Oil Market Report: 13 September 2011

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Highlights

  • Uncertain global economic and financial prospects underpinned volatile oil futures prices in August and early September. WTI and Brent followed divergent paths last month, with the price spread hitting record levels of over $27/bbl in early September. Prices at writing were $111/bbl for Brent and $86/bbl for WTI.
  • Global oil demand is revised down by 0.2 mb/d for 2011 and by 0.4 mb/d for 2012 on lower non-OECD readings and reduced economic growth expectations. Global GDP growth is now seen at 3.9% in 2011 and at 4.2% in 2012 with significant downside risks. Demand estimates now stand at 89.3 mb/d in 2011 (+1.0 mb/d y-o-y) and 90.7 mb/d in 2012 (+1.4 mb/d y-o-y).
  • World oil supply rose by 1.0 mb/d in August, to 89.1 mb/d, with non-OPEC production up by 0.8 mb/d. Rising US and Latin American production offset heavy maintenance and field outages in the North Sea. Non-OPEC supply has been revised lower to 52.8 mb/d in 2011 on outages in the Middle East and China, rising to 53.8 mb/d in 2012.
  • August OPEC crude oil output was up by 165 kb/d, to 30.26 mb/d with production still 1.04 mb/d below the 31.3 mb/d 3Q11 'call on OPEC crude and stock change'. However, the 'call' for 4Q11 has been lowered by 0.2 mb/d to 30.5 mb/d, due to weaker demand. With the end of Libya's civil conflict on the horizon, we have revised up our Libyan capacity outlook for 4Q11 by 0.1 mb/d, to 0.3 mb/d.
  • Global refinery crude runs have been revised down by close to 0.3 mb/d for both 3Q11 and 4Q11 in light of the weaker demand outlook and higher outages scheduled for a number of countries. Global throughputs are now seen rising 1.7 mb/d in 3Q11 versus 2Q11, to 75.6 mb/d and averaging 75.4 mb/d in 4Q11.
  • OECD industry oil inventories rose by 10.8 mb to 2 687 mb, or to 58.4 days of forward demand, in July. Stocks fell below the five-year average for the first time since the economic recession of 2008. Preliminary data indicate OECD stocks remained tight in August, rising by a modest 0.6 mb.

The demand - price paradox?

Market observers are puzzling over the 'paradox' of weakening economic growth and oil demand indicators on the one hand, and $110/bbl crude on the other. Not everyone is paying $110/bbl of course, and refiners with ready pipeline access to heavily discounted crude in the US Midwest are enjoying bumper margins, unlike their brethren in Europe and elsewhere. WTI aside however, benchmark Brent crude since early May has see-sawed in a range of between $105 and $120/bbl. True, the IEA Libya Collective Action in late-June, and the broader equity and commodity sell-off seen in early-August caused prices to plunge by around $10/bbl each time. But prices have stubbornly reclaimed lost ground again within weeks, raising anew questions about the key drivers of prices.



There are certainly growing concerns about the health of the global economy. Government debt in the OECD and the spectre of inflationary pressures and currency protectionism in emerging markets raise fears that expectations of 'business-as-usual' 4.5-5% world GDP growth are unsustainable. Our own GDP assumptions for 2011 and 2012 are this month scaled-back nearer to 4% annual growth, with the bulk of the downgrade focused on the OECD countries. Oil demand growth is trimmed as a result, now averaging 1.0 mb/d this year and 1.4 mb/d next. Repeating the still-lower GDP sensitivity of June's MTOGM, which cuts a further one-third off GDP growth looking forward, oil demand growth slips to a much weaker 0.7 mb/d and 0.4 mb/d in 2011 and 2012 respectively. This latter case is not our 'most likely' prognosis, but the financial and economic headwinds are nonetheless gathering momentum.

However, the potential for slightly easier market fundamentals in the months ahead needs to be viewed against a backdrop of an actual and pronounced tightening in the market evident since mid-2010. Demand strength in 2H10 saw consumption running ahead of supply to the tune of nearly 1.4 mb/d. The focus has now switched more to supply, amid slowing demand growth in 1H11, with both the Libyan disruption and temporary, but widespread, non-OPEC outages leading to a continued market tightening. We estimate that supply lagged demand by over 0.5 mb/d in 1H11, and July and August have also seen OECD industry stocks fall below the five-year average for the first time since June 2008. Add in the quality dimension, whereby supply outages have overwhelmingly been concentrated in light-sweet grades, and the flip of Brent into backwardation after many months of contango seems perfectly logical.

Our underlying 'call on OPEC crude and stock change' for 3Q11 now stands at 31.3 mb/d, and for the next three quarters looks likely to  average between 30-30.5 mb/d, near recent OPEC output levels. That suggests that the recent spell of market tightening could moderate in the short term, assuming that recent supply disruptions also recede. News from Libya at the time of writing that oil production has begun once again is very welcome, although the road back to full operational recovery is likely to be a long and difficult one. Given the ever-present scope for demand and supply-side surprises, so too could be the route to a more comfortable market balance.

Demand

Summary

  • Forecast global oil demand is revised down by 200 kb/d for 2011 and by 400 kb/d for 2012, with lower than expected 3Q11 readings in the non-OECD and a downward adjustment to global GDP growth assumptions. Stronger-than-expected OECD monthly submissions and preliminary data - largely in the US - provide some offsetting support, as do power generation needs in Japan, the Middle East and an anticipated recovery in Libyan consumption. Global oil demand is expected to rise to 89.3 mb/d in 2011 (+1.2% or +1.0 mb/d y-o-y) and reach 90.7 mb/d (+1.6% or +1.4 mb/d) in 2012.


  • Projected OECD demand for 2011 is now 45.8 mb/d (-0.8% or -370 kb/d) for 2011 and 45.6 mb/d (-0.5% or -240 kb/d) for 2012. We have cut GDP growth assumptions for both 2011 and 2012, particularly in North America and Europe. In 2011, stronger-than-expected oil data for North America and the Pacific roughly balance weaker European readings and the GDP changes, resulting in a net revision of only -20 kb/d. In 2012, OECD demand is revised down by 220 kb/d. While economic slowing provides downside risks, oil-fired power generation in Japan lends upside potential.
  • Estimated non-OECD oil demand for 2011 and 2012 is revised down on average by 180 kb/d to 43.5 mb/d (+3.3% or +1.4 mb/d) and 45.1 mb/d (+3.8% or +1.7 mb/d), respectively. We have downgraded GDP growth moderately, largely due to China. Lower than expected June/July oil readings in Asia and Latin America combined with the GDP adjustment drive the demand revisions. The Middle East and a reassessment of Libyan demand provide demand upside, however.
  • An economic sensitivity analysis, with GDP growth one-third lower than in our adjusted 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 0.7 mb/d and 0.4 mb/d, respectively.

Global Overview

Amid recent negative economic developments, this report has lowered global real GDP growth assumptions for 2011 and 2012 to 3.9% and 4.2%, respectively, down from 4.2% and 4.4% previously. The downgrade is larger on the OECD side, though weaker prospects in China have reduced non-OECD growth as well. These adjustments do not reflect an update to the IMF outlook; rather they represent pre-emptive and preliminary moves to better align our assumptions with consensus views. Still, the September release of updated IMF forecasts will likely prompt further adjustment in next month's issue. For now, our 2012 price assumption, based on the futures strip, remains unchanged, with nominal Brent at $108/bbl. We have revised down 2011 and 2012 oil demand by 200 kb/d and 400 kb/d, respectively, largely as a result of the GDP changes and lower than expected July preliminary demand readings. A -40 kb/d adjustment has also been made to 2010 baseline demand, stemming from JODI database revisions to Chinese Taipei and Thailand.

Overall, global oil demand continues to expand at only a tepid pace. In July, the annual increase is assessed at 1.1%, though this is higher than the 0.5% growth (revised up from zero in last month's report) in June. Our expectation is for global demand growth to average less than 1% for the remainder of the year, with 2011 as a whole increasing by 1.2%, or 1.0 mb/d. In 2012, demand is expected to rise by 1.6%, or 1.4 mb/d. Both of these rates correspond to historical oil demand-income relationships, with sustained high prices keeping growth below-trend levels.

Paradoxically, recent data have shown oil demand marginally higher than preliminary estimates, rebuffing for now some of the more extreme market prognoses that further future demand downgrades are inevitable. In the US, oil demand based on government submissions and preliminary data, albeit declining on an annual basis, has been revised up for the summer, with stronger than expected diesel performance. Japanese oil demand appears to be recovering from March's earthquake and tsunami with oil burning in power generation there lending upside risk. Widespread power outages have not emerged in China, but July oil demand growth was notably higher than anaemic June readings. With coffers flushed with oil export revenues, the energy intensive Middle East also remains a strong source of demand support. Moreover, this report now assumes a gradual recovery of Libyan oil demand, which had fallen to minimal levels, based on a recent easing of the conflict there (see As Fighting Subsides, Libyan Oil Demand Set to Rebound).

Nevertheless, significant economic threats remain, which skew the overall demand side risk to the downside. Consumer confidence has plummeted in OECD countries, with manufacturing indicators easing globally. High unemployment, an overhang of sovereign debt and uncertain fiscal and monetary pictures remain persistent features. As such, we continue to run a sensitivity analysis that shows an indicative view of oil demand should GDP growth come in around one-third lower than our now adjusted base case. Under such conditions, global oil demand would be reduced by 0.3 mb/d versus our base case for 2011 and by 1.3 mb/d for 2012, with annual growth at 0.7 mb/d and 0.4 mb/d, respectively.





OECD

According to preliminary data, OECD inland deliveries (oil products supplied by refineries, pipelines and terminals) contracted by 1.3% year-on-year in July, with declines in OECD North America and OECD Europe outweighing growth in the OECD Pacific. All principal products posted declines except for diesel, which rose by 1.4% year-on-year.



Revisions to June preliminary data were significant, at +500 kb/d, with North America (+390 kb/d) and the Pacific (+70 kb/d) accounting for most of the adjustment. In both regions, positive revisions were concentrated in diesel, jet fuel/kerosene and 'other products'. In OECD Europe, revisions to German naphtha demand from January through June provided some downward offset. Overall, the revisions boosted the trend in total OECD demand from -2.2% year-on-year to -1.1%. Most product categories posted annual declines, save for diesel (+2.9%), LPG (+0.6%) and 'other products' (+0.3%).

With the incorporation of lower GDP assumptions, the prognosis for 2011 has been cut moderately, by 20 kb/d to 45.8 mb/d (-0.8% or -370 kb/d versus the previous year). This minor revision stems from stronger-than-anticipated official submissions for June and higher preliminary data for July and August, which partly offset the impact of lower GDP on demand from September to December. By contrast, the economically downgraded 2012 outlook has been lowered by 220 kb/d to 45.6 mb/d (-0.5% or -240 kb/d year-on-year).



North America

Preliminary data show oil product demand in North America (including US territories) falling by -1.3% year-on-year in July, following a 1.0% decline in June. Economic prospects have turned gloomy, with GDP growth revised down by 0.8% in 2011 and by 0.6% in 2012, the largest change of any region. Paradoxically, the prognosis for 2011 demand is revised up moderately by 30 kb/d to 23.6 mb/d (-0.8% or -190 kb/d), with upward revisions from submitted and preliminary data (particularly in diesel) offsetting downward adjustments from the GDP changes. For 2012, however, demand has been revised down by 120 kb/d to 23.4 mb/d (-0.6% or -140 kb/d).



June revisions were strong (+390 kb/d) and stemmed largely from the US (+360 kb/d). Diesel (+220 kb/d) led the upgrades, followed by 'other products' (+210 kb/d) and jet fuel/kerosene (+90 kb/d). These outweighed downward adjustments to motor gasoline (-120 kb/d) and residual fuel oil (-90 kb/d). Weekly-to-monthly revisions for the US continue to be volatile. During the first half of 2011, preliminary data alternated between positive and negative revisions, with gasoil 'other products' and LPG particularly vulnerable. By contrast, gasoline revisions, which averaged -280 kb/d, were consistently negative.

Adjusted preliminary weekly data for the United States (excluding territories) indicate that inland deliveries - a proxy of oil product demand - declined by 0.7% year-on-year in August, following a 1.7% fall in July. Gasoline demand has remained weak through the summer driving season, declining by -3.8% and -3.0% in July and August, respectively, with a less pronounced seasonal upswing compared to historical norms. Amid gasoline prices 25% higher in June versus the prior year, and a slowing economy, consumers continued to cut vehicle miles travelled that month, with readings showing a year-on-year decline of 1.4%. Diesel demand, however, continued to expand robustly, with August growth estimated at 7.2%, even amid evidence of slowing manufacturing activity. US GDP is now assumed to grow by 1.6% in 2011 and 2.0% in 2012, versus 2.5% and 2.7% previously. Nevertheless, due to stronger than expected preliminary data, 2011 demand is revised up by 30 kb/d to 19.0 mb/d (-0.9% or -170 kb/d year-on-year). By contrast, 2012 demand is revised down by 100 kb/d to 18.9 mb/d (-0.6% or -110 kb/d).



In Mexico, oil demand remained relatively flat in July (+0.2% year-on-year), with persistent weakness in jet/kerosene (-7.6%) and gasoline (-3.6%). Diesel demand continued to grow strongly, however, rising by 6.5% in July. Jet fuel/kerosene demand has steadily recovered since last summer's bankruptcy of Mexicana airlines. Still, consumption in July was sharply below year-ago levels, down 7.6%.

Europe

Preliminary inland data indicate that oil product demand growth in Europe declined by 3.9% year-on-year in July, with all product categories falling except for LPG (+3.7%). Declines were particularly heavy in gasoline (-7.3%) and naphtha (-10.5%) on the back of weak deliveries of heating oil and falling gasoline. Heating oil tank filling appears to have started rising seasonally, though demand still remains weak (-6.3%) compared to 2010 due to higher prices.



Revisions to preliminary June demand data were positive, at +40 kb/d, with higher readings for most products outweighing downward revisions to naphtha (-130 kb/d), largely in Germany, and gasoline (-30 kb/d). With lower expected GDP growth, our OECD Europe forecast is revised down by 90 kb/d in 2011 and by 110 kb/d in 2012. Demand is now expected to decline by 240 kb/d (-1.7%) to 14.3 mb/d in 2011 and by 100 kb/d (-0.7%) in 2012 to 14.2 mb/d.

In July, according to preliminary data, oil product deliveries in Germany posted a decline of 6.3% year-on-year. The incorporation of baseline revisions from January to June lowered naphtha demand on average by 50 kb/d during that period, with downward adjustments partially carried through to preliminary and forecasted values. All categories declined in July except heating oil (+3.6%), suggesting that consumers have begun their seasonal tank refilling.



Demand fell by 3.1% in France in July, with declines in all products, except for naphtha and the 'other products' category. Gasoline demand (-7.5%) was weak, partially due to unfavourable holiday weather conditions. Spain (-3.2%) and Italy (-8.6%) also posted total product declines. In June, government submissions showed demand rising in both Turkey (+10.3%) and the UK (+5.7%). The former was marked by a strong monthly increase in diesel, while jet fuel/kerosene demand rose sharply in the latter.

Pacific

Preliminary data indicate that oil demand in the Pacific grew by 3.6% year-on-year in July with all categories rising except for gasoline, jet fuel/kerosene and residual fuel oil. The regional economic picture has been trimmed for 2011 and 2012, though oil demand appears to be recovering from Japan's devastating earthquake and tsunami in March. Revisions to June preliminary data, at +70 kb/d, were led by heating oil, diesel and jet fuel/kerosene. Despite evidence of economic weakness and high prices weighing upon regional demand, our assessment is revised up by 30 kb/d to 7.9 mb/d (+0.9% or 70 kb/d) for 2011 and is largely unchanged at 7.9 mb/d for 2012 (+0.0% ).



In Japan, oil demand rose by 4.0% year-on-year in July. LPG (+11.3%), heating oil (+5.9%) and 'other products' (+30.2%), which include direct crude burn, posted the strongest gains. Japan's demand growth partially stems from increased oil usage in the power sector - despite cooler temperatures, main utilities reported 35 kb/d higher consumption than in July 2010 (3Q10 was marked by hot weather and strong oil usage to meet peak power demand). In addition, stronger values across other product categories suggest a speedier recovery from March's earthquake and tsunami. Nevertheless, we still assume rising oil-fired generation needs ahead with the uncertain state of Japan's nuclear power. Though the overall profile has not changed since last month's report, assumptions have been tweaked to allow for slightly more crude oil versus fuel oil growth based on recent data. Overall, Japanese total oil demand is revised up by 20 kb/d in 2011 and remains largely unchanged for 2012. Demand in 2011 is expected to grow 60 kb/d (+1.4%) to 4.5 mb/d, while 2012 demand should grow marginally (+0.1%), remaining near 4.5 mb/d.



Meanwhile in Korea, the picture has strengthened with oil demand growing by 4.4% in July, versus an average 6.2% decline during the prior three months. Gains were strong in LPG (+16.6%), diesel (+9.2%), gasoline (+9.3%) and naphtha (+11.2%). Yet, with the economic outlook downgraded this year and given the recent volatile nature of oil demand growth, forecast adjustments remain conservative. The outlook is revised up by 10 kb/d in both 2011 and 2012. However, oil demand is still expected to decline, by 1.4% and 0.4% this year and next, respectively, to around 2.2 mb/d.

Non-OECD

Preliminary demand data indicate that non-OECD oil demand grew by 3.8% year-on-year (+1.6 mb/d) in July, up from 2.2% in June. Much of the pick-up stemmed from relatively stronger demand growth in China and India. July demand is estimated at 43.8 mb/d, while June levels have been revised down by 90 kb/d to 43.9 mb/d (+1.0 mb/d year-on-year). Growth in most product categories increased in July, particularly in gasoline (+4.3%), gasoil (+4.6%) and 'other products' (+4.9%). At the regional level, the largest change occurred in Asia, where a rebound in Chinese demand boosted July growth to 4.7%. The FSU (+7.5%) and the Middle East (+3.4%) also continued to show healthy expansions.







An updated GDP profile has cut non-OECD economic growth by 0.1% for both 2011 and 2012, largely due to a weaker China outlook. As such, demand has been revised down by 180 kb/d for 2011 and by 170 kb/d for 2012. Non-OECD annual growth is now assessed at +3.3% (+1.4 mb/d) for 2011, with demand reaching 43.5 mb/d, and at +3.8% (+1.7 mb/d) for 2012, as demand climbs to 45.1 mb/d.

China

China's monthly apparent demand (calculated as refinery output plus net product imports) rose by 6.1% year-on-year in July as refinery runs rebounded. Apparent demand in June was revised up by 140 kb/d, though growth for that month, at 0.1%, remained marginal. July demand was led by year-on-year increases in gasoil (+7.9%), residual fuel oil (+10.6%) and gasoline (+5.0%). Despite the increase in gasoil, demand has not surged, suggesting little of an earlier anticipated widespread ramp-up of diesel generators in the face of summer power constraints. Electricity shortages remain a risk with some market sources pointing to potential outages through the autumn and winter given weak hydropower supplies in some areas and high coal prices. Still, our forecast does not envisage a similar 300 kb/d rise in gasoil demand in 4Q11 as experienced in the prior year amid coal-fired power restrictions.







In part, the power sector picture looks more secure due to moderating economic activity. The manufacturing purchasing manager's index, at 50.9 in August, indicates only moderate expansion while still-high inflation has constrained monetary policy. Our assumptions for Chinese GDP growth have been trimmed to 9.5% and 9.1% for 2011 and 2012, respectively, down from 9.6% for both years. To be sure, views over Chinese growth remain divided, with differing opinions over the degree of the economy's "soft landing" and some forecasters seeing growth in 2012 at less than 8.5%. Our forecast has revised down Chinese demand by 20 kb/d in 2011 and by 50 kb/d in 2012, with growth now seen at a still-substantial 5.8% and 5.1%, respectively.

Other Non-OECD

In India, oil demand rose by 4.3% year-on-year in July, notably higher than the 1.0% increase registered in June. Growth accelerated in gasoline (+4.5%), gasoil (+4.3%) and 'other products' (+16.0%). Similar to many countries, India's manufacturing sector has slowed in recent months, with purchasing managers' activity falling in August. Yet, expansion remains more robust than in China and OECD countries. Moreover, though India's passenger car sales, which rose by 18% year-on-year in 1H11, have slowed, the market is among the world's fastest growing. Our outlook for demand has changed little, with 2011 nudged higher by 10 kb/d and 2012 unchanged. Growth is now seen at 3.4% this year and at 4.2% next year, though further economic slowing remains a downside risk.







Middle East demand continues to grow strongly, up by an estimated 3.4% in July. Iraqi consumption reached a post-war high (800 kb/d) in June, growing by 5.2% year-on-year. Gasoil (+21.8%) and gasoline (+12.2%) were particularly robust with rising diesel generator usage to meet cooling needs and increasing vehicle travel. Kuwaiti demand (+33.2%) seemingly surged in July, following growth of 27.9% in June, with sharply rising gasoil and residual fuel oil. Saudi Arabia grew by only 2.6% year-on-year, even as oil-fired generation needs rose seasonally. Recent months' JODI data for both Kuwait and Saudi Arabia has been volatile, however. As such, our adjusted growth rates may only serve as tentative indicators. In contrast to the regional picture, Iranian consumption continued to decline, falling by 2.5% in July on weak deliveries of gasoline and jet fuel/kerosene, which are supply constrained by international sanctions, amid now-higher domestic petrol prices versus a year ago.

As Fighting Subsides, Libyan Oil Demand Set to Rebound

In Libya, recent events have pushed the country closer to resolution of the conflict that has raged since February. Though the situation on the ground remains fluid, oil demand has likely started a gradual recovery. Based on JODI submissions (which may only be an approximate measure, given events on the ground), we estimate that Libyan demand fell to minimal levels (just over 100 kb/d) from March-July. Refinery shutdowns, disrupted port operations, damaged infrastructure and reduced economic activity pushed demand down from an average 260 kb/d in 2010. Localised product shortages and weak economic activity are likely to continue weighing on demand through 2012. Nevertheless, a combination of increased refinery output and re-established fuel imports should ease supply constraints going forward. Smuggling from neighbouring countries will likely also play a role, though its impact is harder to measure. As such, we see consumption recovering to 200 kb/d by the end of 2011 and averaging 225 kb/d in 2012 (+45% or +70 kb/d year-on-year) with potential upside should reconstruction proceed faster than anticipated.





In Brazil, product demand expanded by 1.3% year-on-year in June, led by jet fuel/kerosene (+10.2%) and gasoil (+3.9%). Gasoline demand (+1.1%) increased moderately amid high ethanol prices. A disappointing sugarcane harvest and tight ethanol supplies, even with increased imports from the US, have prompted the government to cut required anhydrous alcohol blending in gasoline from 25% to 20% from 1 October. At the same time, Petrobras is increasing gasoline imports to support rising interfuel substitution, and naphtha imports, to allow for greater refinery gasoline production. The Brazilian economy has shown evidence of slowing. Indeed, with a weaker than expected June, our total oil demand forecast is revised down by 20 kb/d for 2011, but left largely unchanged for 2012. With still robust demand growth in the face of underinvestment in the ethanol sector and domestic petrol price caps, Brazil's short gasoline position is likely to continue through this year and next.



Supply

Summary

  • Global oil supply rose by 1.0 mb/d to 89.1 mb/d in August from July, with non-OPEC providing 80% of the total increase. Compared to a year ago, global oil production increased by 1.2 mb/d, almost 40% of which stemmed from higher OPEC NGLs production and another third from increased OPEC crude output.
  • Non-OPEC supply rose by 0.8 mb/d to 52.9 mb/d in August, with new outages in the Middle East and China mitigated by increasing production in Latin America and the conclusion of maintenance in Alaska and Kazakhstan. Non-OPEC supply is expected to increase during the second half of the year on growth from the US, Latin America, and the Caspian region. Some shut-ins at the ConocoPhillips-operated Peng Lai field in China and storm outages in the Gulf of Mexico should dent non-OPEC production growth in the second half of the year. Non-OPEC supply growth in 2011 is now expected to total around 0.2 mb/d, down from estimates of 0.4 mb/d last month.
  • OPEC crude oil output in August was up by 165 kb/d, to 30.26 mb/d. Despite the group's higher output levels, August production is still 1.04 mb/d below the 31.3 mb/d 'call on OPEC crude and stock change' estimated for 3Q11. However, the 'call' for 4Q11 has been revised lower by 0.2 mb/d to 30.5 mb/d, due to a downward revision for demand amid a weaker global GDP outlook.
  • With the end of Libya's civil strife seemingly on the horizon, analysts have been reviewing the outlook for restoration of the country's production. A myriad of reports on the timing and scale for a resumption of oil production have circulated, but foreign oil company partners, alongside industry analysts, remain cautious. We have revised up our Libyan capacity outlook for 4Q11 by 100 kb/d, to an average 300 kb/d. Capacity reaches 350-400 kb/d by end-2011, rising to 1.1 mb/d by 4Q12.


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

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

OPEC Crude Oil Supply

OPEC crude oil output in August was up by 165 kb/d, to 30.26 mb/d.  Higher output by Saudi Arabia, Nigeria, Angola, Iraq, Kuwait, and the UAE more than offset a combined cut of 40 kb/d by Iran and Venezuela. Production by the OPEC-11 with output targets, which excludes Iraq, increased by 130 kb/d to 27.58 mb/d in August, around 2.74 mb/d above the group's formal, but now largely irrelevant, output target of 24.845 mb/d.

Despite the group's higher output levels, August production is still 1.04 mb/d below the 31.3 mb/d 'call on OPEC crude and stock change' expected for 3Q11. However, the 'call' for 4Q11 has been revised down by 0.2 mb/d to 30.5 mb/d, due to a downward revision for demand on the back of weaker global GDP outlook. As a result, the gap between the 'call' and recent supplies has narrowed to just under 250 kb/d. The 'call' for 2012 has been lowered by 200 kb/d to 30.6 mb/d. OPEC spare capacity is estimated at 3.24 mb/d in August, with the continued absence of Libyan supplies only partially offset by higher output from other producers. August crude supply is still 0.2 mb/d below pre-Libyan crisis levels.



With the end of Libya's civil strife seemingly on the horizon, analysts are reviewing their forecasts for the restoration of the country's production. We have made a modest upward revision to our Libyan capacity outlook for 4Q11 of 100 kb/d, to an average 300 kb/d and reaching 350-400 kb/d by end-2011, before rising to a total of 1.1 mb/d by 4Q12 (see 'Short-Term Oil Supply Prospects in Libya as Endgame Nears').

Saudi Arabia's supply was pegged at 9.8 mb/d in August, up 100 kb/d from July's downwardly revised estimate of 9.7 mb/d. Exports appear largely unchanged from July levels, with the increased volumes dedicated to meet higher demand for direct crude burn. Saudi Arabia's implied direct burn was estimated at just over 700 kb/d for July versus around 615 kb/d in June. The country's need for direct crude burn typically peaks in August, which last year averaged around 910 kb/d.

Fellow Gulf producers Kuwait and the UAE both increased output to 2.53 mb/d, up 20 kb/d and plus 30 kb/d, respectively, in August. 

Crude oil supplies from Iran were slightly lower month-on-month, off 20 kb/d to 3.51 mb/d in August. Iranian output continues to be undermined by the lack of foreign investment due to stiffer international sanctions. The drop in production stems from declining output at southern fields, according to Iranian officials. A top official at Iran's state-owned National Iranian South Oil Company (NISCO) reported that the country's production was declining at an average 300-330 kb/d a year compared with other estimates by the government of around 100 kb/d. NISCO produces around 80% of the country's output. The country's higher-than-reported decline rate partly reflects the lack of new field development and partly the severe delays to the country's South Pars projects, which have constrained the amount of gas available for planned enhanced oil recovery at its ageing fields, the NISCO official said.

Iraqi supply rose 35 kb/ to 2.68 mb/d in August, due to higher exports from southern terminals. Total exports were up by 20 kb/d, to 2.19 mb/d. Shipments of Basrah crude were reportedly running flat-out, up around 20 kb/d to 1.73 mb/d while exports from the northern port of Ceyhan on the Mediterranean were largely unchanged at 450 kb/d in August (a further 10 kb/d was sent by truck to Jordan).

Angolan production rose by 20 kb/d, to 1.69 mb/d as output from the Greater Plutonio field edged higher. After maintenance and repair work curtailed output to 100 kb/d in April-June, production is now estimated at 170 kb/d, but still short of its 200 kb/d nameplate capacity due to continued technical issues related to the water injection system.

Meanwhile, first oil from the Total-operated 220 kb/d deep-water Pazflor field arrived ahead of its scheduled 4Q11 start-up on 24 August. Production on 31 August was estimated at around 45 kb/d, with three 950,000 barrel cargoes expected to load in September. However, start-up of the PSVM field operated by BP has been delayed from 4Q11 to March/April 2012 due to problems found with equipment during an inspection at the construction yards in Singapore.

Nigerian August crude oil production rose to the highest level in five years, up by 60 kb/d, to 2.32 mb/d. Major attacks on oil infrastructure have abated following the government's October 2009 ceasefire and amnesty agreement with militants in the Niger Delta, enabling IOC's to increase production. That said, acts of sabotage, oil theft and illegal bunkering continued to disrupt oil flows last month. Once again, Shell declared force majeure on some Bonny Light loadings from 23 August through October, following sabotage to several key pipelines by suspected oil thieves.  On 11 August, militants bombed a Chevron-operated pipeline that carries Escravos crude to the 20 kb/d Dibi flow station in the Warri region. Oil thieves also caused a fire at ENI's Tebidaba Brass pipeline in late August, but the impact on output was reportedly minimal.



Short-Term Oil Supply Prospects in Libya as Endgame Nears

The prospects for partial restoration of Libyan hydrocarbon supplies in the short term have improved following the fall of Tripoli to rebel forces on 21 August. A myriad of reports on the timing and scale for a resumption of oil production have circulated, but foreign oil company partners, alongside industry analysts, remain cautious. Damage to production facilities, pipelines, refineries and ports, although believed comparatively light, will need to be fully assessed, and security on the ground assured before major increases in production can be expected. The pace of the restoration of production will also hinge on whether the fields were professionally shut-in and done in a rushed, haphazard manner.

For now, we have modestly revised up our expectations of Libyan crude production capacity to 350-400 kb/d by end-2011, rising to a total of 1.1 mb/d by 4Q12. The projection is predicated on an imminent end to the civil unrest, and assuming that political stability and security on the ground are achieved in the very near term. The Zawiya and smaller Tobruk refineries may restart operations relatively quickly once crude supplies are available, but Ras Lanuf, the country's largest, may take several months (See Refining section, 'Libyan Refinery Status'). Depending on the prioritisation of domestic oil use vs revenue needs, crude exports might attain 200-250 kb/d in 4Q11, rising to 650-850 kb/d by end-2012.

With Colonel Gaddafi still at large at the time of writing, and pockets of loyalist resistance still putting up a fight, security remains uncertain. Indeed, the twin challenges of creating political stability and security on the ground in order to enable foreign oil companies to return to the country are formidable. Prior to the civil uprising, Europe took over 85% of Libya's crude exports, with about 13% heading East of Suez. In 2010, Libya exported 1.2 mb/d of crude oil to IEA countries. An additional 0.1 mb/d of crude oil from Libya went to China in 2010, accounting for some 3% of the total Chinese crude imports.

Upstream Oil Restoration

As the endgame in the country's uprising gathers momentum, international organisations have moved swiftly to lift sanctions and remove other impediments to restoring civil society as the new National Transitional Council (NTC) takes over the reins of government. The international grouping called the 'Friends of Libya' met in Paris on 1 September to offer support, including urging countries to unfreeze funds held by the former regime, while the EU lifted sanctions on Libyan overseas assets, ports and oil companies.

There have been widely disparate reports on the state of the country's oil and gas sector. The NTC and state Arabian Gulf Oil Co (AGOCO) have both publicly announced a very ambitious timeline for restarting oil production, which most external analysts believe will not be met. AGOCO said production could restart by mid-September and reach 500-600 kb/d within two to three months and full production of 1.6 mb/d within a year. However, the country's interim oil minister, Ali Tarhouni, said production initially would be in the tens of thousands barrels a day rather than hundreds but ultimately reach pre-disruption levels within a year. Industry experts and IOCs previously operating in the country estimate it could take anywhere between one to three years to get production fully restored. Several issues highlight upside and downside risks to the oil outlook. Cause for optimism stems from:

  • The lifting of EU sanctions on 1 September, liberating an estimated $15 billion of frozen Libyan assets to help meet short-term needs;
  • NTC statements that an armed force has been dispatched to protect the eastern fields, accounting for 80% of Libyan output, and that technical teams will be sent to the Sarir and Mesla fields in the Libyan desert to investigate damage in the first week of September following Ramadan;
  • An imperative to re-start crude production as soon as possible for the associated gas needed to run the country's power generation facilities;
  • News that the 510-kilometre GreenStream BV undersea gas pipeline system between Mellitah (near Tripoli) and Gela in Italy, has been repaired, with exports expected to resume by mid-October.
  • On the other hand, technical, security-related and institutional barriers remain to rapid and full restoration:

  • Ongoing resistance from Gaddafi loyalists, with the risk they implement a scorched earth policy. There are credible reports that loyalist forces have also heavily mined some strategic oil facilities.
  • Divisions within the new leadership along tribal and regional lines may stall progress in creating a sustainable government necessary for renewed investment. There is evidently friction between the NTC and various rebel groups from Misrata and the western mountain region, and many analysts fear that Islamist groups will pose the largest obstacle to creating a unity government.
  • Securing equipment and workers to assess damage and manage repair work could take much longer than assumed, given security issues. The operating status of almost all of Libya's oil infrastructure remains unclear, notably the country's largest oil terminal, the 450 kb/d Es Sider facility.
  • Given these many uncertainties, we persist with a deliberately cautious set of assumptions for available crude oil production capacity through the end of the year. In the Medium-Term Oil and Gas Markets (MTOGM) projection in June 2011, we assumed hostilities continued through end-2011, with some form of resolution in early 2012. What now looks like an earlier-than-expected end to full-scale hostilities has prompted our modest upward revisions. From zero output currently (and hence below the 200 kb/d baseline deployed in MTOGM), production is now assumed to ramp up to an average 300 kb/d in 4Q11, reaching 350-400 kb/d by the end of 2011. Production is also now seen reaching around 1.1 mb/d by 4Q12, with many local and international experts envisaging a two to three year time frame before the country regains 2010 levels of around 1.6 mb/d.



    Initially, we assume production from the smaller offshore Bouri and Al-Jurf fields, with a combined nameplate capacity of around 100 kb/d, will be restarted relatively quickly. This offshore oil, however, is heavier, sour crudes rather than the country's typical light, sweet grades.

    An additional 250 kb/d will come from the Mesla and Sarir fields in the eastern region once repairs to pipelines and pump stations are completed. Indeed, AGOCO reported on 12 September that it was in the process of starting up production at Sarir. The crude will flow to the Marsa el-Hariga terminal near Tobruk but with a capacity of only 150 kb/d, the remaining crude would have to be blended with other grades and exported from the larger Ras Lanuf terminal. However, it is understood that the Ras Lanuf refining, terminal and port complex suffered significant damages and it may take months for repairs, capping exports to those out of Tobruk.

Non-OPEC Overview

Non-OPEC oil supply is estimated to have increased by 0.8 mb/d to 52.9 mb/d in August, largely due to increasing output from the US, Latin America, and Caspian region.  These gains are mitigated in part by declining production in non-OECD Asian countries.  A review of field level and historical data for the first half of 2011, as well as revised estimates from OECD countries for May and June 2011, has resulted in a baseline revision of -0.1 mb/d for the second quarter of 2011.  This suggests that output during the second quarter was 52.2 mb/d or 0.4 mb/d lower than during 2Q2010.  During the third quarter of 2011, the onset of heavy North Sea maintenance and other unplanned outages including hurricanes (see chart below) restrict the rise in 2Q11 to 3Q11 non-OPEC supply to 0.4 mb/d. 



With baseline revisions for 2011 included, our 2H2011 forecast is revised down 330 kb/d. Revisions stem primarily from heavier than expected maintenance in Denmark, Norway, and Kazakhstan. A review of recent NGL and biofuels production trends for the first half of 2011 has also resulted in a combined downward revision of 35 kb/d for Asia and OECD Europe's NGL production growth for the year as a whole, and a 40 kb/d downward revision to global biofuels annual production growth, largely due to Brazilian ethanol production. Unplanned outages in China (oil spill) and Yemen (pipeline sabotage and worker strikes) account for 50 kb/d and 15 kb/d of this annual revision, respectively. In sum, 2011 growth in non-OPEC supply is expected to total 190 kb/d, around 200 kb/d lower than last month's estimate.

Some of these changes necessitate a reassessment of our non-OPEC supply outlook for 2012, which has now been revised downwards by 150 kb/d to 1.0 mb/d. Around 65 kb/d of the 2012 revision is due to lower than expected NGL production growth in Asia, OECD Europe, and Brazil in 2011, which has been carried through our outlook. Global biofuels are also revised downwards by 20 kb/d in 2012. Other major negative changes to the 2012 outlook stem from analysis of field-level data in Russia, Oman, Kazakhstan, Brazil, and Australia, which show output levelling off at a number of fields previously underpinning supply growth.

Our outlook for 2012 of 1.0 mb/d growth remains largely consistent with our first assessment in the July release of the MTOGM.  At that time, we estimated 2011 annual production growth at slightly over 0.5 mb/d, in contrast to 0.2 mb/d in this month's forecast.  It is worth pointing out that unexpected outages will reduce 3Q11 output by around 0.4 mb/d, something that is not envisaged carrying through in our forecast for 2012 to the same degree. We customarily assume a more modest 0.2 mb/d annual adjustment in our outlook, largely for potential equipment failures at mature assets in the OECD.



OECD

North America

US - July Alaska actual, other states estimated:  US oil supply dipped to an estimated 7.6 mb/d in July as output at Alaska's Prudhoe Bay field fell by 0.1 mb/d due to assumed summer maintenance, augmented by some minor leaks in July. In August, preliminary data show that field output has rebounded to pre-maintenance levels by the end of the month, raising total US oil output to 7.8 mb/d. We expect Gulf of Mexico production to fall by around 220 kb/d from August to September due to hurricane-related disruptions based on a five-year average. Hurricane Lee has already reduced monthly Gulf of Mexico output by roughly 165 kb/d at the time of writing. Historical upward adjustments in Colorado and New Mexico, as well as a downward adjustment to Wyoming, from Petroleum Supply Monthly data have been carried through the forecast. This has resulted in annual production estimates that are 10 kb/d higher in both 2011 and 2012, bringing US supply to around 7.9 mb/d in those years.



Canada -June actual:  Second-quarter oil production in Canada exceeded expectations by 6 kb/d largely as a result of higher-than-expected bitumen production in June 2011. Rebounding production from Suncor in June and expectations of increased production from new wells at Hibernia offset reduced production from the CNRL Horizon mine/upgrader and declining production in Saskatchewan. CNRL reports that production restarted at 75 kb/d in mid-August and should return to pre-fire levels of 110 kb/d in a couple weeks. In a reversal of growth shown over the last six months from Saskatchewan, 2Q11 output is now 30 kb/d below 1Q11 levels, raising the possibility of further forecast downgrades in months to come.   Canadian oil output should average 3.6 mb/d in 2012, an increase of 160 kb/d from 2011 levels.

Mexico - July actual:  Mexican crude oil production fell by 21 kb/d in August compared to prior month levels. Overall, Mexico's output continues to decline, and 2Q11 crude oil output is 5 kb/d lower than the 2010 equivalent. Despite rising production from northern onshore areas and the Chicontepec field, which is now producing around 50 kb/d, output at the Ku-Maloob-Zaap (KMZ) field has dropped back to 4Q10 levels of slightly more than 800 kb/d. For the remainder of 2011, we expect KMZ output to rebound to 840 kb/d. Mexico is looking to Pemex's new service contract model to stem declining oil output. Three new offshore projects, Ayin, Tsimin and Xux, could add 20-80 kb/d by 2015 and new production at the KMZ complex from Kayab and Ayatsil could add 90-100 kb/d over the same time period.

North Sea

Norway - June actual, July provisional: Following a faster-than-expected ramp up of seasonal maintenance and the delayed restart of the Visund field due to technical problems, Norway total oil production has been revised downwards by 40 kb/d and 90 kb/d in June and July, respectively. It is now seen to average 1.94 mb/d and 2.05 mb/d in June and July, with 2Q11 assessed at 1.99 mb/d, a drop of 200 kb/d when compared to the previous quarter. Maintenance and other outages are estimated at 167 kb/d for 3Q11, of which almost half is due to seasonal maintenance, and will keep overall production flat during the third quarter with no pronounced uptick expected until 4Q11. Recent reports indicate that the restart of the fire-damaged Valhall platform has been delayed until the middle of September, resulting in lower output expectations for the remainder of 2011.



UK - June actual: Following widespread maintenance, June UK oil production has been revised downwards by 70 kb/d to 1.1 mb/d and is now assessed at 1.2 mb/d in 2Q11. June output fell by 40 kb/d from May, with the downward trend continuing into July and August, as the maintenance season reached its seasonal peak, before an uptick in September. Output has been trimmed by 5 kb/d in both August and September because of the shut-in of the Gannet A platform following its widely reported leak. However, in September this has been offset by the return of the Buzzard field from maintenance. The field is currently expected to ramp up to its pre-maintenance level of 205 kb/d by October. Total UK production is now estimated to average 1.24 mb/d in 2011, increasing to 1.26 mb/d in 2012.

Pacific

Australia - June actual: For Australia, June data show production remained at a lower-than-expected 420 kb/d, although output should increase later in the year with rebounding volumes from the Cossack and Van Gogh fields and new output from the Kitan and Pyrenees field. Our outlook envisages that production maintains an upward trajectory in late-2011 and 2012. Downward-adjusted 2011 and 2012 production levels now average 470 kb/d and 600 kb/d, respectively. Downward revisions stem from lower recent NGL output, which we have carried through the forecast, and from a detailed field-level review of sources of expected growth from the Carnarvon and Bonaparte Basins. The Skua and Montara fields in the Bonaparte basin are still expected to come online in January 2012 and should add 35 kb/d to Australia's output.

Non-OECD Asia

Thailand - June actual:   Output from Thailand is around 10 kb/d lower in 1H11 than the same period last year, showing almost no growth in NGL and condensate output. Government-reported condensate output of 79 kb/d in June was the lowest total since November 2009. We had forecast some growth in NGL and condensate output, but reviewing six months of lower-than-expected output, we have revised downward our assessment of total Thai oil output by around 14 kb/d each in 2011 and 2012.

Indonesia - June actual: Despite government forecasts that Indonesia's output will reach 1 mb/d again by 2013, recent output statistics show a downward trend. Overall, oil output for the last six months has fallen by 75 kb/d versus the same period in 2010, of which 12 kb/d is from declining NGL output. New government-reported historical data for NGL output has reduced Indonesian output by 10 kb/d for 2011, and our estimate for 2012 by 7 kb/d. We estimate Indonesian crude oil production will continue to decline from 910 kb/d in 2011 to 860 kb/d in 2012. 

Elsewhere in non-OECD Asia, in Vietnam the Te Giac Trang crude oil field began producing at 16 kb/d on 22 August, and is expected to ramp up to levels of 40-55 kb/d by the end of the year, in line with our forecast. Overall output from Vietnam is assessed at 300 kb/d in June, but should ramp up to 330 kb/d by year-end with added output from Te Giac Trang and the Dai Hung (Big Bear) field.

China - July actual:  China's oil production fell by 100 kb/d to 4.1 mb/d in July, due primarily to shut in production at the Peng Lai 19-3 field in Bohai Bay. We assume the shut-ins to last into September but are partially offset by sustained production growth elsewhere. Production for 2011 is estimated to average 4.2 mb/d, which would represent annual growth of 80 kb/d, or +2%. In 2012, production is expected to rebound to 4.3 mb/d on resumed Peng Lai volumes and Chinese producers' ability to stem decline at some of its largest and mature fields. For example, oil production from the over fifty-year-old Daqing field averaged 800 kb/d in 2009, but 1H2011 data show that the field has sustained output at levels of almost 810 kb/d. All told, the Peng Lai leaks (see below), knock 50 kb/d off our 2011 Chinese outlook and 30 kb/d from 2012.

Leak at ConocoPhillips' Peng Lai 19-3 field to reduce 2H2011 Chinese output

Two separate oil leaks were discovered at the Peng Lai 19-3 field in China's offshore Bohai Bay, at platform B on 4 June and platform C on 17 June. These platforms were producing around 47 kb/d up until China's State Oceanic Administration (SOA) ordered a production suspension on 13 July. In June, the Peng Lai field produced around 150 kb/d from seven platforms, which includes 181 producing wells and 54 injecting wells. After further leaks were identified in August, the SOA ordered the shutdown of the entire 19-3 field. Based on CNOOC and ConocoPhillips statements, we estimate that the suspension of output reduced total production by 31 kb/d in July, 47 kb/d in August, and 150 kb/d in September. Looking forward, we believe the field could to have difficulty reaching its former peak production levels due to operator safety concerns and damage to the reservoir from the shut-in. We assume platforms B and C  remain offline until late in the fourth quarter, and we expect the other platforms to return sooner.

Former Soviet Union (FSU)

Russia - July actual, August provisional:    Russia's oil output hit another post-Soviet high of 10.6 mb/d in August, driven by expanding output at TNK-BP greenfields, sustained output at Rosneft and Gazprom Neft's brownfields, and continued growth in condensate output from Gazprom. The Russian energy ministry has revised up its oil production forecast for 2011 by 100 kb/d, and says the introduction of a new export tax regime on 1 October should lead to higher exports (see Russia: Upstream and Export Impacts of the 60-66 Tax Regime). We have revised up our estimates for Russian supply for 2011 and 2012 due to recent production data showing higher-than-expected production from Bashneft, Russneft, and TNK-BP. At the Uvat fields in West Siberia, TNK-BP plans to further increase output by 17 kb/d by year-end with new wells. Also, TNK-BP's Verkhnechonsk oil field in East Siberia has moved up its target to reach peak production of 154 kb/d to 2014.

ExxonMobil and Rosneft recently announced plans to develop hydrocarbon deposits in the Russian sectors of the Arctic and Black Sea. The investment planned for the two areas is $3.2 billion and ExxonMobil will receive a 33.3% share in each newly-established JV. Rosneft receives the remaining shares and also receives footholds in several Gulf of Mexico, Texas, and Canadian deposits where ExxonMobil is active. Looking forward much will depend on government follow-through to ease tax constraints for Arctic exploration and the results of exploration in the Kara Sea, where the seismic data is very uncertain.

Russia: Upstream and Export Impacts of the 60-66 Tax Regime

Russia is expected to introduce a new crude and export duty regime on 1 October after various government ministries and Prime Minister Putin agree to the plan. Although the new tax system aims to modernise Russia's downstream sector, there are medium-term implications for oil supply, export levels, and Russian budget revenues. The new 60-66 tax regime will see the marginal export tax for most crude oil exports cut to 60% of the price of Urals, from 65% currently, and a unified oil products tax rate set at 66% of the duty for Urals. Although Prime Minister Putin signed the order to equalise the export duty for refined products at the end of August, the plan to reduce the crude oil export duty to 60% requires a separate government decree to be signed later by Prime Minister Putin. The export duty for gasoline and naphtha will remain at 90% of the export duty for Urals (set at that level since end-April to limit exports and domestic shortages), but should, according to energy minister Shmatko, gradually decline to the 66% set for other products over coming months. The export duty for light and heavy products is currently 67% and 46.7% respectively of that of Urals (See Refining section for more details).

The major implication for upstream-focused companies in Russia is that it secures them additional cash flow. Rosneft, Tatneft, TNK-BP, and Surgutneftegaz are poised to benefit the most from the rebalancing according to Russian analysts. Integrated companies, which derive most of their profits from their downstream segments (such as Bashneft) could see reduced overall profitability, and analysts expect the government to compensate them with lower mineral extraction tax (MET) rates or discounts on rail product transport tariffs.

A 5% reduction in crude export duty would allow producers to improve brownfield well productivity. Production from mature fields with high lifting costs and low flow rates could see enhanced productivity under the new regime because it increases the number of profitable wells. One investment bank estimates that the return on an average LUKoil West Siberian brownfield well would increase from less than 10% to over 20%. Broadly speaking, analysts estimate that at a $100/barrel crude price, upstream unit profitability increases by $4/barrel.

The new tax regime is likely to favour the exporting of crude over products, but this does not necessarily mean that crude shipments will rise beyond 9 mb/d because of increasing domestic demand for crude. So, what does this mean for our outlook on oil production? The companies that will benefit directly from the change in crude export duties comprise around half of Russian oil output. Due to output performance exceeding our expectations in 2010 and the first half of 2011, our outlook already includes 45 kb/d annual growth for 2012, including growth of over 120 kb/d from Rosneft's fields. Although the 60-66 changes should increase brownfield production, integrated companies are still expected to see their refining margins reduced. Also, the changes are unlikely to affect Russia's greenfield output.  On the downside, it is worth noting that in addition to losing its crude export duty discount, Rosneft's 300 kb/d Vankor field has also lost its mineral extraction tax exemption.  

On balance, although the government seems committed to introducing these tax changes by 1 October, many observers hope for broader changes to the oil sector tax regime such as the introduction of a profits-based, rather than revenues-based, tax regime that would benefit greenfield production in frontier areas. The government also recently introduced a reduction in the mineral extraction tax for small fields (<18 million bbl).  To add to the uncertainty, this is an election year in Russia, which means the government could repeal these exemptions to maintain steady budget revenues especially if oil prices fall. All told therefore, we have not substantially changed our production outlook because of the tax changes due to the remaining uncertainty with the implementation of the crude oil export duty reduction.

Kazakhstan - July actual:  In July, Kazakhstan's oil production fell to 1.5 mb/d with unexpected additional maintenance at the 550 kb/d Tengiz field, which reduced output by around 150 kb/d. July data also show the marginal effect on production of the oil workers' strike on Karazhanbasmunay and Uzenmunaigas production. The strike continued to affect similar levels of output in July and into August. While crude oil production growth prospects in Kazakhstan remain largely unchanged from last month's outlook, the ongoing shareholder dispute at the Karachaganak gas and gas condensate field has caused us to keep output static at the field. Recent reports indicate a resolution in upcoming months, but this has delayed implementation of the field's Phase III expansion. The expansion would have cost up to $23 billion and resulted in around 30 kb/d of additional condensate output.



FSU net oil exports reached their lowest level since end-2008 in July, down by 480 kb/d to 8.82 mb/d, with the fall evenly split between crude and products. Crude shipments fell to 6.08 mb/d, 90 kb/d lower than the previous year, in response to supply problems outside of Russia. Notably, Azeri volumes were disrupted following scheduled maintenance on the Chirag platform and the Baku - Supsa pipeline. Black Sea cargoes dropped by 130 kb/d while flows on the BTC pipeline fell by 100 kb/d. Strikes in Kazakhstan also began to bite, with deliveries through the CPC pipeline decreasing by 20 kb/d. In comparison, exports through the Russian Transneft network rose by 110 kb/d, with Druzhba flows up by 70 kb/d on the month as deliveries along the Northern leg to Poland grew by 100 kb/d. In the Baltic, shipments from Primorsk fell by 90 kb/d following maintenance on the Baltic Pipeline System. In the East, although fields supplying the ESPO saw export tax breaks removed from 1 August, Kozmino loading schedules suggest pipeline flows could continue unabated.

Product exports fell by almost 50% (-270 kb/d) to 2.80 mb/d, led by an exceptional 190 kb/d drop in fuel oil shipments (including vacuum gas oil). Reasons for this slump are unclear with reports suggesting a combination of a fall in refinery throughput, increasing domestic demand and after government pressure, refineries re-orientating to stockpile more light products, were responsible. Additionally, the 90% gasoline and naphtha export tax recently introduced in response to domestic gasoline shortages has had the desired effect of reducing shipments  by 80 kb/d. September product volumes may rebound in expectation of the new 60-66 fiscal regime (see: Russia: Upstream and Export Impacts of the 60-66 Tax Regime). However, crude exports are expected to remain low, as pipeline and field maintenance reaches a seasonal peak.

Other Non-OECD

Brazil - June actual: Oil output remained at 2.2 mb/d in the second quarter, on par with first quarter levels. On a monthly basis, crude and NGL output rose by 65 kb/d in June, but growth in output from Brazil during 3Q2011 from the start up of the Marlim Sul field is mitigated by seasonal maintenance at platforms in several offshore fields, including Marlim (P-20, P-35 and P-37), Albacora Leste (P-50), Parque das Baleias (FPSO Capixaba), and units of the Cabiúnas chain. In addition, we have revised the ethanol output forecast by -30 kb/d in 2011 and by -20 kb/d in 2012 because of a disappointing sugar cane harvest. In sum, we estimate that output from Brazil during 2011 and 2012 will average 2.2 mb/d and 2.4 mb/d respectively, mostly on par with growth estimates from last month's assessment and not including the changes to biofuels production estimates.

In Yemen, although some 110 kb/d of shut-in crude oil production resumed in mid-July, the Marib oil pipeline, which carries crude to the Ras Issa terminal, was bombed again in late August. Reports indicate that the pipeline was repaired and capacity was restored. However, companies report that drilling operations have been stopped, which means there may be longer-term implications for Yemen's output. We have conservatively reduced output by 125 kb/d in September pending historical data showing that output has indeed reached earlier levels. Nexen, which operates two blocks in Yemen reported that its production is suffering from natural field declines following the completion of development drilling activities. In the absence of an agreement to renew its existing two concessions and with the threat of worker strikes, Nexen's 35 kb/d output is expected to fall further. Downward revisions to surrounding months from the aforementioned pipeline disruption have lowered Yemen's output in 2011 to just over 200 kb/d, which is 70 kb/d lower than 2010 and a -15 kb/d revision from last month's estimate.

In Oman, an analysis of Ministry of National Economy and JODI data has caused us to reassess our baseline production estimate, thereby reducing our estimate for 2H11 and 2012 output by 20 kb/d. A field level analysis indicates that production from the Occidental Mukhaizna EOR project may take longer to reach targeted levels of 150 kb/d due to quadrupled project costs. Thus, we have revised downwards our estimates by 15 kb/d for this project. In sum, Oman's crude and NGL output are expected to grow to 930 kb/d by 2012, an increase of 40 kb/d from projected 2011 levels.

In Sub-Saharan Africa we have revised output downwards in Uganda and Ghana due to revised project timelines reported by UK-based Tullow Oil. In Ghana, Tullow modified its timetable for peak production from the Jubilee field and is now set reach 105 kb/d in October and 120 kb/d by the end of the year, down from original plans to reach 120 kb/d in August.  Tullow attributed the delay to water reinjection problems.  In Uganda, Tullow projects first oil from the Albert basin in 2015, which is later than earlier estimates that assumed some initial production during 2012. As a result, Ugandan output is trimmed by 10 kb/d to zero in 2012.

New EU Sanctions on Syria Unlikely to Affect Syrian Crude Oil Production

EU sanctions on Syrian oil imports ban the purchase and transport of Syrian crude and refined products. The regulation also bans the import of crude or petroleum products if they "originate in" or "have been exported from Syria." Existing contracts that were concluded prior to 3 September are exempt from the sanctions until 15 November. The embargo will not ban the supply of refined products from the EU to Syria, nor will it seek to prevent European companies from delivering Syrian oil to non-EU countries. US sanctions already restrict investment in the country, and further EU sanctions if they occurred, to include the operations of non-US companies, could have a more long-term impact.

Syria has two primary crude blends, Syrian Light and Souedieh. Souedie, produced from the Souedie and Jebeisseh fields, is heavy and high in sulphur, while Syrian Light comes from production at the AFPC JV (Shell, 80 kb/d) and Total's Deir ez Zor (25 kb/d). Based on data submissions from IEA member countries, we estimate that Syria exported 157 kb/d of crude oil in 2010 and 127 kb/d in 1H11 to OECD Europe countries. Based on data from Syria's General Petroleum Corporation (GPC), an additional 26 kb/d of crude exports went to non-OECD countries in the first half of the year. It is also worth noting that there is anecdotal evidence of Chinese refiners taking crude oil from Syria. The loss of around 25 kb/d of Syria light crude to European refiners is unlikely to have a large impact on European refinery operations, although it might cost refiners more to find substitute crude oil to replace Syria light. Reports indicated that Italy, the destination of over 60% of Syrian crude oil, had recently been taking more Syrian crude to substitute for lost Libyan exports.

We do not believe that the sanctions currently in place will affect crude oil production volumes from Syria, which the IEA estimates at 332 kb/d in August, although they could exacerbate already-declining mature production in the country. Depending on the extent to which Syria discounts its Souedie blend crude oil, these volumes should find other customers elsewhere. Oil marketing organization Sytrol is already reported to be exploring Asian markets for Syrian exports.

OECD Stocks

Summary

  • OECD industry oil inventories rose by 10.8 mb to 2 687 mb, or 58.4 days of forward demand cover, in July. Seasonal product restocking, led by gains in middle distillates and 'other products', drove the overall monthly gain, while counter-seasonal declines in crude and 'other oils' provided a partial offset. The July build was weaker than the typical 26.8 mb seasonal increase. As a result, inventories fell 12.8 mb below the five-year average and 81 mb below year-ago levels. This is the first time total oil industry stocks have slipped below the five-year average since the economic recession of 2008.
  • Preliminary data indicate a modest 0.6 mb build in OECD industry oil stocks in August. Stronger refinery runs reduced industry crude holdings by 10.6 mb, while product stocks rose by 13.8 mb. Although the products increase and crude draw mimic typical seasonal trends, the last five years have seen a much larger average 14.0 mb August build. The stock levels are subject to revision upon the receipt of more complete data next month, yet OECD inventories appear to have remained tight in August, at 26.3 mb below the five year average and 108 mb below year-ago levels.
  • Short-term oil floating storage fell to 48.3 mb in August, down from 50.5 mb in July. Offshore crude oil holdings declined to 37.6 mb, as some Iranian volumes were offloaded in the Middle East Gulf. Refined products held in floating storage fell to 10.7 mb in August, as discharged volumes in the Middle East Gulf, Asia Pacific and Northwest Europe outweighed increases off West Africa.


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

OECD oil industry stocks rose by 10.8 mb to 2 687 mb in July. By contrast, inventories built on average by 26.8 mb over the past five years, driven entirely by strong product gains. This year, product restocking drove July's increase in stocks, but stronger refinery runs combined with lower production reduced crude oil inventories counter-seasonally. As a result of this weaker-than-average monthly stockbuild, OECD inventories fell 12.8 mb below the five-year average and 81 mb below year-ago levels. This is the first time total industry stocks have slipped below the five-year average since June 2008.



As anticipated in previous reports, refiners increased crude runs over the summer in line with seasonal trends. Nevertheless, and despite extra supply deriving from both OPEC producers and the IEA Collective Action (see IEA Libya Collective Action: Oil from Government Stocks Relieving the Market), this resulted in a counter-seasonal 14.0 mb crude draw in July. The decline was concentrated particularly in Europe, where crude oil stocks fell 11.7 mb, to almost 24 mb below year-ago levels. At 310 mb, European crude stocks apparently stand at their lowest level since January 2007, although these data are subject to revision.

In contrast, OECD industry inventories of refined products soared by 29.0 mb in July, with a build in 'other products' accounting for almost two thirds of the restocking. Middle distillates contributed by gaining 9.5 mb, although the accumulated distillate overhang diminished, narrowing to 5.4 mb above the five-year average in July, from 80 mb two years ago. Meanwhile, gasoline stocks rose counter-seasonally by 1.3 mb, in part due to a fairly weak driving season in the US.



OECD forward demand cover stood at 58.4 days in July, marginally higher than June's 58.3 days and 1.4 days above five-year average levels. Stock cover rose modestly in July driven by gains in 'other products' holdings and despite the prospects of rising distillate demand over the next three months.

Upon receipt of more complete data, estimates of total OECD industry oil holdings were revised down by 1.1 mb for June and by 1.0 mb for May. Despite the downward revision to stock levels, the implied monthly draw remains 11.9 mb in June, in line with our previous assessments. Readings for distillates and 'other products' came in lower, while upward adjustments were centred on gasoline and 'other oils'.



According to preliminary data from the US, Japan and Euroilstock, OECD industry inventories remained virtually flat in August, rising by a modest 0.6 mb. Stronger refinery runs reduced industry crude holdings by 10.6 mb, although deliveries from public stocks prevented a still-sharper draw from occurring. Product stocks built by 13.8 mb, driven by distillate, 'other products' and fuel oil gains, while a decline in gasoline inventories provided partial offset. By contrast, stocks rose on average by 14.0 mb over the past five years, with sharp distillate-led builds in refined products tending to outweigh draws in crude.

IEA Libya Collective Action: Oil from Government Stocks Relieving the Market

Oil from government reserves released as part of the IEA Libya Collective Action entered the markets in July and August, thus providing a partial relief to already tight markets constrained by lost Libyan supplies and production outages in the North Sea and elsewhere. Although OMR analysis focuses primarily on developments in industry stocks in OECD countries, the most recent evolution in government holdings merits a closer look. In addition, tables 4 and 5 in the annex of this report show the levels of both government-controlled (public) and industry stocks.

Based on available delivery schedules we estimated last month that approximately 40% of the over 38 mb of public oil stocks were delivered in July, with the remaining 60% likely to be taken up in August. Preliminary indications from governments now suggest that, as a result of the emergency stock release, public stocks declined by at least 13.6 mb in July. This draw accounts for 35% of total pledged oil volumes from government reserves. However, the magnitude of public stock draw is only indicative and we will be able to better assess July deliveries from government stocks next month, after the receipt of complete inventory data, including a detailed breakdown of public and industry inventory levels.

The draw from public stocks can be clearly seen in the data, but with a multitude of factors affecting end-month industry stocks, a direct inverse relationship between public and industry stocks cannot be clearly identified. Likewise, in the case of mandatory industry stocks, the lowering of stockholding obligation, while providing operators with a greater degree of flexibility, may not directly translate into a stock change.



The most recent consolidated information from the US Department of Energy, also available on their website, indicates that all Strategic Petroleum Reserve (SPR) volumes were delivered by 31 August as originally scheduled, showing 8.3 mb of crude were delivered in July and 22.3 mb in August. This has confirmed preliminary US weekly data showing a decline of 7.8 mb of crude oil from the SPR in July, and a further 21.1 mb drop in August.

In Europe, preliminary information indicates that at least 1.8 mb of crude and products from public stocks were delivered to market participants. German government-controlled stocks are estimated lower by 1.4 mb, of which 1.1 mb was likely crude and the remainder products. Preliminary information from the Netherlands signal at least a 0.4 mb draw in crude oil public reserves.

In Korea, 3.5 mb of oil from government reserves reached the market in July. First indications suggest that almost 2.0 mb of crude oil, 0.4 mb of gasoline and 1.2 mb of distillates from public reserves were loaned to industry, helping to bolster otherwise fairly tight regional industry stocks.

Analysis of Recent OECD Industry Stock Changes

OECD North America

Commercial oil inventories in North America surged by 21.2 mb to 1 356 mb in July. Crude oil inventories declined seasonally by 4.2 mb and stood below year-ago levels following a rebound in regional crude runs. A delivery of 7.4 mb of crude from the US SPR in July likely counterbalanced the monthly industry stock draw. At the same time, higher refinery throughputs boosted product inventories by 27.1 mb, as 'other products' and distillates rose more sharply than the seasonal average and a 2.5 mb gasoline build also contributed.



EIA weekly data point to a 4.4 mb increase in US industry stocks in August, including a 0.9 mb contra-seasonal gain in crude stocks. The 21.1 mb of US SPR delivered to industry buyers in August helped offset heightened refinery activity. Meanwhile, Cushing inventories fell by 2.6 mb to 32.7 mb, the lowest levels since November last year, but still well above five year average levels. The draw came despite a sharp uptick in crude imports reported in the US Midwest at the end of August.



A hike in US refinery throughputs provided sufficient product supplies to cover for a seasonal increase in demand and thus raised refined product inventories by 7.3 mb in August. The bulk of the monthly stock build came from a gain in 'other products' (largely propane), but distillates and fuel oil stocks also increased and outweighed a gasoline draw.

OECD Europe

In Europe, industry oil inventories plummeted by 14.3 mb to 922 mb in July, strongly contrasting with a more typical 3.6 mb seasonal build. Crude oil stocks contracted by 11.7 mb to the lowest level since January 2007, following the loss of Libyan supplies and 2Q11 average crude imports of 10.9 mb/d, some 400 kb/d lower than a year ago. Production outages and field maintenance in the North Sea and elsewhere forced refiners to delve further into industry crude oil holdings, which stood at almost 32 mb below the five-year average in July. That said, July data are provisional and subject to later revision.



Refined products held up rather better, with industry inventories dropping by a more modest 2.4 mb in July, driven by draws in all categories bar 'other products'. An uptick in distillate demand curtailed stocks by 1.5 mb and the overhang observed over the past few years almost disappeared. This relative tightness might continue as we forecast distillate demand in Europe to increase sharply in September, partly due to traditional restocking of German end-user heating oil stocks. At end-July, German consumer heating oil stocks stood at 53% of capacity, up from 50% a month earlier.



Preliminary Euroilstock data show total oil industry stocks fell by 0.5 mb in the EU-15 and Norway in August. Distillate inventories posted a modest increase of 1.5 mb, outweighed by a 2.0 mb counter-seasonal draw in gasoline. Meanwhile, refined product stocks held in independent storage in Northwest Europe fell in August, led by draws in gasoil and gasoline.

OECD Pacific

Industry oil inventories in the OECD Pacific rose by 3.8 mb to 409 mb in July. The monthly build was weaker than the typical 9.3 mb seasonal increase and was led by gains in 'other products' and crude oil, with modest declines in other product categories.



Industry crude oil inventories increased by 1.8 mb, while product inventories gained 4.3 mb, as a build in 'other products' outweighed modest draws in gasoline, distillates and fuel oil. Yet, the regional industry stock build is likely supported by 3.5 mb of public oil reserves loaned to industry in Korea (see IEA Libya Collective Action: Oil from Government Stocks Relieving the Market).



Weekly data from the Petroleum Association of Japan (PAJ) point to a 3.4 mb draw in Japanese commercial oil inventories in August. Increases in refinery throughputs drove crude oil stocks lower by 10.5 mb, while, product stocks rose by 6.0 mb driven by kerosene and gasoil restocking. Before the March earthquake Japanese kerosene inventories were on a declining trend. However, stocks have risen sharply since March, as both domestic refinery runs have recovered and imports from elsewhere in Asia have arrived.

Recent Developments in China and Singapore Stocks

According to China Oil, Gas and Petrochemicals (China OGP), Chinese commercial oil inventories declined by an equivalent of 0.8 mb (data are reported in terms of percentage stock change), to just below 351 mb in July. Crude oil stocks gained 3.3% (6.9 mb) as crude imports remained elevated at the time when several refiners reduced runs due to maintenance. As a result, product stocks contracted by around 7.7 mb, led by a 5.4% (4.1 mb) draw in gasoil. Gasoline inventories dropped by 5.0% (2.7 mb) and kerosene fell by 7.6% (0.9 mb).



Refined oil product stocks in Singapore rose by 0.2 mb in August, as a gain in fuel oil inventories outweighed draws in light and middle distillates. Fuel oil stocks rose by 1.7 mb following the arrival of several shipments at the end of the month. Meanwhile, gasoline and middle distillate stocks declined by 1.0 mb and 0.5 mb, respectively, led by lower imports following an outage at Formosa's refinery in Taiwan. At the same time, regional demand was strong and product exports to Vietnam increased during seasonal maintenance at the country's sole refinery.



Prices

Summary

  • Uncertain global economic and financial market prospects underpinned volatile oil futures prices in August and early September. After plunging in tandem with the large sell-off in financial and commodity markets in early August, WTI and Brent futures partially retraced their losses on tighter Asian and European markets. Prices at writing were $111/bbl for Brent and $86/bbl for WTI.
  • Spot crude oil prices tracked the downturn in futures markets, with benchmark grades in August lower month-on-month. By mid-month, however, physical markets were strengthening on the back of robust demand from refiners, especially in Asia, and on supply outages in the North Sea, US Gulf of Mexico and China.
  • The light end of the product barrel continued to show strength in August, whereas middle distillate markets weakened throughout the month. In late August, Hurricane Irene propped up product prices. However, moving into September, product crack spreads fell as the rise in crude prices more than outpaced those for products and as a disappointing US driving season came to an end.
  • Refining margins strengthened month-on-month in most benchmark regions in August. One exception was the US Gulf Coast, where margins showed diverging trends. Early-September saw margins falling in all regions again, as product prices lagged behind resurgent crude.
  • Freight rates remained in malaise throughout August, with earnings on all benchmark routes close to or below break-even levels. In the crude tanker market, data suggest that global oil in transit has fallen steadily from its June peak. As such, rates on the benchmark VLCC Middle East Gulf - Japan route remained anchored at close to $10/mt, which, when combined with persistently high bunker fuel costs, translates into negative earnings.


Market Overview

Precarious global economic and financial market prospects underpinned volatile oil futures prices in August and early September. After plunging in tandem with the large sell-off in markets in early August, WTI and Brent futures prices partially retraced their losses on disruptions to supplies in the North Sea stemming from operational problems, weather-related closures in the US Gulf of Mexico, technical issues at fields in China's offshore Bohai Bay, and sabotage to pipelines in Nigeria's troublesome Delta region. Prices were also supported by stronger Asian and European demand as refineries re-entered service after turnarounds.

Benchmark futures prices on average ended lower in August, with WTI down by around $11/bbl to $86.34/bbl and Brent off by a smaller $6.83/bbl to $109.93/bbl. Brent then reclaimed a four-week high of around $115.80/bbl on 6 September, before retracing gains to around $111/bbl at writing. WTI was pressured lower by a weaker-than-expected jobs report in early September but another wave of stormy weather in the US Gulf of Mexico, which forced the precautionary shut-in of oil platforms, briefly added upward pressure before prices eased again, with WTI last hovering around $86/bbl.

The WTI and Brent markets continued on divergent paths in August, with the price spread between the two hitting record levels of over $27/bbl in early September. WTI remains under pressure from relatively high US crude stocks, especially in the land-locked US midcontinent. The latest record spread, however, is in large part due to the continued shut-in of Libyan crude, compounded by continued planned and unplanned shut-ins of North Sea crudes as well as the most recent force majeure on Nigerian Bonny Light crude, which has tightened the market for Brent-linked grades.



The 12-month forward price strip for WTI is hovering in a relatively narrow range around $90/bbl. The WTI M1-M12 contract was largely unchanged in August at -$4.20/bbl (contango) compared with an average -$4.35/bbl in July but narrowed again in early September to -$2.65/bbl. The M1-M36 contract widened to an average -$7.30/bbl in August, compared with an average -$5.50/bbl in July and -$3.35/bbl in June. However, after peaking in early August, contango narrowed again over the course of the month, which in part reflects growing market expectations that the economic slowdown will be protracted, further undermining global oil demand for the next few years.

By contrast, the Brent M1-M12 backwardation deepened to around $4/bbl in early September compared with $1.55/bbl in August, and $0.80/bbl in July. The longer-dated M1-M36 for Brent contract also saw backwardation widen to over $10/bbl in early September, compared with an average $6.65/bbl in August, $6.20/bbl in July and $8.05/bbl in June.



The potential for weaker oil demand is tempering price moves to the upside. Oil prices have been held hostage to almost daily negative economic and financial market reports, with heightened concerns over European and US debt issues and fears of a double-dip recession prompting a downgrade in GDP expectations for this year and 2012. In response, this report has lowered forecast global oil demand by 0.2 mb/d for 2011 and by 0.4 mb/d for 2012.

Supply woes may yet keep a floor under prices heading into the 4Q11 winter demand period however. OPEC crude oil output in August was up by 165 kb/d, to 30.26 mb/d, but despite the group's higher output levels, production is still 1.04 mb/d below the 31.3 mb/d 'call on OPEC crude and stock change' expected for 3Q11. The supply gap is becoming increasingly apparent in reported stock holdings, with total OECD commercial oil stocks falling below the five-year average for the first time since the recession.

OPEC spare capacity, a key supply barometer for market watchers, currently is estimated at a relatively low 3.24 mb/d, largely due to other producers having raised output amid the continued absence of Libyan production from the markets. The fall of Tripoli to rebel forces on 21 August raised hopes of a quick end to the country's six-month conflict and the prospects for partial restoration of Libyan crude oil supplies, which initially added downward pressure on prices. The price impact was negated as a more cautious consensus emerged on the timeline and scale for the restoration of the country's crude production (see Supply, 'Short-Term Oil Supply Prospects in Libya as Endgame Nears').

Indeed, the continued loss of light, sweet Libyan crude, coupled with the shut-in of North Sea grades and gasoline-rich Nigerian Bonny Light, led to a further widening of sweet and sour price spreads in Europe and Asia, with the Tapis-Dubai differential widening to $13.40/bbl in early September compared with around $11.30/bbl in July and $10.90/bbl in June.

In contrast to the more acute loss of light, sweet Libyan crude, sanctions imposed by the US and EU on Syrian crude and oil products imports are expected to have scant impact on global markets, given the limited export volumes of around 125-150 kb/d. Moreover, other countries not bound by sanctions, such as China and India, are free to lift the Syrian crude (see Supply section, 'New EU Sanctions on Syria Unlikely to Affect Syrian Crude Oil Production').



Futures Markets

Open interest in WTI contracts on New York and London ICE Exchanges showed considerable fluctuations in August. After reaching a four-month peak in the week ending 9 August, open interest in New York declined in futures-only contracts from 1.56 million to 1.52 million contracts. Meanwhile, open interest in futures and options contracts declined by 7.64% to 2.78 million contracts. During the same period, open interest in London ICE WTI contracts increased in futures-only contracts to 0.46 million and declined in combined contracts to 0.51 million.

Producers decreased their net short position during the month of August; they held 27.29% of the short and 15.37% of the long contracts in CME WTI futures-only contracts. Swap dealers, who accounted for 32.3% and 31.9% of the open interest on the long side and short side, respectively, decreased their net long position by 13 115 contracts. In the meantime, both producers and swap dealers reduced their net short positions in London ICE WTI futures contract.



Managed money traders decreased their bets on rising crude oil prices to a nine-month low in the week ending 23 August as a response to renewed fears of another recession in the US and concerns over sovereign debt in Europe. However, they increased their bullish bets in the last week of August from 138 771 to 155 728 contracts and from 21 287 to 21 512 contracts, in New York and in London, respectively, in response to the increase in WTI prices from $85.44/bbl to $88.90/bbl. This bullish attitude was subsequently reversed in the week ending 6 September, as managed money traders cut their bets in New York and London. Similarly, money managers decreased their Brent futures net long position by 58% from 91 994 to 38 646 contracts between 2 August and 23 August, 2011. However, they increased their net long exposure by 30 881 contracts from 23 August to 6 September.

NYMEX RBOB futures and combined open interest increased by more than 3.9% in August. Open interest in NYMEX heating oil increased by 1.83% to 312 753 contracts while open interest in natural gas markets declined by 0.32% to 977 952 contracts. Index investors increased their long exposure in commodities in July 2011. However, they withdrew $1.3 billion from the WTI Light Sweet Crude Oil market in July 2011, which fell from an all time high of 694 000 futures equivalent contracts in March to 673 000 contracts, equivalent to $65.1 billion in notional value.



Commodity Index Traders -- The New Whipping Boys?

An August CFTC conference in Washington DC was organised to highlight and discuss recent academic research on key issues affecting commodity markets. The conference came at a time of intense debate surrounding recent CFTC rulemaking.  Several conference panelists argued that speculators in general, and commodity index traders (CITs) in particular, have affected the functioning of commodity markets and caused oil price swings that cannot be explained by energy market fundamentals - especially during the 2008 financial crisis.  However, in the presentations of that set of papers, we failed to see any detailed accounting for those very fundamentals.  In contrast, the few papers at the conference that focused on fundamentals found no clear-cut evidence of speculators driving prices away from their fundamental values.

Perhaps one of the most discussed papers in the follow-up press coverage was delivered by Stanford University's Kenneth Singleton.  It is worth noting here that Professor Singleton's paper, which has been seized upon by supporters of limits on speculative commodity positions, started as a survey that he conducted for the Air Transport Association of America (ATA).  For this reason and because the paper has received wide publicity, it is worth discussing some of the paper's limitations and methodological shortcomings - which its author himself has acknowledged.

Professor Singleton's paper comprises two parts - a formal model of how speculation could, in theory, temporarily drive commodity prices away from their fundamental value, and an empirical analysis.  The theory part assumes that investors are a heterogeneous bunch. Those market participants, including speculators, try to anticipate their competitors' move given imperfect information on economic fundamentals and on speculative activity. Their decisions are therefore sometimes affected by other participants' behaviour (herding); that is to say, investors sometimes mimic their competitors' moves. Investors might also have different opinions about the future course of economic fundamentals. Although these investors might be using common knowledge, their interpretation of common information might be different, which leads to higher trading volumes and co-movements among different asset classes. This has the effect of moving prices away from their fundamental values, inducing higher volatility and generating booms and busts in prices.

Methodology Questions Abound

Professor Singleton next seeks to provide empirical evidence for his analysis. For his empirical work, he uses CIT positions imputed on the basis of investment advisor Michael Master's methodology.  This extrapolation method has significant problems.  First, the imputation is based on CFTC Supplemental Commitments of Traders (SCOT) report, which does not contain any data for crude oil. To estimate crude oil CIT positions, one must therefore use data from 12 agricultural markets for which the CFTC gathers CIT position information, and then make a number of unlikely assumptions about the relationship between CIT positions in agricultural and energy markets. Second, the SCOT dataset itself is problematic when measuring CITs activity - even for the 12 agricultural commodities. This is because the SCOT, which initially identified 32 (now 43) CITs, classifies all the positions of a trader engaged in commodity index trading as commodity index investment - regardless of the trader's actual trading strategy.  Therefore, as has been pointed out by the CFTC itself, "the published aggregate futures position in the COT-Supplemental may overstate or understate the actual amount of index trading (overstate it to the extent the positions reflect other trading strategies, and understate it to the extent that index positions are internally netted against non-index positions before the net position is brought to the futures markets)."

As was pointed out in another paper presented at the CFTC conference by the University of Illinois' Scott Irwin, the imputation methodology employed by Professor Singleton can lead not merely to some measurement errors but to huge measurement errors:

  • The netting effect might not be important for agricultural commodities where the swap dealers' futures positions are generally limited to long futures hedges offsetting their short OTC exposure to those pension funds or other index-based traders. However, the netting effect might be very important where many swap dealers (as is the case in energy products), in addition to their commodity index-related OTC activity, enter into other OTC derivative transactions in individual commodities, both with commercial firms hedging price risk and with speculators taking on price risk. 
  • Professor Irwin and his co-author Dwight Sanders show that the level of errors is quite large. Comparing the imputed position with Index Investment Data (IID) provides a glimpse of the extent of measurement errors (52% mean absolute errors).  The measurement error at some point leads to a categorisation of some 70-75% of long positions as "index investments", implying that not only all swap dealers' long positions but also managed money traders' positions are categorised as commodity index trading. This is not possible: the CFTC's own " Special Call" data indicates that at most 15-20% of index investment is carried out by money managers.

While some of the other papers presented at the CFTC conference proposed less imprecise alternatives to estimate CIT activity in commodity futures markets, they all relied on time series that the CFTC does not make public. If anything, the data difficulties faced by Professor Singleton and others in proxying for CIT activity points to the need for the CFTC to release more disaggregated position information.  For example, there is evidence that the long positions of commodity swap dealers in near-maturity contracts provide a reasonable proxy for commodity index investment. Clearly, publicly available position data disaggregated by maturity would help underpin more detailed analysis in this sphere.

Finally, the interpretation of Professor Singleton's estimation results also presents some difficulties.

First, to estimate realised excess returns in crude oil prices using weekly data from 12 September 2006 to 12 January 2010, the paper uses the change in the long positions of commodity index funds and money managers as well as some financial variables (such as the change in repo positions on Treasury bonds and lagged returns on emerging market equity positions as explanatory variables). As another paper presented at the conference by the University of California's Professor James Hamilton showed, energy market fundamentals are crucial to understanding crude oil prices. Professor Singleton's estimation procedure, however, does not directly account for oil market fundamentals such as demand growth in emerging market economies (especially in China), inventories outside of the OECD, or rising costs of production. Furthermore, as we have argued in previous issues of the OMR, both excess returns and commodity index flows might be responding to some common shocks (such as expectation of higher growth in China and other emerging countries). The point estimates in the regressions might thus be biased due to this endogeneity problem.

Significance: Economic versus Statistical

Second, the paper should provide descriptive statistics on the variables so that one can assess the impact of a change in index investment on realised returns. Professor Singleton's paper argues that it presents evidence of "an economically and statistically significant effect of investor flows on futures prices, after controlling for returns in US and emerging-economy stock markets, the futures/spot basis, and lagged returns on oil futures." The index investment coefficient is statistically significant, although it is difficult to assess the economic significance of commodity index investment on realised return, given the information provided on the paper.

Finally, as suggested by the University of Houston's Craig Pirrong in his blog, suppose that Professor Singleton's findings do indicate that excess returns on crude oil futures are predictable, conditional on measures of speculative activity. Nonetheless, such a predictability of returns would not imply that speculation has distorted prices. Rather, predictability is the result of market frictions that might create hedging demand, leading to an increase in the risk premium. Professor Pirrong suggests that, in such circumstances, speculative positions can predict changes in futures prices. To prevent the predictability of returns, it might be advisable to reduce constraints on the flow of speculative investment to commodity markets, rather than limiting them.

Spot Crude Oil Prices

Spot crude oil prices retraced early August losses posted in the wake of the financial and commodity market sell-off, with physical markets strengthening on the back of supply outages. Average spot prices for benchmark grades in August closed lower month-on-month but by early September were trading near July's loftier levels. US WTI posted the largest decline, down 11.3% while light Malaysian Tapis was off just 3.7%.

In the US, mounting concerns about the faltering economy, the arrival of SPR barrels into the key US Gulf coast refining region and crude stocks well above the five-year average in the key Midcontinent region continued to weigh on benchmark WTI. Spot prices posted a large decline in August, down by nearly $11/bbl, to an average $86.30/bbl. Spot markets strengthened again from mid-month and by 8 September, WTI had recovered to $87.70/bbl, in part due to supply disruptions caused by Hurricane Irene.



Continued delays with maintenance work curtailed output of North Sea crude in August, which helped stem the price decline last month of Dated Brent, down by around $6.50/bbl to $110.35/bbl. Prices resumed their upward trajectory in mid-August and were around $113.60/bbl on average through 9 September.

Scheduled maintenance work and operational problems in the North Sea, including its largest field, Buzzard, have curtailed the supply of Forties crude for more than four months now.  Forties Blend, which includes output from the Buzzard field, is a key crude used for setting the Dated Brent price. The loss of Forties output pushed differentials to other North Sea grades to the highest in more than three years at end-August, whereas heavier Forties normally trades at a discount to other local grades. 



The prolonged outages of North Sea supplies, coupled with the continued loss of Libyan crudes in the Mediterranean, has had a wide-ranging impact not only in European markets but also on US and Asian trade flows. European markets, already tight due to the shut-in of light, sweet Libyan crude, are shunning regional crudes linked to high-priced Brent and, buying cheaper Middle East crudes such as Oman and Iraqi Basrah Light.

Meanwhile, Brent's premium over WTI continued to breach record levels. WTI traded at an average $24.07/bbl discount to Brent in August compared to an average $19.62/bbl in July. By the end of the first week of September, the spread had widened to more than $27/bbl.

In Asia, Brent's relative strength also distorted pricing relationships with Middle East and African crudes. The price spread between Dated Brent and Dubai narrowed over the month on stronger demand for relatively cheaper Middle Eastern crudes compared to Brent-linked African grades. Dubai's discount to Dated Brent averaged $5.35/bbl in August compared with a deeper $6.89/bbl in July. The Brent/Dubai spread, however, was temporarily distorted by the more general plunge in commodity prices in early August. The violent downward move shook out speculative length in Brent contracts while the physical market in the East for Dubai during the price sell-off was tight, so the shock absorber in the equation was the Brent/Dubai spread.



Demand for Mideast crudes is also on the rise ahead of the upcoming seasonal shift in focus to distillate-rich grades. A number of Middle East producers have raised their official selling prices for October, in part due to more robust refining margins. Saudi Aramco raised price differentials for all grades to Asia and Europe while lowering them for US customers. In Asia, prices for Arab Light were raised by $0.90/bbl while Arab Heavy rose by $1.15/bbl, in line with stronger fuel oil crack spreads. In Europe, Arab Extra Light and Arab Light posted the largest increases, as expected, given strong refiner demand for light crudes to replace Libyan barrels. Price differentials for the well-supplied US market were cut by -$0.15/bbl to -$0.25/bbl.



Spot Product Prices

The light end of the barrel continued to show strength in August, whereas middle distillate markets weakened throughout the month. The bottom of the barrel remained relatively strong, but in August lost some support. In late August, Hurricane Irene, together with inventory draws, propped up product prices. However, moving into September product crack spreads weakened as the rise in crude prices more than outpaced those for products and a disappointing US driving season came to an end. A higher than expected build in inventories also added downward pressure.

Gasoline crack spreads improved month-on-month in Europe, Asia and the US East Coast, whereas they weakened on the US Gulf Coast. The US Gulf Coast crack spreads for Mars fell from a strong $15.80/bbl in July to $12.55/bbl in August, while LLS was down a lesser $1.15/bbl, to $10.57/bbl, as falling light sweet premiums helped limit losses. Cracks fell in early August due to a larger-than-expected build in stocks combined with low US demand. However, they improved towards month-end due to reduced stock levels as well as fear of possible shortages due to Hurricane Irene, before weakening again in early September on the relative strength of crude markets.



In Europe, gasoline markets were relatively tight, and crack spreads increased slightly month-on-month; up by $1.18/bbl in Northwest Europe and $0.90/bbl in the Mediterranean. Low stock levels and strong regional demand as well as an open arbitrage to all main markets tightened supplies at the beginning of the month, and Hurricane Irene supported crack spreads towards month-end.

Middle distillate crack spreads improved month-on-month in Europe and the US East Coast, and fell slightly in Asia. At the US Gulf Coast, LLS crack spreads improved, whereas the Mars spreads fell. The European market was also tight as stock levels for these products were low and demand was strong, but an open arbitrage from both the US and Asia pressured cracks lower towards month-end. In Asia, sentiment was influenced by fear of oversupply with the gradual restart of the Mailiao refinery in Taiwan as well as increased exports from Japan.



LSFO discounts widened month-on-month in Europe as peak summer demand passed, and fuel oil prices struggled to follow the increases in the crude price. Although weakening, cracks were still in positive territory in Asia. On the other hand, HSFO discounts narrowed month-on-month in all regions, with strong Asian bunker fuel oil demand, less exports from the Middle East and refining maintenance tightening the market in the beginning of the month. Throughout August, discounts widened however, with increasing stock levels pressuring European markets and increased refinery runs weighting on the Asian markets.



Refining Margins

Refining margins strengthened month-on-month in most benchmark regions in August with the exception of the US Gulf Coast, where margins showed diverging trends, and Daqing hydroskimming margins in China, which dropped in the second half of August. Early September saw margins falling across all regions as product prices lagged behind increasing crude prices.



European refining margins were supported by both strong gasoline and middle distillates crack spreads. Simple refineries had some support from narrow fuel oil discounts in the first half of the month, but the discount widened throughout August, depressing margins for simple refineries back to all-too-familiar weak levels, with losses widening to above $7/bbl for Urals hydroskimming margins in the Mediterranean.

The picture was mixed on the US Gulf Coast. Brent and LLS margins improved as did those for Maya, whereas margins for Bonny Light and Mars fell. Margins improved on increasing gasoline crack spreads, while LLS and Brent margins benefited from falling light, sweet premiums. This is in contrast to Mars margins, which were pressured by more expensive feedstock. In Singapore, refining margins strengthened in August based on high readings at the start of the month, but then weakened as the month progressed. The main factors pressuring margins were a widening fuel oil discount in August and stronger Tapis. Chinese margins improved in August with the exception of Daqing hydroskimming, as Daqing strengthened in August. Cracking margins were stable in August as gasoline crack spreads remained strong due to high demand and reduced refinery runs in the region.

On the US West Coast, refining margins all improved, especially Kern coking margins, which increased their calculated profit to above $15/bbl on average in August. Margins were pushed higher as Kern traded at a larger deficit than usual in August and due to strong gasoline crack spreads.



End-User Product Prices in August

During August, average end-user prices for selected IEA countries, in US dollars ex-tax, saw a marginal decrease in most survey nations, bar the steep increases seen in Japan and the UK. On the one hand, transport fuels saw month-on-month average price decreases of 0.28% and 0.04% for gasoline and diesel, respectively. On the other hand, heating oil declined by a meagre 0.11% and LSFO fell by a sizeable 3.35%. From an annual standpoint, year-on-year growth rates for all fuel prices range between gasoline (37.8%) and LSFO (40.4%).

On a month-on-month basis, gasoline, diesel and heating oil fell most sharply in Canada by 2.9%, 2.7% and 3.2%, respectively. Concerning LSFO prices, the largest monthly decline was reported in France where prices fell by a hefty 5.6%. Notably, prices leapt in Japan during the period, bar those for LSFO. Gasoline, diesel and heating oil prices in Japan increased month-on-month by 5.7%, 4.9% and 4.5%, respectively.

Freight

Freight rates remained in malaise throughout August, with earnings on all benchmark routes close to, or below, break-even levels. In the crude tanker market, data suggest that global oil in transit has fallen steadily from its June peak. As such, rates on the benchmark VLCC Middle East Gulf - Japan route remained anchored at close to $10/mt, which, when combined with persistently high bunker fuel costs, translate into negative earnings. Reports indicate that rates for Suezmax and Aframax did manage to remain in positive territory, although they were reportedly well below 'acceptable' levels for owners.



In the product tanker market, the situation was slightly brighter with rates generally holding their ground throughout August. The exception to this was the Caribbean - US Atlantic Coast route which took a downturn late month following extremely slow chartering activity.

Despite this exceedingly grim situation, owners are still resisting laying-up their tankers due to the costs and time involved and in order to maintain their approvals with oil majors. EA Gibson shipbrokers recently estimated another 50 new VLCCs are due to enter circulation by mid-2012, this expansion is expected to outpace oil demand growth and may ultimately force owners into laying-up their vessels.

Short-term floating storage of crude and products fell by 2.2 mb to 48.3 mb at end-August, its lowest level since end-2008. Crude recorded its fourth consecutive monthly fall (-1.2 mb), to 37.6 mb. There is no longer any speculative floating storage of crude, with volumes now only being stored on the water due to operational and logistical issues. Iran is the main owner of this crude, currently holding 19.3 mb (-2.2 mb m-o-m) as NITC continually shuttles unsold volumes to Ain Sukhna as well as storing some cargoes in the Middle East Gulf. Additionally a ULCC has been anchored off Brazil since November 2010 holding 3.1 mb of crude for logistical reasons. Floating storage of products fell by 1 mb to 10.7 mb and is now concentrated off West Africa, with this region accounting for two-thirds (7.1 mb) of the global volume.

Refining

Summary

  • Global refinery crude runs have been revised down by close to 0.3 mb/d for both 3Q11 and 4Q11 in light of a weaker demand outlook and higher outages scheduled for a number of countries. The largest changes have been made to Europe, the FSU and 'Other Asia', with some offset from stronger North American and OECD Pacific runs. Global runs are now seen rising 1.7 mb/d in 3Q11, to 75.6 mb/d, and averaging 75.4 mb/d in 4Q11.
  • Estimates for global crude throughputs for 2Q11 have been lifted by 120 kb/d since last month's report on higher US, Middle Eastern and 'Other Asian' runs. Combined with a weaker outlook for global demand and hence refinery needs for the remainder of the year, the seasonal increase from 2Q11 to 3Q11 is now more in line with historical trends, at 1.7 mb/d. 2Q11 and 3Q11 runs now see weak annual growth of around 0.2 mb/d, compared with over 2.0 mb/d in the previous four quarters.
  • OECD crude runs rose by 570 kb/d in July, to 37 mb/d. The seasonal increase was smaller than expected, on account of persistently weak European runs and a higher US June baseline. A year-on-year deficit is still evident, with total runs 710 kb/d below a year earlier, and only the Pacific showing annual growth. In all, OECD runs are pegged at 37.0 mb/d for 3Q11, falling to 36.3 mb/d in 4Q11.
  • OECD refinery yields increased for middle distillates and other products at the expense of all other product categories in June. Gasoil/diesel and kerosene yields rose 0.8 percentage points (pp) and 0.1 pp respectively, while OECD gasoline yields decreased slightly, mainly on a decrease in North America. OECD gross refinery output increased by 1.4 mb/d compared with May, but was still 1.1 mb/d lower than the five-year average.


Global Refinery Overview

Global crude runs have been cut by close to 0.3 mb/d for both 3Q11 and 4Q11, following a weaker demand outlook and higher outages scheduled for a number of countries. The most significant changes have been made to the European outlook, where refinery runs remain persistently weak, despite rapidly diminishing product stocks and additional crude made available through the Libya collective action. The latest data were almost 200 kb/d below expectations, and more than 0.5 mb/d lower than a year earlier. Our Russian outlook is also slightly weaker than in our previous forecast, due more to a higher maintenance schedule rather than because of the new export duty regime (see Implications of Russian Tax Changes on Refining More Long-Term). Apparent delays in starting up new capacity in India, and continued outages at Taiwan's large Mailiao refinery weigh on the 'Other Asian' forecast. Recent robust runs in the US and South Korea, both supported by strong product exports, provide some offset. Global runs are seen rising by 1.7 mb/d in 3Q11, to 75.6 mb/d and then easing to 75.4 mb/d in 4Q11.

Estimates for global crude throughputs for 2Q11 have been lifted by 120 kb/d since last month's report, on higher US, Middle Eastern and 'Other Asian' runs. Combined with a weaker outlook for global demand and hence refinery needs for the remainder of the year, the seasonal increase from 2Q11 to 3Q11 is now more in line with historical trends, at 1.7 mb/d.  2Q11 and 3Q11 runs now see weak annual growth of around 0.2 mb/d, compared with over 2.0 mb/d in the previous four quarters. Growth in the FSU, China, Latin America and Other Asia is offset by structural and temporary declines in the OECD and Africa, respectively.



Global crude runs are thought to have peaked seasonally in August, at 76.1 mb/d. This is a 3.5 mb/d swing from this year's April low. As the peak summer driving season has ended, refinery runs have already started to wind down and will fall further as seasonal maintenance picks up. While the autumn turnaround schedules are not as heavy as in the spring, up to 5.0 mb/d of capacity is normally taken off line in October, the peak month. Relatively heavy maintenance in Russia and India this autumn add to regular OECD turnarounds.

Refinery margins improved somewhat in July and August, especially for European cracking refineries. US Gulf Coast margins also strengthened, especially for LLS cracking and Maya coking plants. Singapore even saw hydroskimming margins turning positive for Dubai in August. Nevertheless, margins remain under pressure, and the recent announcement from US East Coast refiner Sunoco of plans to exit the refining sector comes neither as a surprise nor is it likely to be an isolated case. More plants will have to shut before enough of the structural capacity overhang is eroded to allow the market to again rebalance.



OECD Refinery Throughput

OECD refinery throughputs rose by 570 kb/d in July, to average 37.0 mb/d. While runs rose in all regions, the seasonal increase was weaker than expected and only OECD Pacific throughputs stood above year-earlier levels. North American and European runs were 420 kb/d and 540 kb/d below July 2010 respectively, as demand over the peak summer season has been lacklustre at best and deliveries have come from storage. A higher baseline for North America, following upward revisions to June data, nevertheless lifts the North American prognosis, and provides an offset to a weaker outlook for Europe. In all, OECD crude runs are pegged at 37.0 mb/d for 3Q11, falling seasonally to 36.3 mb/d in 4Q11.



OECD North American crude runs rose by 120 kb/d in July, less than the 350 kb/d increase indicated by preliminary data, on a combination of higher US crude runs for June and weaker Canadian and Mexican runs in July. Total regional runs were still some 420 kb/d below year earlier levels. Weekly data from the EIA show US runs rising further in August. In all, North American runs are expected to average 18.1 mb/d in 3Q11, before falling to 17.3 mb/d in 4Q11.



US crude runs were stronger than expected in August, at 15.5 mb/d (+90 kb/d compared with last month's report). Gulf Coast runs in particular rose to their highest monthly average in over a year, supported by healthy coking and LLS cracking margins. Only Brent margins were negative. US East Coast refiners suffered losses when Hurricane Irene ripped through the region in late August. While only ConocoPhillips' 238 kb/d Bayway (NJ) refinery shut down ahead of the storm, other refineries in the region operated at reduced rate to allow for phased shutdowns if needed.

Another Refiner Bows Out - Sunoco Announces Refinery Exit

US refiner and fuel marketer Sunoco announced on 6 September it will exit the refinery business and attempt to sell its Marcus Hook and Philadelphia refineries in Pennsylvania. The two refineries, with capacity of 175 kb/d and 330 kb/d, respectively, account for almost 35% of US East Coast operable refining capacity. While the company has stated it will do its utmost to find suitable buyers, it might struggle to do so by the July 2012 deadline. By that date, if no buyers have been found, the plants' main processing units will be idled and pre-tax charges of up to $500 million for contract terminations, staffing costs and severance paid.

Sunoco's announcement does not come as a surprise, as the company's refining and supply business has lost money in eight of the last ten quarters. Refining losses amounted to $316 million in 2009, $8 million in 2010 and $182 million in the first six months of 2011. With this in mind, the company will likely struggle to find buyers for its plants and closure looks to be a strong possibility. Furthermore, the plants "face significant capacity outlays to satisfy environmental requirements and ensure safe, reliable operations" Sunoco CEO Elsenhans said during a conference call. This is not taking into consideration the large investment requirements needed to improve margins and profitability.

If the plants end up closing, it will have a significant impact on the US East Coast refining sector, increasing the region's reliance on product imports and providing some relief to remaining operators. Sunoco already shut its Eagle Point refinery in New Jersey in 2009 and sold its 170 kb/d Toledo refinery in Ohio, along with a petrochemical facility in Philadelphia, to PBF Holding in May of this year. The US East Coast already imports large volumes of gasoline from the Gulf Coast and Europe. In August, the region imported 630 kb/d of gasoline grades according to EIA data.



Sunoco, which mainly processes Nigerian and other African light sweet crudes, is at a disadvantage to Gulf Coast and Midwest refiners who benefit from discounted WTI-related crudes. Furthermore, since the Libyan disruption, Sunoco has had to scramble to source adequate low-sulphur barrels and has imported crudes from not only West Africa, but also from Norway, Brazil and Azerbaijan at higher costs, further pressuring margins.

CEO Elsenhans said Sunoco's decision to exit the industry was influenced by weak US Northeast crack spreads. Because Sunoco produces a significant volume of residual fuel, a 6-3-2-1 crack spread (6 barrels of crude, yielding 3 barrels of gasoline, two barrels of distillate and one barrel of fuel oil) is used to assess market conditions. While some improvements have been seen recently, this has clearly not been enough to retain Sunoco's interest in the assets.

European refinery activity continues to disappoint, and July estimates have been revised down by close to 200 kb/d since last month's report. While total regional throughputs gained 195 kb/d versus June, mostly on higher German runs, they nevertheless stood 540 kb/d below July 2010. Notably, Italian runs have remained weak since the start of the Libyan disruption. Italian refiners were the largest buyers of Libyan crude prior to the disruptions, importing almost 370 kb/d of crude oil from Libya in 2010. While the seasonal increase in runs has been weaker than normal, the release of crude and product stocks and the lowering of stockholding obligations through the Libya collective action provided flexibility to operators as to how to best meet demand. Euroilstock data released on 9 September show Euro15 + Norway runs rising by 85 kb/d in August.



Despite the bleak situation, ConocoPhillips announced on 10 August that it had finally found a buyer for its 260 kb/d Wilhelmshaven refinery in Germany. The plant, which has been mostly idle since 2009, was in the process of being converted to an oil terminal, when Dutch Hestya Energy signed the agreement to buy the plant, storage facilities and marine terminal. Despite the recent sale, we think it is unlikely that the plant will be restarted (at least in the near term) given the dire hydroskimming margins in Europe and the large investment requirements needed to improve light product yields from the current 53%. Conoco scrapped plans to upgrade the plant in 2010, which had included a coker and a hydrocracker, estimated at more than $2 bn. Instead, the company will likely use the plant for its midstream assets.

OECD Pacific crude runs for July rose by 260 kb/d from June's levels, slightly less than anticipated in last month's report. Year-on-year gains of some 250 kb/d are entirely concentrated in South Korea, which continues to see exceptionally strong product exports. July data from the Ministry show refined product exports of 42.22 mb (1.36 mb/d), up 31% on a year earlier and a new record high. Korean runs averaged 2.5 mb/d in July, unchanged from a month earlier, but 240 kb/d above July 2010.



Japanese crude runs were revised slightly lower for July, to average 3.2 mb/d. According to weekly data from the Petroleum Association of Japan, runs rose further in August, before declining seasonally by end-month. The country's largest refinery JX Nippon Oil and Energy announced it would cut runs in September, to 9% below last year's level due to scheduled maintenance at the Mizushima refinery during September/October. The company also stated that it expects its Kashima plant to reach full operating rates from around November, compared with current levels around 70%. Petrobras' 100 kb/d Nishihara refinery on Okinawa was damaged in a typhoon in early August and only restarted in mid-August.

Non-OECD Refinery Throughput

Non-OECD crude runs have been revised lower for the remainder of 2011, by about 200 kb/d on average. Weaker-than-expected runs in both India and Brazil in July have partly been carried forward, and higher refinery maintenance schedules in Russia and a new export tax system there lower our FSU forecast slightly. Apparent delays in starting up new capacity in India have also been factored in.

Despite these revisions, annual throughput growth is again seen stemming entirely from the non-OECD, with China, Latin America and Other Asia offsetting decline in the OECD and Africa. The non-OECD is growing by 0.9 mb/d on average in 2Q11-4Q11 period, compared with throughput growth of more than 2.0 mb/d in 1Q11 and 1.3 mb/d on average in 2010. In all, non-OECD runs are forecast to grow from 38.1 mb/d in 2Q11 to 38.5 mb/d in 3Q11 and 39.1 mb/d in 4Q11.



After an exceptionally weak June, Chinese refinery runs rebounded in July, posting annual growth of 520 kb/d, or 6.3%, compared with only 0.6% in June. At 8.8 mb/d, total runs were 175 kb/d higher than a month earlier, and 110 kb/d above expectations. Runs are expected to increase further in August and September, despite continued problems at PetroChina's Dalian refinery. The 400 kb/d plant was forced to shut one of its two crude distillation units in mid-July, when a fire broke out. A second fire broke out during restart of the unit at end-August, forcing the head of the plant to resign.



While maintenance shutdowns are expected to remain around July's levels in August, industry surveys show state-owned refiners planning to lift run rates to meet seasonally higher product demand. There were also reports of Sinopec starting up a new 160 kb/d crude unit at its Changling plant in August, with an aim to start commercial operations in September. It is not clear if the plant's current 70 kb/d CDU will be shut, or if there is enough pipeline capacity to run the plant at full rates. Maintenance schedules start to unwind from September, suggesting increasing runs through the latter part of the year.

Other Asian refinery runs are seen dipping in August and September, on the shutdown of Taiwan's Mailiao refinery and maintenance in Vietnam and India. Indian crude runs were lower than expected in July, and have been revised down by 220 kb/d since last month's report. It seems that BPCL/Oman Oil's 120 kb/d Bina refinery is still experiencing start-up problems related to power supply and full rates are now not expected until September (we had previously assumed the plant would already be running at full capacity from July). Reports are that HPCL/Mittal's 180 kb/d Bathinda plant also started processing crude in late August. While company estimates suggest the plant will be fully operational by November, some market observers say it will only be commissioned at the end of this year at the earliest. Indian capacity will be further boosted when an 80 kb/d expansion at Essar's Vadinar refinery becomes operational in early 2012. The 280 kb/d plant will undertake a 35-day complete shutdown to tie in new units from 18 September. Total Indian crude runs are estimated at 4.1 mb/d in July, adjusted 0.7 mb/d above ministry data, to account for runs at Reliance's export refinery at Jamnagar and the recently commissioned Bina refinery, not included in official statistics.



In Taiwan, Formosa restarted one of its three 180 kb/d crude distillation units at the end of August. The entire 540 kb/d Mailiao plant had been closed since the end of July, when the seventh fire in a year broke out at the facilities. We assume that all three units will be operational by the end of September, although start-up still depends on the government's approval. Elsewhere, Vietnam restarted the 140 kb/d Dung Quat plant ahead of schedule on 26 August after a planned two-month complete turnaround from mid-July. The plant was originally to restart in mid-September.

Russian crude runs fell slightly from June's record-high; to average 5.32 mb/d. Runs were nevertheless 5% above a year-earlier, with gasoline output in particular higher year-on-year. These were up 1.8% and 9.3% on a monthly and annual basis, respectively, as refiners are struggling to prevent further domestic gasoline shortages. Despite the higher-than-expected July figures, we have revised down our outlook for Russian refinery runs for the remainder of the year. The most recent schedules released by the Energy Ministry show extensive maintenance at several large plants planned for September and October.

Implications of Russian Tax Changes on Refining More Long Term

The new Russian export duty regime discussed in Russia: Upstream and Export Impacts of the 60-66 Tax Regime in the Supply section could also have an impact on the refinery industry, but most likely more so in the longer term.

The aim of the new tax rules is two-fold. Firstly, to reduce the tax burden on oil producers to encourage upstream investments in new fields and to stem depletion. Secondly, to encourage refiners to upgrade their plants and reduce fuel oil yields. The 19% increase in fuel oil duties will slash the steep discount in fuel oil duties to crude and light products currently, starting in October. While the new regime will lower profitability for refiners exporting fuel oil, the impact on refinery runs and trade patterns is less clear-cut.

According to some traders, exports of straight-run fuel oil will remain profitable even with the higher duties, while others think fuel oil exports could take a hit from higher crude exports. In addition to some 400 kb/d of fuel oil imports from the FSU in 2010, OECD Europe imported more than 200 kb/d of refinery feedstocks from the region last year, with 65-70% coming from Russia. Given recent domestic product shortages and a tight market for light products, margins remain relatively strong in Russia, and we think runs will be sustained at relatively high rates to feed domestic demand for light products. As a result, fuel oil production and exports will likely be sustained close to current levels in the immediate future.

In the very short run, refiners could try to maximise runs and increase product exports through September, and several companies have talked about postponing maintenance work until after the 1 October tax change. Reportedly, Lukoil is to postpone work at its Perm and Norsi plants until October, while Gazpromneft is also to postpone planned shutdowns at its Omsk and Moskow refineries until October and November, respectively.

Longer term, the new taxes should provide incentives for refiners to invest in upgrading and modernisation of plants. From January 2015, the fuel oil duty is set to increase to 100% of the crude duty, potentially making oil product exports unprofitable - even with modernisation. This would significantly increase the rate of return on upgrading investments, but its implementation is still a key uncertainty.

While it is impossible to predict the exact effects of the new tax regime on runs and export patterns, we have adjusted down our crude runs forecast slightly for the tail-end of the year, and now see crude runs fall from 5.2 mb/d in 3Q11 to 5.1 mb/d in 4Q11.

Latin American crude runs declined marginally over June and July, on lower throughputs in Brazil. The latter fell from 1.92 mb/d in May to 1.68 mb/d in June and 1.73 mb/d in July. Lower runs at Petrobras' 240 kb/d Reduc (Duque de Caxias) refinery in Rio de Janeiro state and RPBC (Pres Bernandes) Cubatao refinery, most likely due to maintenance shutdowns, prompted the declines. Also owned by Petrobras, a 31 kb/d refinery in Bahia Blanca in Argentina was shut on 10 August after an explosion killed one worker. While the plant restarted on 17 August, provincial authorities have threatened to close the plant again, unless the company provides some assurances on safety. Argentinean refinery output was cut in June, when strikes in the Santa Cruz region cut into production and limited deliveries.



In non-OECD Europe, Lukoil resumed operations at its 140 kb/d Neftokhim plant in Bulgaria in early August, after Sofia's administrative court overturned the customs authorities' decision to suspend the Russian major's fuel depot license. The license had been suspended after the firm failed to meet a deadline to install flow meters linking the refinery to the Bulgarian customs agency, and as a result the plant had to stop crude processing briefly in late July.

Libyan Refinery Status

Libyan refinery operations came to a complete halt in August, when the 120 kb/d Zawiya refinery, located 50 km west of Tripoli ceased throughputs. The plant had been one of the few sources of fuel for Colonel Gaddafi's troops and the people of Tripoli since the beginning of the conflict, but rebels took control of the plant on 17 August and the pipeline linking it to Tripoli was severed. Most recent estimates suggest that the refinery was operating at 40 kb/d before the complete shutdown, due to lack of crude supplies. Both Zawiya and the smaller Tobruk refinery (20 kb/d) are not believed to have sustained serious damage and are likely to restart operations relatively quickly as crude supplies are restored. State-owned Agoco said in early September, Tobruk and the smaller 10 kb/d Sarir refinery could be restarted by end-month, coinciding with a planned production start-up at the Sarir and Mesla oil fields.

The state and likely start up of the 220 kb/d Ras Lanuf refinery, is more uncertain. The plant, which is the country's largest, has been closed since February, when staff left and the plant was shut down for security reasons. According to the refinery manager, the plant is intact and the company is planning to restart the complex. Other reports, however, indicate more serious damage to the facilities, and on 12 September Gaddafi forces reportedly attacked the plant, killing 15 guards. Moreover, the beach around Ras Lanuf and its port has reportedly been heavily mined, further impeding re-start of facilities there. Start-up will depend not only on the state and accessibility of these facilities, but also on the resumption of crude production and infrastructure to bring feedstock to the refinery. The Ras Lanuf plant is therefore assumed to remain offline for some more months to come.

In the meantime, Italy's Eni has agreed to "provide a first supply of refined products to the NTC to contribute to the basic and most urgent needs of the Libyan population", according to a statement on 29 August. On 30 August, there was a flurry of reports of product shipments heading from Malta to the Libyan ports of Benghazi, Misrata and Khoms. This follows press reports that trader Vitol continued to deliver products to rebel forces in eastern Libya throughout much of the conflict.

OECD Refinery yields

OECD refinery yields increased for middle distillates and other products at the expense of all other product categories in June. Gasoil/diesel yields rose 0.8 percentage points (pp), with OECD Pacific being the largest contributor, leaving yields 0.2 pp above last year's level and above the five-year range. Jet fuel/kerosene yields rose a modest 0.1 pp, as increases in both North America and Europe were offset by a decrease in the Pacific. OECD gasoline yields decreased slightly in June, mainly on a decrease in North America, whereas yields in the other two main regions were more or less unchanged vs May. OECD gross refinery output increased by 1.4 mb/d compared with May, but was still 1.1 mb/d lower than the five-year average as especially OECD European runs were trending below their five-year average.



In OECD North America, yields increased for gasoil/diesel as distillate crack spreads were strong due to high export demand and expectations of tighter markets ahead. Gasoline yields decreased slightly in line with seasonal trends, but yields are still high, and at 47.9% they stand 1.2 pp above the five-year average.



In OECD Europe, both gasoil/diesel and gasoline yields were practically unchanged compared with May. In contrast to North America, European gasoline yields have been 0.4-0.7 pp lower than last year's level so far this year, reflecting reduced regional demand for the motor fuel. Gasoil/diesel yields on the other hand were just below last year's level in June, supported by improved distillate crack spreads.

In OECD Pacific, gasoline yields increased somewhat, and at 23.3% they were 0.1 pp higher than last year's record-high level for June. Gasoil/diesel yields increased 1.8 pp, and stood in June some 1.5 pp above the five-year average and 1.3 pp above last year's level. The increased yields for these product categories were supported by stronger product cracks and expectations of strong demand, especially for gasoil/diesel.