projected for 4Q11. The 'call' for 2011 is unchanged at 30.6 mb/d while it has been revised up for 2012, by 100 kb/d, to 30.8 mb/d.


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

Note:  Random events present downside risk to the non-OPEC production forecast contained in this report. These events can include accidents, unplanned or unannounced maintenance, technical problems, labour strikes, political unrest, guerrilla activity, wars and weather-related supply losses. Specific allowance has been made in the forecast for scheduled maintenance in all regions and for typical seasonal supply outages (including hurricane-related stoppages) in North America. In addition, from May 2007, a nationally allocated (but not field-specific) reliability adjustment has also been applied for the non-OPEC forecast to reflect a historical tendency for unexpected events to reduce actual supply compared with the initial forecast. Currently, this totals ?200 kb/d for non-OPEC as a whole, with downward adjustments focused in the OECD.

OPEC Crude Oil Supply

OPEC crude oil supply rose to 30.05 mb/d in July, up by 115 kb/d, largely due to a concerted effort led by Saudi Arabia to increase output to replace lost Libyan supplies. Indeed, Saudi Arabia lifted production to the highest level in three decades. A sharp uptick in output by Angola also helped offset production declines by Iran, Iraq, Ecuador, Nigeria and Libya.

Current crude oil production, however, is still below pre-Libyan crisis levels. OPEC spare capacity is estimated at 3.32 mb/d for July due to the loss of Libyan production, with Saudi Arabia accounting for just under 70%. Market expectations that production in eastern Libya, which theoretically falls under control of Libya's new National Transitional Council, would restart in 2H11, may prove optimistic given the lack of progress at both the political and military level.

Despite the group's higher output levels, July production is still some 1.1 mb/d below the 31.2 mb/d 'call on OPEC crude and stock change' expected for 3Q11 and 550 kb/d below the 30.6 mb/d projected for 4Q11. The 'call' for 2011 overall is unchanged at 30.6 mb/d, while it has been revised up by 100 kb/d for 2012, from 30.7 mb/d to 30.8 mb/d.



Saudi Arabia's output rose to a 30-year high of 9.8 mb/d in July, up 100 kb/d over June levels. The Kingdom's production in July was up by a steep 1.1 mb/d since January and has essentially replaced close to 70% of lost Libyan supplies. The last time Saudi Arabia produced around the 10 mb/d mark was in 1981, after the Kingdom had earlier surged output to offset lost supplies from Iran following the fall of the Shah. Saudi Arabia will step in again in 2011 to replace Iranian supplies, this time sending an extra 3 mb to India in August due to the ongoing payment problems between Iran and India in the wake of international sanctions.

While the incremental Saudi output is largely aimed at replacing shut-in Libyan barrels, increased demand for direct crude burn at power and desalination plants has also absorbed some of the extra barrels. Saudi demand for direct crude burn is projected to increase by around 10% to 580 kb/d on average in 2011 (see 'Saudi Arabia's Power from Crude,' OMR 13 July 2011).

Iranian production in July fell to its lowest level in more than eight and a half years, down by 130 kb/d to 3.53 mb/d. An explosion on a 40 kb/d pipeline along the border with Iraq may reduce supplies further in August. Tanker data underscore the lower July export levels but at the same time show the country offloaded an estimated 3 mb held in floating storage. Shipbroker data show Iranian floating storage declined 4.1 mb by end-July, from 25.6 mb to a still relatively high 21.5 mb.

Reduced exports to India due to the seven-month impasse over payment methods may partly underpin lower production levels. Iran normally exports around 400 kb/d to India but the tighter international sanctions imposed a year ago have forced India to halt payments for the crude. Various news reports emerged in July that Iran was halting exports to India until arrears, which according to some reports may now top $5 billion, were cleared. Progress in setting up a payment mechanism for India to clear back payments via third parties reportedly moved forward, but it appears only a trickle of payments have so far been made. Moreover, still to be worked out is a payment mechanism for future purchases that does not violate sanctions. Iran is reportedly owed a further $4 billion by South Korean refiners. A new US Government Accounting Office (GAO) report released in July also underscored the impact of sanctions on the country's faltering production.

Iraqi supply was down by 40 kb/d to 2.68 mb/d in July. Total exports were off around 100 kb/d to 2.17 b/d, with the lower volumes partly due to increased domestic demand during the summer season. Shipments from the northern port of Ceyhan on the Mediterranean accounted for 80 kb/d of the decline, and averaged 455 kb/d. Higher production from the Kurdistan region was offset by lower output of Kirkuk crude. Southern exports of Basrah crude were down around 20 kb/d to 1.71 mb/d. Buyers of Iraqi crude report that southern export terminals are bumping up against maximum capacity levels.

Kuwait increased production by 20 kb/d to 2.51 mb/d while output from fellow Gulf states UAE and Qatar were unchanged, at 2.5 mb/d and 820 kb/d, respectively. The three countries have a combined spare capacity estimated at just under 500 kb/d.



Angolan production rose to the highest level in a year, up 170 kb/d to 1.66 mb/d. Output rebounded following completion of maintenance and repair work at the BP-operated Greater Plutonio complex and Total's Dalia fields. Angola's production capacity is expected to increase to 2 mb/d by the end of the year following the 4Q11 start-up of the 220 kb/d Pazflor project and the 150 kb/d PSVM.

Libyan production was estimated at just 60 kb/d in July. The eastern authorities exported one cargo in July but output is now reportedly totally shut-in due to extensive damage and mine laying in the country's eastern fields. There continue to be conflicting reports on the state of the country's eastern oil field operations but in late July a spokesman for the rebel-led Arabian Gulf Oil Company said all the region's oil infrastructure was under repair and a quick restart was not possible.

Operator ENI, which prior to the civil war produced 115 kb/d of crude, told shareholders in July that it would need at minimum a full year to restore production given the age of the fields in Libya once the political situation was resolved. Other sources have been more optimistic, suggesting post-hostilities resumption taking anything from a few weeks to six months. Meanwhile, at a gathering of business executives in London last month other companies said that internal political upheaval even once there was a formal end to hostilities would delay their return to the country on the grounds the investment risks were too high.

Nigerian crude output fell by 20 kb/d to 2.26 mb/d in July. Shell lifted the force majeure mid-month on loadings of Bonny crude, following a fire and leaks at the Trans-Niger pipeline in mid-June but operational problems elsewhere curtailed output overall for the month. Nigerian production is expected to recover in August judging by robust export schedules.

Non-OPEC Overview

Non-OPEC oil supply rose by 0.4 mb/d to 52.7 mb/d in July, as output started to recover from seasonal maintenance and other outages. Inclusion of lower consolidated historical production data in the US brought some minor revisions to 2010 and prior years, which are partly carried through the forecast, but this fails to overturn the return to US annual growth which is set to continue through 2011 and 2012. In the shorter-term, lower recent oil production in Alaska, the North Sea, Australia and Azerbaijan results in a 0.1 mb/d downward revision to 2011 production, which is now seen averaging 53 mb/d, and as a result a slightly smaller year-on-year increase of 0.4 mb/d over 2010, when compared to last month's report. Having said that, the second half of 2011 is expected to see production 1 mb/d higher than in the first half as temporary shut-ins recede (notably from Yemen, the UK and Canada) and as new fields come onstream in Brazil, Canada and Australia (see Non-OPEC Supply Curbs Persist but Ease in 4Q11).



Average 2012 supply is also revised down by 0.1 mb/d to 54 mb/d on some project slippage in the North Sea, Canada and a lower biofuels outlook, though this is partly offset by higher projections for Russia and China. Annual growth in 2012 is now seen at a slightly higher 1 mb/d. Incremental supply is expected from Brazil, Canada, global biofuels, Australia, the FSU and China. In contrast to previous years, oil production in OECD Europe could stay flat year-on-year, as North Sea production experiences a minor uptick, with a handful of new fields coming online.



Non-OPEC Supply Curbs Persist but Ease in 4Q11

As outlined in previous reports, non-OPEC supply this year continues to suffer from a variety of outages, estimated to total around 0.7 mb/d in both 2Q11 and 3Q11, albeit around one-third of this is typical for this time of year. Seasonal maintenance always affects the North Sea in particular. The hurricane season in the US Gulf of Mexico has started, with one storm so far - Tropical Storm Don - forcing brief precautionary shut-ins in late July, and in sum, our hurricane adjustment for the third quarter, based on the five-year average, amounts to -112 kb/d. Outages at the UK's Buzzard field (prolonged workover, as well as maintenance), and curtailed production in Canada, Malaysia, Yemen and Argentina make up the rest.

However, heading into 4Q11, these outages are seen to ease. Notably, repairs at a key crude pipeline in Yemen have enabled production to restart from mid-July. The political situation there remains highly volatile, but without evidence to the contrary, we assume normal production (as we do in Syria, despite reports of a crude pipeline bombing). We estimate that Buzzard production should be back to normal at around 200 kb/d in the course of September, while North Sea maintenance is normally minor in the fourth quarter. The Horizon mine and upgrader in Canada, hit by a fire in January, are also expected to resume operations in 3Q11 and be back to normal in the fourth quarter. All told, curbs to non-OPEC production should shrink by 0.4 mb/d and added to incremental supply of 0.6 mb/d, total non-OPEC supply could rise by as much as 1 mb/d in 4Q11 over 3Q11.

OECD

North America

US - July Alaska actual, others estimated:  US oil supply dipped to an estimated 7.6 mb/d in July as Alaskan output at the Prudhoe Bay field fell by 0.1 mb/d due to assumed summer maintenance, augmented by some minor leaks in July. By contrast, reported May US data was lifted by 170 kb/d on higher NGLs output. Pre-2010 production levels were slightly revised, following the receipt of finalised historical data. For 2010, lower crude output, notably in the Gulf of Mexico, but also in other areas, was partly offset by higher NGLs output. In part, the historical adjustment is carried through the forecast and includes a more robust outlook for onshore production. Production estimates for 2011 and 2012 are left largely unchanged, each at around 7.9 mb/d, albeit modest year-on-year growth continues.

The US House of Representatives passed a bill requiring the Obama administration to either approve or deny a permit for the construction of the Keystone XL pipeline by 1 November. The decision technically falls to the State Department, and Secretary Clinton recently said that her department remains committed to arriving at a decision by year-end. A final Environmental Impact Statement will discuss alternative routes for the pipeline, and the State Department plans a series of consultative meetings in the states through which the pipeline might pass.



Canada - Newfoundland June actual, others May actual:  Second-quarter oil production in Canada was revised down by 40 kb/d, due to the earlier-than-expected onset of seasonal maintenance at the Hibernia field offshore Newfoundland and Labrador, and slightly lower recent NGLs production. Total oil supply is estimated to have hovered around 3 mb/d in June due to reduced synthetic crude output - in part seasonal maintenance, in part shut-in production at the fire-hit Horizon mine/upgrader. Output is expected to pick up again in 3Q11. Production levels for 2011 and 2012 are revised down minimally, and are expected to average 3.4 mb/d and 3.6 mb/d respectively, with growth driven largely by oil sands-related output.

North Sea

Norway - May actual, June provisional:  Following a June uptick from early maintenance to 2.0 mb/d, Norway's production is expected increase to 2.1 mb/d in July despite fires at the 150 kb/d Ekofisk and 40 kb/d Valhall complexes, ongoing problems at Gullfaks and seasonal maintenance. In addition to unplanned shut-ins, we expect seasonal maintenance to reduce production by around 100 kb/d in both August and September. Other field problems and work could reduce overall production in Norway by another 100 kb/d in August and over 60 kb/d in September.



But Norwegian production is projected to rebound slightly in the latter part of 2011 compared to 1H11 levels due to the completion of maintenance, upgrades at the Asgard field, and the start-up of the 80 kb/d Skarv project. Overall, Norway's production should average 2.1 mb/d, which is 40 kb/d lower than in 2010. Looking ahead, Canada's Talisman Energy announced an additional six-month delay to the projected start-up date for the Yme field, now seen to come onstream in May 2012, and with an expected 60 kb/d capacity. The 2012 outlook is revised downward by 15 kb/d to 2.1 mb/d largely due to the delay at Yme, but output is nonetheless projected to grow marginally on increasing output at new fields.

UK - May actual:  In the UK, new May production data show oil production declined from the prior month to 1.1 mb/d with the onset of seasonal maintenance. During the summer months crude output should average less than 1 mb/d due to work on fields that is estimated to total 120 kb/d in July and 250 kb/d in August. Over the past few months, unscheduled maintenance has reduced production at the 200 kb/d Buzzard field to less than half of its capacity, but we expect production to return to capacity during September. Other outages that are affecting the UK's output this summer include repair to the Gryphon field from a storm-damaged FPSO and planned maintenance at the Total-operated Elgin and Franklin fields. The Forties pipeline should also carry less crude in August in order to remove an unexploded World War II mine. These outages have lowered estimates for August and September by 80 kb/d and 30 kb/d respectively, and have reduced the outlook for 2011 by around 20 kb/d to 1.24 mb/d. Projections for 2012 (1.27 mb/d) are curbed by a similar amount due to a six-month delay with the start up of the 30 kb/d Huntington field and a slower rebound from the Elgin/Franklin and Schiehallion fields. On a longer-term basis BP has approved a major workover of the Schiehallion/Loyal field, for start-up around 2015/16, which it claims could boost output to 150 kb/d from recent effective capacity of around 50 kb/d.

Pacific

Australia - May actual:  In Australia May data show production at a lower-than-expected 420 kb/d, although output should increase later in the year with rebounding volumes from the Cossack and Apache fields, as well as increasing NGL production. Australian oil production has been curtailed due to longer-than-expected maintenance at the Van Gogh field. Operator Apache has reduced output at the 40 kb/d field several times since October 2010, although a recent company statement indicates that production resumed in early August. The replacement of the floating production, storage and offloading (FPSO) vessel at Cossack has also curtailed production. Our outlook envisages that production should maintain an upward trajectory in late 2011 and 2012 with ramping up of production at Van Gogh and the Pyrenees field, as well as start-up at Montara and Kitan. A downward-adjusted 2011 is now estimated to average 490 kb/d, with production rising to 620 kb/d in 2012.

Former Soviet Union (FSU)

Russia - June actual, July provisional:  Russian total oil supply rose by 60 kb/d to 10.57 mb/d in July, again nearly touching a record high for post-Soviet times. 2011 production should average 10.56 mb/d, unchanged from last month's report, while the 2012 estimate is nudged up slightly and is expected to average 10.6 mb/d. Annual growth of 110 kb/d in 2011 and projected 45 kb/d growth in 2012 has slowed considerably from an average of 220 kb/d in 2009/10, let alone the average yearly increment of +650 kb/d seen in the first half of the past decade.



Uncertainty and Age Hold Russian Oil Production Outlook Flat

Russia's oil production continued to rise in the first half of 2011, recently hitting a new post-Soviet record of 10.6 mb/d, as several new fields, mostly in Eastern Siberia, continue to ramp-up production, and as decline in Russia's maturing heartland areas such as Western Siberia has been partly stemmed. But while 2011 and 2012 are both forecast to see combined production growth of 150 kb/d, output is projected to decline slightly in later years. Our recent Medium-Term Oil and Gas Markets (MTOGM) projected a net decline from 10.45 mb/d in 2010 total oil supply, to 10.32 mb/d in 2016. Growth in NGLs, including field condensate (from 650 kb/d to 800 kb/d) is offset by a decline in crude production (from 9.8 mb/d to 9.5 mb/d). Given the maturity of its large producing base, this is actually no mean feat and Russia remains in the upper echelon of oil producers with Saudi Arabia and the US, well ahead of others.

But while Russia's resource base is unquestionably sufficient to sustain current output levels, a degree of uncertainty nonetheless hangs over the medium and longer-term trajectory of its oil production - and even the relatively modest decline projected in the MTOGM. The issues at stake are the degree of government intervention, politicisation of energy markets/flows, access to reserves, the upstream fiscal regime and somewhat heavy-handed tinkering with the downstream and retail sector.

Recent oil production growth has in part been stimulated by tax breaks for new, challenging or remote fields, notably in Eastern Siberia, while upstream profitability was boosted by higher oil prices. Key projects, such as Vankor, Talakan and Verkhnechonsk have also benefited from lower export duty requirements, while many smaller fields in other frontier areas enjoy reduced mineral extraction tax (MET) levels. But Russia's government, which is expected to receive over half of its revenues from taxing hydrocarbons production in 2011, has recently attempted to trim or eliminate some of these tax breaks, arguing that higher oil prices should enable sufficient returns to operators. As a result, preferential export duties for the above-mentioned three fields were eliminated in May this year, while it was just announced that another six would lose them from August (Alinskoye, Ayanskoye, Danilovskoye, Dulisma, Markovskoye and Yaraktinskoye). As in May, the decision came with very short notice, adding to uncertainty for operators (Verkhnechonsk and Talakan were originally supposed to keep them until January 2012 and January 2013 respectively).

Furthermore, the region of Khanty-Mansiysk, a core producing area in Western Siberia, recently announced that it might cut some other tax breaks for local operators. Lukoil and TNK-BP, which both have a large presence there, threatened this could severely cut into attempts to maintain output at mature fields. Rosneft in turn, which protested vehemently at the elimination of tax breaks for Vankor, even suggesting future development stages were under threat, is allegedly holding out for preferential taxation for its large Yurubcheno-Tokhomskoye project in Eastern Siberia before giving development the green light.

At the same time, Russian authorities in late July announced that new fields developed in the southern Black Sea, the Okhotsk Sea (neither of which currently produce any oil), as well as the Yamal-Nenets region would benefit from zero MET until a certain volume of cumulative production was reached (ranging from 20-30 million tonnes). The decision was seen to benefit mainly the development of the Yamal LNG project, which would export 15 million tonnes of LNG by around 2020 from a new northern port. As for oil, despite the tax break, Gazpromneft, which holds the licence to develop the large Messoyakh field in Yamal-Nenets, reckons it will need prices sustained at over $100/bbl in the long-term to make development worthwhile.

It is also unclear what effects Russia's most recent proposed tinkering with the export duty for crude and refined products will have. For several years, refined products have incurred a substantially lower export tax than those for crude, the idea being that Russian refiners would be encouraged to upgrade plants to realise exports of high-quality products. Increasing tightness in Russia's domestic market for higher-quality refined product (even though largely self-inflicted, by a cap on domestic prices) has spurred the government to examine the current system, and potentially reverse the advantage hitherto enjoyed by exported products.

Uncertainty and Age Hold Russian Oil Production Outlook Flat  (continued)

A pattern seems to be emerging, whereby new proposals for changes to the fiscal environment are frequent, while timing and details of implementation often remain uncertain. In past years, there have been numerous proposals for changes to upstream conditions, often seemingly conflicting, stemming from different parts of the administration with different objectives. More generally, Russian oil and gas producers have long called for taxes based on profit, which is the case in many other countries, rather than on the current revenue-based system.

Aside from fiscal uncertainties, the prospects for renewed IOC joint venture involvement in Russian upstream oil ventures suffered a knock with the recent failure of the proposed BP-Rosneft Arctic alliance and Chevron's decision to pull out of a Black Sea exploration venture, also with Rosneft. Neither setback was due to any government-created impediment. That said, the government's recent statement that it may sell all or part of its majority stake in Rosneft could conceivably make it more difficult for future joint ventures with Rosneft to gain access to major, strategic reserves (which require state involvement). All told, the failure of these two joint ventures, allied to BP's ongoing travails with its existing partners in TNK-BP, reinforce an impression that doing business upstream in Russia remains difficult. Foreign companies seeing these recent developments, and mindful of some of the problems incurred by Sakhalin joint venture partners in Russia's Far East, may conclude that undertaking new developments in Russia requires greater certainty on taxes and contract terms before proceeding.

Many proposed or actual changes to the regulatory and fiscal regime for Russia's oil sector have legitimate and reasonable goals, but to succeed they will have to balance Russia's own needs for fiscal revenue with the imperative to sustain investment by local and foreign companies alike. Opacity over details, timing and implementation create huge uncertainty when it comes to considering investment in Russia's upstream and downstream sectors. The government recognises that its desire to maintain oil production at over 10 mb/d requires significant investment in the upstream. More specifically, the development of technically challenging, remote and offshore resources, as well as maximising recovery from mature assets, will likely require significant foreign technological input. Changes across the breadth of the investment framework may be the only certainty we can expect for now.

Azerbaijan - April actual:  Azerbaijan's crude and condensate production volumes remain somewhat curtailed, at around 0.98 mb/d in May. At the Chirag part of the Azeri-Chirag-Guneshli (ACG) complex, planned maintenance has cut production for June and July and output is only expected to return to full capacity by early 2012. On the basis of detailed 1Q11 data and with ACG production continuing to underperform since a major gas leak in 3Q08, we assume that further anticipated ramp-up at the complex is postponed yet again. As a result, total Azerbaijani production for 2011 is revised downwards by 40 kb/d to 0.98 mb/d. For 2012, projected output is revised down minimally, to 1.0 mb/d.



Kazakhstan - June actual/preliminary:  In June, Kazakhstan's oil production recovered to 1.67 mb/d, following an earlier-than-expected end of maintenance at the large Tengiz field. This came despite an oil workers' strike, which in the end may have only shut-in around 20 kb/d. The strike continued to affect similar levels of output in July and into August. Kazakhstan's total oil production is expected to average 1.67 mb/d in 2011 and to decline marginally to 1.65 mb/d in 2012 in the absence of any new incremental capacity at major fields.



FSU net oil exports fell by 150 kb/d to 9.3 mb/d in June, with crude and products declining by 80 kb/d each. Total crude exports fell to 6.29 mb/d, largely due to a sharp seasonal increase in Russian refinery runs to record levels. Consequently, Transneft shipments fell to 3.94 mb/d (-230 kb/d m-o-m), their lowest since November 2010, with Baltic and Black Sea ports bearing the brunt of the cuts. Indeed, Primorsk exports fell by 80 kb/d, while Transneft shipments through Novorossiysk fell by a steep 140 kb/d. In contrast, flows through the Eastern Siberia-Pacific Ocean (ESPO) pipeline remained at capacity, with just over 300 kb/d each shipped to Kozmino and Daqing. In the six months since ESPO flows to China started, it is apparent that Russia has made a considerable effort to guarantee volume and quality on each leg, albeit at the expense of other outlets. Notably, the quality of Urals oil shipped from Novorossiysk has periodically deteriorated as some light, Western Siberian oil is sent east to supply the ESPO, and with exporters having to pay penalty fees associated with a drop in quality below agreed limits. It is expected that this issue will continue for the foreseeable future until more East Siberian fields are connected to the ESPO network.

Outside of Russia, flows along the BTC and CPC pipelines increased by 110 kb/d and 50 kb/d, respectively. Product exports fell by 80 kb/d on the month as falls in the 'other products' category (-130 kb/d) and gasoil (-50 kb/d) offset a 100 kb/d increase in fuel oil shipments. Gasoline exports, included here under 'other products' contracted by 85 kb/d, their largest fall in over two years. This was attributed to the effect of Russia's gasoline-specific export tax designed to alleviate domestic shortages and introduced a month earlier.

Other Non-OPEC

China - June actual:  China's oil production returned to 4.2 mb/d in June, despite ongoing problems at the offshore Bozhong complex since an FPSO problem in April, curbing an estimated 40 kb/d. In mid-July, leaks at the Penglai complex, also in the Bohai Bay area, forced the shut-in of at least 45 kb/d, following the intervention of the authorities (the leak had reportedly first been noticed around one month earlier). We assume the shut-ins to last into September, though this is offset by sustained output growth elsewhere. Production for 2011 is estimated to average 4.2 mb/d, which would represent annual growth of 135 kb/d, or +3.3%. This compares with a recent estimate by China's Ministry of Industry and Information Technology of +3.4%. Our 2012 projection is nudged up by 20 kb/d to 4.3 mb/d, on reports that China is increasingly successful at stemming decline at some of its largest and mature fields, while especially offshore production continues to grow.



Indonesia - May actual:  JODI data for Indonesian oil production in May suggest a sharp uptick to 975 kb/d, which is however not matched by Oil Ministry data nor justified by any new field start-ups. This report therefore estimates production averaged 930 kb/d in May, closer to Oil Ministry estimates. Delays with boosting output at the Banyu Urip field, as well as a lack of other new projects, as baseload production declines, is keeping Indonesia's production on a downward trend. In recognition of this, the government recently trimmed its official annual production target for 2011 yet again, to 945 kb/d from an earlier 970 kb/d. Our estimate for the year is a more conservative 915 kb/d, falling further to 860 kb/d in 2012.

In Yemen, around 110 kb/d of shut-in crude oil production started to resume from mid-July, after a key pipeline to the coast was repaired. Output had been shut-in since April. The political situation remains volatile and violent, but for the moment, we are assuming production will be fully back to normal by 4Q11, averaging 255 kb/d. In Syria, there were reports in early July that a crude oil pipeline had been bombed, amid a deteriorating political situation. But as yet there are no reports of oil production, which averaged an estimated 385 kb/d in 2010, being affected. Fighting appears to have receded in disputed oil-producing regions that straddle the border between Sudan and newly-independent southern Sudan, and oil production is assumed to be back to normal, around 450 kb/d. But negotiations over transit fees between the north, which controls export infrastructure, and the south where production is centred, continue. The sum of production in these three countries in 2010, which remains at potential risk, is 1.1 mb/d.

OECD Stocks

Summary

  • OECD industry stocks fell by 11.8 mb to 2 678 mb in June, contrasting with a 1.8 mb five-year average build. Stronger declines in crude and main product categories led this monthly draw, but a gain in 'other products' provided partial offset. The surplus to the five-year average narrowed significantly, from 18.2 mb in May to 4.7 mb in June.
  • OECD forward demand cover remained below year-ago levels for the third consecutive month at 58.4 days in June. Stronger forecast demand for distillates over the next three months drove stock cover lower from 59.2 days in May, although June remained 1.8 days above the five-year average.
  • July preliminary data show an 18.5 mb gain in OECD commercial inventories. Seasonal builds in middle distillates and 'other products' drove the increase, while crude oil holdings fell sharper than average. By comparison, over the past five years July stocks rose by 27.2 mb on average.
  • Short-term oil floating storage fell to 50.5 mb in July, from 54.4 mb in June. Crude floating storage declined by 1.8 mb to 38.8 mb on offloading in the Middle East Gulf, while products dropped by 2.1 mb to 11.7 mb, as products held off West Africa were transferred ashore.


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

OECD industry oil inventories fell counter-seasonally by 11.8 mb in June, to 2 678 mb, or 58.4 days of forward demand. The monthly decline contrasted with a 1.8 mb average build for June observed over the past five years. Crude oil stocks plummeted by 15.6 mb, with the majority of the decline in North America, where a rebound in refinery throughputs reduced holdings. Product inventories gained 5.7 mb, as rising 'other products' outweighed falling gasoline, middle distillate and fuel oil stocks.



Despite a counter-seasonal June stockdraw, OECD inventories grew by 47 mb in 2Q11, in line with a 50 mb five-year average build. The stocks rose more strongly than normal in April and May and were further increased by upward revisions to OECD inventories upon receipt of more complete monthly data. May OECD industry holdings were revised 9.3 mb higher, implying a stronger 31.9 mb stockbuild than the previously reported 23.9 mb increase. Upward adjustments centred on crude, 'other products' and 'other oils'.

We have also made several baseline adjustments this month. US final monthly data for 2010 have been incorporated. The more complete figures raise the 2010 baseline by 4.1 mb on average and almost 70% of the adjustments occurred in crude oil stocks. Meanwhile, Japan reclassified a portion of crude oil inventories in response to a December 2010 lease agreement between the Japanese government and Saudi Arabia, which allows the Kingdom to hold up to 3.8 mb of crude oil stocks in storage in Okinawa. This modification 'removed' 1.5 mb of crude oil holdings from Japanese industry oil stocks from January 2011 onwards. However, the data do not account for February and April vessel arrivals and thus will likely be subject to further revisions in coming months.



Preliminary July data signal an 18.5 mb increase in OECD oil industry inventories. A further increase in refinery runs led to strong product builds, which outweighed crude stock draws. Short-term oil floating storage fell by 3.9 mb in July, to 50.5 mb. Further offloading of Iranian crude oil in the Middle East Gulf drove crude floating storage lower to 38.8 mb, yet new vessels in the US Gulf provided a partial offset. Products held in floating storage declined to 11.7 mb as some products held off West Africa were transferred ashore.

Update on the IEA's Libya Collective Action

On 23 June, the IEA initiated its Libya Collective Action, designed to add liquidity to the market in light of the ongoing disruption to Libyan crude supplies, the impending seasonal rise in 3Q11 oil demand and to act as a bridge to an expected rise in supplies from other OPEC producers. A total of 59.8 mb of oil has been brought to the market from the Collective Action. This includes the volumes of public stocks taken up through tender, loan or direct sale, with the remainder of the volume being supplied by lowering the stockholding obligations on industry in several IEA Member countries. For background and details on the various ways in which emergency stocks are released, see The IEA's Libya Collective Action Explained in the Oil Market Report dated 13 July 2011.

More than 97% of 39.2 mb of public stocks offered to the market in the form of tenders and loans was taken up. This is higher than the 73% uptake of public stocks in the 2005 Collective Action, when a total of 28.8 mb were drawn from public stocks compared to the 39.5 mb offered in loans and tenders. Approximately 40% of the public oil stocks were delivered in the month of July, while delivery of the remaining 60% will be completed in August.

In a 30-day review of the action, announced publicly on 21 July, the IEA and its Member countries agreed that, having bridged the gap to higher OPEC supplies and with oil from the initial release still entering the market, the IEA would continue to closely monitor market conditions and stands ready to augment the action if conditions again warrant. The IEA has encouraged countries to be flexible when considering emergency stock replenishment in order to avoid prompting any additional market tightening in 2H11.

A portion of public stocks reached oil markets in July. The US sold via auction 30.64 mb of crude oil from its SPR. First shipments began in the week of 18 July and 8.7 mb were scheduled to be delivered in July, while the remainder will be delivered by end-August. US weekly data show 6.8 mb of the scheduled volume were delivered by 29 July. Korea released 3.5 mb from public stocks in the form of loans, with all deliveries completed by end-July. German market participants bought 66% (2.8 mb) of public oil stocks offered via a tender. The refined products were taken up immediately in July, as was more than half of the crude volumes. The remainder of the crude is expected to be lifted by the end of August. The Netherlands released a total of 1.2 mb from public stocks via tender and direct selling contracts, and all amounts were delivered in July. Belgium contributed 0.8 mb from both public and industry stocks. Regarding public stocks, 95 kb of jet/kerosene were delivered to the market during the month of July 2011.

The use of obligatory industry stocks accounts for 21.7 mb of the total action. Of the eight countries contributing with obligatory industry stocks, seven countries lowered the obligation proportionately across all industry (e.g. importers, refiners, product suppliers or wholesalers); in the case of Turkey, the obligation was lowered on refineries only. Japan and France will likely maintain their relaxed obligations on industry until end-2011, while Spain and the UK will likely also not request their replenishments earlier. Poland and Turkey will re-establish the obligation by end-March 2012. Belgium and Italy will provide companies with a derogation of the stockholding obligation for at least 3 months.

Analysis of Recent OECD Industry Stock Changes

OECD North America

Industry oil inventories in OECD North America rose by 0.8 mb to 1 340 mb in June. The modest monthly gain contrasted with a 10.8 mb five-year average build. A seasonal increase in US refinery throughputs reduced crude oil stocks by 14.5 mb. Meanwhile, gains in middle distillates and 'other products' lifted North American product inventories by 16.6 mb in June. Distillate stocks rose in line with the five-year average by 4.6 mb, while 'other products' grew by a stronger 13.6 mb. Gasoline stocks dipped by 1.3 mb after a counter-seasonal increase in May.



Weekly data from the US Energy Information Administration point to a strong 22.1 mb increase in July industry stocks. The build was entirely driven by products, as middle distillates, 'other products' and gasoline rose by 11.9 mb, 14.4 mb and 2.6 mb, respectively. As such, a 27.3 mb increase in products outweighed a 5.2 mb draw in crude and other feedstocks.



US crude stocks fell by 3.6 mb in July. However, the draw was partially mitigated by a delivery of 6.8 mb of SPR oil sold last month as part of the wider IEA Libya Collective Action (see Update on the IEA's Libya Collective Action). According to the weekly data, the overhang in the US Midcontinent and around Cushing, Oklahoma eased after a series of pipeline problems and production outages. Cushing stocks declined by 1.1 mb in July, and stood almost 6 mb below their peak recorded in the first week of April. The overhang developed after the start-up of new pipelines transporting crude from Canada and the Bakken area in April 2010 and February 2011 and will likely persist until new pipelines are completed in 2013 and beyond, which allow crude to be evacuated to the US Gulf Coast refining region.



OECD Europe

Industry oil inventories in OECD Europe fell by 13.3 mb to 931.5 mb in June, the lowest level since November 2007. The deficit to the five-year average widened from 23.4 mb in May to 26 mb in June. By comparison, European stocks drew on average by 10.6 mb over the past five years in June.



Crude oil stocks declined marginally on the back of rising refinery throughputs, as companies secured alternative supplies to replace the lost Libyan volumes. However, crude inventories remained 18.3 mb below the five-year average. Product holdings fell by a sharp 12.7 mb, to below the five-year-average. Middle distillates drove the decline as they dropped by 7.4 mb, while draws in gasoline and fuel oil inventories also contributed. German consumer heating oil stocks stood at 50% of capacity at end-June, up from previously-reported levels at 47% of capacity at end-April.



Preliminary July data from Euroilstock signal a 1.4 mb stockbuild in the EU-15 and Norway. Crude oil holdings declined by 2.9 mb, as refiners increased crude runs on the back of seasonally higher demand, improved margins and increased supply of crude in the Atlantic Basin. Reportedly, some crude cargoes were redirected from the US to Europe following the release of light, sweet crude from the US SPR. A sharp gain in distillates drove product inventories higher by 4.3 mb. Middle distillates rose by 4.1 mb and gasoline built by a further 1.1 mb. Meanwhile, refined oil product inventories held in independent storage in Northwest Europe fell, led by gasoil draws.

OECD Pacific

Industry oil inventories in the OECD Pacific rose by 0.7 mb to 406 mb in June. Strong distillate gains in Korea drove the overall monthly increase, which was directionally in line with a 1.6 mb five-year average build. Korean inventories rose by 4.7 mb, with distillates adding 2.6 mb as product exports dropped. Higher crude imports drove crude oil stocks higher by 1.2 mb. As such, rising stocks in Korea, Australia and New Zealand offset sharp draws in Japan. Japanese industry inventories fell by 6.3 mb in June. A rebound in refinery runs cut 3.4 mb of crude oil holdings and products edged 1.7 mb lower as regional product exports resumed.



Weekly data from the Petroleum Association of Japan (PAJ) point to a 5.0 mb draw in Japanese commercial oil inventories in July. Crude oil stocks fell by 4.8 mb driven by a further increase in refinery throughputs. Meanwhile, product stocks fell by 2.0 mb and resumed regional exports likely contributed, as confirmed by recent data from Singapore. Yet, a 1.7 mb gain in 'other oils' mitigated the overall draw.



Recent Developments in Singapore and China Stocks

According to China Oil, Gas and Petrochemicals (China OGP), Chinese commercial oil inventories rose by an equivalent of 1.8 mb (data are reported in terms of percentage stock change), to almost 352 mb in June. Crude oil stocks gained 3.2% (6.5 mb) as several refiners reduced runs due to maintenance. Product stocks declined, led by a 7% (4.1 mb) draw in gasoline. Gasoil dropped by 1% (0.8 mb) outweighed by an 1.3% (0.2 mb) build in kerosene.



Refined product oil stocks in Singapore declined by 1.3 mb in July, led by draws in middle distillates and fuel oil. Middle distillates fell by 0.9 mb on higher regional demand and arbitrage exports. A partial offset came from renewed imports of diesel from Japan after earlier refinery outages there. Fuel oil holdings declined by 0.5 mb, while light distillates increased by 0.1 mb.



Prices

Summary

  • The relative calm of oil markets in July was shattered by the collapse in global financial and commodity markets in early August. Political wrangling in Washington over the US debt ceiling, escalating sovereign debt issues in the euro zone and the downgrade of America's triple-A credit rating triggered a broad market sell-off, which in turn has shaved around $15-20/bbl off prices over the past ten days at writing. Brent and WTI futures were last trading around $103/bbl and $80/bbl.
  • Spot prices for benchmark grades were up by around $1-3/bbl on average in July before shedding more than $14-20/bbl in the ten days to 9 August. Increased supplies of relatively cheaper Middle East crudes are also exerting downward prices on prices in August. Saudi Arabia took the market by surprise in early August when it announced sharper-than-expected cuts to price formulae for Asia and the US for September liftings, with other Middle East producers expected to follow suit.
  • Refining margins largely improved in the major centres in July, with stronger gasoline cracks the main driver behind the increase, especially lifting margins at complex refineries. Nonetheless, European refining margins remain weak, with Brent cracking margins in Northwest Europe showing a calculated average profit of only $0.80/bbl in July.
  • Crude tanker rates continued at depressed levels throughout July as vessel oversupply vastly outweighed brisk chartering activity. The Suezmax West Africa - US Atlantic Coast trade was the only benchmark route to experience an uptick in rates during the month. Shipbrokers attributed this to a knock-on effect of the IEA stock release. As many US East Coast refiners preferentially booked light, sweet oil released from the US SPR, European refiners chartered Suezmaxes to move newly available West African cargoes northwards, resulting in a slight firming mid-month.


Market Overview

The meltdown in global financial and commodity markets in early August is reminiscent of what was seen in early-May, and signals a rather more circumspect view now on market prospects looking ahead. The relative calm in markets in July following the IEA stock release has been replaced by a much darker outlook for the remainder of 2011 on escalating fears of a double dip-recession and sharply lower oil demand growth. Protracted political wrangling in Washington over the US debt ceiling ignited increased volatility, while escalating sovereign debt issues in the euro zone fanned the flames further, triggering  a broad market sell-off in early August. After the extreme volatility seen by the week ended 5 August, oil prices were shaved by a further $6-7/bbl after rating agency Standard & Poor's removed the US's top-tier credit rating. Oil futures prices have plummeted $15-20/bbl from late-July highs by writing on 9 August. That compares with futures prices posting modest month-on-month increases, with WTI up $1.05/bbl and Brent up $2.85/bbl on average in July. Prices for Brent and WTI futures were last trading around $103/bbl and $80/bbl, respectively.



Efforts are underway by the Group of Seven major industrialised nations to stem financial market contagion, but repercussions from a renewed financial crisis are expected to be far-reaching, with the outlook for oil demand growth prospects fragile for both OECD and non-OECD countries. Even before the latest meltdown, exceptionally bearish economic and demand data for both the US and China weighed on oil markets.

The spectre of a sharp slowdown in economic growth near-term, particularly in the US, is prompting some industry forecasters to cut global oil demand estimates for this year and 2012. This month's OMR sees global demand for 2011 revised down by 60 kb/d, with growth now expected at 1.2 mb/d, although our base case retains near 4.5% global GDP growth in 2012 and demand growth near 1.6 mb/d as a result.  In the wake of recent market and economic turmoil, a lower demand sensitivity of 3% GDP growth next year generates only a 0.6 mb/d demand increment for 2012 (See Demand, 'Growing Economic Downside Risks to Prompt Lower Oil Demand?'). For refiners and traders, however, signs of more ample supply were already emerging in the market before the latest crisis, in part after the IEA Libya Collective Action and also due to planned refinery turnarounds in China and an unplanned outage of the 540 kb/d Taiwanese Formosa plant. However, increased crude demand for oil-fired power generation in Japan is expected to partially offset refinery outages elsewhere in Asia (see Demand, 'Nuclear Outages See Japan's Power Sector Turn to Thermal').



Moreover, OPEC has also cranked up production over the past two months by 1.0 mb/d, to 30.05 mb/d in July. In response, discounts for Middle East crudes were emerging. Saudi Aramco unexpectedly reduced Asian September's official selling prices for Arab Light by $0.60/bbl while cutting even more sharply Arab Medium and Heavy prices by $1-$1.40/bbl, which increased the price spread between the light and heavy grades to just over $4/bbl. As a result, traders had already factored in a weaker outlook for heavier, sour crudes in September and October.

Additional supplies to the market are also adding downward pressure on front-month contracts. The Brent M1-M12 contract flipped from backwardation into contango on 8 August, to -$0.20/bbl compared with $0.80/bbl in July and an average $2.26/bbl in June.  The WTI M1-M12 contract also saw its contango structure widen, to around -$4.80/bbl from 1-8 August compared with -$4.35/bbl in July and -$3.80/bbl in June.

The longer-dated M1-M36 for Brent flattened amid the changing price structure. The Brent M1-M36 contract narrowed to $3.25/bbl by 8 August compared with an average $6.20/bbl in July and $8.05/bbl in June. WTI posted the reverse trend, with the M1-M36 contracts widening to almost $11/bbl by 8 August compared with an average $5.50/bbl in July and $3.35/bbl in June.



Futures Markets

Open interest in WTI contracts in New York in the CME and London ICE Exchanges were little changed in July but still hovered near May's record levels. Open interest in New York increased in July in both futures-only and combined futures and futures-equivalent options contracts from 1.52 million and 2.7 million contracts to 1.53 million and 2.703 million contracts, respectively. At the same time, open interest in the London ICE WTI contract declined in futures-only contracts, to 0.46 million and increased in combined contracts to 0.51 million.

Managed money traders increased their bets on rising crude oil prices to a six-week high on 26 July after gradually cutting their net long exposures in the light, sweet crude oil contracts since mid-April, at both CME and ICE London exchanges. However, they decreased their net-long positions from 180 013 to 157 139 and from 25 315 to 22 839 in the last week of July, in New York and in London, respectively, in response to the fall in WTI prices from $99.59/bbl to $93.79/bbl. Meanwhile, money managers increased their net-long positions in the London ICE Brent contract by 47%, from 62 694 to 91 994 in July.

Producers increased their net-short positions during the month of July; they held 25.49% of the short and 13.69% of the long contracts in CME WTI futures-only contracts. Swap dealers, who accounted for 32.73% and 32.79% of the open interest on the long side and short side, respectively, reversed their recent trend of declining net shorts by reducing 9 772 gross long contracts. Both producers and swap dealers increased their net-short positions in the London ICE WTI contract.



NYMEX RBOB futures and combined open interest increased by more than 6% in July. Open interest in NYMEX heating oil increased by 2.0% to 302 304 contracts while open interest in natural gas markets decreased by 0.7% to 968 004 contracts.

Index investors reduced their long exposure in commodities in June 2011. They withdrew $2.5 billion from the WTI Light Sweet Crude Oil contracts in June 2011, which fell from an all-time high of 694 000 futures equivalent contracts in March to 689 000 contracts, equivalent to $66.40 billion in notional value.



OTC Market Regulations: Where Do We Stand?

Market participants still await final rules which will govern global OTC derivatives markets. Meanwhile, according to the latest Bank of International Settlements (BIS) survey, total notional value of all OTC derivatives reached $601 trillion at the end of December 2010, of which $2.92 trillion (0.5%) was commodity -related derivatives. However, at their peak at end-June 2008, the total notional value of commodity derivatives had reached a far higher $13 trillion, or 2.5% of the total market. Although the size of commodity-related over the counter derivatives contracts is relatively small compared to the overall OTC derivatives market, new regulations will have important implications for commodity markets in general, and energy markets in particular.

When G20 leaders set the broad reform agenda to be implemented by the end of 2012 to reduce systemic risk and increase transparency in the OTC derivatives markets, they might not have anticipated the complex nature of the instruments they are dealing with. Although these regulatory efforts have intensified in the last year, as pointed out by the Financial Stability Board (FSB), clear signs have emerged that substantial differences exist across multiple countries in the pace of implementation as well as in some rule-making areas that could lead to regulatory arbitrage. In this case, market participants will seek out jurisdictions with less strict regulations, thereby shifting the risk rather than mitigating it. Greater international coordination is needed to ensure more consistent and effective oversight in OTC markets. 

Previous issues of the Oil Market Report (OMR) and the Medium-Term Oil & Gas Markets (MTOGM) reports extensively analysed US and EU proposed regulations on over-the-counter derivatives markets. Although there are differences between these two regulatory frameworks in clearing, membership of central clearing

houses, margin requirements, swap execution facilities and position limits, a working group has already been set up to harmonise these regulations. Without consensus, some policy makers in the US already raised the probability of revisiting proposed rules and how to meet Dodd-Frank Act requirements for improved prudential safety. Apart from different proposed rules, a recent ruling by the federal appeals court against the so-called proxy access process on the basis of flawed economic analysis will potentially force regulators to revisit some of their proposed rules. For example, as the February OMR suggested, the CFTC did not provide a cost-benefit analysis for its proposed speculative position limit rule, which the Commission is planning to take up in September. We anticipate that some of the rules may be challenged on the basis of a lack of cost-benefit analysis, as well as inadequate consideration of public comments, which could lead to further delays in the implementation of the rules.

Of course, any legal challenges risk further difficulties and delays in reaching international consensus among regions, especially in Latin America and Asia. Traditionally, both regions had much smaller derivatives markets than those in the US and Europe. However, given the nature of global OTC markets, they have already either started implementing their own financial regulatory reforms or have been waiting to see the changes in the US and Europe before finalising their own rules. Given the slow progress in the US and Europe, it might be very challenging for some of these countries to meet the deadline of end 2012.

In Latin America, both in Brazil and Argentina, most derivatives are traded on exchanges (estimated  at  90% and 70%, respectively). Brazil has only one central clearing house where all futures are traded and some OTC derivatives are cleared. Furthermore, derivatives that have not been cleared must be reported to a local trade depository. Likewise, exchange traded derivatives in Argentina are all centrally cleared and the Central Bank requires all financial institutions to provide quarterly statements about their derivatives activity. Neither country is planning to introduce mandatory clearing, a key measure in both US and Europe regulation for financial entities according to the Financial Stability Board's OTC Derivatives Market Reforms Report on Implementation, dated April 2011. This might raise the question whether financial market participants in the US and Europe are likely to migrate their OTC transactions to these countries.

Although most Asian countries support the G20 commitments on OTC markets regulations, legislators have taken a wait-and-see approach as rules are being finalised in the US and Europe. According to the International Swaps and Derivatives Association (ISDA), Asian countries might not be able to meet the G20 deadline of end-2012 to implement OTC market regulations. However, there is substantial variation in the speed of implementation across countries. Japan already enacted legislation requiring mandatory clearing and is working on its regulatory implementation and reporting rules to trade repositories. In Korea, the government finalised its plan for mandatory clearing but is waiting to see final rules in the US and Europe before proposing legislation for approval. A central clearing house will be established in mid-2012. Clearing OTC derivatives through a Central Counterparty Clearing House (CCP) as well as reporting of OTC transactions to trade repositories is expected to start next year in Hong Kong. The Singapore exchange meanwhile already launched a clearing of interest rate swaps last year. India has already established the Clearing Corporation of India to act as a CCP as well as trade repository. Although there is no firm timetable for implementation, consideration of OTC derivatives regulations in China, Australia and Indonesia is already underway.

Slow progress on agreed reforms to meet the end of 2012 deadline, as well as the apparent lack of international consensus between regulators on how to achieve the key elements of the reform agenda, could undermine the impact of new regulations even in countries where more stringent rules are to be implemented due to regulatory arbitrage opportunities. It is even suggested that different regulatory regimes will lead to fragmented markets, which will eventually lead to weaker institutions and greater risk to the global economy. On the other hand, some market participants dismiss the idea of regulatory arbitrage based on observed close cooperation among regulators for more harmonisation in the last three years.

Spot Crude Oil Prices

Spot crude oil markets traded in a fairly stable range in July before collapsing along with the broader commodity and financial markets in early August. Spot prices for benchmark grades were up by around $1-3/bbl on average in July before shedding more than $15-20/bbl in early August. Increased supplies of relatively cheaper Middle East crudes are also exerting downward pressure on prices in August. As noted earlier, Saudi Arabia announced sharper-than-expected cuts to price formulae for Asia and the US for September liftings, with other Middle East producers are expected to follow suit. In Asia, which accounts for roughly 60% of Saudi sales, the price cuts are partly due to refinery outages in China and Taiwan, which is expected to constrain demand for crude.

In July, US land-locked WTI posted the smallest monthly increase, up by $1.05/bbl to $97.26/bbl. By contrast, continued prompt demand for light sweet crudes saw a sharper increase of $2.69/bbl, to $115.86/bbl, for LLS on the Gulf Coast. In August, prices for LLS may be capped by the arrival of two-thirds of the released SPR crude oil barrels into the key US Gulf Coast refining centre. Just under 10 mb out of a total 30.64 mb of light, sweet crude had already reached markets by 3 August.



Brent crude posted the largest monthly increase in July at $2.85/bbl, to $116.88/bbl, reflecting ongoing scheduled and unplanned shut-ins of North Sea supplies. Outages in the UK and Norwegian sector of the North Sea in August are forecast to nearly double July levels of around 300 kb/d. In July, unplanned outages accounted for almost two-thirds of the decline while a heavier maintenance schedule in August is behind almost two-thirds of the 600 kb/d shut-in supplies. Relatively stronger prices for Brent led to a further widening of the WTI discount to the North Sea crude, to averaging just over $22/bbl in early August compared with an average $19.62/bbl in July and $17.82/bbl in June.



The Brent/Dubai price spread, an indicator of the premium for light sweet grades over heavy sour supplies, deepened on average in July, to $6.89/bbl compared with $6.27/bbl in June, in part due to higher supplies of Middle East crudes. By early August, however, the premium had narrowed again to around $4.50/bbl, in part reflecting reduced exports of Middle East crudes in August due to increased domestic demand during the peak summer cooling month.

In Asia, spot prices for usually sought-after Malaysian Tapis rose by only around $1.50/bbl to $120.87/bbl on average in July, in part due to increased competition from similar African grades. The Tapis/Dubai premium eroded as well, to $10.88/bbl in July compared with around $11.50/bbl in June and $13.10/bbl in May. However, by early August the price spread widened again to just below $11.00/bbl.





Spot Product Prices

Product crack spreads improved for gasoline and naphtha in all regions in July, and the LSWR crack spreads in Asia showed unusual strength on additional Japanese power needs. Middle distillate crack spreads continued to be fairly robust, and strengthened moderately in July. Moving into August, both crude and product prices plummeted in absolute terms, but product crack spreads were more or less unchanged. The only exception was US gasoline crack spreads, which dropped as inventories increased more than expected, and with low US demand readings and a worsening European debt crisis adding to the bearish sentiment.

Gasoline crack spreads improved month-on month in all regions in July. On the US Gulf Coast, crack spreads for Mars increased from $12.64/bbl in June to an average $15.80/bbl in July. Crack spreads moved within a relatively large range from $12.80/bbl to $19.48/bbl, with the highest readings in the beginning of the month, and narrowing throughout July. At the Atlantic coast, crack spreads for WTI moved within a higher, very robust $30.73-39.29/bbl range. The cracks were supported by tight supply and lower US gasoline stocks at the beginning of the month, partly due to strong export demand to Latin America, but were pressured lower again with increasing gasoline production as well as lower US gasoline demand readings in July.



European gasoline crack spreads improved by a smaller $2.50/bbl on average in Northwest Europe and a higher $3.88/bbl in the Mediterranean. In addition to increased arbitrage due to the tightness in both the US and Latin American markets, European cracks were supported by strong gasoline demand from the Middle East, as the PetroRabigh refinery in Saudi Arabia had problems restarting its FCC unit after maintenance, and also amid increased West African demand. Asian gasoline cracks also improved, supported by strong seasonal demand both due to the Ramadan holiday and regional refinery maintenance.

Naphtha crack spreads also posted strong gains in July as demand for gasoline blending increased in line with assumed higher gasoline production in both the US and Europe, and higher petrochemical demand from South Korea.

Middle distillates markets were quiet in July, but crack spreads were fairly strong and moved within narrow ranges in Europe and Asia. In contrast, crack spreads in the US were somewhat more volatile, increasing at the beginning of the month before weakening again. The European market looked tighter, as exports from Russia were reduced and the arbitrage from the US was closed in addition to high local demand before the August holiday period. In Asia, refinery maintenance supported crack spreads on prospects of tighter markets ahead, even though the outlook for Chinese diesel demand seems to have softened. In the US on the other hand, high demand from Latin America gave support to cracks but increased refinery runs and inventory building throughout July pressured middle distillate crack spreads lower.



LSFO discounts remained narrow in July, and the Asian LSWR to Dubai differential continued to be in positive territory and increased by an impressive $4.98/bbl, to an average $6.19/bbl. It increased further in the beginning of August as product prices lagged behind the large drop in crude prices.

The main driver behind the surge is increased Japanese demand for LSWR for power generation. Usually demand peaks in July/August but this year demand is boosted by the nuclear outages, which generate additional fuel oil power generation needs. Also, HSFO markets continued to show strength in July, especially in Asia on the back of high power generation demand from the Middle East and high bunker fuel demand in Singapore.



Refining Margins

Refining margins strengthened in all regions in July, except for Urals hydroskimming margins in Northwest Europe and Chinese Daqing hydrocracking margins, which posted small decreases. Stronger gasoline cracks were the main driver behind the increase, especially at complex refineries. However, US refining margins fell early August as an increase in US gasoline stocks made gasoline prices drop.

Although improving in July on the back of stronger gasoline crack spreads, European refining margins are weak, with Brent cracking margins in Northwest Europe showing a calculated average profit of only $0.80/bbl. The differential between Urals and Brent narrowed in July, explaining the more modest increases for Urals margins.

At the US Gulf Coast, refining margins improved from June, although the improvement was mostly due to both strong gasoline and middle distillate cracks at the beginning of the month. Throughout the month, margins weakened in line with narrowing product cracks, and early August Mars cracking margins were close to break-even.



Tapis margins saw the largest improvements in Singapore. These margins have been showing large calculated losses since early this year, when the sweet-sour crude spread started to widen. However, the spread narrowed in early July, giving support to Tapis-based margins. Additional support came from the narrowing LSWR discount. Also Chinese refining margins were pushed higher in July, mainly from a strong fuel oil market.



End-User Product Prices in July

During July, average end-user prices for selected IEA countries, in US dollars ex-tax, saw a marginal change for transport fuels and a small increment for heating fuels. The current month corresponds to the high season for driving and the low season for heating demand in the Northern hemisphere. Despite this, the heating oil and low-sulphur fuel oil (LSFO) price changes actually exceeded those for gasoline and diesel. Transport fuel prices showed meagre movements of 0.13% and -0.6% for gasoline and diesel, respectively while heating oil and LSFO strengthened by 0.8% and 2.1%.

Regarding individual countries, on a month-on-month basis, Canada registered the highest price movement of gasoline (3.4%) followed by Japan (2.9%), but this rise, when measured in domestic currency, corresponds to smaller increases of 1.1% and 1.6%, respectively. On the other hand, the slightly weaker position of the Euro in the same period produced the opposite effect in countries where this currency is used.

Freight

Crude tanker rates remained at depressed levels throughout July as vessel oversupply continued to vastly outweigh brisk chartering activity. The Suezmax West Africa - US Atlantic Coast trade was the only benchmark route to experience an uptick in rates during the month. Shipbrokers attributed this to a knock-on effect of the IEA stock release. As many US East Coast refiners preferentially booked light, sweet oil released from the US SPR, European refiners chartered Suezmaxes to move newly available West African cargoes northwards, resulting in a slight firming mid-month.

Despite reports of a high number of fixings out of the Middle East Gulf, rates on the benchmark VLCC Middle East Gulf - Japan trade remained lethargic, with earnings now reportedly below break-even levels. With low rates combining with extremely high bunker fuel costs, anecdotal reports suggest that most owners are now routinely slow-steaming their ships to cut fuel consumption in an effort to maintain their earnings in positive territory. This trend is likely to continue amid an austere short-term outlook of new builds continually entering the market, unless an uptick in floating storage helps absorb the over-supply.



The product tanker market in July was slightly less bleak, with many routes exhibiting modest rises. Following higher demand, the Middle East Gulf - Japan route increased by $2/mt over the month. In contrast, the benchmark transatlantic UK - US Atlantic Coast trade continued its sharp fall during early-month, bottoming out at close to $19/mt by mid-month and holding this level for the remainder of July.

Short-term floating storage of crude and products fell by a combined 3.9 mb to stand at 50.5 mb at end-July, its lowest level since December 2008. Crude fell by a net 1.8 mb as Iranian storage fell by a further 4.1 mb to 21.5 mb, as two VLCCs discharged their cargoes while storage in the US Gulf built by 2.3 mb to 9.9 mb. Iranian floating storage volumes are assumed to result from structural rather than speculative drivers. Although it has fallen from the May 2010 peak of 51 mb, Iranian crude still accounts for 55% of total crude floating storage, emphasising the minimal interest in speculative storage despite current low vessel chartering costs. Products drew by 2.1 mb following a significant 4.7 mb fall in products held off West Africa and a smaller 0.8 mb decline in the Mediterranean, which offset builds in Asia Pacific (1.5 mb), the Middle East Gulf (1.1 mb) and Northwest Europe (0.8 mb). The storage fleet now numbers 32 vessels, largely VLCCs, and remains at its lowest level since 2008.

Refining

Summary

  • Global refinery crude runs for 2Q2011 have been revised higher by 0.1 mb/d since last month's report, primarily on surging Russian throughputs in June. Weaker-than-expected Chinese throughputs provided some offset. 2Q11 global runs are now assessed at 73.7 mb/d, only 60 kb/d above a year earlier, compared to average annual growth of more than 2.0 mb/d in the previous four quarters.
  • 3Q11 global refinery runs are largely unchanged from last month's report, at 75.9 mb/d. Slightly improved prospects for the OECD are offset by the closure of Taiwan's 540 kb/d Mailiao refinery following a fire in late July and expected lower Chinese runs. Improved refinery margins in July, and stronger weekly Japanese data, underpin the higher OECD estimates.
  • OECD crude runs rose by close to 0.9 mb/d in June, with increases recorded for all regions. While the OECD total of 36.3 mb/d was in line with our previous estimates, runs were nevertheless more than 1.0 mb/d lower than a year earlier, resulting in sharp draws in product inventories. Weaker year-on-year runs in both Europe and North America were partly offset by year-on-year growth in the Pacific, despite continued refinery closures in Japan resulting from the March earthquake.
  • OECD refinery yields increased seasonally for gasoline and 'other products', and fell for all other products in May. OECD gasoil/diesel yields continued to fall, reversing the trend from 2010, where they increased from 29.4% to 31.5% by year-end. OECD gross output rose by 245 kb/d in the month, but was 1.9 mb/d below the five-year average, on low refinery runs in Europe and North America.

Global Refinery Throughput

Global crude runs have been revised up by 110 kb/d for 2Q2011, mostly on record-high Russian throughputs in June. Smaller upward revisions for May, to North America and to some non-OECD countries also contributed, while weaker than expected runs in China in June provided some offset. Runs for 2Q11 are now pegged at 73.7 mb/d, about in line with the same quarter last year, compared to average annual growth of more than 2.0 mb/d in the previous four quarters.



Annual growth in global throughputs is expected to resume in 3Q11, averaging 0.5 mb/d, and potentially taking runs to 75.9 mb/d. Downward revisions to Chinese and 'Other Asian' crude runs offset a stronger-than-expected rebound in Japanese crude runs in July, and a slightly more optimistic view of European and FSU throughputs. Recently weak Chinese figures, in part due to poor margins, and an expected slowdown in annual demand growth (from a high base in the latter part of 2010), have prompted a 125 kb/d downward adjustment to 3Q11 Chinese runs since last month's report, though annual growth remain at 520 kb/d for the quarter. A fire and subsequent closure of Taiwan's 540 kb/d Mailiao refinery could tighten regional product markets in the short term. While it is not yet certain how long the plant will remain shut, as the fire is the seventh in 12 months, safety inspections and restart permits could take some time.



In the OECD, recent runs have been mostly in line with seasonal trends and our forecast. An improvement in margins in July, in part due to the release of light sweet crude in the Atlantic Basin through the IEA coordinated stock release, but also due to higher seasonal demand and rapidly depleting product stocks, is expected to support runs through summer. Downside risks from any further slowdown of the global economy and oil demand growth, however, could materialise in coming months.

OECD Refinery Throughput

Submitted June data show total OECD refinery throughputs rising 880 kb/d from May, to 36.3 mb/d, with gains in all regions. Runs were in line with our previous forecast overall, though masking smaller regional offsets. North American crude runs rose 450 kb/d m-o-m as US refiners ramped up rates after maintenance and to meet peak summer demand. European throughputs rose 275 kb/d, to 12.2 mb/d, while Pacific runs gained 150 kb/d m-o-m, due to recovering Japanese runs. Total OECD crude runs were nevertheless more than 1 mb/d below a year earlier. North American and European throughputs were 0.5 mb/d and 0.8 mb/d below June 2010 respectively, partially offset by higher Pacific runs.



Preliminary July estimates have been revised up by 280 kb/d since last month's report, in large part due to higher-than-expected Japanese crude runs. According to the Petroleum Association of Japan (PAJ), Japanese refiners processed nearly 3.3 mb/d in July, up from 2.9 mb/d in June. Both June and July throughputs were slightly stronger than a year earlier, despite two refineries still shut since the earthquake in March. Prevailing surplus refining capacity in the Japanese market means that other plants have been able to raise runs and more than offset the damaged plants' capacities.



North American crude runs are unchanged for 2Q11 and assessed only slightly higher for 3Q11, at 17.5 mb/d and 18.0 mb/d respectively. While final May data were some 100 kb/d higher than preliminary weekly data had suggested, June and July weeklies were in line with previous estimates. EIA data show total US refinery crude runs inching up another 250 kb/d in July, to average 15.4 mb/d. The gains came primarily from the East Coast, which saw runs recover to the highest level since October 2009, above 1.3 mb/d. The restart of PBF's Delaware City Refinery in the second quarter contributed to the gains. The plant, which was sold to PBF in 2010 after Valero shut it due to poor economics in November 2009, has just completed a major overhaul. PBF has stated that a full restart of the plant will stretch into 3Q11, however, as some upgrading units still have to come online. Runs on the West Coast also rebounded m-o-m, while the remaining districts were mostly unchanged from June's levels.



Refinery runs in the US Midwest remain at elevated levels, supported by discounted WTI crude and subsequent healthy profits. The WTI-Brent front month spread reached a new record high of $23.88/bbl in early August, while WTI-LLS traded at a $24/bbl differential. As a result, Midwest refiners processed a record high 3.5 mb/d in July, albeit average 2Q11 runs stood only 40 kb/d higher than 2Q10. That said, 2Q11 saw independent refiners enjoy stronger operating earnings for the quarter in the Midwest, as Mid-Continent margins rose by about 80% from a year earlier.



ConocoPhillips Spins off Downstream to Become Largest Independent Refiner in US

ConocoPhillips announced on 14 July that it will split into two companies by spinning off its refining business, in the process surpassing Valero as the US's largest independent refiner. The company will become two separate, publicly traded entities by the end of next June, at which time Chief Executive Officer Jim Mulva, who engineered the creation of ConocoPhillips through a $25 billion merger in 2002, will retire. Conoco's announcement came only two weeks after Marathon completed its own downstream spinoff, creating the new Marathon Petroleum Co, and has raised questions as to whether a new industry trend towards 'de-integration' is emerging.

The news from ConocoPhillips does not come as a surprise. The decision to split the company in two is the culmination of a restructuring programme started in 2009 and accelerated earlier this year. The company also has backed out of planned refinery projects and sold its 20% stake in Russia's OAO Lukoil. Even before the announcement, ConocoPhillips had committed to shedding underperforming assets. According to the company, it expects to dispose of $10 billion to $12 billion company-wide.

Following the split, ConocoPhillips's fuel business become the largest US independent refiner, with more than 1.8 mb/d of processing capacity (2.0 mb/d including two plants held jointly with Canadian oil-sands producer Cenovus Energy Inc., though no decision has been made yet on where to put that venture). Valero Energy Corp. will then be the US's second independent refiner, with total capacity of 1.7 mb/d.

Marathon completed the spinoff of its large oil refining business as a separate entity at the end of June and has relaunched as a much smaller oil and gas exploration and production company. Marathon had announced already in 2008 that it was looking to spin off its downstream division, which includes six oil refineries, to unlock more value from its largely overshadowed upstream oil and gas business. The plans were postponed in early 2009, however, amid the global financial collapse, and only revived in January of this year.

While BP announced plans in February to halve its US refining capacity by selling its Texas City, Texas and Carson, California refineries within two years, and Shell and others have sold off European refineries, there is no sign that other major integrated companies will divest their downstream divisions altogether. Less profitable assets will nevertheless likely be disposed of to free up capital for more lucrative ventures.

OECD European crude runs rose seasonally in June, to 12.2 mb/d, up by 270 kb/d from May, but 60 kb/d less than our previous forecast. In part due to an exceptionally sharp rise in regional throughputs in June of last year, the most recent data show the year-on-year deficit increasing to 780 kb/d. European refiners are, however, raising runs seasonally and as the IEA strategic stock release increased supply of light sweet crude in the Atlantic Basin. European refiners were the most affected by the loss of Libyan crude supplies since March and a year-on-year deficit in 2Q10 runs of 375 kb/d, due to the loss of Libyan supplies and poor margins, has left regional product stocks falling to below the five-year average. Total European industry oil product stocks by end-June were almost 45 mb lower than at the end of January.

The IEA expects runs to rise further in July and August, boosted by seasonally higher demand and improved margins. Brent cracking margins rose by $1.08/bbl in Northwest Europe in July, from a negative -$0.28/bbl in June. Urals cracking margins in the Mediterranean also bounced back into positive territory in July, recouping $1.18/bbl on average, to $0.85/bbl.



OECD Pacific refinery throughput estimates have been revised higher for June and July by 120 kb/d and 220 kb/d, respectively. The higher June number follows stronger than expected South Korean throughputs for that month, at 2.5 mb/d. South Korean runs and product exports have been driven by a tighter regional product market due to lower operating rates in Japan and, although product exports came down from April and May's highs in June, they were almost 100 kb/d higher than in June 2010.

The revision to July estimates was entirely accounted for by higher-than-expected Japanese crude runs. According to weekly data from the PAJ, Japanese runs rebounded sharply in July, to 3.3 mb/d, or 375 kb/d above June. Both June and July throughputs were slightly higher than a year earlier, despite two refineries still shut since the earthquake in March. A prevailing surplus of refining capacity in the Japanese market means that other plants have been able to raise runs and more than offset the damaged plants' capacities. JX Nippon announced in early August that it plans to restart the 145 kb/d Sendai plant by the end of 1Q2012, as opposed to a previous target of summer 2012.

Elsewhere in the region, Shell Australia confirmed that it will convert the 80 kb/d Clyde refinery outside Sidney to a storage terminal by mid-2013, due to "increased competition from mega-refineries in Asia, supply and demand in the region and Clyde's small size".



Non-OECD Refinery Throughput

Non-OECD refinery crude runs have been revised down by 220 kb/d for 3Q11, on lower expected Chinese throughputs and following the shutdown of Taiwan's 540 kb/d Mailiao refinery in early August. Weaker than expected crude runs in China in June have partly been carried forward to 3Q11 based on stated company operating plans and known maintenance schedules. The complete halt to operations at Mailiao, one of the world's largest refineries, due to yet another fire could tighten Asian product markets, depending on how long it takes to repair and restart the facilities. In all, non-OECD runs for 3Q11 are assessed at 38.7 mb/d, up 585 kb/d from 2Q11.

2Q11 estimates on the other hand have been lifted by 75 kb/d since last month's report, to 38.1 mb/d, as record high Russian crude runs more than offset weaker than expected Chinese runs. Russian throughputs hit a post-Soviet high in June of 5.4 mb/d, up 300 kb/d versus month-earlier and 470 kb/d above June 2010. As the spike in runs is likely related to recent product shortages and expectations of changing export duty on oil products, we have not materially altered the outlook for Russian refinery operations for the remainder of the year. The latest data clearly show upside potential to FSU throughputs in coming months, however. Smaller revisions have also been made to Middle Eastern and 'Other Asian' estimates, though these largely offset each other.



According to the most recent data released by the National Bureau of Statistics, Chinese crude runs hit a nine-month low of 8.7 mb/d in June, some 210 kb/d less than expected. Company operating plans and known maintenance schedules point to lower runs still in July. While we still show an increase from the very weak June numbers, our 3Q11 estimates have been adjusted down by 125 kb/d since last month's report. Runs are expected to continue to recover further in August, once maintenance is completed, yet annual growth in throughputs could slow in line with sharply lower demand growth at the end of this year (from a high 2010 base). Furthermore, after two years of extensive capacity growth, very little new crude distillation capacity is expected to be commissioned this year. Annual Chinese throughput growth is currently 6.3% in 2011, compared to 8.5% forecast by the Ministry of Industry and Information Technology in August.

Financial Losses Cutting into Chinese Refinery Runs

Poor refinery economics could have exacerbated Chinese throughput declines due to maintenance. While China has raised retail prices for refined oil products twice this year, increases have not kept pace with rapidly rising crude oil prices. According to the Ministry of Industry and Information Technology, ex-refinery oil product prices rose 12.21% y-o-y for gasoline and 14.25% y-o-y for gasoil compared to a 31.44% annual increase in crude oil feedstock prices in the first five months of this year. The Ministry released a report in early August, stating China's refining industry recorded a net loss of Yuan 3.09 billion ($480 million) in May, the "first loss" by the industry since 2009. According to a separate report published by China's National Development and Reform Commission in July, China's refining industry incurred losses of $2.6 billion (Yuan 17 billion) in the first five months of this year, almost 10 times higher than losses recorded in the same period last year.

In Other Asia, the latest government data from India and our estimates show that domestic crude runs averaged 4.2 mb/d in June, 100 kb/d above May, and in line with our forecast. The monthly figure is 4.7% higher than a year earlier, and includes assumed runs of 670 kb/d at Reliance's Jamnagar export plant (calculated from the quarterly earnings report), which are excluded from official statistics. Official data also exclude crude processed at the 120 kb/d Bina refinery, which was commissioned at end-May, thus we have also adjusted June to account for this (50 kb/d). The 180 kb/d Bathinda refinery is now expected to start up in August, with secondary units progressively commissioned by November. Essar's latest announcements indicate that its expanded Vadinar refinery will start operating in 1Q12.



Taiwan's Formosa Petrochemical Corp. had to shut its 540 kb/d Mailiao refinery after a fire on 30 July. While the damage caused by the fire is thought to be minimal and only to secondary units, the government forced the company to immediately halt operations at the facilities for safety checks. The recent fire is the seventh in the last 12 months, and led to two senior executives, including the company chairman, resigning. Formosa has declared force majeure on its product exports for August and is reportedly trying to resell some crude cargoes though with difficulty (or at steep losses) as crude prices have come down sharply since the refinery made its purchases. It will likely take two weeks to repair the affected unit, after which more time will be needed for the government to inspect the facility and issue a restart permit. Our working assumption is that the plant will be off for about a month before a gradual restart of its three CDUs. Even after a restart, utilisation rates will likely be lower as the government also ordered the company to conduct a "rotational closure" of the whole complex over the next 12 months to thoroughly assess its safety standards, and upgrade equipment if needed.

Middle Eastern crude run estimates have been lowered slightly since last month's report for both June and July (100 kb/d), mainly due to lower assessed Saudi Arabian runs. Delays and problems restarting a 90 kb/d FCC unit at the Petro Rabigh refinery, which was completely shut from end-April to early June, likely also reduced crude throughputs slightly. The latest reports are that the unit restarted on 1 August and that the refinery will reach full capacity by 15 August. The recent problems have forced Saudi Arabia to import increasing volumes of gasoline through August.



Refinery runs at Yemen's Aden refinery are expected to return to normal as domestic crude production resumed in July, after repairs to a key pipeline were completed. The refinery restarted on 20 June after receiving the first tranche of a 3 mb donation of Arab Light from Saudi Arabia.

Russian refining runs surged to a new post-Soviet high of 5.41 mb/d in June, up 300 kb/d from May and 270 kb/d higher than our previous forecast. June's refining volumes surpassed the previous high reached in August 2010 by nearly 300 kb/d, a rise driven by the end of spring maintenance and efforts to respond to the government's call for increased fuel supply following the earlier gasoline shortages. Runs could also have been supported by expected changes to export duties, currently favoring products over crude. While still difficult to assess, we believe crude runs fell back in July to around 5.2 mb/d.



Prime Minister Vladimir Putin's speech to the oil industry in Kirishi earlier in July laid blame for fuel shortages and rising prices on Russia's oil companies. At the meeting Putin accused Russia's refiners of failing to do their job properly and warned of potential sanctions. The prime minister said the companies had ignored state requirements to maximise capacity and boost light product yields, despite promising to do so in return for lower downstream taxes. To prevent future fuel shortages, Russia plans to create a stock of up to 2 million mt of oil products by November, held by oil companies, Energy Minister Shmatko announced in July.



In Africa, an Algerian Energy official denied reports that the country's largest refinery, Skikda, had been shut for maintenance in July and August, saying the plant was operating at 100% in early July. Tenders by Sonatrach for six gasoil cargoes (180 kt) for delivery in August had fuelled rumours that the plant was struggling with output. The company had reportedly purchased four gasoline cargoes from the Mediterranean market in July, pushing up gasoline prices in the region. An alternative explanation for the increased imports has been that fuel is being smuggled into Libya. For now, we assume the refinery continues to operate at full rates as the reports remain unconfirmed. Libyan runs are assumed to remain at the current levels estimated around 80 kb/d, despite some reports that the Tobruk and Zawiya refineries had problems to operate given crude oil supply shortages.

OECD Refinery Yields

OECD refinery yields increased seasonally for gasoline and other products, and fell for all other product categories in May. The increase in gasoline yields was mostly driven by an increase in OECD Pacific yields, as OECD North American and OECD European yields were practically unchanged from April. OECD gasoil/diesel yields continued to fall, reversing the trend from 2010, when gasoil/diesel yields increased from 29.4 % to 31.5 % over the course of the year. OECD gasoil/diesel yields were 30% in May vs. a five-year average of 29.7 %. OECD gross output in May increased by some 245 kb/d compared with April, and was still 1.9 mb/d below the five-year average, mainly on low refinery runs in both Europe and North-America.



In OECD North America, gasoline yields increased marginally in May, and were still around one percentage point (pp) above last year's level. Higher demand before the summer driving season and strong gasoline cracks at the beginning of the month were factors supporting marginally higher gasoline yields. OECD North American gasoil/diesel yields continued to decrease, reflecting weaker middle distillates markets, and stood at 24.6 % in May, just below the five-year average.

European gasoline yields in May were almost unchanged from April as well, and were 1.2 pp below the five -year average. Refineries were struggling with low European demand, but this was to some extent offset by stronger demand from the Middle East providing an outlet for surplus production. Gasoil/diesel yields on the other hand were 1.16 pp above the five-year average, although falling from April to May, as middle distillates cracks weakened.



In OECD Pacific, refinery yields increased for gasoline, gasoil/diesel and other products. This was in line with seasonal trends. As opposed to the Atlantic basin, middle distillates demand in Asia was strong in May, partly due to preparation for the refinery maintenance season, and Asian gasoline yields were also supported by strong Middle East demand.