Oil Market Report: 12 September 2012

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Highlights

  • Oil prices extended earlier gains in August, but crude prices seemed to plateau in the second half of the month. Brent was last trading at $115/bbl after reaching a high of near $117/bbl around mid-August, while WTI traded at $97, close to its August high. Increases in product prices outpaced and outlasted the crude rally, with gasoline, naphtha and middle distillate prices all posting steep gains.
  • Demand projections for 2012 and 2013 have been raised by 100 kb/d on data revisions for 2011, to 89.8 mb/d and 90.6 mb/d, respectively, though demand growth forecasts are little changed at around 0.8 mb/d for both years. Demand grew by 1.2 mb/d in 2Q12, buoyed by Japanese utility burn to replace idled nuclear generators.
  • Global oil supply fell by 0.1 mb/d m-o-m to 90.8 mb/d in August from upwardly revised July estimates. OPEC liquids production growth, led by Nigeria, Angola and Iraq, failed fully to offset unplanned outages in non-OPEC countries. Crude oil imports from Iran are estimated to have inched up in August to 1.1 mb/d, from below 1 mb/d in July. Non-OPEC annual supply growth slowed to just 0.2 mb/d in 3Q12.
  • The 'call on OPEC crude and stock change' is projected to rise by 1.3 mb/d in 3Q12 to 31.1 mb/d, on the back of a seasonal, quarter-on-quarter uptick in demand of 1.4 mb/d.
  • Improved refining margins spurred steep gains in OECD refinery runs in July and August, lifting global crude throughput estimates for 3Q12 to 75.7 mb/d, up 1.3 mb/d on 2Q lows and 450 kb/d y-o-y. Non-OECD gains are projected to keep runs flat through 4Q12, lifting annual growth to 1.3 mb/d.
  • OECD industry crude stocks contracted by 16.5 mb in July and a preliminary 23.7 mb last month on strong refining crude runs. Products built by 32.8 mb and 4.2 mb, respectively. Total industry oil builds of 10.6 mb for July were below normal and preliminary data hint at counter-seasonal draws in August.

Conflicting perspectives

Mixed signals are nothing new in the oil market. Ever since the 2008-2009 financial crisis, analysts have fretted about the tug of war between downside price risks emanating from a fragile economy and upside risks raised by geopolitical turmoil, chronic supply disruptions and the so-called "Iranian premium." The idea of an oil market torn between opposing bullish and bearish forces became widely accepted as the fizzling of the economic recovery and a slowdown in demand growth served as bearish backdrop for market disruptions and ongoing geopolitical concerns on the supply side. It has since reached a new paroxysm.

On the one hand, a retail product rally has set off alarm bells in the world's capitals even as greater-than-expected compliance with international sanctions on Iran removed large volumes of oil from the market. Non-OPEC supply has been hit by unprecedented unplanned outages, while fears of potential conflict in Iran and a spillover from the Syrian civil war are on the rise.  There have even been some bullish signals on the demand side as estimates of global demand, belying bearish forecasts, beat expectations for 1H2012, and preliminary data suggest that OECD oil stocks drew down counter-seasonally last month.

On the other hand, concerns about the health of the global economy are also rising in the wake of bearish economic indicators from the US, the euro zone and now, increasingly, the engine of oil demand growth of the last decade: China. Recent demand strength notwithstanding, low expectations of future demand are such that the OECD stock cushion actually looks more comfortable today when measured in days of forward demand than before the latest draws. And not all supply news is bullish. A revolution in North American unconventional oil is creating a mid-continent supply bonanza, while long-depressed Iraqi output recently rose to highs unseen since the Iran-Iraq war.

Statistical ambiguity reinforces the market's inherent dichotomy and muddles the picture as single data points can lend themselves to conflicting interpretations.  Bearish indicators of a deteriorating economy are enthusiastically greeted by the market as bullish signs that stimulus measures are on the way. OECD inventory readings, once a reliable proxy for global stock movements, are losing relevance as non-OECD economies catch up with mature economies in oil use and OECD stock draws come along with large but unreported builds in non-OECD countries. The rise of those implied stocks has been nothing short of dramatic, as shown in the resurgence of a significant "miscellaneous to balance" item in OMR balances - a clear indication that reported supply, demand and OECD inventories only tell part of the story.

Given wide disparities in OECD stocks between regions and products, whether reported inventories look tight or comfortable may depend on one's point of view. An apparent overhang in US crude stocks offered meagre protection against supply disruptions when those stocks were landlocked and not easily accessed by the market. High OECD crude stocks in recent months have hidden uncomfortably tight product inventories, notably for middle distillates. Conversely, the latest crude stock draws may not be as alarming as they appear, inasmuch as they reflect an unsung renaissance in OECD refining. Emerging from protracted rationalization, OECD refiners have responded to this summer's high margins and low product stocks with a vengeance. The transatlantic clean tanker trade, long depressed, is reviving as products are rushed to premium markets. For consumers, relief may be on the horizon.

Then again, we have yet to assess the full impact of the restructuring of the refining industry. Small facilities serving dedicated markets are increasingly being replaced with large, low-cost, cutting-edge, export-driven plants in centres stretching from the US Gulf Coast to India to the Middle East. Global inter-dependence in product supply is increasing. That could be good news or bad news: the market is becoming more flexible, but also more volatile. The implications of those changes for markets and security are many. Keeping up with them without taking anything for granted is a challenge, but more necessary than ever.

Demand

Summary

  • Global demand is forecast to grow at a steady rate of around 0.8 mb/d (0.9%) in both 2012 and 2013 against a weak macroeconomic backdrop. Assuming GDP growth of 3.3% in 2012 and 3.6% in 2013, total oil product demand is forecast to average 89.8 mb/d in 2012, rising to 90.6 mb/d in 2013.
  • Revisions to historical data leave the 2011 demand estimate 0.2 mb/d higher than reported last month.  That in turn lifts estimated absolute demand by 100 kb/d for both 2012 and 2013, though the forecast of demand growth for both years has been adjusted marginally downwards from last month. The US, Brazilian and Canadian series lead the upside revisions for 2011, respectively up by 115 kb/d, 105 kb/d and 35 b/d.
  • Latest demand estimates show robust 1.2 mb/d (1.4%) year-on-year growth in 2Q12, led by gains in Japan. Japanese oil demand grew by 0.4 mb/d (10.0%) in 2Q12, as electric utilities sought to replace idled nuclear power generation capacity.


Global Overview

The pace of oil demand growth is expected to remain relatively steady over the next eighteen months, with annual gains of just 0.8 mb/d (0.9%) in both 2012 and 2013 (to 90.6 mb/d). This modest growth rate reflects the combined effects of sluggish global economic activity, historically elevated oil prices and global improvements in energy efficiency. Despite moderating from late-April through mid-June, Brent at the time of writing remained above $110 per barrel, a high level by historical standards. The forward price curve assumed relatively little change in 2012, with Brent futures averaging $107/bbl (compared to $108 in 2011), before falling to just below $99/bbl in 2013. Persistently high prices create an incentive to reduce consumption; this is best encapsulated by the rapid decline in global oil intensity, which is forecast to fall by 2.3% in 2012 and 2.5% in 2013, a greater decline rate than the previous 15-year average of 2.2%. Heightened developed world debt constraints, combined with elevated commodity prices, have helped dampen the macroeconomic backdrop, with a global expansion of around 3.3% foreseen in 2012, accelerating only moderately in 2013 to 3.6% (see 10 August OMR).

Despite the relatively tepid headline growth, changes in consumption vary greatly by product. Gasoil demand is forecast to expand more rapidly than oil as a whole, with gains of 1.1% in 2012 (to 26.4 mb/d) and 1.4% in 2013 (to 26.8 mb/d). Four key factors are driving gasoil's advance: industrial growth in emerging markets, power generation (non-OECD), a continued shift in transportation fuel demand towards diesel and tighter environmental regulations, which have forced many water-borne vessels to swap fuel oil gasoil bunkers for gasoil. The only other demand segment that looks likely to retain anything approaching strong growth is LPG, which in our balance includes ethane, up 1.0% in 2012 (to 9.3 mb/d) and accelerating to 2.0% in 2013 (to 9.5 mb/d), as petrochemical usage continues to expand.



Year-on-year (y-o-y) global demand growth picked up momentum in the second quarter, as demand surged to 89.0 mb/d, up by 1.2 mb/d (1.4%) on 2Q2011, compared to growth of 0.5 mb/d for 1Q12. Japan accounts for much of the strong performance in 2Q12: Japanese demand rose by 0.4 mb/d (or 10.0%) to 4.3 mb/d, a consequence of the country's tsunami-related nuclear shortages. The global 2Q12 demand estimate also benefited from upward revisions totalling 115 kb/d from the previous month's estimate, led by adjustments in Brazil (+125 kb/d), Turkey (+65 kb/d) and Canada (+65 kb/d). Despite these additions the 2012 forecast remains restrained, as 2H12 sees slower non-OECD demand growth, while Japanese growth ebbs (on returning nuclear capacities) and Korea decelerates (on government efforts to curb imports).



OECD

OECD oil demand is expected to decline by around 0.3 mb/d (or 0.7%) in 2012, to 46.2 mb/d, as diverging regional trends offset each other. Growth is projected in OECD Asia Oceania on the back of Japanese nuclear outages (+3.3%), contrasting with steep declines in Europe (-2.6%) due to sluggish economic growth and more modest drops in the OECD Americas (-0.8%). The overall outlook is little changed in 2013, when demand is again expected to contract by 0.3 mb/d (-0.7%), but the regional discrepancies wane. A gradual recovery in Japanese nuclear capacity is forecast to reduce oil requirements in Asia Oceania (-1.9%), while a more robust European economic outlook in 2013, with GDP growth of +0.8% assumed following recession in 2012, supports a milder decline rate of 1.3%. Consumption in the Americas essentially remains little changed (+0.1%).

Rising prices and continued economic unease suppressed demand in July, which according to preliminary data contracted by 0.5% y-o-y to 46 mb/d. The sharpest declines were seen in Italy (-5.1% to 1.4 mb/d), Germany (-1.3% to 2.4 mb/d) and Mexico (-1.1% to 2.1 mb/d). In contrast, demand grew in Japan (+3.7% to 4.4 mb/d), France (+3.3% to 1.9 mb/d) and Korea (+0.3% to 2.2 mb/d).



Americas

The OECD Americas region (North America plus Chile) saw a modest y-o-y demand contraction of around 0.3% to 23.9 mb/d, according to preliminary data for July. For the year as a whole, demand is projected to decline by around 0.8%, to an average 23.9 mb/d in 2012, driven by steep efficiency gains. Demand is forecast to remain unchanged in 2013, at 23.9 mb/d, as rebounding sentiment is balanced against continued efficiency gains.



Latest weekly estimates for US product demand continue to imply a falling y-o-y trend, with average consumption in the four weeks through to end-August down 1.0% on the corresponding period a year earlier. Distillates (-9.3%), jet/kerosene (-6.0%) and residual fuel oil (-4.5%) accounted for the bulk of the decline, offsetting gains in propane (22.8%) and gasoline (0.7%). Preliminary estimates for July implied a marginally smaller 0.2% y-o-y drop, to 18.8 mb/d, itself an improvement on the revised 1.7% contraction seen in June, to 19.0 mb/d. Despite a fair amount of noise in monthly and weekly data, US consumption of oil products looks persistently biased to the downside. A forecast decline rate of 0.9% is assumed for both 2012 (to 19.0 mb/d) and 2013 (to 18.8 mb/d), as fledgling economic recovery looks set to counterbalance the onset of long-term, structural US consumption decline.

This month's report also includes substantial revisions to US historical baseline data, following the release of the EIA's Petroleum Supply Annual, resulting in an upward adjustment of 115 kb/d to consumption estimates for 2011. The bulk of this incremental demand was attributable to LPG, with an average of 100 kb/d of extra demand added in 2011, lifting total LPG demand estimates to 2.3 mb/d for the year. Even though the underlying growth rates, post-2011, are little changed, the base effect means higher numbers throughout.



Canadian oil demand seasonality has changed since 2010, due in part to fast-paced development of the energy-intensive natural resource sector. The economy grew steadily through 1H12. In August, however, the PMI reading dropped to 53 - a level still indicating expansion, but about 1.2 points below average, thus signalling a possible slowdown in growth. In June, strong demand gains for gasoline (14.4%) and diesel (37.5%) were offset by drops in heating oil (-22%), LPG (-17.7%) and 'other products' (-13.7%). Aggregate consumption fell by 7.6% year-on-year. Total oil products demand is to contract marginally by 0.3% in 2012, before rebounding by 0.9%, in 2013. Oil demand remained relatively flat in June (+0.3% on year earlier), after growing by 4.7% in May and 2.7% in April. A baseline addition of 35 kb/d is made to 2011.



In Mexico, oil demand decreased in July (-1.1% y-o-y), extending June's marginal fall (-0.3%). The drop was driven by fuel oil (-18%), which more than offset increases in gasoline (2.3%) and diesel (5.1%). The decline in fuel oil is partially explained by fuel substitution, which is itself driven by low natural gas and coal prices and the addition of new power generation capacity, including 814 MW in combined cycle capacity and 750 MW in hydroelectric capacity). On the other hand, gasoline consumption is expected to remain robust, as consumers increase purchases of light-duty and heavy-duty vehicles, up 11.8% and 9.1%, respectively.

Europe

Ailing macroeconomic conditions, not helped by persistently high oil prices, maintained Europe's unenviable position of possessing the weakest growth trend of all the main regions. European oil demand fell by 2.4% in June, to 14.1 mb/d, with transportation fuels particularly suffering: jet/kerosene demand down 5.8% (to 1.2 mb/d) and gasoline down 5.2% (to 2.1 mb/d). Preliminary July estimates point towards a further decline of 2.5%, to 14.1 mb/d.



The euro zone officially entered a second, or double-dip, recession in 2Q12, as GDP fell by 0.2% over 1Q12. The indicators for 3Q12 remain downbeat, with manufacturing sentiment - encapsulated by the euro zone PMI - firmly down and below 50. The PMI fell to a 37-month low of 44 in July, before rising modestly to 45.1 in August. Concerns about the region's economic outlook in September led the European Central Bank to agree to buy a potentially unlimited quantity of a country's bonds of one- to three-year maturity, as long as the said country agrees to certain fiscal adjustments. European demand is estimated to fall by around 2.6% in 2012, to 14.0 mb/d, with a moderating decline rate of 1.3% assumed for 2013 (to 13.8 mb/d) as the economic backdrop modestly improves.



According to preliminary data, oil product deliveries in Germany posted a y-o-y decline of 1.3% in July, down dramatically on the sharp 8.6% gain seen in June. Heating oil (-16.8%), Naphtha (-9.2%) and gasoline (-2.4%) led the decrease, while LPG (+20.9%), residual fuel oil (+19.0%) and jet/kerosene (+7.2%) partially offset those declines. Economic growth in 2Q12 showed its worst performance since 4Q10, growing by only 1.7% year-on-year, as the weakening export sector dampened the overall economy. The German PMI fell to a 37-month low of 43 in July, bouncing only marginally in August (44.7), as the economy turned back to domestic consumers to boost growth. Retail price gains in August, with diesel and gasoline up 12% on July, undermining transport fuel demand. Oil demand in 2012 and 2013 is expected around 2.4 mb/d, contracting marginally by 0.8% and 0.1%, respectively. This forecast is subject to revision on the downside in view of the latest bearish economic indicators.

Meanwhile in Italy, total oil demand continues to plummet as growth decreased by 5.5% in July, extending 17 consecutive months of contraction (-7.9% average). The greatest losses were seen in diesel (-5.5%), 'others' (-12.3%) and residual fuel oil (-12%). Fiscal consolidation, weak employment and high transport fuel taxes are depleting Italian disposable income and undermining consumer confidence and oil demand. The outlook for both 2012 and 2013 remains depressed, with oil demand in Italy forecast to decline by 8.5% and 3.0%, respectively, averaging out at around 1.3 mb/d in both years.



Asia Oceania

A challenging economic environment, high oil prices and lower-than-expected oil demand from Japanese electricity generators combined to curtail the pace of previously steep demand growth in Asia Oceania (i.e., OECD Pacific plus Israel). Preliminary estimates for July point towards a y-o-y decline of 2.4%, to 8.1 mb/d, compared to the previous six-month average of 7.0%.



In Japan, oil demand rose by 3.7% year-on-year in July, a less dynamic increase when compared with the previous three-month average of 10%. Residual fuel oil (30%), 'other products' (8.5%) and LPG (16.3%) led the increase, but most of the gains were offset by sharp decreases in naphtha (-7.8%) and heating oil (-11.2%). The sudden stall of demand is partially explained by two compounding factors. The first is the comeback of two nuclear plants in the Ohi Prefecture adding 1 TWh of power generation in July, which would scale up to 1.8 TWh in August. The second factor was comparatively low cooling demand in July, as early-summer temperatures were milder than last year and closer to the ten-year average. However, the return of high temperatures in August may signal an increase in residual fuel oil and direct crude burning in the power sector, to compensate for still idle nuclear capacity. During 2Q12, total power generation remained within the normal range, but the share of thermal power was almost 50 TWh more than normal. In 3Q12 we expect thermal generation to account for 65% of total power generation. Currently, our base case scenario includes only two active nuclear reactors in 2012, rising to between four and six by the end of 2013. The latter will require that the new oversight authority of the nuclear industry in Japan approve the restart of some idle capacity. Overall, demand in 2012 is expected to grow to 4.6 mb/d, up by 180 kb/d (+4.0%).



Returning seasonal downtrends in LPG demand led to steep deceleration in South Korean oil demand growth. Having risen by as much as 9.1% in June (and 7.9% in May), total oil product demand growth eased to 0.3% in July, to average 2.2 mb/d. Comparisons with July 2011 were likely to have a downwards bias, as peak transportation fuel demand arrived a month early in 2011 and year-earlier reference levels were thus exceptionally high. Government efforts to reduce oil consumption, coupled with the ongoing global economic slowdown, are forecast to reduce the predicted annual 2012 expansion to 1.7%, to 2.3 mb/d, before flattening in 2013.





Non-OECD

The same conditions that have plagued OECD oil consumption - weaker economic growth and price pressures - have also affected non-OECD economies.  In their case, however, the result has been slower growth rather than falling demand. Having stalled at around 2.5% growth in June, to 43.7 mb/d, preliminary estimates for July imply an acceleration to 3.2%. Reports of the demise of non-OECD gasoline demand appear to be premature, with growth of 4.6% seen in June (to 8.8 mb/d) and 4.9% in July (to 8.9 mb/d). 'Other products' demand expanded at a robust pace in both months, by 6.5% and 3.2%, respectively, with crude for direct burn in the power sector a notable contributor.



Growth of 2.7% is forecast for 2012 as a whole, to 43.5 mb/d.  Transportation fuel demand is expected to lead the growth: gasoline demand is forecast to rise by 4.8% (to 8.8 mb/d) while gasoil posts a 2.3% gain (to 13.4 mb/d). A modest deceleration in total non-OECD oil product demand is projected for 2013, up 2.6% to 44.7 mb/d, as economic headwinds curtail the outlook.

China

Despite clear signs that the Chinese economy is slowing, apparent demand growth picked up momentum in July, according to preliminary estimates. Figures for July show a rise of 2.2% y-o-y, to 9.4 mb/d, its strongest growth rate since March. Robust gasoline demand in July led the way, up 16.4% to 2.0 mb/d, supported by still rapidly expanding vehicle usage. Petrochemical demand supported 12.5% growth in naphtha consumption, to 0.5 mb/d.



Falling jet fuel prices provided moderate support for jet/kerosene demand, up 0.9% y-o-y in July to 410 kb/d. Jet fuel prices averaged 6 670 yuan/metric tonne in July, a decline of nearly 10% on the month earlier, as steeply lower international prices outweighed any support provided by the weaker yuan.

Slower growth in the broader Chinese economy is projected to restrain oil demand growth to a comparatively muted 2.6% in 2012, taking annual average demand up to 9.5 mb/d, with a modest acceleration foreseen in 2013, up 2.9% to 9.8 mb/d. This is significantly slower than the annual growth of nearly 9% seen in 2002-2006, and the double-digit percentage point expansions seen through much of 2010 and early 2011. Government support for the economy will likely restrain the worst of any downside momentum.



Other Non-OECD

The rapid expansion in Indian demand, seen in both May (+4.0% y-o-y) and June (+7.0% y-o-y), continued in July, with the preliminary estimate up 9.4% to 3.7 mb/d. Rampant gasoil demand led the upside, 13.2% higher in July to an average of 1.4 mb/d. Lower than normal monsoon rains, throughout most of July, required extra diesel, as the parched agriculture sector required additional irrigation pumping. Late-July electrical blackouts added to gasoil demand, as many emergency diesel-fired-generators were required. Indian demand growth will likely abate somewhat in the second half of 2012, reflecting the global economic malaise, with a gain of 3.8% assumed to take total demand up to an average of 3.6 mb/d.



Large historical data revisions for notoriously-hard-to-predict Russia were seen through 2Q12, as roughly 75 kb/d was taken out of the historical Russian demand estimate for this period. Preliminary estimates of July demand point towards a 4.7% y-o-y gain, to 3.5 mb/d. More testing economic conditions will likely see a modest slowdown in second half demand growth, leaving an annual expansion of about 4.5% for the year as a whole, to 2.4 mb/d. Assuming the worst of the economic slowdown is reserved for 2012, demand growth in Russia will accelerate in 2013, to 5.1%, as total oil product demand averages 3.6 mb/d. 

Supply

Summary

  • Global oil supply fell by 0.1 mb/d month on month (m-o-m) to 90.8 mb/d in August from upwardly revised July estimates, as OPEC liquids production growth failed fully to offset unplanned outages in non-OPEC countries. Compared to a year ago, global oil production stood 2.0 mb/d higher, with all of the increase coming from OPEC crude and NGLs.
  • OPEC crude oil supplies rose by 45 kb/d to 31.55 mb/d in August from an upward-revised July assessment. West African producers Nigeria and Angola as well as Iraq posted the largest increases, which were partially offset by reduced supplies from Iran and Saudi Arabia. Imports of Iranian oil inched up to 1.1 mb/d in August from below 1 mb/d in July. Increased exports, however, may be temporary; both US and European officials have proposed to tighten sanctions further from the lack of progress in negotiations with Tehran over its country's nuclear programme.
  • The 'call on OPEC crude and stock change' for 3Q12 was raised by 100 kb/d to 31.1 mb/d due to an upward revision to this month's demand estimates. However, a projected recovery in non-OPEC supplies in 4Q12 is forecast to cut back the 'call' by a substantial 500 kb/d in the last three months of the year, to 30.6 mb/d, from 3Q12 levels.
  • Non-OPEC supply fell by 0.2 mb/d in August from the prior month and by 0.1 mb/d compared to August 2011. Planned and unplanned outages slowed down growth in non-OPEC supply to just 0.2 mb/d in 3Q12, from 0.6 mb/d and 0.5 mb/d in the first and second quarters, respectively. Non-OPEC supply is forecast to grow by 0.4 mb/d in 2012 and 0.7 mb/d in 2013, unchanged from last month's assessment.


All world oil supply figures for July discussed in this report are IEA estimates. Estimates for OPEC countries, some US states, 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. After heavy outages seen in 2011 and 2012, this adjustment now totals ?500 kb/d for non-OPEC as a whole, with most downward adjustments focused in the OECD.

OPEC Crude Oil Supply

OPEC crude oil supply in August posted a modest rise, up by 45 kb/d to 31.55 mb/d compared to an upwardly revised July estimate of 31.5 mb/d. West African producers Angola and Nigeria posted the largest month-on-month increases, with smaller increments coming from Iraq, the UAE and Ecuador. By contrast, Saudi Arabia, Iran and Libya posted monthly declines. August output is in line with average year-to-date OPEC supply of 31.54 mb/d. OPEC's effective spare capacity is assessed at 2.49 mb/d.

An upward revision to this month's demand estimates has led to an increase of 100 kb/d to the 'call on OPEC crude and stock change' for 3Q12, to 31.1 mb/d. But that effect is expected to be short-lived, as a projected recovery in non-OPEC supplies is forecast to cut back the 'call' by a substantial 500 kb/d in 4Q12, to 30.6 mb/d, from 3Q12 levels. Full-year 2012 estimates of the 'call' were raised by 100 kb/d, to 30.3 mb/d.



Iranian crude supply in August declined by 50 kb/d to 2.85 mb/d, with production now 650 kb/d below end-2011 levels. Despite the July implementation of stricter US sanctions and the EU embargo of oil imports, crude exports edged up slightly from record-low levels last month. Iranian floating storage levels are estimated to have fallen by 5 mb since end-July while preliminary reports indicate August imports of Iranian crude rose to 1.1 mb/d, compared to an estimated 930 kb/d in July. Given the lack of transparency in shipping data and delay in customs data, both import and export estimates remain subject to revision. Turkey posted the largest increase last month, up around 150 kb/d to 200 kb/d, followed by Malaysia, which saw volumes rise by 100 kb/d to 130 kb/d. Japan, after suspending imports entirely in July, imported slightly less than 100 kb/d in August, well short of average imports of 175 kb/d in 2Q12 and 300 kb/d in 1Q12. Both Japan and India implemented state-backed insurance programs to cover cargoes of Iranian oil. Iran also launched a program to provide insurance cover for oil tankers entering its waters.

Press reports suggest that Iranian exports may post further gains this month. China, South Korea, India and others are poised to increase liftings in September. In addition, a cargo was reportedly sold through the private sector after Tehran, in a bid to maintain exports, allowed for the first time sales outside of the state oil company. The government has granted a consortium of private Iranian companies the right to sell 20% of its oil exports to international markets.

The increase in exports since July's lows, however, may be temporary. Both US and European officials look poised to tighten sanctions further given the lack of progress in negotiations over Iran's nuclear program. In addition to cracking down on international banking institutions engaging in financial transactions with Iran in recent months, US officials have been vigilant in monitoring illegal reflagging of Iranian tankers by other countries. In response, Tanzania and Sierra Leone deregistered a combined total of 45 tankers that were illegally flagged in their countries. Both governments reported shipping agents acting on behalf of Iran illegally registered the vessels. US lawmakers also targeted the small Pacific island nation of Tuvalu, which reflagged 22 Iranian oil tankers.

Meanwhile, European leaders from France, Germany and the UK are calling for tougher sanctions on Iran due to Tehran's intransigence over its nuclear programme. In addition to the EU oil embargo, which went into effect 1 July, European officials indicated they are prepared to implement more comprehensive sanctions on Iran's oil and financial sectors and plan to discuss new measures in coming weeks.



After six months of output hovering around the 10 mb/d mark, crude oil production from Saudi Arabia in August edged lower by 100 kb/d, to 9.9 mb/d. Lower output last month may, in part, reflect a dip in buying interest from customers. Demand for Saudi crude from Asian buyers may have rebounded this month given relatively more attractive refining margins. A series of computer attacks on Saudi Aramco's communications system in early August caused protracted disruptions in email traffic with customers. Nonetheless, the company was able to maintain communications via fax and telex throughout the disruption and production operations remained unaffected. It was reported that an Iranian group claimed responsibility for the attack.

Iraqi crude oil production in August reached its highest level in more than three decades at 3.07 mb/d, up 50 kb/d over July. Increased shipments from the southern ports also lifted exports by close to 50 kb/d to a new high of 2.57 mb/d. Despite persistent problems with lack of storage facilities and low pipeline flows to the country's two new single point mooring (SPM) terminals, incremental volumes are slowly being added, with Basrah shipments up by 36 kb/d to 2.25 mb/d. Additional output is coming from a number of joint-venture projects, including ExxonMobil's West Qurna-1, Eni's Zubair field and the CNPC-led Halfaya project.



Exports of Kirkuk crude were up by 13 kb/d at 313 kb/d, including 8 kb/d trucked to Jordan. In a goodwill gesture toward Baghdad, exports from the Kurdish Regional Government (KRG) resumed in August. The KRG had suspended exports in April over payment disputes to its foreign contractors by the central government. The KRG initially planned to export 100 kb/d starting in early August but an attack on the Turkish side of the northern export system thwarted those plans. It had initially set a deadline of 31 August to receive the payments but due to the attacks said it would delay suspension of exports until 15 September. Baghdad has responded by making demands of its own regarding past due royalties it says the KRG owes. The deadlock is likely to result in a renewed cut-off of KRG volumes into the northern pipeline system later this month. Meanwhile, oil producer Genel Energy reportedly is using as many as 500 trucks a day to ship its crude oil output from the Kurdish region to Turkey.

Crude oil supplies from Angola posted a steep rebound in August as maintenance work at the Girassol field and Palanca export terminal ended. Output rose by 120 kb/d to 1.75 mb/d. Loading schedules indicate Angolan supplies will slip again in September, however. Continued ramp-up of the 220 kb/d Pazflor field and the 140-kb/d Kizomba D satellite fields as well as start-up of the 150 kb/d PSVM field will increase the country's production capacity in 4Q12 to a nameplate 1.9 mb/d. President Jose dos Santos, recently re-elected to continue a 33-year rule, pledged during the electoral campaign to increase crude production and use more of the country's oil wealth for the benefit of the population.



Nigerian crude production also recovered in August, up 100 kb/d to 2.26 mb/d, following the lifting in early August of force majeure on Bonny Light crude exports, which had been in place since May. However, loading schedules for September indicate exports may fall to an 11-month low.

Libyan crude supplies were down 70 kb/d in August, to 1.38 mb/d, from a revised 1.45 mb/d for July. The 220-kb/d Ras Lanuf refinery restarted on 31 August and may lead to reduced crude exports of its primary feedstock, light sweet Sarir crude.

Non-OPEC Overview

Both planned and unplanned outages contributed to a 190 kb/d fall in August non-OPEC output from the prior month as the US was hit by the most disruptive hurricane since 2008, and North Sea output suffered from strike-related disruptions and planned maintenance. At a 3Q12 average of 52.9 mb/d, non-OPEC supply is still 200 kb/d (0.4%) higher than the prior year, but that rate is much lower than the more than 0.5 mb/d growth seen in the prior two quarters.

Hurricane Isaac in the US and strikes in Norway were just the latest in a string of disruptions that have kept the level of unplanned shut-ins in non-OPEC countries above 1 mb/d in the last several months. In 3Q12, unplanned outages are expected to reach almost 1.3 mb/d, centred in Sudan, Yemen, Syria, Norway and the US. In the US, Hurricane Isaac has caused a supply shortfall of almost 13 million barrels since 26 August, reducing Gulf of Mexico output by more than 200 kb/d in August and in September. Output from Sudan and South Sudan is expected to remain offline until 2013 pending a comprehensive agreement. Specific field outages at Frade (Brazil), Elgin/Franklin (UK), and Peng Lai (China) are also reducing output in those countries. In the month of September alone, planned maintenance at the Buzzard field in the UK, as well as planned and unplanned maintenance at other North Sea fields will reduce North Sea and Brent-Forties-Oseberg-Ekofisk BFOE output in half to slightly more than 600 kb/d, a record-low level.

Despite persistent unplanned outages in non-OPEC countries, we expect production to rise to 53.6 mb/d in 4Q12, 380 kb/d higher than the prior year, thanks to both continued growth in North American oil sands and light, tight oil output and a recovery in North Sea and Gulf of Mexico production. In 2013, a recalculated contingency factor of 0.5 mb/d is implicit in the estimate of 750 kb/d growth, which is 30 kb/d higher than last month's estimate.

Revisions include downwards adjustments to Azerbaijan, Brazil and China in 2012 that are offset by upwards revisions in Norway and the US.



OECD

North America

US - August preliminary, Alaska actual, other states estimated:  US crude oil production fell by 120 kb/d in August on maintenance at fields connected to the Trans-Alaska oil pipeline and on the impact of shut ins to Gulf of Mexico production from Hurricane Isaac. In Alaska, output fell to around 400 kb/d, the lowest level since July 1977, while Isaac slashed Gulf of Mexico output by 210 kb/d to 1.2 mb/d in August. Peak shut-in rates reached 1.3 mb/d for four days at the end of the month, with over 90% of oil producing platforms evacuated. Recent US statistics indicate that platforms are in the process of being restaffed, and output is recovering by 50-100 kb/d per day. Shut ins will persist until mid-September, reducing Gulf of Mexico output by an average 210 kb/d for the month. Based on a five-year average of historical tropical storm impacts, the shut-in rate exceeded expectations by around 40 kb/d in 3Q12, assuming no further weather event in September. Our projection of US oil output for 2013 is raised slightly by 90 kb/d, due to higher expectations from the Bakken, especially in 1Q13. US liquids output is now expected to grow from 8.9 mb/d in 2012 to 9.4 mb/d in 2013, a growth of 460 kb/d.

Revisions to US crude and other liquids output from the EIA Petroleum Supply Annual result in a minor -10 kb/d revisions to the US outlook in 2003 and in 2009, with much of the revisions centred in Texas. Williston Basin (ND) production is revised upwards due to increased drilling activity, and output should average in excess of 0.7 mb/d in 2013.



Canada - June preliminary:   Canadian oil production reached around 3.7 mb/d in June based on preliminary government data and is expected to breach the 4.0 mb/d mark as early as October. Despite discounts of $10-$20/bbl to WTI in July and August, August data from oil sands producers indicate synthetic crude output has risen by over 200 kb/d since June, to around 1.0 mb/d. Suncor's North Steepbank extension has enabled output of synthetic crude oil to exceed 350 kb/d, and news reports indicated that Cenovus has brought on Phase D of its Christina Lake project, consistent with our expectations.  Tropical Storm Leslie is likely to move through Eastern Canada's offshore producing areas.  Most of these fields are already offline for planned maintenance, but the storm's impact could cause a slower restart.  Canadian output is expected to average 4.0 mb/d in 2H12 and 4.1 mb/d in 2013, largely unchanged from last month's estimate.

North Sea

North Sea liquids production fell by 0.2 mb/d to around 2.8 mb/d in August based on preliminary data, with 3Q12 production also 9% lower than in 2011. A Norwegian oil workers strike reduced output by 60 kb/d in June, 90 kb/d in July, and 40 kb/d in August bringing Norway's oil production to 1.8 mb/d in August. Further labour action was averted in September when oil workers and management agreed on a salary increase and cash payment. In September, production of Brent, Forties, Oseberg and Ekofisk crudes, which together comprise the BFOE benchmark, is likely to reach a record low of around 610 kb/d, with planned maintenance at the Troll field in Norway and at Nexen's Buzzard field in the UK. The 200-kb/d Buzzard field's planned turnaround began on 4 September and is expected to last until mid-October. Planned maintenance of around 300 kb/d and unplanned outages of 110 kb/d in Norway and 120 kb/d in the UK reduced North Sea output to 2.8 mb/d in 3Q12. Planned maintenance of 170 kb/d in 2Q and 3Q12 was around 20 kb/d higher than in the same quarters of 2011, though maintenance was more evenly spaced last year.

Despite the outages, the latest data for June, July, and August indicate production slightly higher than anticipated in both the UK and Norway, resulting in a small (20 kb/d) upwards revision to North Sea supplies in 2H12. The outlook has been adjusted downward by 30 kb/d in Norway in 2013 due to a slight delay to Goliat to 2014, and poor field performance at Gjoa and Alvheim/Klegg that have been carried through the forecast. Taking these revisions into account means Norway's oil supply should fall by 7% to 1.8 mb/d in 2013 and the UK's should fall by 5% to 0.9 mb/d.



Non-OECD

Former Soviet Union

Russia - August preliminary:   Russian oil production rose by 60 kb/d to a new post-Soviet record of 10.7 mb/d in August, thanks to rising Eastern Siberia and NGL output. Gazprom's condensate output increased by around 60 kb/d compared to the prior month, despite a reduction in natural gas supplies. Production at Rosneft's Vankor field rose by 12% month-on-month to almost 400 kb/d. Meanwhile, mature assets in Western Siberia performed better than expected. Lukoil, in particular, managed to reduce the decline rate at its Western Siberian fields from 5% in 2011 to only 2% in the 1H12.

Yet the outlook for the remainder of the year and 2013 may not be as promising as recent performance would suggest. Year-on-year growth rates of crude output slowed slightly to 1.0% in 3Q12 from 1.1% in 2Q12. In the third quarter, brownfield declines have regained momentum, blunting the impact of higher contributions from greenfields. Bashneft, which grew its expensive, heavy oil output by 4% over the last year to over 300 kb/d, has said it does not expect further growth in 2H12. After strengthening by 1% in 2012, Russian production looks set to decline by -0.5% in 2013, unchanged from last month's report.

Other FSU:  Oil production in Azerbaijan is stagnating at around 870 kb/d in 3Q12, roughly 7.4% lower than last year. Based on the latest data, production rates are not fully recovering from planned maintenance at the East, West, and Central Azeri fields that occurred in 4Q11. The outlook is therefore revised downward for 2H12 (-30 kb/d) and for 2013 (-20 kb/d) based on the lower baseline. Liquids output is expected to fall by 1.5% next year to average around 890 kb/d. In Kazakhstan, the North Caspian Operating Company that is developing the super-giant Kashagan field confirmed that output would not begin until spring 2013, due to problems completing the Bolashak onshore processing plant. According to press reports, construction and installation are 98% complete but commissioning and connections are only 70% complete. Commercial volumes of oil are expected to begin around June, reaching up to 350 kb/d. Meanwhile, maintenance at the Sour Gas Injection/Second Generation Plant at the Tengiz field is expected to reduce output by 6% y-o-y in Kazakhstan to only 1.5 mb/d in 3Q12, the lowest level since late 2008.

FSU net exports slumped by a seasonal 0.2 mb/d to 8.8 mb/d in July, their lowest level since November 2008, as high Russian refinery runs reduced the availability of crude for export. Total crude shipments dropped by 0.2 mb/d to 6.1 mb/d, their lowest level in a year. Transneft volumes accounted for 130 kb/d of the decline after higher volumes from Baltic ports failed to offset persistently constrained Druzhba pipeline flows and lower deliveries from the Black Sea.

The dramatic decline of Druzhba flows to 940 kb/d, a significant 230 kb/d below year-ago levels, has forced many buyers to look elsewhere for alternative supplies. Only Slovakia has maintained its deliveries at year-ago levels. Shipping data indicate that Poland imported seven seaborne Urals cargoes (160 kb/d) in July, compared with only one earlier in 2012, despite the extra cost incurred via tanker deliveries. Poland's more recent import patterns suggest that Druzhba flows likely remained depressed in August. Poland has since imported another six seaborne Urals cargoes (140 kb/d) plus additional cargoes from Norway and even an Aframax cargo of Urals MED.

Black Sea shipments were hit by maintenance at TCO's Tengiz field which restricted flows through the CPC pipeline to 650 kb/d (-50 kb/d m-o-m). Kazakhstani rail shipments to Novorossiysk fell by an additional 80 kb/d. In the Baltic, 327 kb/d (+90 kb/d m-o-m) were sent via Ust Luga, which offset low maintenance-affected flows from Primorsk. Meanwhile, product export tariffs were lowered, resulting in steady product export levels, maximizing outflows while the terms were preferential. Producers are expecting an increase in crude tariffs in August after a recalculation from the higher Urals price. The resilient level of product exports occurred in spite of healthy domestic demand.



Middle East

Two estimates of Syrian oil output emerged this month from official sources. One Syrian government official who travelled to Russia to conclude an oil-for-products barter deal said that output was currently 200 kb/d, while another reported output at 140 kb/d, compared to pre-sanctions petroleum production of around 370 kb/d.  This report assesses that Syrian output averaged 170 kb/d in 1H12, assuming that at least some of the pre-conflict 240 kb/d of refining capacity is operating and that a trickle of crude is still able to find an outlet. The reported barter deal, if concluded, would provide the Syrian regime with much needed gasoline and diesel. The Wall Street Journal reported in August that despite international sanctions, Syria's Sytrol has secured 11 contracts to sell crude and that it had secured deals to import half the diesel fuel Syria is projected to need annually, mainly for military and industrial uses.

Market observers optimistically greeted news that Yemen's 120-kb/d Marib pipeline had been repaired over the course of the summer and that exports would soon increase, yet two new bombings of the pipeline reported in the span of only one week could hinder flows. Currently, operators are holding crude in storage until the line is repaired, and the government asserts that output has not been affected.

Africa

Sudan and South Sudan - Sudan and South Sudan inched closer to a comprehensive agreement that would restore oil exports. In August, the two sides agreed to a one-off compensation from South Sudan to Sudan, as well as pipeline tariffs from the two major oil producing areas in South Sudan. Though South Sudan's leading negotiator to the African Union originally forecasted that output would resume in September, the country's oil and finance ministries do not expect a restart for 4-6 months. The two sides were meeting in Addis Ababa in early September to settle remaining contentious issues on border demarcation. Consistent with our expectations last month, we do not expect a restart to the oil fields in Blocks 1, 2, and 4 until at least mid-2013, while output from Blocks 3 and 7 could restart as soon as January.

Latin America

Brazil - July actual:  Brazilian crude output slid slightly for the second month in a row to 2.0 mb/d in July due to continued stagnating output at Campos basin fields. In the second and third quarter, output in the basin fell by around 3% annually, in contrast to 3% and 1% growth in 2010 and 2011. Some of the annual decline is due to the continued shut-in of the 70-kb/d Frade field, but steep offshore decline rates and maintenance at Roncador, Marlim Leste, Marlim Sul, and Cachalote fields is also reducing output. It is clear that decline rates at the Campos basin, which contributes over 80% of Brazil's crude output, are taking a toll, offsetting pre-salt growth from the Santos basin. In 2013, a mid-year restart of the Frade field, a 3Q12 start-up at the 100-kb/d Cidade de Anchieta (Baleia Azul field) FPSO, and new wells at some Campos fields are expected to lift Brazilian crude output by 200 kb/d (1.3%), to 2.3 mb/d. Petrobras' October 2012 target for the start-up to the Baúna and Piracaba (formerly Tiro/Sidon) fields seemed optimistic even before news of a fire at its unfinished FPSO in Singapore looked set to push back the launch to 2013.

Asia

Chinese output bounced back by 70 kb/d to 4.1 mb/d in July after falling sharply in June. Output rebounded from the 30-kb/d Turpan-Hami field and from other offshore fields. Continued lack of information about the timing of a possible restart to the Peng Lai field has caused a 70 kb/d downward revision to 2H12 and a 20 kb/d revision to 2013.

In India, ONGC's Mumbai High oil field has been suffering from increasing water cut and lower-than- anticipated recovery rates from new development wells. The company also reported closure of a few wells due to low availability of natural gas for gas recovery. The downturn is broadly in line with expectations and should result in Indian output averaging around 900 kb/d in 2012.

OECD Stocks

Summary

  • July OECD industry stocks posted weak seasonal builds of just 10.6 mb, ending at 2 714 mb. The gain was roughly half the five-year average build for the month of 20.7 mb.  Inventories slipped to 9.2 mb below the five-year average, from a revised deficit for June of 0.8 mb, much narrower than previously estimated.
  • On a forward demand basis, inventory cover looks more comfortable, due mostly to diminishing demand prospects through October.  Total OECD stock cover now stands at 58.3 days, 0.2 days above end-June and 0.6 days above a year ago.
  • Preliminary data suggest that OECD stocks fell counter-seasonally in August, declining by 21.8 mb. Crude oil led the decline, slumping by 23.7 mb, reflecting both higher refinery runs and disruptions to US production and imports due to Hurricane Isaac.
  • The implied Chinese crude oil stock change, calculated as the gap between reported refinery throughput and net imports and production data, stands at 4 mb in July, suggesting that Chinese SPR filling has continued into the third quarter.


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

OECD commercial oil stocks built by 10.6 mb in July, the fifth consecutive monthly increase, to stand at 2 714 mb at end-month. This rise, however, was significantly weaker than the average 20.7 mb build for the month.  Consequently, inventories slipped to 9.2 mb below the five-year average from June's revised deficit of 0.8 mb (previously estimated at 19.2 mb). As in previous months, inventories remain unevenly distributed among the main OECD regions.  OECD Americas remains approximately 50 mb in surplus to the five-year average, whereas OECD Europe and Asia Oceania remain 55 mb and 3 mb in deficit, respectively. On a forward demand basis, the inventory picture looks slightly more comfortable, largely due to diminishing demand prospects through October. Total OECD stocks now stand at 58.3 days, 0.2 days above end-June and 0.6 days above a year ago.

The July stock build was driven by a 32.8 mb rise in products.  Yet despite that build, OECD total product holdings still lag the five-year average by 42 mb, as stockholders appear unwilling to steadily increase stocks while product markets are in backwardation. Middle distillates and 'other products' accounted for the bulk of the July product stock build, rising by 13.7 mb and 12.7 mb, respectively.  Both of those builds were in line with seasonal patterns. Additionally, gasoline rose by 5.9 mb after a sharp counter-seasonal 3.7 mb climb in OECD Europe.

Meanwhile, OECD crude inventories posted a seasonal, albeit steep, draw of 16.5 mb spanning all regions, as spring refinery maintenance wound down. It is noteworthy that June preliminary data were revised upwards by a steep 20.2 mb, 19.4 mb of which was crude oil, largely concentrated in OECD Americas and OECD Europe. Crude oil inventories in the Americas were revised upwards by 10.7 mb, with Canada accounting for 7.4 mb of the revision. OECD Europe crude stocks were adjusted upwards by 7.1 mb following receipt of more complete data.



Preliminary data imply that OECD total oil stocks drew counter-seasonally in August, declining by 21.8 mb compared to a five-year average 8.3 mb build. However, much of this draw was located in the US where Hurricane Isaac disrupted production and import operations at end-August. Crude oil holdings plummeted by 23.7 mb, with the US slumping by 16.5 mb while Japanese and European stocks declined by 3.3 mb and 3.9 mb, respectively. OECD total product holdings increased by 4.2 mb, driven by rises in 'other products' and middle distillates of 8.6 mb and 8.1 mb, respectively, which offset a 10 mb decrease in gasoline concentrated in the US.



Analysis of Recent OECD Industry Stock Changes

OECD Americas

Commercial oil inventories in OECD Americas rose by 9.5 mb in July after a 20.9 mb build in products outweighed an 11.3 mb drop in crude, NGL and feedstocks holdings. The steepest draw was reported in crude oil, stocks of which fell by a seasonal 6.8 mb, mostly in the US, after a 140 kb/d dip in imports combined with an uptick in refinery runs.

Total products remain close to the five-year average. 'Other products' inventories continued to lead product builds, rising by 11.8 mb on the month, a significantly steeper build than the 7.2 mb five-year average. As with the previous few months, these inventories have been lifted by stronger-than-seasonal restocking of propane in the US, linked to burgeoning domestic natural gas liquids supply. Elsewhere, middle distillates, which have been running below last year's levels due to growing exports to Latin America, built by a seasonal 8.5 mb as seasonally weak demand more than offset a dip in refinery output.



August preliminary data indicate that US total oil stocks slid further by a steep 13.6 mb, led by a 16.5 mb drop in crude oil. Hurricane Isaac, which disrupted operations in the Gulf Coast region during the last week of August, explains much of the draw. In addition to the closure of the Louisiana Offshore Oil Port (LOOP terminal) for three days, which restricted imports, a portion of regional liquids production was also shut in. PADD 3 crude stocks slumped by 7.1 mb during the week ending 31 August, a drop which might have been even greater had Hurricane Isaac not also idled 1.2 mb/d of regional refinery capacity.

After a slow start to the US driving season, gasoline stocks have been on a steady downward path since early-July.  Latest data indicate that they fell by 9.0 mb in August to end the month at 202.9 mb, 10 mb below a year-ago. Reports indicate that US consumers stocked up on gasoline ahead of Hurricane Isaac, with four-week average gasoline demand rising to 9.2 mb at end-August, its highest level in a year.  Reports also suggest that this tightness in supply is bringing in extra volumes from abroad, notably from Europe.

OECD Europe



OECD Europe commercial oil holdings drew by 2.3 mb in July after a 5.6 mb build in products failed to offset a significant 7.6 mb decline in crude oil. Total oil inventories continue to lag the five-year average, with the deficit widening to 55.2 mb, from 54.3 mb in June. Crude oil stocks fell after European refineries hiked production (+ 600 kb/d m-o-m) in response to reportedly the highest refinery margins since 2008. The heaviest draws were noted in France (-2.4 mb), the United Kingdom (-2.2 mb) and Germany (-1.5 mb) which offset rises elsewhere, notably Italy (+1.5 mb).

The rise in refinery output subsequently drove product stocks higher with increases in motor gasoline (+3.7 mb) and middle distillates (+2.1 mb) compensating for minor draws elsewhere. Motor gasoline holdings grew after a rise in France (+2.5 mb) and Germany (+1.3 mb). The build in middle distillates was led by Germany where inventories increased by 2.3 mb on the month, despite consumers' heating oil tanks reaching 56% of capacity, a climb of three percent over both the previous month and year-ago levels.

Preliminary data pertaining to products held in independent storage in Northwest Europe indicate that despite a monthly uptick, inventories still remained in deficit to the five-year average by end-August. Holdings grew after rises in gasoil and gasoline offset falls in naphtha fuel oil and jet kerosene. Data from Euroilstock for EU-15 and Norway signal that stocks fell by 5.6 mb in August led by a seasonal 3.9 mb drop in crude. Meanwhile, refined products drew by 1.6 mb following losses in motor gasoline (-1.3 mb) and fuel oil (-1.2 mb).

OECD Asia Oceania



Commercial oil inventories in OECD Asia Oceania (for now excluding Israel) built by 3.4 mb in July with a 6.4 mb rise in product holdings offsetting a combined 3.1 mb drop in crude, NGLs and feedstocks. Japanese crude stocks drew by 2.2 mb after a ramp-up in refinery inputs following second quarter maintenance, outpaced a 200 kb/d hike in crude imports. Regional refinery runs rose by 400 kb/d between June and July outpacing demand with the majority of products being placed in storage. All product categories showed builds during the month, with a notable 3.2 mb rise reported for middle distillates, mostly in Japan.

Weekly data reported by the Petroleum Association of Japan indicate that total industry holdings slumped below the five-year average drawing by 2.6 mb in August. Crude fell by 3.3 mb for the second consecutive as refineries ramped up further. However, this masked the volatility of crude stocks during the month after they initially inched up for the first three weeks of the month before plummeting by over 5 mb in the last week of August and the first week of September. In contrast, product inventories rose by 0.9 mb, as a 2.3 mb increase in kerosene holdings offset draws in naphtha and residual fuel oil of 1.4 mb and 0.5 mb, respectively.

Recent Developments in Singapore and China Stocks



According to China Oil, Gas and Petrochemicals (China OGP), Chinese commercial oil inventories fell by an equivalent 1.1 mb (data are reported in terms of percentage stock change), to 372 mb at end-July. Crude holdings rose by 7.1 mb as rising crude production and imports outpaced sluggish refinery runs. Products drew by 8.2 mb after refinery output failed to keep pace with demand. Gasoil stocks declined by a significant 6.1 mb while gasoline and kerosene fell by 1.0 mb and 1.1 mb, respectively.

Commercial oil inventories now stand approximately 21 mb higher than year ago levels. However, the implied Chinese total stock change (calculated as the difference between reported refinery runs, net imports and production data) for this period is 104 mb. Notwithstanding the likelihood that this also includes statistical difference and stock changes at 'teapot' refineries, the largest component of this is the filling of recently completed SPR capacity. Indeed, the gap still stands at 4 mb in July implying that SPR building has continued into early 3Q12.

Data from state trade agency, International Enterprise indicate that Singapore onshore product stocks slipped further below the five-year average decreasing by 2.8 mb to stand at 35.7 mb by end-August. Light distillates slid by 1.6 mb over the month but had fallen to three-year lows mid-month after strong gasoline demand from Malaysia and Indonesia combined with low imports of naphtha from Taiwan. However, inventories rebounded somewhat at end-August after exports to the Atlantic Basin dried up. Elsewhere, fuel oil drew by 1.9 mb while middle distillates rose by 0.6 mb.



Prices

Summary

  • Crude oil prices extended their earlier gains into August, but the rally ran out of steam in the second half of August and early September. On the ICE market, front-month Brent futures reached a high of $116.90/bbl on 16 August, then slid back and traded sideways. Light, sweet crude futures on the CME peaked slightly later at 97.26/bbl on 22 August, ending the first week of September at $96.42/bbl.
  • Product markets outperformed crude prices in August on very low product inventories across the OECD and concerns about refinery outages, including a deadly blast at Venezuela's giant Amuay refinery and precautionary plant shutdowns in a US Gulf Coast hit by the first major hurricane since 2008. Robust refining margins incentivised higher runs at operating refineries across the OECD, where refining throughputs surged in July and August.
  • Market activity on oil futures exchanges reversed the recent trend of slipping away from the New York CME and London ICE WTI contracts towards the ICE Brent futures contracts.  Data on open interest show the ratio of Brent futures on the London ICE to New York and London WTI oil positions declined more than 5.6 percentage points to 58.2% between 31 July and 4 September.
  • Tanker markets were sluggish in August on low demand and a glut of available vessels.  Clean tanker markets in the Atlantic Basin were a notable exception, as light product exports to the US recovered. Rates on the Middle East-Japan trade fell back in August from recent highs, following an increase in Japanese refinery runs.


Market Overview

Crude oil markets extended earlier gains into August, buoyed by very steep July and August increases in OECD refinery runs and unplanned outages in non-OPEC crude production. Thanks in part to that resurgence in refining activity, OECD crude inventories posted counter-seasonal draws in August, extending seasonal but steeper-than-usual draws in July. In late August, Hurricane Isaac disrupted crude production and imports in the US Gulf of Mexico, though the effect of that supply shortfall was partly offset by lower crude demand due to precautionary refinery shutdowns and run cuts. Lower exports of Iranian barrels since July may have been a contributing factor.

Yet despite resurgent refinery demand and continued supply concerns, the crude rally appeared to lose momentum in the second half of the month, with ICE Brent prices retreating after 16 August and CME light, sweet crude futures peaking about a week later amid market rumours of an imminent release of US strategic stocks.



In contrast, product prices, which rose along with crude early in the summer, proved more resilient and continued to rally even after crude price gains came to a halt. OECD product inventories had been on the low side, depleted by months of subdued refining output and plant closures in the OECD, especially for key products such as middle distillates. A string of summer refinery outages, including, but not limited to, a deadly blast at Venezuela's giant Amuay refinery and a fire at a large US West Coast refinery, further supported prices in August, as did short-lived but large-scale hurricane-related plant shutdowns in the US Gulf towards the end of the month.



Exceptionally tight product markets resulted in strong product crack spreads, providing refiners with an incentive to raise their output. Spurred by that resurgence in margins, OECD refiners dramatically increased their throughputs in July and August. The transatlantic arbitrage window reopened for gasoline and later on even for ultra-low sulphur diesel to the US. US RBOB crack spreads, having surged in late August on hurricane news, subsequently retraced some of their gains, though distillate cracks remained well supported.

Meanwhile, money managers raised their net long positions in CME light, sweet crude futures and in ICE Brent futures to their highest level since last May, spurred in part by expectations of fresh economic stimulus and geopolitical concerns.

Futures Markets

Activity Levels

Market activity on oil futures exchanges reversed the recent trend of slipping away from the New York CME and London ICE WTI contracts towards the ICE Brent futures contracts.  Data on open interest show the ratio of Brent futures on the London ICE to New York and London WTI oil positions declined more than 5.6 percentage points to 58.2% between 31 July and 4 September, driven by increases of 9.75% and 9% in CME and ICE WTI open interest, respectively. Stripping out ICE WTI contracts, the ratio of Brent to WTI open interest fell even faster, by 7.5 percentage points to 76.5%. In contrast, trade volumes followed a different path. Total trade volumes in CME WTI contracts fell 32% in August 2012 y-o-y and by 19.8% year-to-date, to 11.7 million and 98.7 million contracts, respectively. In contrast, Brent monthly volume inched up by 3% to 12.6 million contracts last month from 12.3 million in August 2011. Year-to-date Brent volume jumped by 17% to 101.5 million contracts, exceeding the volume in CME WTI by more than 2.8 million contracts.

Open interest increased in August in both CME and ICE WTI oil contracts but declined in ICE Brent contracts. At CME, combined open interest in WTI futures and options increased by 7.67% to 2.5 million, while open interest in futures-only contracts increased by 9.75% to 1.53 million, the highest level since May 2012. Over the same period, open interest at the London ICE rose to 0.48 million for WTI futures-only contracts and by 10.5% in futures and options, to 0.59 million contracts. Meanwhile, open interest in ICE Brent futures inched down  by 0.06% to 1.17 million contracts, while ICE Brent futures and options increased by 4.7% to 1.5 million contracts from 31 July to 4 September 2012.





Against the backdrop of weak global economic activity, investor expectations of new stimulus measures and the perception of increased possibility of war in the Middle East seem to be the driving force behind the bullish market sentiment.

Economic indicators were downbeat in August and early September, including steeper-than-expected manufacturing contraction in the US and euro area and yet another weak Chinese OPMI index reading. Seeking to back up his July pledge to do "whatever it takes" to preserve the euro, ECB President Mario Draghi announced on 6 September that the ECB Governing Council had agreed to a fully sterilised sovereign bond-buying program, allowing the ECB to buy an unlimited amount of eurozone government debt with maturities of one to three years, provided that governments agree to certain conditions.

Across the Atlantic, Fed Chairman Ben Bernanke lifted expectations of new stimulus measures in his speech at the Fed's annual conference in Jackson Hole, Wyoming. Stopping short from committing to any specific move, Bernanke unambiguously signalled that the Federal Reserve would do more to address the weakness in the US economy. Following a disappointing US jobs market report for August, economists are increasingly convinced that the Federal Reserve will unveil a new set of stimulus measures as early as its 12-13 September meeting, including possibly an extension of its commitment to zero rates into 2015 or a third round of bond purchases meant to lower long-term interest rates and encourage more borrowing and spending.

Reflecting heightened expectations of fresh stimulus  measures and higher oil prices, money managers raised their net long positions in CME WTI futures contracts by close to 48% between 31 July and 4 September 2012 to 177 037 contracts, the highest level since May 2012. Money managers in London ICE Brent contracts followed a similar pattern and boosted their bullish wagers, reaching the highest level since 1 May 2012, at 94 723.





Producers accounted for 20.1% of the short positions and 17.4% of the long positions in CME WTI futures-only contracts at end-August, reducing their net short positions by 14.5% to 41 115 contracts. Swap dealers, who accounted for 25.2% and 38.8% of the open interest on the long side and short side, respectively, increased their bets on falling prices by 60% to 208 137, the largest net futures short positions ever recorded. Producers' and swap dealers' trading activity in the London ICE Brent contracts followed an opposite pattern from CME WTI contracts. Producers in London ICE Brent contracts reduced their net short positions from 175 610 to 153 302 contracts. Similarly, swap dealers reduced their net long positions from 97 219 to 80 345 contracts.

NYMEX RBOB futures and combined open interest increased by more than 15% to 284 399 and 302 817, respectively, over the same period. Open interest in NYMEX heating oil futures contracts was up by 9.3% to 331 284 contracts while open interest in natural gas futures market declined by 2.2% to 1.1 million contracts.

Index investors' long exposure in commodities in July 2012 decreased by $3.1 billion to $281 billion, after edging up by $14.2 billion in June. The notional value of long exposures in both on- and off-WTI Light Sweet Crude Oil futures contracts declined by $1.3 billion in July. The number of long futures equivalent contracts decreased by 31 000 to 523 000, equivalent to $46.4 billion in notional value.

Market Regulation

The US CFTC published its final rule on the definition and interpretation of swaps in the Federal Register on 13 August 2012. The rule will become effective on 12 October 2012, which will also trigger the compliance dates for several other Commission rules, including swap dealers' (SD) and major swap participants' (MSP) registration, SD and MSP swap data reporting and record-keeping, real time reporting of swap transaction and pricing data, internal and external business conduct standards, and position limits.

On 16 August, the US CFTC approved a proposed rule, which will exempt swaps between certain affiliated entities within a corporate group from the clearing requirement if certain conditions are satisfied, while still requiring variation margin for inter-affiliate swaps. The proposed exemption would be limited to (a) swaps between majority-owned affiliates whose financial statements are reported on a consolidated basis (b) swaps between U.S. affiliates, and swaps between a U.S. affiliate and a foreign affiliate located in a jurisdiction with a comparable and comprehensive clearing regime or the non-United States counterparty is otherwise required to clear the swaps it enters into with third parties in compliance with United States law or does not enter into swaps with third parties. Additionally, the proposed rules would require centralized risk management, documentation of the swap agreement, variation margin payments (for financial entities), and satisfaction of reporting requirements.

The comments period for the proposed US CFTC's interpretive guidance, issued on 29 June, on the extraterritorial application of US derivatives regulations ended on 27 August 2012. European and Asian regulators and other market participants raised concerns about the unintended consequences of cross-border application of swaps rules, including potential market disruption or fragmentation resulting in increased systemic risks and reduced market liquidity. The problem of non-US nationals facing compliance and registration requirements with overlapping and sometimes conflicting regulations in the US and their home country was also brought up.

On 10 September, the US CFTC issued a guidance document to clarify the timing of registration requirements for swap dealers. The swap dealer registration rule will take effect on 12 October. Under the current rule, derivatives traders will have 60 days to register as a swap dealer starting from the end of the month in which they hit the $8 billion swap transactions threshold set by the US CFTC for the interim period, implying that earliest registration deadline will be January 2013. Entities, which will hit the threshold level later than October, will have more time to register as a swap dealer.

The European Parliament's Economic and Monetary Affairs Committee (ECON) is expected to finalise and vote its version of Markets in Financial Instruments Directive (MiFID) II in September. ECON is expected to have two meetings on 10 and 13 September, followed by a final vote on 26 September. The vote was delayed in July due to contentious issues such as the creation of organised trading facility, pre-trade transparency waivers, measures to limit high-frequency trading and position limits on commodities trading.

On 4 September, Intercontinental Exchange (ICE) announced that it plans to transition all existing over-the-counter (OTC) cleared energy swaps and option products to economically equivalent future and option products on 15 October, earlier than the initially announced date of January 2013, due to strong customer demand. ICE's switch date now corresponds to the compliance dates for several new swaps rules and thereby reduces their clients' exposure to compliance costs associated with the new rules imposed on swap transactions.

Forecasting Price on Opaque Oil Markets

The summer of 2008 saw a spike in crude oil prices to $147/bbl, followed by a steep correction in late 2008/early-2009.  A subsequent rebound over the last three years has brought the question of whether it is possible to accurately forecast prices over the medium and longer term.

Making reliable forecasts of oil prices has been of interest to a wide range of economic agents, including policymakers, oil producers and consumers as well as other market participants. However, in a rapidly changing oil market, any forecast of oil prices, especially at longer horizons, is highly uncertain, a fact illustrated by the wide confidence bands around price predictions. Research shows that forecasts based on futures prices, surveys of analyst forecasts, forecasts based on a variety of simple time series regressions and other common forecasting techniques are generally inferior to the random-walk forecast, which implies that the best forecast of crude oil spot prices is simply the current price of oil. Some models improve short-term forecasts up to a year; however, at longer horizons a random walk forecast outperforms all models with the exception of forecasts based on expected inflation due to the large inflation component in the nominal price of oil at longer horizons (See, e.g., Kilian and Baumeister (2012) and Kilian, Alquist and Vigfusson (2012)).

Apart from these simple forecasting techniques, recent research based on more sophisticated VAR-based models showed substantial improvement in short term price forecasting up to a year, and even longer horizon improvement in directional accuracy. These models, using percent change in global oil production, oil price, real global activity and global inventories as their main variables, can be used to not only measure the impact of demand and supply shocks on the price of oil but also to generate projections conditional on different economic scenarios. Although promising, these models also suffer from two distinct limitations. Firstly, they only allow for temporary shocks to global oil supply, such as a disruption in Iranian production, as opposed to a persistent decline in oil supply growth driven by resource constraints, such as finite oil reserves. Secondly, and more importantly, key macroeconomic as well as oil market-specific variables that are the subject of forecasts are not available to the forecaster in real time. Most data are available with a time delay. Furthermore, preliminary data tend to be revised over time. As a result, forecast accuracy is done using ex-post revised data. Therefore, it is not possible to measure the accuracy of forecasts, as opposed to forecasts based on more easily observed futures prices or expected inflation.

Future of Oil Price Forecasting

Recent advances in VAR-based modelling and forecasting are very promising. However, the success of these models relies on timely and accurate data on oil market as well as on other macroeconomic indicators. There is an urgent and growing need for more and better data on oil reserves, production, consumption, refining, exports, imports, inventories from both OECD and, particularly, from non-OECD countries, including data on floating storage and storage costs to fully understand oil price dynamics.

Furthermore, models should be augmented to capture the feedback effects of futures prices on producers' and consumers' activities. Recent research using state-of-the-art econometrics finds no systematic, deleterious causality running from so-called 'speculative' activity to prices. However, this research fails to measure the impact of activities of financial players on the formation of expectations by physical market players.  At the same time, data limitations are not limited to physical oil markets. Energy derivatives markets are also partially opaque. Therefore, transparency in both the physical and financial markets is essential to better understand possible linkages between the two markets, as well as price dynamics in oil markets more generally.

Spot Crude Oil Prices

Physical crude markets extended their late June and July gains in the first half of August and into the second half, but with few exceptions the rally then seemed to mark a pause. Spot crude price movements mimicked and amplified those in futures markets. On the ICE market, front-month Brent futures appeared to cap a six-week rally around mid-month, reaching a high of $116.90/bbl on 16 August, then slid back to a low of $112.26/bbl on 27 August and ended the first week of September roughly half way between those two points. Light, sweet crude futures on the CME peaked slightly later on 22 August, when the front-month contract reached 97.26/bbl, then fell in the last week of August to a daily low of $94.62/bbl and traded sideways, ending the first week of September at $96.42/bbl.



Spot crude prices followed a similar path, but posted by and large stronger gains in the first three weeks of August than benchmark futures, only to fall back more steeply in late August and early September. Prices in Asia were particularly robust in the first part of August: average weekly prices for Brent in Asia and Dated Tapis rose by roughly $5/bbl between the first and the third week of August, significantly more than gains of $3.38/bbl and $2.40/bbl for CME light, sweet crude and ICE Brent, respectively. By the first week of September, however, both Brent in Asia and Dated Tapis had given up more of their gains than futures benchmark, shedding roughly $1.50/bbl from the third week of August, compared to drops of 81 cents and 21 cents for CME light, sweet crude and ICE Brent, respectively. Similarly, North Sea Dated, after rising by nearly $3.60/bbl between the first and the third week of August, gave back half of those gains by the first week of September.



Spot crude price movements did not closely track shifts in measured crude oil inventories. Hurricane Isaac in the US Gulf of Mexico provided North American spot prices with some price support. Not surprisingly, coastal US grades led the region's gains: on average, Light Louisiana Sweet prices gained $8.22/bbl, or nearly 8%, in August versus July, while Poseidon gained $9.19/bbl (or 9.4%) and Mars $8.54/bbl (8.7%). In contrast, grades in markets spared by the hurricane posted more modest advances: WTI at Cushing gained only $6.22/bbl, Alaskan North Slope $7.14/bbl, Californian Kern River $6.70/bbl and Mexican Maya $6.72/bbl. Steep draws in US crude inventories led a counter-seasonal decline in OECD oil stocks in August: US crude stocks declined by an estimated 16.5 mb for the month, compared to 23.7 mb for OECD oil stocks as a whole.

Yet oil prices in August gained less in North America than in other markets. Hurricane effects on crude markets tend to be a wash: weather events rarely disrupt field crude production without also curtailing regional refinery demand. Isaac was no exception: precautionary shutdowns and reduced runs at refineries on the hurricane's onshore path helped blunt the impact on crude supply from the evacuation of offshore platforms.  In contrast, planned and unplanned summer outages in North Sea production helped lift prices for North Sea crudes by more than $10/bbl in August.  Several West African grades showed even steeper gains of more then $11/bbl, despite a substantial ramp-up in production. Prices for Urals in both Northwest Europe and the Mediterranean, as well as other Mediterranean grades including Es Sider, Suez Blend and Saharan Blend, also posted steep gains in August, with the latter three each gaining more than $11/bbl.

Reduced exports from Iran may have been a factor behind the strength in Mediterranean, North Sea and West African prices in August. In terms of magnitude, the loss of Iranian export barrels since international sanctions were tightened in July dwarfs the deep yet relatively short-lived effect of Hurricane Isaac. That loss is most directly felt in Europe and Asia, traditionally the main export outlets for Iranian crude. In North America, a market long closed to Iranian crude, the effects of reduced Iranian exports are indirectly felt.



Perhaps not surprisingly, Middle East benchmark Dubai posted one of the strongest performances of all crude grades in August and into early September. Whereas most other major crude gains saw the August price rally fizzle out in the last week of the month and bounced back only marginally in the first week of September, Dubai prices remained relatively firm. Dubai crude gained $5.63/bbl from the first week of August to the third, more than most other grades. Yet while spot crude markets subsequently fell back across the board, Dubai bucked the trend and inched up marginally in late August and early September, extending earlier gains.

Spot Product Prices

While the crude oil rally, which started in late June, appeared to lose steam in the second half of August, the rally in product prices proved more resilient throughout August and into early September, buoyed as it was by refinery outages in the Americas and Asia and robust global demand for middle distillates. Broadly speaking, product markets, especially for middle distillates, have been far tighter than crude markets. In US futures markets, CME RBOB found stronger support from Hurricane Isaac than crude futures. Prices rallied until end-August, falling back only in early September. Heating oil futures rose more slowly than RBOB futures in the second half or August, following steep gains in the first half, but subsequently held their ground, and by early September showed stronger month-on-month gains than did RBOB prices. In spot markets from the US Gulf Coast to Northwest Europe, the Mediterranean and Singapore, gasoline and naphtha prices posted some of the strongest gains of the product complex in August compared to July. In all markets, Ultra-Low Sulphur Diesel (0.05% gasoil in Asia) remained the highest-priced product, however, with the exception of the US where super unleaded gasoline traded at a premium, albeit a narrowing one.

In August, strength in naphtha markets continued from July, on firm demand from petrochemical producers and a sharp increase in the price of propane, the alternative feedstock. Gasoline and diesel crack spreads rose in both Singapore and the US Gulf coast due to unexpected refinery outages and Hurricane Isaac at the end of the month. However, in Europe gasoline and diesel margins remained lukewarm (with the gasoline crack edging up and the diesel crack falling).  Not only were those markets less directly affected by Hurricane Isaac and refinery outages, but margins there were also adversely affected by gains in Brent and Urals prices. Meanwhile, fuel oil markets weakened, mostly on plentiful supply.

Naphtha margins rose by $1.41-1.43/bbl in Europe and by $2.41/bbl in Asia. Naphtha demand from petrochemical companies remained firm, notably in Korea. In Europe, the price of alternative feedstock propane rose steeply, overtaking that of naphtha for the first time since March, thus boosting demand for naphtha from the petrochemical sector. Firm gasoline demand also supported price for naphtha, which can be reformed into gasoline or used as gasoline blending stock. Moreover, naphtha stocks in the ARA region fell by more than 460 kb during the month of August.



Gasoline margins edged up by $0.26/bbl to Brent in Northwest Europe and by $0.30/bbl to Urals in the Mediterranean. Even stronger were the gasoline crack spreads in Singapore and the US Gulf, increasing by $4.56/bbl to Dubai and $4.90/bbl to LLS, respectively.

Seasonal driving demand continued in the US and drew gasoline stocks by some 9.0 mb in August. In Asia, demand for gasoline increased in Malaysia and Indonesia during Eid al-Fitr, the culmination of the month-long Muslim fasting holiday of Ramadan. Moreover, the abrupt shutdown of the Dung Quat plant, the only refinery in Vietnam, and an outage at Chevron's Richmond refinery, California's second-largest, boosted market sentiment.

Approaching the end of the month, as Hurricane Isaac swept through the US Gulf coast, the price of gasoline in the region skyrocketed for a few days, also leading the increases in gasoline prices in other regions partly. Almost at the same time, news of a deadly blast at the Amuay refinery in Venezuela also supported gasoline crack spreads, though PdV claimed that its exports of refined products remained unaffected.

Diesel margins were a mixed bag. They fell by $0.82-0.86/bbl in Europe but rose by $1.91/bbl in Asia and $2.79/bbl in the US Gulf coast. Yet market sentiment remained relatively bullish, even in Europe, where the decline in diesel cracks stemmed both from Brent and Urals price gains and from a strong supply response.  European refiners ramped up diesel production to meet demand, and diesel imports from the Baltic port of Primorsk also weighed on prices.



Refinery outages in Asian countries such as India, Japan and Vietnam tightened gasoil supplies in the region. India in particular steeply increased its imports for off-grid power generation after huge blackouts earlier in the summer. Indonesian and Pakistani high-sulphur gasoil consumption also rose. In the US Gulf, low inventory levels supported prices. For the whole month of August, middle distillate stocks have been below their five-year range. The temporary shutdown of Pemex's Cadereyta refinery also boosted diesel margins.



Fuel oil markets weakened in all regions, with HSFO discounts to crude widening in Europe and Singapore. Week Chinese demand for straight-run fuel oil and abundant bunker fuel supply weighed on the fuel oil market, reportedly leading straight-run fuel oil supply in China to be diverted to the Singapore bunker fuel market.



LSWR cracked fuel price differentials in Singapore decreased $1.83/bbl while LSFO discounts to Brent widened to $5.25/bbl in Northwest Europe and to $4.64/bbl to Urals in the Mediterranean. Although demand for power generation was firm, exports from South Korea and south Asian producers were plentiful. Moreover, with Japan's stocks now more comfortable than in 1H12, demand for LSFO became lacklustre. In the meantime, the abrupt shutdown of Amuay refinery, a major source of fuel oil shipments to Asia-Pacific, did not seem to impact on the price of fuel oil.

Freight

Crude tanker rates weakened or at best remained flat in August as the traditional third quarter malaise in line with decreasing oil on the water took hold of markets. When an 8% month-on-month increase in the cost of bunker fuels is factored in, however, time-charter equivalent earnings (TCE's) slumped to finish the month in negative territory. Rates on the VLCC Middle East Gulf - Asia trade remained anchored below $9/mt for most of the month, resulting in the lowest TCE's in more than a decade.



Suezmax markets fared little better. Even with a reasonable amount of activity the benchmark West Africa - US Gulf Coast route traded flat at under $13/mt throughout the month. Despite a three-day closure of the US Gulf Coast LOOP terminal at end-month due to Hurricane Isaac, no upward momentum was reported on trades into the region, again underscoring the bloated nature of the tanker pool. Northwest European Aframax markets were similarly depressed. Production outages in the North Sea reduced the amount of available cargoes and even an uptick in Russian volumes coming out of the Baltic was not enough to create forward momentum.

Clean product tanker markets in the Atlantic Basin have recently been a bright spot in a generally depressed freight market, performing significantly better than those East of Suez. Previously outperforming all other routes due to wide gasoline arbitrage to the US, between end-May and mid-July the transatlantic UK - US Atlantic Coast rate had steadily declined from $23/mt to a low point of below $14/mt after opportunities to move product dried up. Over the past six weeks, however, the rate has rebounded as the US driving season has belatedly taken off, with rates peaking at over $20/mt in the third week of August, largely on fears that Hurricane Isaac could disrupt domestic US gasoline supply. Meanwhile, following steady firming since May, rates on the Middle East Gulf - Japan trade have recently slumped to approximately $27/mt from a high of nearly $30/mt a month earlier. This softening likely resulted from waning Japanese demand for imports after refineries there ramped up following maintenance.

Refining

Summary

  • Exceptionally strong OECD runs in July and August lifted global crude oil refinery throughput estimates for 3Q12 by 210 kb/d since last month's report. Global runs are now seen at 75.7 mb/d, up 450 kb/d from a year earlier and 1.3 mb/d above the 2Q seasonal low, as gains in the OECD offset a lower outlook for the non-OECD. Runs in 4Q12 are likely to be sustained at 3Q12 levels, as an expected rebound in China, Africa and the Middle East compounds the impact of further growth in 'Other Asia' to lift annual growth to 1.3 mb/d.
  • OECD crude runs surged more than 1 mb/d in July, as tightening global product markets led to much improved refinery margins. European runs rose by 0.6 mb/d on the month despite the region's continued demand contractions and recent refinery rationalisations. While US refinery intake plunged in the last week of August, as Hurricane Isaac hit the US Gulf Coast, plants sustained minimal damage and most were restarted quickly. OECD runs averaged 38.2 mb/d in the month, but are seen declining through October as maintenance picks up.
  • Gasoil markets are seen as particularly tight ahead of the northern hemisphere winter, with product inventories low in all key consuming markets. Atlantic Basin gasoline supplies were also significantly curtailed at end-August, with Hurricane Isaac reducing US Gulf Coast runs and Latin American runs crimped by a deadly refinery fire in Venezuela. European gasoline stocks built up in July, however, providing additional supplies available for transatlantic shipment.
  • Refinery margins generally improved through August, with European and US Gulf Coast indicator margins rising sharply, while US Midcontinent and Singapore margins fell back from end-July levels. On balance, our new global indicator margins, developed with the help of KBC Advanced Technologies, show a significant improvement in global margins since mid-May, to near-four-year highs in June, as product markets tightened relative to crude. Hurricane Isaac and the deadly explosion at Venezuela's Amuay refinery provided support at end-August.


Global Refinery Overview

Despite a sharp seasonal uptick in global refinery crude demand, reductions in baseline OECD refining capacity have helped global product markets tighten, leading to improved product cracks and refinery margins in most key consumer product markets. Preliminary data show global crude runs rising 1 mb/d in June and another 1 mb/d in July, as maintenance wound down in most refining centres and companies took advantage of better margins. The steep increase in OECD runs in July exceeded expectations, given continued weakness in demand and recent capacity rationalisation. While refinery shutdowns in the last few years have not fully eliminated overcapacity in mature markets, strong margins provided refiners with an incentive to rebuild depleted product inventories and take advantage of strong export demand.

Non-OECD throughputs saw smaller increases month-on-month than those in the OECD, but continue to provide the lion's share of annual growth. In 2Q12, non-OECD, led by Other Asia, provided two-thirds of global increases. Looking forward, the non-OECD region accounts for virtually all projected growth. In addition to continued growth in Other Asian refinery throughputs, an expected rebound in Chinese demand and refinery runs, as well as increased runs in Africa and the Middle East, lift non-OECD runs by 600 kb/d and 1.3 mb/d over year-earlier levels for 3Q12 and 4Q12, respectively. OECD runs stagnate or even contract further in the same timeframe.



In August, product markets were buoyed by Hurricane Isaac in the US Gulf Coast and a deadly refinery accident in Venezuela. Both events took out significant refining capacity and further tightened Atlantic Basin product supplies -particularly gasoline. Globally, diesel markets remain tight ahead of the northern hemisphere winter. Margins have for now improved to a point where refiners are responding to market signals and raising runs as a result.



Refinery Margins are Back

After a two-month hiatus, this month's Oil Market Report resumes our coverage and estimations of refinery margins. With the help of KBC Advanced Technologies (KBC), we have developed a new set of global indicator refinery margins for primary refined product markets in Northwest Europe, the Mediterranean, the US Gulf Coast and Midcontinent as well as Singapore. These refinery margins include refinery fuel (energy cost), but exclude other variable costs, depreciation and amortisation as explained below.

The resumption of our refinery margin analysis occurs at a time when refining margins themselves are staging a come-back. Margins in Europe have recorded near four-year highs in June and later again in August, while US margins spiked on hurricane shutdowns and outages in late August. Even Singapore indicator margins have improved on recent distillate tightness in Asian markets.

Refinery Yields:

The new refinery margins are based on refinery yields derived from KBC's Petro-SIM simulation, which is a non-linear refinery simulation software. The software includes robust unit-specific models, simulating major refinery process units. Standard calibrations of individual process units enable the production of generic refinery simulations of any configuration and generate, on an optimised basis, blended refinery yields and energy consumption data for any mix of available crudes and refinery feedstocks.

Refinery yields have been prepared for 23 separate cases on a barrel/barrel volumetric basis (volume percent product yield based on volumetric intake of one barrel of indicator crude oil). Exceptions are that petroleum coke is reported on a specific mass basis and the intake of natural gas, which is used in US refineries, is specified on a specific energetic basis. These yields are used to calculate margins using standard product pricing bases. A summary of the results is available to subscribers on our website.

The yields assumed in these indicator cases may not be fully representative of those at modern refineries, however. Constraints imposed by a simplified crude slate, a lack of available feedstocks/blendstocks and a simplified product slate lead to indicative yields that might not fully reflect the economics of a well optimised complex refinery in today's market environment. In some cases, given the constraints of producing simplified 'indicator' margins on the basis of a single crude oil assay without the availability of purchased feedstocks, some product specifications have had to be loosened to enable the model to solve.

Regional differences:

Operating principles and practices vary by region. Within a given continent, they are assumed to be the same. Middle distillate yields are maximised in Europe and Singapore, while US refiners have historically maximised gasoline. This is reflected in the cut-point settings. The CDU and HC kerosene/diesel cut-point is higher in the Singapore cases to further maximise kerosene.

  • European refinery cases are prepared on a distillate-maximising basis. Yields are set to minimise gasoline production and produce the widest cut of distillates without producing fuel oil uneconomically. Gasoline produced in the European cases meets EuroBOB standards (European blendstock for oxygenate blending). The model assumes 7% volumetric blend of ethanol to produce the current European grade of finished gasoline in compliance with EN228. The calculation will be adjusted as EU member states move towards an EU-wide 10% energetic requirement by 2020. Diesel produced in the European cases conforms to EN590 ultra-low-sulphur diesel, with a specific gravity target of 0.842, which will accommodate post refinery blending of FAME biodiesel. Biofuel blending for distillates is an increasing requirement of the EU pool. However, finished diesel can be blended by either the refinery or marketer. This varies from country to country. These yields assume that the refiner will only receive the margin for producing the conventional fossil distillate. Fuel oil produced for sale generally conforms to international bunker fuel oil quality for low or high sulphur fuel oil. Refinery fuel in Europe is refinery fuel gas topped up with refinery fuel oil. With natural gas generally priced on a fuel oil equivalent basis, margins would be similar whether fuel oil or natural gas is burned as refinery fuel.
  • All US cases blend to standard US product specifications; no export quality products are assumed. US gasoline is blended to an RBOB specification that will yield finished gasoline when blended to 10% ethanol. The base RBOB conforms with US specifications and is blended to a road octane of 83.7 (R+M)/2 basis. The model does not take account of blending ethanol and thus the gasoline should be valued as RBOB rather than finished motor gasoline. US diesel is blended to a conventional ultra-low sulphur No. 2 fuel oil product meeting the standard US on-road diesel specification. Biodiesel blending in the US is assumed to be an additive to the conventional blend in this refinery model and is blended after it is sold from the refinery. Hence, no specific effort is made to incorporate biodiesel in the model cases for US diesel blending. At present, US biodiesel blending is 1-2% in most markets. As in other cases, fuel oil production meets international bunker fuel standards for LSFO and HSFO. All US cases assume the use of purchased natural gas as an energy source after refinery-generated fuel gas. This boosts the refinery's net product yields by around 2% relative to other regions.
  • Singapore refinery cases are prepared on a distillate maximising basis, with an emphasis on marginal kerosene, which is a high value product in the Singapore market. They produce a naphtha yield of five weight percent on crude oil, conforming to a volume yield of 6-6.5% depending on the crude oil used. Gasoline is produced to a 95-research octane (RON), 10 ppm sulphur content and is assumed to be 100% conventional with no biofuel blending. Diesel is produced to a ULSD equivalent with 10 ppm sulphur, a cetane number of 51 and a maximum specific gravity of 0.845, with no accommodation made for FAME biodiesel blending. As in the other regions, fuel oil produced for sale generally conforms to international bunker fuel oil quality for LSFO and HSFO. Refinery fuel is refinery fuel gas and fuel oil.

Operating costs:

Operating costs are highly dependent on a number of key parameters, including size and complexity of the refinery, utilisation rates, local wage expectations for refinery workers, employment and environmental regulations. Different countries/regions thus have a wide variation in operating expenditures (Opex), which has a direct impact on refinery net cash margins. Operating costs vary with refinery throughput, as some components of costs are fixed (such as labour, insurance) while other vary with throughput (such as catalyst and chemical consumption). Thus low throughputs on economic and maintenance bases can lead to higher per barrel Opex. A further difficulty with refinery operating cost information is that it is not necessarily reported on a common basis, possibly including or excluding energy costs, financing costs, maintenance costs, depreciation etc.

Operating cost indications are usually considered commercially sensitive information, though it is often possible to glean this information from public companies, and especially from pure-play independent refining companies, since their financial reporting tends to give more detailed information about their refinery sector operations. From these types of reports, we assume typical operating costs for the margin cases as follow:

Indicative Refining Operating Cost (Opex), excluding energy, depreciation and amortisation

  • US Gulf Coast and US Midcontinent $3.30/bbl
  • Northwest Europe and Mediterranean $4/bbl
  • Singapore $3/bbl
  • Opex here excludes energy cost, which is accounted for in the refining margins, and depreciation and amortisation, which will vary widely with refinery configuration, age and local accounting/tax requirements.

For more information regarding the model, yields and assumptions please see a more detailed document available on our website at http://www.oilmarketreport.org/refinerysp.asp



OECD Refinery Throughput

OECD refinery throughputs were much stronger than anticipated in July, surging more than 1 mb/d in total, as refinery margins improved and maintenance wound down to seasonal lows. Increases in European throughputs were particularly strong, both on a monthly and annual basis, especially in view of continued sharp regional demand contractions and recent capacity rationalisation. By tightening product supply in the Atlantic Basin, however, the latter helped regional refinery margins surge from mid-May to June, when they reached highs unseen since 2008. Japanese refinery runs also rebounded in July from their June seasonal low-point as some refiners returned from maintenance. North American runs in the meantime were largely unchanged both on an annual and yearly basis.

OECD Americas refinery runs were roughly flat m-o-m in July, in line with preliminary data and estimates. Regional runs averaged 18.8 mb/d, slightly below year earlier levels, when Hovensa's 350 kb/d St. Croix refinery was still in operations. US refiners maintained relatively high utilisation rates through July, averaging more than 88% of capacity, on healthy margins and robust export demand. US product exports in June totalled some 3.2 mb/d, of which 31% went to Latin America, 14% to Mexico, 14% to Canada and 21% to Europe. Canadian refinery throughputs also rebounded in July, to its highest level since February, as Imperial's Edmonton refinery completed maintenance and possibly on higher domestic oil sands production. Preliminary weekly data indicate Canadian runs rose further in August.



US refinery crude intake remained high through August, until the season's first major hurricane, Hurricane Isaac, caused US Gulf Coast runs to plummet in the last week of the month. As a result, US refinery runs were adjusted downward by 185 kb/d since last month's report, to 15.3 mb/d. At the storm's peak, 1.2 mb/d of refinery capacity was shut, with the precautionary closure of five refineries. Another six refineries in the storm's path reduced runs, cutting Gulf Coast runs by almost 700 kb/d in total for the week ending 31 August. That left total US crude intake at 14.6 mb/d, some 770 kb/d below a week earlier and 1.2 mb/d below the July peak. By early September, most refineries were restarting operations, with only Phillips 66's 247 kb/d Alliance refinery still shut due to flooding and a power loss.



Refinery runs on the US West Coast also fell during August, in part due to a fire and subsequent shutdown at Chevron's Richmond refinery in California. The plant's only crude unit was damaged in a fire in early August. The repairs could take months to complete according to industry experts. In the meantime, all other units at the refinery continue to operate, producing gasoline, diesel and jet fuel at reduced rates. Margins on the West Coast were also supported by an outage at Valero's Benicia refinery in California.

On the East Coast, throughputs were expected to rebound in late September. Regional runs had fallen to around 1 mb/d since the end of last year from 1.3 mb/d during the summer of 2011. The 185 kb/d Trainer refinery in Pennsylvania, which Delta Airlines bought from Phillips 66, was in the process of restarting in early September. The new owners announced they would produce jet fuel at full capacity by the end of the month. The plant had been closed since September 2011, but is finishing a complete turnaround. Delta is reportedly looking to source Bakken crude for its new plant, as a lower-cost alternative to its previous North Sea and African diet. The refinery would bring in the crude by rail. Other refineries in the region have been betting on cheaper US crude supplies. PBF Energy recently announced it was expanding rail facilities to bring in US crudes to its 190 kb/d Delaware City refinery.

OECD European refinery throughputs surged almost 0.6 mb/d in July, to their highest level in 20 months, to 12.7 mb/d. Crude intake in Spain rose 180 kb/d, while France, Germany and Italy also recorded gains of around 150 kb/d each. Preliminary data show no decline in UK runs despite the shutdown of the 220 kb/d Coryton plant in early June. The UK administrator of bankrupt Petroplus sold the plant to a joint venture (JV) including Dutch storage firm Vopak, Shell and UK fuel supplier Greenergy, which will convert the site to a product terminal. Compounded by upwardly revised June estimates, July data were some 400 kb/d above our previous expectations.



The surge in runs in July comes after margins in both Northwest Europe and the Mediterranean rose by an average $3.9/bbl in June. Margins eased somewhat in July, but remained relatively high, and were again boosted in the second half of August, on both refinery outages in the US and Venezuela and ahead of September plant maintenance in Europe and Russia. Product cracks for both gasoline and diesel led the improvement in margins, as earlier inventory drawdowns tightened Atlantic Basin product markets. Inventory building and improved export demand provided support, as year-on-year regional demand growth remained negative. European demand has contracted annually by nearly 0.5 mb/d so far this year, and the near-term outlook remains weak.

European refinery closures completed or announced since the start of the economic downturn in 2008 now amount to 1.6 mb/d of aggregate capacity, including 530 kb/d in 2011 and 345 kb/d so far this year. Another 150 kb/d will be shed in the fourth quarter with the shutdown of ERG's Rome refinery and as Exxon reduce capacity at its Fawley plant in the UK later this year.

OECD Asia Oceania throughputs surged 420 kb/d in July, led by the return of Japanese refiners from maintenance. Japanese crude oil intake rose 360 kb/d from a month earlier, while other Asian countries inched marginally higher. South Korean operators sustained runs above 2.6 mb/d, representing a 96% utilisation rate, the highest in the OECD. Korean refiners exported 1.2 mb/d of oil products in July, of which 42% was diesel and another 21% jet fuel. According to weekly data from the Petroleum Association of Japan, Japanese crude runs rose another 100 kb/d in August. A powerful typhoon hit the Japanese island of Okinawa in late August, when Japanese refiner Nansei Sekiyu shut its 100 kb/d Nishihara refinery for a week. The plant resumed operations on 31 August.



Also in Japan, Cosmo Oil announced in late August that it will permanently shut its 140 kb/d Sakaide refinery in July 2013. The company said it would probably have to further cut capacity to comply with regulations requiring companies to either reduce distillation capacity or upgrade its units to boost clean-product yields by 2014. Japan has so far committed to shut 830 kb/d of capacity since early 2008, of which about 50% has been completed, as domestic demand is in structural decline (down 0.9 mb/d from 2005 to 2011).

Non-OECD Refinery Throughput

Non-OECD throughput estimates are largely unchanged for 2Q12 since last month's report, averaging 37.7 mb/d. Slightly higher than expected runs in Asia mostly offset lower runs in Africa, FSU and the Middle East. Annual growth in non-OECD crude runs stood just above 0.5 mb/d, compared to 0.3 mb/d in 1Q12. Increases were almost entirely accounted for by non-OECD Asia, in particular India.



The outlook for non-OECD refinery runs has been lowered somewhat for 3Q12, although growth is expected to be sustained at nearly 0.6 mb/d. A downward revision of 120 kb/d since last month's report stems mostly from Latin America, where a deadly accident at Venezuela's largest refinery in August lowered crude intake. Annual growth is expected to accelerate in 4Q12 to 1.3 mb/d, as Chinese refinery runs rebound and growth resumes in Africa with the restart of Libya's Ras Lanuf refinery in August. Middle Eastern crude intake may also grow as Saudi Aramco and Total start trial runs at the 400 kb/d Jubail refinery at the end of the year.

China's refinery crude throughput averaged 8.9 mb/d in August, slightly higher than July, and 2.6% above a year earlier and the strongest growth since November 2011. The increase in refinery runs came as Chinese refiners took advantage of higher gasoil and gasoline prices. Refiners also replenished product inventories, which had been depleted over preceding months. China's National Development and Reform Commission raised retail guidance prices for gasoline by 4% to Yuan 390/mt ($61/mt) and diesel by 5% to Yuan 370/mt, effective August 10. Industry surveys suggest companies were planning further increases in September.

Looking ahead, we expect refinery runs to improve with a rebound in oil demand after the 2Q slump, both over 3Q and in particular for 4Q12. Sinopec, which is planning to start up a new 200 kb/d crude unit at its Maoming refinery, is expected to raise runs at the plant from 280 kb/d this year to 340 kb/d next year. That is less than incremental capacity, as an older crude unit will be retired and secondary units will not be completed before 2014. PetroChina is also planning to expand refining capacity before the end of the year at its Sichuan Hohhot and Huabei facilities. Including Sinopec's 160 kb/d Jinling expansion, which was to start in September, total Chinese additions could amount to 800 kb/d before end-year.

In 'Other Asia', runs continue to be supported by healthy growth in India. Indian crude intake is estimated to have averaged 4.4 mb/d in July, 250 kb/d higher than a year earlier, with increases stemming from new capacity. In particular, Essar's Vadinar refinery reported crude runs of 410 kb/d, compared to 250 kb/d a year earlier, as the plant was expanded earlier this year, first to 360 kb/d in March then to 400 kb/d in June, from 210 kb/d previously. Other increases came from the new Bina refinery, which was just starting trial runs last summer. We also assume 150 kb/d runs at the Bathinda refinery, compared to nameplate capacity of 180 kb/d. The plant was reportedly commissioned in March, and formally inaugurated in April.

Elsewhere in the region, Singapore's refinery runs fell 50 kb/d in July as Shell shut a crude unit at its 500 kb/d plant. The unit, which has a capacity of 170 kb/d, is now expected to be offline until mid-September. Meanwhile, Vietnam's Dung Quat refinery resumed full operations in August, after having been closed since June. Sri Lanka shut its only refinery in late August after a floating pipeline in the port of Colombo was damaged. The repairs were expected to only take a few days, but state run Ceypetco was looking to secure gasoil and fuel oil cargoes for September delivery to make up for the shortfall.

Russian refinery runs were sustained at elevated levels through August, averaging just over 5.5 mb/d. This is substantially higher than a year ago, but is largely due to Taneco's new Nizhnekamsk refinery, which started refinery runs in August 2011. Russian throughputs are expected to decline markedly in September, as refiners embark on planned autumn turnarounds. A total of 495 kb/d of capacity is estimated to be offline in September and 400 kb/d in October (compared to less than 200 kb/d over the summer months). The refinery turnarounds, which also include a lot of hydrotreater shutdowns, is expected to cut gasoil exports. Elsewhere in the FSU, Belarus will also cut runs in September due to maintenance work at the 320 kb/d Mozyr refinery, though partly offset by higher runs at the Novopolotsk plant which was shut for parts of August after a fire on 1 August.



Middle Eastern refinery runs were lower than expected in June. According to JODI data, Saudi Arabian crude intake fell 70 kb/d from May, in contrast to a slight improvement expected, to 1.69 mb/d. Yemen's Aden refinery restarted runs in early August, after an eight-month shutdown. The 150 kb/d refinery has not operated above 85 kb/d in the last seven years. Regional crude runs could be augmented before the end of the year, when the Aramco-Total JV Jubail refinery starts test runs. Full operations at the 400 kb/d project are now targeted for 3Q13.

In Latin America, a devastating explosion at Venezuela's Amuay refinery significantly curtailed the regional outlook for August and September. The 645 kb/d plant is believed to have been running significantly below capacity before the explosion, which killed as many as 42 people on 25 August. Some units have reportedly resumed operations, and the plant reached runs of about 260 kb/d by early September, according to the oil minister, who added that runs would return to normal rates within days. Brazil's refinery runs were largely in line with expectations, averaging 1.93 mb/d in July, up 40 kb/d from a month earlier and 170 kb/d above 2011. Separately, Valero announced in August it will convert its Aruba refinery to an oil product terminal by the end of the year, as profitability of the plant remains poor and no buyers have been found. The refinery already stopped processing crude in March of this year.



African refinery runs remained depressed over the summer due in part to serious maintenance shutdowns of Algeria's largest refinery, the 300 kb/d Skikda plant. The refinery, which was completely shut for a 15-day period in July is expected to undergo extensive maintenance shutdowns lasting until December. Providing some regional relief, Libya's largest refinery, the 220 kb/d Ras Lanuf plant, reportedly resumed operations at the end of August, a month earlier than expected. While current throughput rates are unknown, we assume the plant will run at reduced rates until the end of the year.