Oil Market Report: 11 September 2014

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Highlights

  • Oil prices fell sharply in August, weighed down by abundant supplies and further indications of slow global economic and oil-demand growth. ICE Brent futures tumbled below $100/bbl on 8 September for the first time in over a year and were last trading at $98/bbl. NYMEX WTI was around $91.40/bbl.
  • Global oil demand growth for 2014 and 2015 has been curbed to 0.9 mb/d and 1.2 mb/d, respectively, to reach 93.8 mb/d in 2015. A pronounced slowdown in demand growth in 2Q14 and a weaker outlook for Europe and China underpin the downward revisions.
  • Global supply was down 400 kb/d in August, to 92.9 mb/d, on lower non-OPEC production. Compared with a year ago, global supply was 810 kb/d higher, with an increase in non-OPEC of 1.2 mb/d more than offsetting a 370 kb/d OPEC decline. Non-OPEC supply is set to expand by 1.6 mb/d in 2014, and 1.3 mb/d in 2015, to reach 57.6 mb/d.
  • OPEC production fell by 130 kb/d in August to 30.31 mb/d as a steady recovery in Libya failed to offset lower supply from Saudi Arabia and Iraq. The 'call on OPEC crude and stock change' was lowered by 200 kb/d for 4Q14 to 30.6 mb/d and 300 kb/d for 2015 to 29.6 mb/d on a weaker demand outlook and robust non-OPEC supply growth.
  • OECD industry inventories built seasonally by 15.5 mb in July, to 2 670 mb, on soaring US 'other products' stocks. Preliminary data indicate that stocks continued on their upward trajectory during August, rising by 19.5 mb, further cutting the deficit to the five-year average which stood at 57 mb/d at end-July.
  • Global refinery crude throughputs surged by more than 2 mb/d over July and August to a seasonal peak of 78.7 mb/d before autumn maintenance curbed activity again from September. Global crude runs projections for 2H14 are largely unchanged since last month's Report, averaging 77.9 mb/d in 3Q14 and 77.5 mb/d in 4Q14.

Price signals help mitigate risks

While festering conflicts in Iraq and Libya show no sign of abating, their effect on global oil market balances and prices remains muted amid weakening oil demand growth and plentiful supply. US production continues to surge, and OPEC output remains above the group's official 30 mb/d supply target. Latest data on oil deliveries show further signs of a clear slowdown in global demand growth. Against this backdrop, it is not surprising that prices have been easing, with front-month Brent futures slipping below $100/barrel for the first time in a year. The Brent futures market has shifted into contango, providing market participants with an incentive to build stocks. As supply risks remain elevated, market signals effectively are encouraging participants to build up buffers against potential disruptions.

While much attention has been paid to the relentless growth in North American unconventional supply, demand headwinds have perhaps been less widely noticed. The recent slowdown in demand growth is nothing short of remarkable. Latest statistics show that demand growth slowed to below 500 kb/d year-on-year in 2Q14 for the first time in two and a half years. Demand projections for 3Q14 have been revised downwards, as have been forecasts for 2014 and 2015 as a whole. While demand growth is still expected to gain momentum, the expected pace of recovery is now looking somewhat more subdued.



OPEC supply has been remarkably robust in view of the troubles in Libya and Iraq, with output from the producer group assessed at about 30.3 mb/d for August, just slightly down from July on the back of lower Saudi and Iraqi production, partly offset by a continued rebound in Libya. This production level was not too far off from the estimated 'call on OPEC and stock change' for 3Q14, and the latest dip in Saudi supply seems primarily to reflect reduced import demand from US refiners, as well as weaker-than-expected crude demand in Europe and Asia.

Shifts in the direction of OPEC export flows are as noteworthy as the group's aggregate production levels. In recent years, surging LTO production has backed out US imports of West African crude, which are now moving to Asia. Saudi exports seem to be showing the beginning of a similar shift. Saudi exports as a whole are likely to have run below 7 mb/d for the last four months, their lowest level since September 2011. Exports to the US led the drop amid rising Saudi domestic demand for crude burn and refinery runs. State oil company Saudi Aramco appears to be pricing oil out of the US market by ratcheting up Official Selling Prices to North America, while OSPs to Asia have come off, likely setting the stage for a broad rebalancing of trade flows. Thus is the global crude market continuing to adjust to the new North American supply reality.

Despite market talk of oil traders scrambling to secure tankage to store crude, there is relatively scant evidence yet of a large build-up in commercial inventories. But oil stock data are lagged and mostly limited to the OECD, whereas much of the reported speculative stock builds are said to have occurred in such non-OECD locations as Saldanha Bay in South Africa or Fujairah in the Persian Gulf. Within the OECD, data show a seasonal build in total oil stocks of roughly 15 mb in July and a provisional build of nearly 20 mb for August, twice the monthly average. Clearly the price structure encourages further builds. Given the volatile situation in the MENA region, this is a benefit to global energy security.

Demand

Summary

  • The global oil demand trend showed clear signs of weakening in 2Q14, as growth eased back to a near two-and-a-half year low of around 480 kb/d year-on-year (y-o-y).  Euro zone economic growth is petering-out, while US petrochemical usage fell alongside pronounced declines in Japanese power-sector demand. Total oil product demand averaged 91.6 mb/d in 2Q14, 125 kb/d below the estimate carried in last month's Report.
  • Preliminary assessments of 3Q14 demand point towards a modest acceleration in global momentum, with reports of business confidence rising in some countries (such as the US) supporting the still relatively weak forecast y-o-y gain of approximately 840 kb/d. The uptick in demand momentum comes despite the overall forecast of 93.3 mb/d in 3Q14 being revised down by approximately 120 kb/d from the previous estimate.
  • The forecast of oil demand growth for 2014 has been trimmed by 150 kb/d to 0.9 mb/d, taking projected demand for the year to 92.6 mb/d. Curbed outlooks for China and Europe are the key downside contributors.
  • The growth forecast for 2015 has also been tempered, to 1.2 mb/d, from 1.3 mb/d previously, taking global deliveries up to 93.8 mb/d in 2015, approximately 165 kb/d below the previous projection. This new forecast still amounts to a notable acceleration on 2014, as the International Monetary Fund (IMF) anticipates global economic growth accelerating to +4.0%, from 3.4% in 2014, according to July's World Economic Outlook. The reduction in the forecast uptick comes as we anticipate a marginally weaker GDP projection with the publication of the IMF's October update.
  • Non-OECD oil demand growth will lead the forecast upside in 2015, rising by 1.3 mb/d (after a rise of 1.2 mb/d in 2014), an increase that more than offsets the modest 0.1 mb/d reduction foreseen for OECD economies (versus the 0.3 mb/d reduction expected in 2014).
  • Chinese demand is forecast to average 10.3 mb/d in 2014, up 2.4% on the year earlier, a notable downgrade on the previous projection as ongoing declines in the recent gasoil demand data feed through. The generally gloomier macroeconomic backdrop has also influenced the curtailed 2015 forecast, to 10.6 mb/d, albeit with a modest acceleration still foreseen (+3.2%) as mildly positive gasoil demand growth is forecast to return

Global Overview

Ongoing weakness in both the European and Chinese economies, coupled with lower-than-expected oil deliveries in Japan and Brazil, saw the 2014 demand forecast reduced. This month's Report sees the projected 2014 growth rate for total oil demand curbed back to +1.0% (or 0.9 mb/d), versus the previous +1.1% (or 1.0 mb/d) assessment. This adjustment occurred as the majority of the latest oil delivery data has come out below prior expectations, while the generally deteriorating macroeconomic picture pares back the overall forecast 2H14 uptick. Total global oil deliveries are now expected to average 92.6 mb/d in 2014, 65 kb/d below the estimate cited last month, with lower assessment of Chinese, Japanese and German oil demand leading the revisions.

At 91.6 mb/d, the 2Q14 global oil demand estimate has been revised down by 125 kb/d since last month's Report. Leading the 2Q14 downgrade were notably reduced estimates of German, Brazilian and UK deliveries. Indeed, weaknesses were seen across the euro zone, where the economic recovery came to a halt in 2Q14, with both German and Italian GDP declining in quarter-on-quarter (q-o-q) terms while France stagnated for a second consecutive quarter. Even previous strongly rising demand centres, such as Brazil, have shown signs of slowing recently, with Brazilian oil demand growth at a near one-and-a-half year low y-o-y in June.

Preliminary estimates of 3Q14 oil demand were also reduced, by around 120 kb/d over last month's Report to 93.3 mb/d, on lower assessments of oil demand in Japan and softer economic growth in Europe. The US provides a significant 3Q14 offset, +145 kb/d on last month's Report, in response to the recent strength in the US oil delivery data, figures that have themselves been revised up as continued gains emerge in the US industrial outlook. Manufacturing sentiment indicators for the US, from the Institute for Supply Management (ISM), climbed to a near three-and-a-half year high in August, firmly pointing towards strongly expansionary territory over 2H14. This strengthening industrial sentiment/activity supports the rising US oil demand outlook.

The recent demand picture can be split along two distinct trends: that of stronger US deliveries, versus weaker conditions in China and Europe; the latter force currently outweighing the former. Indeed, the macroeconomic malaise experienced across much of Europe recently has been the dominant downside influence. Euro zone economies, already struggling with stagnation (i.e. weak-to-falling economic growth coupled with high unemployment), are getting perilously close to deflation. The risk being that falling European prices trigger a deflationary spiral that causes further reductions in economic activity, as market participants delay investment/purchasing decisions, which in-turn curb production and overall economic output. In response to such concerns, the ECB announced a surprise ten basis point cut in interest rates, taking its benchmark interest rate to 0.05%, and reduced its GDP forecasts for the euro zone to 0.9% in 2014 (two-tenths of a percentage point below the 1.1% forecast cited by the IMF in July).

China has been the other significant downside contributor to this month's demand revisions. After months of anaemic Chinese oil demand growth, it is becoming ever clearer that even with an assumed uptick in 2H14, Chinese oil demand growth will struggle to get much above 2%. Falling gasoil/diesel deliveries, on the back of absolute contractions in domestic coal use, as less diesel has been required to move coal from mines to power stations, lay at the heart of this downside revision and will likely remain a heavy restraint throughout 2014.

The 2015 global demand forecast has also been revised down sharply since last month's Report, as total oil deliveries are now forecast to average roughly 93.8 mb/d in 2015, approximately 165 kb/d below the previous projection. The two prime contributors to the reduced 2015 forecast are the same as for the year earlier revision, i.e. curbed projections for both Chinese and European demand. Despite this downgrade, overall growth momentum is still expected to accelerate in 2015, to 1.2 mb/d from 0.9 mb/d in 2014, an uptick supported by the assumed strengthening of the macroeconomic backdrop; it is just that the potential additional demand has now been tempered on a slightly less upbeat outlook for the world economy. Non-OECD countries dominate the 2015 growth forecast, contributing approximately 1.3 mb/d of additional deliveries forecast for 2015, which more than offsets the forecast OECD contraction of 0.1 mb/d.

Top 10 Consumers

US

The June US demand data, at 18.8 mb/d, was roughly unchanged on the estimate carried in last month's Report. June deliveries rose by a modest 0.2% y-o-y, after a 1.4% y-o-y decline in May. Notable weakness was seen in the naphtha, residual fuel oil and 'other products' categories. The strongest growth was reserved for gasoil/diesel, up 4.4% y-o-y in 2Q14, specifically higher by 5.9% on a y-o-y basis in June after a 4.7% gain in May. Naphtha deliveries fell heavily, down by 28.6% in June after a 23.3% decline in May, as maintenance closures trimmed available petrochemical cracker capacity, while gasoil/diesel's strength reflected increased activity in the US construction sector.



Early estimates of US July demand, based on US Energy Information Administration weekly releases, show a further augmentation in US oil deliveries to 19.2 mb/d, supported by seasonally higher gasoline demand and strong y-o-y gains in jet/kerosene. A further gain, to 19.5 mb/d is assumed in August, not only amounting to a strong 1.8% gain on the year earlier but also the highest absolute level of US demand experienced since November 2013. With both forecasts, for July and August demand, now significantly above those carried in last month's Report, respectively higher by 270 kb/d and 130 kb/d, the projection for the year as a whole has also been raised, by 40 kb/d to 19.0 mb/d. The forecast growth trend in 2014 is accordingly higher, +0.4% versus the previous +0.3% forecast. A further gain of around 0.4% is then foreseen in 2015, as the US economy is likely to gain additional momentum.



The latest data from US Department of Transportation's Bureau of Transportation Statistics confirm the relative strength that has emerged recently in one of the key upside supports for US demand, jet fuel, with total US airline jet fuel purchases coming in at 3 240 million gallons in 1Q14, up 1.1% on the year earlier. Of the big three US airlines, American Airlines reported a 5.3% gain in purchases (to 905 million gallons), followed by Delta (+1.9%, to 730 million gallons) and United (-0.3%, to 745 million gallons). International flights, to and from the US, accounted for the majority of the 1Q14 increase, as roughly 1 275 million gallons were reported in 1Q14, up 2.6% on the year earlier, outpacing the more subdued 0.2% gain seen domestically.



The historical data for the US were revised up in this month's Report, with approximately 20 kb/d of additions being made to the 2013 US demand estimate. Notably higher estimates of US gasoline (+60 kb/d) and LPG (+20 kb/d) demand were made, offsetting reductions in the 'other products' category (-55 kb/d). Total deliveries across the fifty states of the US are now estimated to average 19.0 mb/d in 2013, equivalent to a gain of 2.4% (or 440 kb/d) on the year earlier, versus the 2.1% expansion previously cited.


China

The latest estimate of Chinese apparent oil demand, at 10.4 mb/d in July, was roughly 140 kb/d less than the forecast carried in last month's Report as two of the key components that make up our apparent demand estimate fell: refinery output and net product imports. From approximately 1.4 mb/d in 2013, net product imports fell to 1.2 mb/d in July as domestic requirements eased. Compared to the year earlier, total Chinese oil deliveries eased back by around 70 kb/d in July, with the sharpest reversals seen in the industrially important gasoil/diesel and residual fuel oil categories. These declines came in contrast to the large gains experienced in the still thriving domestic transport fuel markets of gasoline and jet/kerosene. The petrochemical sector, meanwhile, continued to support strong gains in LPG and naphtha.



Given the clear weakness in the recent Chinese data, the forecast for the year as a whole has accordingly been revised down, with a more muted +2.4% forecast now carried for 2014 versus the previous 2.9% assessment. Even with this reduced forecast, a modest upturn in Chinese demand growth is expected over the remainder of the year, with a near 3% growth trend assumed post-July, a forecast that is broadly supported by manufacturing business sentiment indicators. HSBC's Manufacturing Purchasing Managers' Index (PMI), for example, which provides a proxy for activity in the heavily energy-intensive manufacturing sector up to six-months ahead, rose to a five-month high in July of 51.7, clearly above the key-50 'expansionary' threshold, before dipping back perilously close to it in August to 50.2. This August dip accordingly curbs the 4Q14-1Q15 forecast. Looking further ahead, the outlook for 2015 is for Chinese oil demand growth accelerating back to around +3.2%, taking deliveries up to an average of around 10.6 mb/d in 2015. This upturn in momentum is based upon the projections of continued strong gains in the transport and petrochemical sectors, and the return of modest gasoil/diesel demand growth after a two-year hiatus.



One of the strongest recent performing Chinese demand sectors has been the jet/kerosene market, with double-digit percentage point gains seen recently as increases in flight numbers shrug-off the current economic woes. The Civil Aviation Administration of China (CAAC) reported turnover of six billion tonne kilometres in May, a gain of over 10% on the year earlier. Over 30 million air-passenger trips were made in May, up 9.8% on the year earlier, while monthly air-cargos rose by 7.7% in May to 505 tonnes. The CAAC estimates that passenger numbers will rise by 12% y-o-y in July and 13% in August, alongside respective gains of 7% and 7.5% in cargo.

The introduction of tighter environmental restrictions on gasoline use in many areas, could meanwhile, provide additional support to the 3Q14 Chinese gasoline demand forecast, as the fuel's lower required octane content essentially means more gasoline will be required to move the same distance. Since July, petrol stations in southern Guangdong have been required to only stock gasoline which meets the China 5 standard, a quality of fuel with notably lower levels of sulphur, olefins, octane and manganese.


India

The Indian demand forecast for 2014 is little changed from recent issues of this Report as the latest petroleum product sales data, from the Ministry of Petroleum and Natural Gas, closely matched our own pre-existing projections. Roughly 4.0 mb/d of oil products were delivered in June, falling to 3.7 mb/d in July as seasonal diesel use eased. The dominant Indian gasoil/diesel segment, however, still leads y-o-y growth momentum, rising by 5.3% in June to 1.6 mb/d and 6.3% in July to 1.4 mb/d. Diesel demand gained additional support as numerous power outages required additional diesel-powered emergency generators to be used. The forecast for the year as a whole is for a gain of 2.4% in 2014, to 3.9 mb/d, accelerating to 3.0% in 2015 as additional macroeconomic momentum likely supports extra gasoil demand.


Japan

Preliminary indicators of Japanese demand in July point towards a near 10% y-o-y decline rate, with sharp reductions experienced across most of the product spectrum. Particularly heavy drops were concentrated in the naphtha, jet/kerosene, residual fuel oil and 'other product' (which includes the direct crude burn of the electrical generating sector) segments. Deliveries of these last two categories fell in July, as power sector oil usage declined, while weaker petrochemical demand curbed naphtha deliveries.



July's double-digit percentage point decrease amounted to a sharp deterioration on the upwardly revised 2.2% drop now reported for June (previously -3.0%). The estimate for year as a whole, at 4.3 mb/d, has accordingly been based, not just on this lower July estimate (110 kb/d below last month's Report) but also on the reductions in the August demand forecast (-75 kb/d), as transportation fuel demand likely eases consequentially on an unusually heavy typhoon-season.

Russia

The Russian demand data has surprised on the upside recently, with approximately 3.7 mb/d of products delivered in July, 90 kb/d above the forecast cited in last month's Report. A combination of strong July gains for residual fuel oil, 'other products' and jet/kerosene, more than offset absolute declines in gasoline and LPG, to leave overall demand roughly 1% higher y-o-y in July. This escalating-demand environment comes despite the continuation/build of Russian/Ukrainian tensions and the implementation of sanctions with the West. The Russian economy is currently expected to expand by a muted 0.2% in 2014, according to the consensus of economic forecasters quoted in early-September's Economist magazine. Such an economic outlook is down significantly on the plus 1% growth rate seen in 2013, but even this curtailment is unlikely to be sufficient to bring Russian demand growth much below the current near +1% forecast, given the strength of January-July data.


Saudi Arabia

Saudi Arabian oil demand totalled roughly 3.5 mb/d in June, 6.4% up on the year earlier as strong gains were seen in the gasoil, 'other products' and LPG product categories. Petrochemical demand remains relatively robust, with a near 4% y-o-y gain in LPG deliveries reported in 2Q14 to 745 kb/d. This follows news that SABIC, the state-owned petrochemical company, declared a 7% y-o-y gain in profits in 2Q14. Producers are responding to concerns that market share could be lost to the US, as American shale feedstocks threaten the country's previous competitive advantage (see Medium Term Oil Market Report, 2014), by diversifying petrochemical outputs into high value and speciality chemicals. The outlook for the Saudi Arabian petrochemical sector is for continued expansion, with near 3% growth foreseen in LPG demand in both 2014 and 2015. Underlying such a demand forecast is the potential export market for relatively cost-competitive Saudi Arabian fertilizers and plastics, with SABIC's CEO, Muhammad al-Mady, stating that he believes Africa will provide a particularly fruitful source of future petrochemical product demand.


Brazil

The latest Brazilian demand data, at 3.1 mb/d in June, was 75 kb/d below the forecast we carried last month, as June data essentially magnified the decelerating trend that we had been alluding to for some time now. Up just 1.6% on the year, June's growth rate amounted to a near one-and-a-half year low and was less than half the previous six-month average y-o-y increase. Notably curbed gains in the domestic transportation sector played a key role in June's slowdown, with motor gasoline demand in June, for example, rising by its slowest rate in 15 months. Having previously enjoyed a 12-month average y-o-y growth rate of 7.8%, June's 4.2% increase in motor gasoline amounted to a near halving in momentum, as ailing consumer confidence (which fell to a five-month low in May) suppressed the numbers of journeys made. Looking ahead, the latest car dealership data suggests that month-on-month (m-o-m) declines in new car sales were seen in both June and July, further undermining the future demand trend.



Once the football World Cup support has finally fallen out of the demand data, i.e. post-July when tourist footfall is projected to ease, a further deceleration in the Brazilian demand trend is foreseen. The latest data suggest that our previously forecast 2H14 deceleration might have started even earlier, hence we have marginally curtailed the forecast for the year as a whole to +2.3% compared to the previous +2.5% projection.

Canada

A strengthening industrial backdrop saw roughly 2.5 mb/d of oil products delivered in June, a modest upside revision on last month's Report, as total industrial production for the overall Canadian economy came in 4.9% above the year earlier. Such supportive conditions sustained a near 3% y-o-y gain in total Canadian oil deliveries. Notably raised estimates were seen for LPG, gasoline and gasoil/diesel in June, more than offsetting declines in naphtha and jet/kerosene.


Korea

July data saw South Korean oil demand post its fifth consecutive month of y-o-y growth, with approximately 2.3 mb/d of oil products delivered in July, a 50 kb/d (or 2.2%) gain on the year earlier and 40 kb/d above the estimate carried in last month's Report. The strongest y-o-y growth was reserved for the LPG, gasoil and jet/kerosene categories, as gains in these products more than offset declines in naphtha, residual fuel oil and 'other product' demand. Relatively high naphtha prices in Asia, however, are reported to have temporarily curbed naphtha demand, which fell by 1.0% on the year earlier to 1.1 mb/d, and similarly boosted LPG.



Relatively strong economic activity across South Korea generally supported the country's recently rising oil demand trend. Consumer confidence is thriving, supporting absolute gains across the Korean transport sector, with the Bank of Korea, for example, citing a consumer confidence reading of 105 in July, whereby any reading above 100 signifies an "improving outlook". Similarly upbeat industrial output - with the official numbers showing growth at a five-month high of 3.4% y-o-y in July - particularly supported deliveries of LPG and gasoil. Looking forward, a near 1.5% gain is foreseen across the year as a whole, to an average of around 2.4 mb/d, a level that is forecast to roughly hold in 2015 as additional efficiency gains are forecast as curbing demand growth.

Germany

The recent German demand data, with an estimated 2.3 mb/d delivered in 2Q14 and 2.4 mb/d in July, is down sharply on the year earlier as the economic picture for Germany has deteriorated sharply recently. Both the June and July German oil demand numbers are down heavily on the projections carried in last month's Report, respectively lower by 135 kb/d and 70 kb/d, with lower gasoil deliveries the key contributing factor. With German economic momentum in 2Q14 falling by 0.2% on 1Q14, the risk of a triple-dip recession looms, resulting in a paring of the 2014 oil demand outlook to 2.4 mb/d, equivalent to a decline of 1.0% on the year earlier. Although something of an uptick is still foreseen in the 2H14, the confidence that such a scenario will occur has been curbed as export flows to Russia likely decline in the face of the recent emergence of economic sanctions between the two countries.



At 2.3 mb/d in June, the officially confirmed German demand data implies a much weaker trend than that previously assumed from the inland-delivery statistics. The 230 kb/d y-o-y contraction (or -9.3%) in June was the steepest decline in 16 months and amounted to a 135 kb/d curtailment on the previous forecast. Notably lower estimates of gasoil, residual fuel oil and 'other product' deliveries led the June revision.

OECD

Having experienced a temporary reprieve in 2013, the OECD oil demand trend returned to a clearly falling trajectory in 2014, something we envisage continuing in 2015. Relatively efficient oil consumption, somewhat subdued macroeconomic conditions and continued product switching made for a particularly unsupportive OECD demand-side environment. Total OECD deliveries are expected to average 45.8 mb/d in 2014, down by around 0.5% on the year earlier, with sharp declines in residual fuel oil and 'other products' (which includes the direct crude burn). Both of these product segments are forecast to experience notable declines in 2014, as the Japanese power sector increasingly switches out of oil products into more cost competitive alternatives. Absolute gains are then foreseen in the gasoil, jet/kerosene and naphtha categories, distillate demand gaining particular support from the US industrial uptick.

The latest OECD demand data impled a hefty 0.8 mb/d (or 1.7%) 2Q14 y-o-y decline, to 44.7 mb/d. The sharp 2Q14 OECD decline took hold as the Japanese power sector made rapid movements out of oil, European economic momentum reversed and US petrochemcial demand eased, curbing both LPG and naphtha deliveries. Although we continue to envisage absolute y-o-y declines in OECD oil deliveries in 2H14, the near-perfect storm of 2Q14 is unlikely to be repeated any time soon, thus supporting the forecast of easing OECD declines across 2H14.



Americas

Despite enduring a 2Q14 correction, OECD American oil demand is forecast to rise on a y-o-y basis in 3Q14, a prediction that gains particular credibility on the basis of the stronger than expected July-August data already alluded to in our US section. Approximately 24.4 mb/d of oil products are expected to be delivered across the OECD Americas in 3Q14, 0.3% up on the year earlier, with notable additions foreseen in gasoil/diesel and jet/kerosene deliveries. The predicted 3Q14 uptick comes after the confirmed 0.8% y-o-y decline in 2Q14, when particularly weak petrochemical demand in the US, caused by some temporary cracker closures, restrained overall deliveries. The forecast for the year as a whole is essentially flat, as demand in the OECD Americas averages roughly 24.1 mb/d in 2014, before posting a very modest gain to 24.2 mb/d in 2015 supported by an intensification of US economic growth. The industrially important LPG (which includes ethane used in the petrochemical sector) and gasoil/diesel categories are forecast to then drive this growth in 2015.


Europe

The weak European economic backdrop has added an additional downside jolt to 2Q14 European oil demand. A downwardly revised 2Q14 European demand estimate, of 13.4 mb/d, was made, 95 kb/d below that carried in last month's Report with weaker deliveries of gasoil, residual fuel oil and 'other products' the key factors. This 2Q14 reduction coincided with Eurostat's official confirmation that in the euro zone economic activity showed no q-o-q growth in 2Q14, with Germany (-0.2%) and Italy (-0.2%) both down a fact reflected in their weaker oil demand trends. With preliminary estimates of July demand also below previous expectations, a further 25 kb/d has been trimmed from the 3Q14 European demand estimate to 13.9 mb/d.



These two factors, coupled with growing concerns that the IMF's July (+1.1% for the euro zone) estimate of economic growth will prove too optimistic, encouraged a reduction of 55 kb/d from our 2014 European oil demand forecast, to 13.5 mb/d, leaving a decline rate of 1.1% (or -145 kb/d) for the year as a whole. This scepticism was confirmed, September 4, when the ECB announced not only a surprise ten basis point cut in interest rates but also a lowering of its euro zone economic outlook to +0.9% growth for 2014.

Growing concerns regarding the sustainability of the European economic recovery have also resulted in a reduction of the 2015 European demand forecast to 13.4 mb/d, amounting to a further decline of 0.4% on the year earlier. This relative easing of the European decline rate, from -1.1% in 2014 to -0.4% in 2015, arises as the ECB forecasts an uptick in euro zone macroeconomic momentum in 2015, to 1.6%; an argument supported by the IMF in July (1.5%) and the consensus of macroeconomic forecasters cited in The Economist magazine at the time of going to press. A close watch must, however, be maintained over the situation with regard to Russia, as a further intensification of sanctions could reduce euro zone economic growth, with a leaked EU document talking about a potential 75 basis points reduction.



Despite these concerns and having endured an exceptionally tough January-through-May, the French oil demand trend has moderated recently. Supported by strengthening demand in the naphtha, jet/kerosene and 'other product' categories, approximately 50 kb/d was added to the French July demand estimate to 1.9 mb/d. This amounts to a 2% correction on the year earlier, which along with June's 0.9% y-o-y decline demonstrates a notable easing from the previous six-month trend (-4.9%). The Italian demand assessment for July was similarly revised up, to 1.3 mb/d, amounting to a 75 kb/d (or 5.4%) decline on the year earlier but 10 kb/d less than the reduction cited in last month's Report.

Asia Oceania

Recent oil demand data for OECD Asia Oceania have been downgraded on account of reduced Japanese power sector oil use, with approximately 7.7 mb/d of oil products delivered in July, 75 kb/d below the estimate cited in last month's Report. The 3Q14 demand estimate has accordingly been curbed, by a more modest 50 kb/d, leaving an average demand forecast of 7.8 mb/d in 3Q14. The forecast for the year as a whole, and for 2015, is for a modest downgrade in demand, to 8.2 mb/d and 8.1 mb/d respectively, as further product shifting occurs alongside enhanced efficiency measures.


Non-OECD

Compressed by reduced forecasts for China and Brazil (see Top 10 Consumers), the total non-OECD oil demand forecast for 2014 has been curtailed by approximately 45 kb/d to 46.8 mb/d. Such a reduction takes the projected 2014 growth rate back to an estimated +2.5%, roughly two-tenths of a percentage point below the forecast cited in last month's Report. Restraining progress will be the relatively subdued gains forecast in both gasoil and residual fuel oil, as absolute Chinese declines in each of these categories quell the non-OECD metric. Contrasting strength in some key transport fuels, both in China and across most other non-OECD countries (bar the economies of the former Soviet Union), provide an offset, with total non-OECD gasoline demand forecast to rise by approximately 3.8% in 2014 (to 9.7 mb/d) and jet/kerosene by 3.6% (to 2.9 mb/d). Overall momentum should then accelerate, up by 2.8% in 2015 to 48.1 mb/d, with rapid gains in petrochemical, transport and industrial fuel oil demand forecast.



With the exception of China, non-OECD Asian oil demand growth is forecast to accelerate in 2014 with relatively strong gains in petrochemical usage expected to support near 4% gains in both LPG (includes ethane) and naphtha deliveries. The forecast for 2H14 should also include a notable acceleration in gasoil demand growth, as both Indian and Indonesian deliveries are projected to ramp up; India supported by a strengthening macroeconomic backdrop (with GDP forecast to climb by 6.4% in 2015, according to the IMF in July) and Indonesia as government efforts to restrict mining exports are removed. The 2H14 reversal of the law that banned Indonesian unprocessed mineral exports is likely to result not only in higher Indonesian mining activity but also additional diesel consumption from this traditionally very gasoil-intensive sector. Looking further forward, we project that, with the generally assumed macroeconomic strengthening that is forecast to occur in non-OECD Asia in 2015, oil demand growth will increase still further, with accelerating transportation fuel demand providing a key support.



After a difficult couple of months, the African oil demand outlook is expected to rise by around 3% in 2014, to 4.0 mb/d and 4.5% in 2015, to 4.1 mb/d. Many of the economies in the region have struggled with challenging circumstances, whether that be the Ebola virus in West Africa or fighting in Libya, but are cautiously expecting to see stronger economic growth in 2014 and 2015. The World Bank's latest Global Economic Prospects, for example, says that "despite emerging challenges, medium-term growth prospects for sub-Saharan Africa remain favourable. Regional GDP growth … (is projected to strengthen) to 5.1% in 2015". Similarly the World Bank's wider "Middle East and North Africa region … (experienced) a recovery in 2014, following a 0.1% (GDP) contraction in 2013, on the back of domestic and regional turmoil and weak external demand. Recovery in oil production, industrial activity and exports are contributing to the pick-up in growth this year," to 1.9% with a further acceleration in GDP growth to 3.6% assumed in 2015. Many recently crisis-hit countries, such as Egypt, Algeria and Libya, will likely continue to struggle in 2014, although even here the World Bank foresees modestly brightening prospects, before hopefully emerging on a more resilient growth trend in 2015.

Supply

Summary

  • Global supply was down 395 kb/d in August, to 92.9 mb/d. Compared with a year ago, global supply was 810 kb/d higher, with an increase in non-OPEC of 1.2 mb/d more than offsetting a 515 kb/d decline in OPEC crude output.
  • August 2014 non-OPEC production fell by 265 kb/d month-on-month, to 56.2 mb/d, on seasonal declines in the North Sea and Alaska, as well as reduced output in Malaysia. Annual growth for 4Q14 is forecast at 930 kb/d, to 56.8 mb/d.
  • OPEC supply fell by 130 kb/d in August to 30.31 mb/d as a steady recovery in Libyan output failed to offset declines from Saudi Arabia and Iraq. The 'call on OPEC crude and stock change' was cut by 200 kb/d for 4Q14 to 30.6 mb/d as the non-OPEC supply estimate was revised up and global demand down. Similar reasoning impacted 'the call' for 2015, which was lowered to 29.6 mb/d.
  • Top OPEC producer Saudi Arabia cut August supply by 330 kb/d to 9.68 mb/d, seemingly in response to lower requests from customers. Output from Libya continued to improve, with flows rising by 110 kb/d from July to 530 kb/d. Early indications suggest the recovery gathered pace in September, with output touching 800 kb/d - over three times the average rate of three months ago.

All world oil supply data for August discussed in this report are IEA estimates. Estimates for OPEC countries, Alaska, Mexico 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 May 2011, a nationally allocated (but not field-specific) reliability adjustment has also been applied for the non-OPEC forecast to reflect a historical tendency for unexpected events to reduce actual supply compared with the initial forecast. This totals approximately ?200 kb/d to -400 kb/d for non-OPEC as a whole.

OPEC Crude Oil Supply

OPEC crude supply fell by 130 kb/d in August to 30.31 mb/d after output declined in Saudi Arabia and Iraq. Rising production from Libya partly offset the decrease. Saudi Arabia, OPEC's top producer, cut August supply by 330 kb/d, apparently in response to lower requests from customers. Libya's output recovery held up in August, with flows rising by 110 kb/d from July to 530 kb/d after the lifting of a year-long rebel blockade allowed vital eastern ports to reopen. Iraq's output fell to the lowest level since January after a decrease in exports from its Gulf terminals due to bad weather and loading glitches.



The 'call on OPEC crude and stock change' was lowered by 200 kb/d in 4Q14 to 30.6 mb/d on a combination of anticipated slower demand and additional non-OPEC supplies. For full year 2015, 'the call' was cut by 300 kb/d to 29.6 mb/d from 2014 levels. OPEC's 'effective' spare capacity was estimated at 3.07 mb/d in August compared with 2.87 mb/d in July, with Saudi Arabia holding 89% of the surplus.



Saudi crude output fell by 330 kb/d to 9.68 mb/d in August, seemingly in response to lower requests from customers. Official data show exports at 6.95 mb/d in June and 6.99 mb/d in May, the lowest levels since September 2011. Exports had been running at more than 7 mb/d since October 2011. During June, Saudi exports to the US market slipped to just over 1 mb/d compared with 1.4 mb/d in the January-May period. The latest tanker tracking data suggest a sharp drop in Saudi shipments in August.

Riyadh is meanwhile burning large volumes of crude at home - more than 800 kb/d - to meet rising summer demand at power plants, while throughput to local refineries - at more than 2 mb/d - is at record rates. And yet more Saudi crude will be kept at home after the Yasref refinery at Yanbu starts operations in October (see Refining).



Saudi Arabia cut official selling prices for its benchmark Arab Light for customers in Asia by $1.70/bbl for October sales, a move widely pinned by market analysts on a bid to protect its Asian market share with Arab Medium and Arab Heavy down by $1.50/bbl and $1.20/bbl, respectively. The deeper-than-expected cuts may have been in response to weak refining margins and head-on competition from West African and North Sea barrels.

Iranian crude oil production edged 40 kb/d higher from July to 2.8 mb/d. Top buyer China reportedly stepped up loadings in August, which would arrive in September or October. Preliminary data show that deliveries of Iranian oil in August to regular buyers in Asia sank below the nominal 1 mb/d limit set by Western powers under an interim deal to curb Iran's nuclear programme.

Total imports - including condensate, an ultra-light liquid hydrocarbon from Iran's South Pars gas project - dropped to 930 kb/d versus 1.2 mb/d in July. Imports during 1H14 averaged 1.4 m b/d. After stripping out condensates, imports of Iranian crude sank to 720 kb/d in August. These figures are subject to revision.

Deliveries into China for August appear to have declined by 145 kb/d on July to just above 400 kb/d - half the level of April's record 800 kb/d, according to initial data. A significant portion of the imports was likely to have loaded during July. China began to ramp up purchases of Iranian oil after an interim nuclear deal struck last November between Tehran and Western powers eased some sanctions on Iran. Rigorous measures are still in place to block sales of Iranian oil to the West.



August data show that Syria and Japan were the only countries to increase imports of Iranian crude oil. After a pause in July, an average 30 kb/d was delivered into Syria, which imported an average 30 kb/d during the first half of 2014. Imports into Japan rose 60 kb/d to 190 kb/d.

Iran's second biggest customer, India, took in 140 kb/d during August versus 210 kb/d in July. India purchased about 285 kb/d during the first half of the year. Korea's purchases dropped by 50 kb/d to average 30 kb/d last month. Shipments into Turkey fell by a similar amount, with average deliveries in August at 108 kb/d. Imports into the UAE ran at 20 kb/d in August versus 80 kb/d in July.

Import volumes are based on data submitted by OECD countries, non-OECD statistics from customs agencies, tanker movements and news reports. Imports also include condensates from Iran's Assaluyeh terminal, which averaged around 200 kb/d during the first half of this year.

To keep up the pressure on Tehran while the nuclear discussions continue, Washington on 29 August punished a number of Iranian and foreign companies for violating sanctions on Iran, mostly in connection to its nuclear work. Iran and the P5+1 are expected to hold talks later this month in New York.

Total production from Iraq, including volumes from the Kurdistan Regional Government (KRG), decreased by 60 kb/d from July to 3.10 mb/d, the lowest level since January. Exports from Iraq's giant southern oil fields, insulated from insurgent attacks in the north and west of the country, slipped to 2.38 mb/d versus 2.44 mb/d in July due to bad weather and loading glitches at the country's Gulf terminals.

The decline in southern production was partly offset by a recovery in the northern KRG region, where flows through the KRG pipeline to Turkey ran at a steady rate of roughly 120 kb/d in August. A build-up in stocks at the Turkish port of Ceyhan allowed for KRG exports of 170 kb/d in August versus just 30 kb/d in July. About 200 kb/d is now moving through the KRG pipeline and deliveries are expected to rise to 300 kb/d by the end of the month. The extra 100 kb/d could arrive from Iraq's prized northern Kirkuk field and nearby Bai Hassan that are now effectively controlled by the KRG and connected by a spur to the KRG pipeline. For now, however, the KRG is struggling to market the oil after Baghdad - which claims sole right to sell Iraqi crude - warned buyers to steer clear of what it calls "smuggled" oil. This issue has come up in the US judicial system as well.



Re-armed and supported by US air strikes, KRG Peshmerga and Iraqi forces have meanwhile reclaimed some oil fields and ground previously gained by Islamic State (IS) militants after they pushed towards the northern KRG region in August. There is lingering concern, however, that IS militants will make periodic attempts on vital infrastructure. The jihadists remain in control of the northern Baiji refinery, Iraq's biggest facility. Their occupation has damaged the Baiji refinery, forced it offline and sharply reduced output by closing the major domestic outlet for crude from the northern fields.

Pumping from Iraq's northern fields has slowed since March, when sabotage along the Iraq-Turkey pipeline halted exports of some 250 kb/d. Production - which had been about 500 kb/d early this year - has now slumped to about 120 kb/d, but most of it is re-injected into the Kirkuk field for lack of an outlet. About 30 kb/d is supplying the Kirkuk refinery.

In a bid to pull Iraq back from the brink, Iraq's parliament approved a new government headed by Haider al-Abadi as Prime Minister on 8 September. The oil portfolio went to former Vice President and Finance Minister Adel Abdul-Mahdi, who replaced Abdul Kareem Luaibi. The senior politician will have his work cut out as he seeks to calm investor fears over security, resolve a long-running feud between Baghdad and the KRG over oil rights and tackle critical infrastructure issues. As a member of the Shiíte Supreme Iraqi Islamic Council, which has strong ties with Kurdish political parties, he could prove more conciliatory towards the KRG. Former Deputy Prime Minister for Energy Hussain al-Shahristani, who ran Iraq's energy policy for much of the past decade, was not appointed to any energy-related positions.

Days before the new government was formed, Baghdad finalised a lower output target for its biggest producing field Rumaila, and extended the life of the contract, as part of a wider effort to temper its production ambitions. Rumaila, operated by BP and China's CNPC, is expected to reach 2.1 mb/d within the next decade - down from an original 2.85 mb/d. The southern supergiant is now pumping around 1.4 mb/d, nearly half Iraq's production. The revised contract also raised the companies' stakes on the technical service contract to 47.6% for BP and 46.4% for CNPC, while reducing Iraq's share to 6%. BP previously held 38% and CNPC 37%. CNPC also signed a new contract to reduce the output target at Halfaya to 400 kb/d from 535 kb/d. Operator CNPC has now got the field pumping at 200 kb/d.

The central government has already reduced capacity targets at other giant southern oil fields such as West Qurna and Zubair, paying heed to growing concerns about the unrealistic targets agreed with foreign partners in 2009-10. The overall aim now is to reach capacity of 8.5-9 mb/d by 2020 - down from an original 12 mb/d.

The Rumaila and Halfaya agreements should help boost investor confidence at a time when Iraq is battling a brutal campaign by Islamic State militants and allow international oil companies to move forward with the next stage of re-development. But foreign companies on the ground say long-standing obstacles such as exceedingly slow decision-making on major contract approvals, the insistence on using state procurement rules and infrastructure bottlenecks have yet to be overcome. One of Abdul-Mahdi's biggest challenges will be to deliver the long-delayed $5 billion-plus Common Seawater Supply Facility (CSSF), a joint water treatment and injection project that underpins the country's massive oil expansion programme.

Qatar's output held steady in August at 730 kb/d while UAE production bumped up 20 kb/d from July to reach 2.85 mb/d. Kuwait also posted a rise, with production up 50 kb/d to 2.85 mb/d in August. The Gulf producer is now targeting output of 3 mb/d after lining up additional crude oil sales to China and securing Philippine refiner Petron as a new customer. State-owned Kuwait Petroleum Corp. is to supply Petron with 65 kb/d of crude in 2015, while supplies to China's Unipec will rise from about 170 kb/d to 300 kb/d under a new 10-year contract. Kuwait is also preparing for limited involvement by major oil companies in its upstream oil sector, with the Ratqa heavy oil development project one such possibility. A tender, using an enhanced technical service agreement (ETSA), could be launched early next year.



In Libya, a tentative output recovery is continuing - with flows rising by 110 kb/d to 530 kb/d in August after major eastern oil ports restarted following an agreement between the central government and the rebels that occupied them. Despite rising violence that is pushing this North African producer towards full-blown civil war, production by early September had surged to 800 kb/d - the highest level in more than a year and a vast improvement on the 240 kb/d of just two months ago.

If higher production can be sustained, exports of roughly 570 kb/d may be possible in September - up from more than 500 kb/d that was shipped in August. Liftings resumed last month from the eastern ports of Es Sider and Ras Lanuf - with combined capacity of 560 kb/d - after being blocked for a year by rebels seeking autonomy in the east of Libya. 

Rising shipments from Es Sider, the country's largest export terminal, drained down storage tanks and allowed oil from the Sirte Basin to move to the port. Output from Libya's Waha Oil Co., which feeds Es Sider, rose to roughly 90 kb/d by early September. Pre-blockade, Waha - a joint-venture of Libya's National Oil Corp. (NOC) and US ConocoPhillips, Marathon and Hess - was exporting about 320 kb/d.

Recent output gains could, however, prove fleeting as the country struggles to hold itself together: armed groups and two parliaments are fighting for control over the North African producer. On a technical basis, 1 mb/d is achievable although there is lingering concern about reservoir pressure at some fields.

The country's oil fields were pumping 1.4 mb/d before spiralling violence brought chaos to Libya's oil sector last spring. The latest fighting, so far, has not touched Libya's oil ports and fields. Further improvements at the western fields of El Sharara and El Feel are supporting the production rise and  account for nearly half the current rate of 800 kb/d. Many Western oil workers have yet to return.

In the midst of Libya's oil revival, the country's acting oil minister Omar Shakmak has resigned and will be replaced by the chairman of state oil firm National Oil Corp (NOC), Mustafa Sanallah.



In OPEC's other North African producer, Algeria, flows held at 1.14 mb/d month-on-month. At the end of September, state-owned Sonatrach, seeking to reverse declining oil and gas output, plans to open bids in its fourth licensing round. Contracts are set to be awarded on 29 October. International oil companies showed little enthusiasm during the previous three rounds, but Algiers has tried to drum up interest by revising its hydrocarbon law and fiscal terms. The proceedings will be overseen by Said Sahnoun, Sonatrach's former upstream vice president, who took over as interim top executive at the state company after Abdelhamid Zerguine was dismissed at the end of July.

Prospects for capacity growth have been dimmed by security concerns following the deadly attack at the In Amenas gas plant in January 2013, bureaucratic inertia and political uncertainty. There are signs, however, of some improvement in the security situation. Following the adoption of more stringent safety procedures, the In Amenas plant is returning to normal operations and is expected to be at full production in a few months. Before the attack, the major gas facility - operated jointly by Norway's Statoil, BP and Sonatrach - provided roughly 11.5% of Algeria's natural gas output.

Angolan crude output rose 30 kb/d on July to 1.71 mb/d in August as flows rose steadily from Total's 160 kb/d capacity deepwater Cravo, Lirio, Orquidea and Violeta (CLOV) project that started up in July. Crude oil production from Nigeria edged down 10 kb/d from July to 1.89 mb/d - a nine-month low - due to ongoing, sporadic loading disruptions during August.



Supply from Venezuela remained steady in August versus July at 2.48 mb/d, but a shake-up in the oil industry saw the sidelining of long-serving Oil Minister and PDVSA chief Rafael Ramírez. As part of a wider cabinet reshuffle, President Nicolás Maduro promoted Eulogio del Pino - former PDVSA Exploration and Production chief - to the state oil company's top slot and tapped Asdrúbal Chávez, the cousin of late socialist leader Hugo Chávez, as oil minister. Ramírez - appointed oil minister in 2002 and PDVSA chief in 2004 - had been running both positions.

The government of Maduro, who took office last year after the death of Chávez, has been under siege since the start of 2014 from opposition groups but - so far - the widening unrest and deepening economic crisis have had little, if any, impact on the oil sector. Foreign investors, concerned by the growing instability, are keeping a watchful eye on the changes in the oil sector's top brass. Though straddling the world's largest oil reserves, Venezuela's development of the massive Orinoco heavy oil belt is running well behind schedule as it struggles to start up projects.

While wholesale changes are not anticipated in the oil sector, there is concern that Venezuela's economic crisis will worsen after Ramírez, regarded as a relative pragmatist, also lost his job as Vice President of Economic Affairs and has been shifted instead to the Foreign Ministry.

Non-OPEC Overview

Non-OPEC output dropped by 265 kb/d in August, to 56.2 mb/d, on the back of a 435 kb/d drop in North Sea oil production. This stems mostly from planned maintenance, but also includes some unplanned outages. Malaysian production was likely down on the month as well, as a dearth of Tapis cargoes was reported for the month. Seasonally low Alaskan production also mitigated production increases in the contiguous 'Lower 48' states of the US.

On the year, August non-OPEC production was up 1.2 mb/d. After year-on-year (y-o-y) gains above 1.5 mb/d since June 2013, with some months above 2.0 mb/d, the more modest (though still substantial) y-o­-y gains are expected in the coming two quarters. Quarterly growth in 4Q14 should be strong as typical with the end of the summer maintenance season and the winding down of the hurricane season. A 485 kb/d gain is expected, such that supply reaches 56.8 mb/d.


OECD

North America

US - August preliminary, Alaska actual, other states estimated: The US produced an estimated 8.5 mb/d of crude oil in August, steady on July levels, as a seasonal low in Alaska was compensated for by gains in Texas and North Dakota, and the US Gulf of Mexico experienced no major storms in the month. Alaska production dropped just below 400 kb/d not only on maintenance at Prudhoe Bay, but also generally lower output rates on equipment optimised to function in extremely cold temperatures. Alaska voted in a referendum on 19 August to retain the new petroleum tax regime that went into effect at the beginning of 2014. Hence, taxes will not be increasing on the oil industry, a possibility that the industry claimed would have impacted production levels.

While the July 2014 Report has discussed the growth on Eagle Ford play in Texas in detail, the Permian region has also been an important contributor to the surge in Texas production past the 3 mb/d mark in May and to an estimated 3.14 mb/d in August. According to US government data, the Permian region has experienced output growth of about 200 kb/d from January to August, to 1.7 mb/d, as drilling has rebounded steeply in 2014, after declining in much of 2013. This rapid growth has created a shortage of mid-stream capacity in the area. Pipeline capacity taking off the Permian is about 1.3 mb/d, so some shippers have applied for permission to use a lottery system to allocate space on lines. Railing is also possible, but the local glut of crude makes it less competitive. Indeed, this glut was clearly visible in the surging WTI Midland-Cushing spread in late July through mid-August, when it approached $20/bbl, before an announced pipeline reversal to Oklahoma reduced the spread in late August.

Final data for June show US crude oil production at 8.5 mb/d, up an exceptional 1.3 mb/d y-o-y. This was in part due to Gulf of Mexico offshore production, up about 300 kb/d y-o-y that month, as the Atlantis and Na Kika projects continued to ramp up and Mars II came online in February 2014. 

Natural gas liquids (NGL) production is surging in the US, with production reaching the milestone of 3 mb/d in June, supported by surprisingly strong output of ethane (which can be seen in storage levels - see Stocks). Although a typical slight seasonal decline is estimated for July and August compared to June, nevertheless, impressive growth of 340 kb/d is forecast for the year as a whole, to average over 2.9 mb/d. Export demand increasingly sustains investment in LPG production, but ethane is often rejected in the US on relatively low prices and the sometimes lack of midstream connectors to petrochemical facilities. The outlook for ethane exports continues to grow, however, with both Borealis of Austria and Reliance Industries of India announcing in August their intention to commence importing US ethane in 2016. Total liquids output (excluding ethanol and processing gain) for August is estimated at 11.8 mb/d, with an impressive 12.0 mb/d now expected to be exceeded by October, and total liquids is expected to stay above that level for the remainder of the forecast period. 

Canada - August estimated:  Total liquids supply is estimated at 4.1 mb/d in August, as synthetics projects were able to produce closer to capacity levels, at about 980 kb/d of output, on reduced maintenance. Crude oil and field condensate production (including bitumen) held steady at about 2.5 mb/d. Despite declines on many conventional heavy oil fields in Alberta, production has been maintained at roughly 150 kb/d for over a year, as Husky Energy has implemented several thermal projects on its conventional heavy fields that have boosted output. The Suncor-operated Terra Nova field, offshore Newfoundland, had heavy planned maintenance on its FPSO for most of August, but came back online on 3 September. Nevertheless, the company is likely to experience an output decline starting in September, as the U1 upgrader on the company's synthetics projects began 11 weeks of planned maintenance.

Despite the country's NGL production being dwarfed by that of its neighbour, Canada remains one of the world's largest NGL producers, with August production estimated at 625 kb/d. Ethane production continues to slowly decline, though some of the country's large petrochemical facilities in Alberta and Ontario have connected to imported US ethane in the past year. Non-refinery propane production in Alberta has risen slightly on increased natural gas drilling, however, just as the 70-kb/d Cochin propane pipeline that previously exported to the US was reversed in July. This has taken the differential with US Conway prices from positive to negative territory in recent months. Canadian NGL production is to average about 655 kb/d for the year, total liquids 4.1 mb/d, with the latter up 170 kb/d y-o-y, mostly on higher Alberta bitumen output.

Mexico - July actual, August preliminary: Despite a generally negative short-term outlook for Mexican crude oil production, preliminary data for August show crude oil production up slightly, by about 30 kb/d, to just over 2.4 mb/d. As was noted in last month's Report, Pemex trimmed its outlook for 2014 to 2.44 mb/d as mainstay shallow-water fields such as Cantarell and Ku have declined more rapidly than expected. New projects, such as Ayatsil-Tekel, have experienced serious delays, taking them out of the short-term forecast. (Such projects may become joint-ventures in the medium term, probably enhancing their likelihood of success and timeliness - see feature box to follow 'Mexican Energy Sector Reform Moves into High Gear'.) However, a new issue that has emerged from data collected by industry regulator CNH is that Pemex's reported production figures include a substantial amount of water—about 160 kb/d in 1H14. This is the gap between reported Pemex production and the amount of oil processed by Pemex's distribution system, according to CNH. CNH, now with a stronger regulatory status as a result of the new laws passed as part of the reform process, may be in a position to curb a problem that has existed for several years, according to CNH data. In late August, Pemex announced that the crude oil production forecast had been lowered to 2.35 mb/d for the year on the basis of more-accurately measured output. However, the August production figure did not seem to indicate any changes in measurement. Indeed, with eight months of data, output in the remaining four months of the year would have to fall to an average of 2.13 mb/d, an unprecedented level of monthly decline in Mexico, in order to arrive at a yearly average of 2.35 mb/d.  Perhaps revisions in historical data are set to arrive before the end of the year, but until we are able to obtain precise monthly revisions, we have maintained our crude oil rate for the year at 2.42 mb/d, with NGLs at 350 kb/d.

Mexico Energy Sector Reform Moves into High Gear

On 11 August, Mexican President Peña Nieto signed into law the various bills approved by the Mexican Congress that together make up the secondary laws for the reform of the energy sector. This reform was initiated by constitutional changes approved in December 2013 (see 'Watershed Energy Reform Approved in Mexico' in the January 2014 Report). These laws clarify how the energy sector will be restructured and opened for private investment, lifting decades-long restrictions. That restructuring process already took an important step forward on 13 August with the announcement of the results of the so-called 'Round Zero.' This is the process wherein those fields and prospective areas that state oil company Petróleos Mexicanos (Pemex) will retain and those that will be made available to other companies (as well as to Pemex potentially) through a public bidding process were decided upon by the government.

The reforms, which go far beyond the oil sector to include restructuring of the electricity and natural gas industries, provide new structures and rules for upstream development and also put in place a framework for the opening of the downstream oil sector beginning in 2018, including refining, pipelines, and service stations.

The laws, despite numerous amendments and changes proposed by members of the Mexican Congress, follow closely the original bills submitted by the current PRI administration. Among the major components of the secondary laws are:

  • The Hydrocarbons Laws, which authorise and regulate the participation of companies other than Pemex in the sector beyond the already-permitted service contracts. These companies will have opportunities to work with Pemex as well as independently from it on projects.
  • The Pemex Laws, which redefine it as a 'productive state company' subject to corporate tax and paying a dividend to the state, as Pemex remains 100% state-owned. (Pemex currently pays the state on the basis of its revenues, not imputed profits.) In addition, Pemex is restructured internally, i.e., merging the natural gas, refining and petrochemical divisions into a single unit.
  • Laws which set up a new fiscal framework for the hydrocarbons sector, defining the various instruments of state revenue.
  • Laws that create and define the new Oil Stabilisation and Development Fund.
  • Local content laws.
  • New environmental and industrial safety laws for the hydrocarbons sector, which include the creation of a new regulatory agency that will administer and regulate these issues specifically within the hydrocarbons sector.

The National Hydrocarbons Commission (CNH) will take a much greater role in administering the sector henceforth, and reportedly, Pemex has already begun seconding employees to the agency so that it can take on these responsibilities. Pemex will now operate more independently in some ways, particularly in a fiscal sense: the company will be taxed more like a non-state company, paying a surface rental fee, royalties based on oil (and gas) prices, and a corporate profit tax. However, Pemex will be limited by the state in its ability to choose which companies it desires to partner with—instead, CNH will make such decisions. Pemex will also transfer its pension liabilities to the federal budget, giving the company additional fiscal room for manoeuvre.

Companies other than Pemex operating in the upstream hydrocarbons sector will do so under three types of contracts (in addition to the already-available service contracts):

  • Profit-sharing ('shared-utility') contracts: companies entering into such contracts with the state receive a percentage of the profits resulting from hydrocarbon development.
  • Production-sharing contracts: companies entering into such contracts with the state receive as payment a percentage of the hydrocarbon extracted, rather than a percentage of profits, though the amount of hydrocarbon is still calculated as the equivalent in value to a percentage of operating income as with a profit-sharing contract.
  • Licenses: In this type of contract, the company essentially has title to the hydrocarbon extracted from a project (or its share of the project) once it is above ground. However, in contrast to concessions offered in some countries, the company does not take ownership with the license until the hydrocarbon is above ground.

In all three types of contracts, companies should generally be able to 'book' reserves, and, in addition, such contracts will usually offer more potential revenues and incentives than service contracts. In the first and second types of contracts, the companies pay an exploration fee (if applicable) and a basic royalty rate, as well as income tax. The state's income in these types of contracts comes mainly from the percentage of the operating income that the state is contracted to receive. These types of contracts also have cost recovery for the companies involved.

Licenses differ significantly from both profit-sharing and production-sharing contracts in terms of potential earnings and payments to the state. For licenses, companies must also pay signature bonuses and there is an additional royalty arrangement (contraprestación), and no allowance for cost recovery. However, there is 100% ownership of extracted assets (in line with the company's share of a project). Hence, licences offer greater risk but greater potential rewards. CNH will specify the type of contract available on a project depending on the risks, difficulty, and capital needs of the project in question, with licenses more likely when these three factors are relatively high. Regardless of the type of contract, CNH will make allocation decisions based on which company or group of companies offer the greatest return to the state over time. In the first two types, the company bids in terms of the highest percentage of income to the state as well as overall investment commitment. In the later type, bidding is essentially in terms of the contraprestación promised, as well as overall investment commitment.

In both cases, requirements for technical capacity will be established, and the new local content laws must be adhered to. The laws specify a general local content requirement for companies operating in the upstream to start at 25%, and rise to 35% by 2025, though there will be flexibility to have lower percentages on some projects if compensated by higher percentages on others.

The Oil Stabilisation and Development Fund will receive payments that are not taxes, e.g. signature bonuses and royalties. The fund will be used domestically to invest the long-run surplus savings from petroleum income and to serve as a stabilisation fund for government revenues, rather than as a pure offshore investment vehicle model of the Norwegian Government Pension Fund Global. The Mexican fund will in some ways compensate for the reduced amount of revenue that Pemex is expected to pay into the Mexican treasury. Further details about this fund are expected this month. The specific government regulations coming from all of this secondary legislation are to be published in October 2014, and additional details on contracts to be published in February 2015.

Round Zero

The term 'Round Zero' has been used to describe the process of deciding which resources Pemex will keep and which ones will be put up for bidding or farm-out in the country's first post-reform bid process ('Round One'). Upon signing the aforementioned legislation, President Peña Nieto noted that he wished to "accelerate" the reform process by having the Energy Secretariat (Sener) reveal its decisions on which assets Pemex would be able to retain monopoly ownership of and which ones would be part of bid round one in 2015. This occurred about a month before the decision was expected to be made public. Hence, just two days later, on 13 August, Sener revealed that Pemex was granted rights to 100% of assets already in production, and overall about 83% of the country's proven and probable reserves, as the company had requested. However, Pemex was granted just 21% of Mexico's prospective reserves, lower than the 31% that the company had requested. Pemex also revealed ten projects that will be made available to joint-venture partners, with more likely to follow. Pemex has, unsurprisingly, selected projects that can benefit

from additional expertise and technology, such as the offshore (shallow-water) ultra-heavy and sour Ayatsil-Tekel and Utzil projects.

For the areas not assigned to Pemex and in Round One, which according to Sener represent 3.8 billion barrels in proven and probable reserves, as well as 14.6 billion barrels of prospective reserves, an auction of 169 blocks is to be held sometime between May 2015 and September 2015. In addition, Pemex announced that 11 service contracts currently in operation will be migrated to one of the new forms of contract available prior to the bid round commencing. Pemex has estimated that this bid round and future ones, as well as new joint-ventures and contract migration will bring about $76.5 billion in new investment in the country in the next ten years. Given that CNH has no experience in handling bid rounds, and that the timeline is fairly tight to accomplish all of the above, challenges for the sector and for the Mexican government remain. 

North Sea

It is estimated that August will be the monthly low for the year for North Sea offshore production (including all Norwegian offshore areas), at slightly more than 2.4 mb/d, as output increases m-o-m in the remaining four months of the year, achieving a 4Q14 average of about 2.9 mb/d. Note that German offshore production has dwindled in the last few years to the point where 99% of that country's crude oil production of 50 kb/d is now onshore.

Norway - June actual, July preliminary: Total output pushed back above 1.9 mb/d in July, as maintenance was very light after a heavy May and still substantial maintenance in June. The Draugen, Skuld, and Valhall fields did experience technical problems, reducing their production, but for other fields it was a very good month, as crude oil production returned to early-spring levels, at over 1.5 mb/d. We expect some maintenance took place in August, though not as much as in May, and the 58-kb/d capacity Troll C floating platform was taken offline for at least a week in late August due to corrosion problems, with Fram production also affected by the outage. Final June data show crude oil production at just under 1.4 mb/d. NGL and condensate output was revised up about 30 kb/d, however, so total liquids came closer to 1.8 mb/d than 1.7 mb/d. Lundin has announced that the start-up of the Brynhild field has been delayed until sometime in 4Q14, attributing problems in preparing the FPSO to its partners on the project.



UK - June actual, July preliminary (crude only): July crude oil production was about 710 kb/d, down about 25 kb/d on June given additional maintenance in the latter month and outage on the Buzzard field. June total liquids output was about 830 kb/d, with July total liquids estimated to have fallen by 30 kb/d m-o-m. Given the lengthy August Forties outage, as well as additional problems on the Buzzard field in the latter part of the month when the Forties system was back online, production is estimated to have fallen just under 600 kb/d for the month. Buzzard output for 2013-2014 is expected to average about 40 kb/d below its peak of 210 kb/d reached in November 2013 due to numerous unplanned outages, though the field is not in decline. The great majority of the UK's offshore production is in Scottish waters, and a referendum on Scottish independence is to be held on 18 September.

BFOE loadings are assessed at 716 kb/d for August, and scheduled to rebound to 920 kb/d in September with only Brent loadings expected to be significantly below the yearly average, at 100 kb/d. Given continued problems with Buzzard and a more gradual return to normal production levels in general after extended outages on the North Sea, we expect September BFOE production to still be curtailed, at 830 kb/d.

Non-OECD

Latin America

Brazil - July actual:  Crude and condensate output continued its upward path in July, inching up by 20 kb/d to reach nearly 2.3 mb/d, Brazil's highest-ever output.  NGL production also set a record, although there have been many months in the past within 5 kb/d of July output of 98 kb/d. Much of the crude oil increase came from the Roncador field in the Campos Basin (Brazil's largest field for the month) and the Lula field in the Santos Basin. The P-62 platform on Roncador continues to ramp up, as does the Cidade de Paraty FPSO on the Lula field. The P-58 platform connected to the Parque das Baleias complex of fields also contributed to the gain. Petrobras connected six new wells at offshore facilities in July, and the Cidade de São Paulo FPSO on the Sapinhoá field reached full capacity output of 120 kb/d on the month.

Despite this, pre-salt production was flat on the month, at 480 kb/d, after many months of increases, and fields such as Marlim (including Leste and Sul) and Albacora (including Leste) continue their long decline. Many platforms required heavy maintenance in July, cutting net gains for the month. Petrobras remains under fiscal pressure, as upstream production in 2Q14 was outstanding, yet profits for the quarter fell by 20% y-o-y as costs increased and write-offs for dry or non-commercial wells were substantial. Net debt rose to $110 billion, given dividend payments and debt-financing the company's investments. In mid-August, the Cidade de Mangaratiba FPSO left its shipyard to head to the Iracema (Sul) field, where production is forecast to commence in December 2014.

Asia

China - July actual: Chinese oil production fell substantially in July, for reasons that are not entirely clear. Crude oil production dropped under 4.1 mb/d, the lowest since September 2013, when the industry was still recovering from the extensive floods of oilfields that summer. The country's two largest, mature fields where IOR/EOR is ongoing experienced reductions: -25 kb/d on the Daqing field, -20 kb/d on the Changqing field. Given the very large size of these fields, this could be natural decline. However, the largest decline m-o-m was in the reported output of 'CNOOC and others', the others being smaller companies undertaking that onshore production not carried out by CNPC and Sinopec. Some offshore maintenance is a possibility; it is also possible that there was flooding in more isolated areas with smaller fields that has not (yet) been reported. This uncertainty has reduced our outlook for China somewhat, with the y-o-y increase reduced to 30 kb/d for 2014, at 4.2 mb/d (total liquids).

Former Soviet Union

Russia - July actual, August preliminary: August output bounced back from July's yearly low of under 10.1 mb/d for crude and under 10.8 mb/d for total liquids, as Gazprom increased condensate output by 90 kb/d m-o-m on higher natural gas production and the completion of major maintenance at Sakhalin brought up PSA operators' output by 90 kb/d. For August, NGL and condensate production increased by 80 kb/d, and crude oil by about 50 kb/d, for total liquids of 10.9 mb/d.

Changes in the subsoil resource tax regime appear imminent, with the Finance Ministry issuing a draft proposal in August to increase the Mineral Extraction Tax (MET) by 57% in 2015, with further increases after that. However, export duties on crude oil and certain oil products would be lowered, offsetting much if not all of the increase in the MET for exporters. This change, brought about in part to harmonise oil export duties with those of Kazakhstan, also shows that the government is willing to allow many producers to retain more of their earnings, as an even higher increase in the MET had been under consideration. The plan also encourages refiners to invest in upgrading, as fuel oil will eventually have the same export duty as crude oil under the proposal, albeit two years later than initially proposed, while export duties on products such as gasoline and diesel are to fall sharply. Another proposal by the Energy Ministry in early September would implement a trial of a tax system that would tax profits (thereby taking into account production costs) rather than merely revenues. However, this would necessitate the creation of a new accounting system, to which the sector may have difficulty adapting, and it is unclear whether this would be a net positive or negative for government revenues. However, the aim of the government may be to raise recovery rates, as a profit tax rather than a revenue tax can make it more economic to develop difficult reserves.

This all comes as, at the time of writing, additional economic sanctions by the European Union have been prepared, but have been put on hold for at least a few days as, according to EU President Van Rompuy on 8 September, "This will leave time for an assessment of the implementation of the cease-fire agreement and the peace plan. Depending on the situation on the ground, the EU stands ready to review the agreed sanctions in whole or in part." Some of these proposed additional sanctions are reported to target the financing of state-owned Russian oil companies. In particular, state-owned companies Gazpromneft, Transneft, and Rosneft would be barred from raising funds on capital markets with a maturity of 30 days or more (under current sanctions it is 90 days). Technology transfer for deepwater projects is also reportedly proposed to come under greater restrictions, in addition the current ban on such transfer for Arctic and shale oil projects.

We forecast a 90 kb/d decline in Russian crude oil production in 2015, but this is an extension of current trends rather than an immediate effect of sanctions. Nevertheless, even in the short term, EU and other sanctions are certainly not helpful to Russian producers, thereby lowering the upside risk of a turnaround from 2015's expected annual decline, the first one since 2008. Rosneft, in particular, has shown some evidence financial strain, though it could be said that sanctions exacerbate more than cause this stress, and 2Q14 financial results were generally positive. Recent declines in oil prices may also be causing concern, though, if the price has dropped below Rosneft's budgeted price for the year. A share in the crown jewel of its upstream assets, the massive and highly-profitable 440-kb/d Vankor field, would likely not have been offered to Chinese shareholders on 1 September if the need for additional financing were not pressing. Other signs that Rosneft is looking to cut costs include reports in the Russian press that the company is planning large-scale staff reductions at its headquarters and has asked the Russian government for financial assistance. In addition to being a state company, and thereby more exposed to sanctions, Rosneft borrowed heavily in order to acquire TNK-BP in 2013, and carries substantial debts. The prospect of drilling at rates even higher than the 83% y-o-y increase in hydrofracs achieved in 1H14 in order to turn around the decline on mature West Siberian assets under its Yuganskneftegas subsidiary seems unlikely. A forecast 45-kb/d decline in 2015 on current production of over 3.7 mb/d is marginal, but medium-term implications could be more severe. Rosneft currently produces some 37% of Russian crude oil output, a quantity by itself greater than that of any OPEC country, save Saudi Arabia, and is a major contributor to the Russian treasury.



Azerbaijan - June actual, July preliminary: Azerbaijani crude oil production reached 885 kb/d in July, including 50 kb/d of Shah Deniz condensate. This is up on June's output of 860 kb/d, likely due to the continued expansion of production from the West Chirag field, which started in January 2014. BP released 2Q14 data on the large offshore ACG fields that are responsible for the majority of the country's production, with West Chirag averaging 41 kb/d for the quarter. The design capacity of its platform is 183 kb/d. Other ACG fields were stable on the quarter, except for West Azeri, which continues its steady decline. 



FSU net oil exports dropped by 250 kb/d to 9.2 mb/d in July as a 200 kb/d increase in crude deliveries failed to offset a steep 450 kb/d decline in product shipments. The hike in crude exports came amid higher exports from Kazakhstan and Azerbaijan, which were largely shipped outside the Transneft network. Flows through the BTC exceeded 740 kb/d (+100 kb/d m-o-m), their highest levels since March 2012, as the State Oil Company of Azerbaijan (SOCAR) shipped more Azeri oil through the line. Preliminary data for August suggest that flows through the line dropped back to June levels. As construction to increase the capacity of the CPC pipeline continues, flows through the line continue to rise, hitting 890 kb/d (the third highest on record) as Kazakhstani crude production rose by over 100 kb/d on the month.

In Russia, crude exports remained level with June at 3.9 mb/d, their lowest level in several years, as domestic demand for crude remains high with refiners keeping throughputs near historical highs. With Russian refinery throughputs at record highs in August, exports will likely continue to be constrained. August loading schedules appear to confirm this, with seaborne deliveries via the Transneft network set to contract by a further 5%. Volumes from Baltic ports are expected to be especially hard-hit with shipments via Primorsk set to decline to near 500 kb/d, their lowest level since at least 2003.

High Russian refinery activity did not translate into high product exports as shipments plummeted by 450 kb/d month-on-month to 3.0 mb/d in July. Reports suggest that some product may have been put into storage as regional demand remained underwhelming while a further constraint on fuel oil exports may have come from marine bunker fuel sales. Anecdotal reports suggest that domestic sales of residual fuel oil from Russian marine bunker suppliers [NB: bunkers are not accounted for as exports] were brisk as prices remained on a downward course throughout June and July.

OECD stocks

Summary

  • OECD industry inventories built seasonally by 15.5 mb to stand at 2 670 mb at end-July. The deficit of total oil stocks versus the five-year average narrowed slightly to 57 mb while refined products covered 29.6 days of forward demand at end-month, a rise of 0.6 days on end-June.
  • Soaring US inventories of 'other products' drove July stocks higher as US market participants continued to seasonally restock amid increasing production and seasonally weak demand.
  • A 15.7 mb downward revision was made to June data, centred on OECD American 'other products' holdings. Therefore, the 13.8 mb stock build for June presented in last month's Report is now seen as a 7.3 mb counter-seasonal draw, halting five consecutive monthly builds.
  • Preliminary data indicate that stocks continued on their upward trajectory during August as they rose by 19.2 mb, more than double their typical seasonal build.

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

OECD industry inventories built seasonally by 15.5 mb to stand at 2 670 mb at end-July. The deficit of total oil stocks versus the five-year average fell slightly to 57 mb at end-month with refined products in OECD Europe accounting for 50 mb of the gap. Inventories have now built for six of the past seven months with only June showing a counter-seasonal draw after data were adjusted downwards.



A 15.7 mb downward adjustment was made to June data. Since May data were revised upwards by 5.4 mb, the steep 13.8 mb preliminary stock build for June presented in last month's Report is now seen as an unseasonal 7.3 mb draw halting five consecutive monthly builds. The revision was centred in the OECD Americas where estimates of 'other products' inventories were adjusted downwards by 9.2 mb but were still seen rising by a steep 15.9 mb. Middle distillates holdings were revised down by 3.0 mb. The second quarter stock build in OECD industrial stocks has been tempered accordingly and is now seen at 67.9 mb (800 kb/d), compared to the 88 mb (970 kb/d) originally presented. This is the steepest quarterly build since 2Q10.



The July build was driven by soaring 'other products' inventories in the US, chiefly ethane and propane as market participants continue to seasonally replenish holdings amid high domestic natural gas production and weak seasonal demand and ahead of the peak demand season for heating and crop drying starting in September. In particular, ethane production in the US achieved record quarterly production of 1.1 mb/d in 2Q14 at a time of reduced demand because of petrochemical facility maintenance. Middle distillates posted a 12.5 mb build, slightly less than the 16.4 mb five-year average build for the month. OECD middle distillate inventories now stand at a 56 mb deficit to average levels, with OECD Americas inventories standing a significant 31 mb below average. All told, refined products inventories rose by a steeper-than-average 33.5 mb. At end-month, they covered 29.6 days of forward demand, a rise of 0.6 days on end-June.

July crude oil inventories showed diverging patterns across OECD regions. In the OECD Americas, inventories dropped seasonally by 16.1 mb, double the five-year average draw for the month, as US refiners ran at extremely high utilisation rates exceeding 90%. Stocks dropped by 7.3 mb in Asia Oceania as refiners came back from maintenance and throughputs rose by a steep 650 kb/d, likely outpacing crude imports. In Europe crude holdings rose counter-seasonally by 7.1 mb as, despite a 760 kb/d increase in refinery activity, throughputs remained 570 kb/d below a year earlier amid low margins.

Preliminary data indicate that stocks continued on their upward trajectory during August as they rose by 19.2 mb, more than double their typical seasonal build. As in previous months, the build was centred on US 'other products' holdings which added a steep 14.5 mb over the month. All told, refined products built by 22.5 mb as middle distillates and fuel oil also increased by 8.7 mb and 1.3 mb while motor gasoline drew by 3.0 mb. Crude oil drew by 5.3 mb as inventories in the Americas and Asia Oceania fell by 6.3 mb and 2.1 mb, respectively, more-than-offsetting a 3.1 mb rise in Europe.

Does the Return of Contango Signal an Uptick in Floating Storage?

Recent declines in prompt month crude and product prices have moved a number of markets into prolonged contango (when oil for future delivery is priced higher than for prompt delivery) for the first time in four years. This raised the prospect of the return of floating storage as a trading 'play'. August saw a flurry of vessel bookings from market participants eager to buy prompt cargoes in anticipation of prices rallying in the future.

Preliminary inventory data for August and tanker tracking data do not support the idea that floating storage has significantly increased and anecdotal reports suggest that market participants have put their extra cargoes into land-based storage. With the price spread between first- and second-month Brent prices on the ICE futures market remaining at about $0.80/bbl over July and August, it appears that the economics support land-based storage but not floating storage which normally requires a sustained contango of at least $1/bbl to cover the higher costs involved such as freight, insurance and bunker fuel.

During August a number of West African, Middle Eastern and North Sea crude cargoes were bought by traders and initially thought to be destined for floating storage, although it now appears that these were shipped to the Saldanha Bay terminal near Durban, South Africa which offers easy export routes into Asian and Atlantic Basin markets. In Europe, there is also evidence that, with a steep contango persisting in the ICE gasoil contract, market participants have put product into land-based storage. Preliminary August data suggest that gasoil volumes in independent storage in Northwest Europe rose while Euroilstock data indicate that middle distillates rose by 1.7 mb. Outside of Europe, reports from shipbrokers indicate that there has been some activity in Asian markets with traders exploiting weak prompt-month fuel oil prices by buying consignments and storing them offshore Singapore.

Discounting semi-permanent storage, global floating storage of crude and refined products is currently assessed at approximately 45 mb. Evidence suggests that this continues to be led by oil stored on the water out of necessity rather than for economic reasons; notably cargoes of Iranian and KRG crude.

Recent OECD Industry Stock Changes

OECD Americas

Commercial total oil inventories inched up marginally by 0.2 mb in OECD Americas over July as a 17.7 mb increase in refined products balanced out a combined 17.5 mb drop in crude, NGLs and other feedstocks. Since the uptick in total oil stocks was weaker than the 10.8 mb five-year average build for the month, the surplus of inventories to average levels more than halved, to 8.8 mb at end-month from 19.4 mb one month earlier. Regional refined product holdings covered 28.7 days of forward demand in July, a rise of 0.6 days on end-June.



Crude stocks tumbled by 16.1 mb, approximately twice the seasonal draw as refiners came back from scheduled maintenance with regional throughputs climbing by 650 kb/d to 19.6 mb. Despite the increased refinery activity, stocks of motor gasoline, middle distillates and fuel oil dipped by a combined 1.1 mb as exports of refined products remained high. 'Other products' led refined products inventories upwards. Although adhering to seasonal patterns, 'other products' stocks have now posted four consecutive steeper-than-average monthly builds, most likely as US NGL production continues to increase compared with a year earlier. These have been driven by increases in US LPG holdings where stockholders are building product rapidly ahead of peak demand for crop drying and the winter heating season (propane is the heating fuel of choice in the US Midwest), and anxious to avoid a repeat of last winter's propane shortages. Data from the US Energy Information Administration (EIA) indicate that half of the July stock build was located in the Midcontinent (PADD 2). At end-July, regional 'other products' stocks stood 11 mb and 22 mb above a year earlier and the five-year average, respectively.

Preliminary weekly data from the US EIA suggest that US commercial oil stocks rose for a seventh consecutive month as they inched up by 2.5 mb in August. However, crude oil inventories sank by a steep 6.3 mb despite throughputs dipping by 100 kb/d following a number of shut-ins at refineries in PADD 2. The draw in crude was concentrated in PADD 3 (-5.4 mb), where refinery runs remained at historical highs. Additionally, the Louisiana Offshore Oil Port (LOOP) was closed mid-month after reports of an oil spill, disrupting crude imports and inbound deliveries of West Texas crude and forcing refiners to draw stocks.

US refined products holdings rose by 9.7 mb in August. As in July, this was led by soaring 'other products' stocks which climbed by a steep 14.5 mb. Stocks of motor gasoline and middle distillates drew by 4.9 mb and 1.5 mb, respectively. US middle distillates inventories remain tight. At end-August they stood 36 mb below average levels after drawing by 5.8 mb since the turn of the year while US middle distillates exports have continued to grow, hitting 1.3 mb/d on average in August.

OECD Europe

Inventories in OECD Europe built by 14.6 mb in July. Since this was counter-seasonal to the 1.5 mb five-year average draw for the month, the region's deficit versus average levels narrowed to 46.2 mb from 62.3 mb one month earlier. Crude stocks rose counter-seasonally by 7.1 mb against a backdrop of regional crude prices flipping into contango. Despite throughputs remaining lower than a year earlier, they posted a 760 kb/d month-on-month (m-o-m) rise which drove refined product inventories 7.9 mb higher.

Middle distillates accounted for 6.9 mb of the build. Stockholders were encouraged to build stocks by favourable economics; contango in the ICE gasoil contract steepened over the month as prompt demand for products remained weak with later months gaining strength in anticipation of winter heating demand. Extra support going forward is likely coming from expectations of increased marine gasoil demand as tighter bunker fuel regulations are introduced in January 2015. Meanwhile, reports suggest that German consumers continued to restock along seasonal lines as stocks hit 59% of capacity in early-August. At end-July regional refined product holdings covered 36.1 days of forward demand, a rise of 0.5 days on end-June but 0.9 days lower than one year earlier. 



Preliminary data from Euroilstock indicate that European inventories rose seasonally by 5.5 mb during August. Despite a slight rise in refinery throughputs, crude oil built by 3.1 mb to climb further above average levels. On the products side, motor gasoline (+1.4 mb) and middle distillates (+1.7 mb) rose while fuel oil (-0.3 mb) and 'other products' (-0.4 mb) posted draws.

OECD Asia Oceania

Commercial oil inventories in Asia Oceania inched up by 0.7 mb in July, weaker than the 5.3 mb average build for the month. This saw the region's deficit versus average levels widen to 19.8 mb from 15.2 mb at end-June. Crude oil holdings dipped counter-seasonally by 7.3 mb as refinery throughputs increased by 650 kb/d m-o-m and outpaced crude imports. Refined products increased seasonally by 7.9 mb as builds in middle distillates (3.9 mb), 'other products' (2.6 mb) and fuel oil (2.0 mb) more-than-offset a 0.3 mb draw in motor gasoline. Following recent refinery rationalisation, Japanese motor gasoline inventories have steadily declined throughout 2014. At end-July, they stood at 10.9 mb, their lowest level since 1992. On a days-of-forward-demand basis, they covered 11.5 days, 1.2 days lower than one year earlier. At end-month, regional refined products covered 21.0 days of forward demand, a rise of 0.9 days on end-June but 0.9 days below one-year earlier.



Preliminary data from the Petroleum Association of Japan indicate that stocks there built by 11.2 mb in August. All oil categories bar crude oil (-2.1 mb) posted builds with demand for crude increasing as Japanese refiners ramped up their runs by 140 kb/d. The increased throughputs saw refined product holdings surge by 10.5 mb. Middle distillates accounted for the lion's share of the build, rising by 8.4 mb on the month. 'Other products', fuel oil and motor gasoline posted more modest builds of 1.5 mb, 0.4 mb and 0.2 mb, respectively.

Recent Developments in Singapore and China Stocks

According to data from China Oil, Gas and Petrochemicals (China OGP), commercial crude stocks built by an equivalent 8.6 mb (data are reported in terms of percentage stock change) in July. Additionally, it appears that China did not add to its Strategic Crude Petroleum Reserve in July as the difference between crude supply (crude production and net imports) and refinery activity indicated an unreported stock draw. Chinese commercial refined products surged by 14.2 mb in July. Soaring gasoil holdings (+16.8 mb) led stocks higher, amid reports of thin demand, while stocks rose by 1.0 mb and gasoline inventories declined by 3.6 mb.



Weekly data from International Enterprise indicate that land-based inventories of refined products in Singapore continue to trend below five-year average levels as stocks of middle distillates and residual fuel oil remain low. On m-o-m basis, inventories remained roughly level, inching up by 20 kb after light distillates soared  by 1.4 mb while residual fuel oil rose by 0.3 mb, offsetting a 1.1 mb dip in middle distillates holdings. Total stocks currently stand at 39.0 mb, 6.4 mb below a year ago.

Recent and Future Developments in Iranian Oil Storage

The Iran Oil Terminal Company (IOTC) recently announced the expansion of storage capacity at Iran's principal crude export terminal on Kharg Island. Four 1-mb tanks have been constructed which take total storage capacity at the port to 28 mb, a significant increase on the terminal's storage capacity of 7 mb at the turn of the millennium. These tanks were originally scheduled to be completed at end-2013 and are now understood to be operational. During 1H14, shipments from the port averaged 900 kb/d and accounted for over 80% of total Iranian crude exports. However, deliveries from the outlet are still significantly lower than pre-2012 levels when it regularly shipped over 2 mb/d. 

Since the adoption of sanctions targeting Iran's crude exports in 2012, Iran has seen its crude exports fall by over 1 mb/d to 1.3 mb/d. At times, sanction's-related export constraints have seen Iran's land-based crude inventories reach storage capacity with the National Iranian Oil Company (NIOC) forced to store crude on National Iranian Tanker Company (NITC)-controlled tankers at sea. At end-August, Iranian floating storage stood at 22 mb, substantially lower than its peak of nearly 50 mb in mid-2012. The expansion of land-based storage increases the flexibility of the Iranian supply chain, which could see floating storage volumes fall further over coming months, which will free-up NITC tankers for deliveries if required.



This map is without prejudice to the states or sovereignty over any territory, the delimitation of international frontiers and boundaries, and to the name of any territory, city or area

This development does not signal the end of the expansion of storage capacity, rather the beginning of a new phase. In early 2014, the Iranian administration announced that it had doubled the budget for energy storage infrastructure projects. In the short term, the Iranian administration plans to commission a further ten storage facilities by end-2015 which will have a combined capacity of 7 mb. Although exact details are scarce, sites earmarked include Omidiyeh and Gurreh. Looking into the medium term, Iran is planning to diversify its crude exports away from Kharg by building a new crude and gas export hub on Jask Island, outside the Straits of Hormuz in the Sea of Oman. Although currently in the planning stage, the $2.5 billion project will reportedly include an extensive tank farm with a capacity of approximately 20 mb while a 2 200 km pipeline will transport crude to the terminal. If approved rapidly, the administration claims the terminal could be completed by the end of the decade.

On the products side, the Iranian administration has reportedly expanded the storage capacity of refined products across the country in recent years to improve the supply and distribution chain. This has involved the construction of facilities at Arak, Kerman, Bojnourd, Qom, Semnan and Gorgan. According to semi-official Fars News Agency, further construction is taking place at Mahshahr, Birjand, Malayer, Shiraz and Orumiyeah, which are scheduled to be completed in 1H15.


Prices

Summary

  • Oil prices fell sharply in August, weighed down by plentiful crude supply and further indications of slow global economic growth. Exports from Libya are recovering despite ongoing violence, while Islamist militants that swept through northern Iraq have yet to trigger a major outage in OPEC's second biggest producer. ICE Brent futures tumbled below $100/bbl on 8 September for the first time in over a year and were last trading at $98/bbl. NYMEX WTI was around $91.40/bbl.
  • Rising Libyan exports, an overhang of West African barrels - resulting from slower US imports - and sluggish demand from refiners in Europe and Asia took their toll on spot crude prices, deflating global benchmarks. WTI showed the biggest month-on-month (m-o-m) loss due in part to unplanned refinery outages that forced a temporary slowdown in run rates while US output surged.
  • Large hedge funds slashed their long positions in crude oil futures in both ICE Brent and NYMEX WTI, reaching lows unseen since July 2012. Long exposure has collapsed from all-times high in July as Iraqi turmoil did not curb supply and push up prices as expected.
  • Clean product tankers rates for the Aframax Middle East Gulf - Japan route rose further in August after having surged in late July, reaching $33.19/mt, a level unseen in one year. Monthly product loadings reached their highest since August 2010, amidst still subdued Japanese refinery runs and growing Saudi throughputs.

Market Overview

Oil prices tumbled for a second consecutive month in August as rising exports from Libya and booming US production deepened the overhang in crude markets and overshadowed any lingering worries of potential output disruptions in Iraq, OPEC's second biggest producer. Further signals of slow global economic growth and a robust US dollar added to the pressure. A strong US dollar makes oil more expensive for buyers using other currencies. ICE Brent futures were down $4.79/bbl to $103.40/bbl while NYMEX WTI fell harder, losing $6.31/bbl to average $96.08/bbl in August. Abundant supply combined with weak economic growth has knocked ICE Brent from a mid-June high above $115/bbl to below $100/bbl on 8 September. Brent was last trading at $98/bbl, while NYMEX WTI was at $91.40/bbl.

The sharper decline on WTI widened the front-month spread with ICE Brent in August to an average $7.32/bbl versus $5.80/bbl in July. The m-o-m decline on US crude was exacerbated by unplanned refinery outages that cut run rates and by the steep backwardation - where prompt oil trades at a premium to future deliveries - that existed when the front-month contract expired.



While WTI remains in backwardation - the WTI M1-M2 spread averaged $1.05/bbl in August - the reverse structure, contango, is in place for European and Middle Eastern benchmarks that are sagging due to oversupply. Nigerian oil accounts for a big portion of the overhang: US purchases of light, sweet crude from the West African producer - which topped 1 mb/d a decade ago - have all but stopped as domestic output surges. Much of that excess has been shifted to Asia thanks to favourable trade economics, with China purchasing near record volumes of September loading-crude from Nigeria.

North Sea Brent remained stuck in contango, where prompt oil trades at a discount to later months, for a second straight month in August. The Brent M1-M2 spread deepened to -$0.66/bbl versus -$0.32/bbl in July, while the average August Brent M1-M12 spread sank to -$0.78/bbl versus $2.06/bbl in July. The contango structure in Brent and Dubai has prompted traders and oil majors to deliver oil into storage in South Africa at the Saldanha Bay storage terminal (see box 'Does the return of contango signal an uptick in floating storage?' in Stocks section).


Futures Markets

August was another extremely bearish month for hedge funds' positioning on crude oil. After having collapsed from record highs, as Iraqi turmoil did not curb supply and prices fell for two consecutive months, money managers' long positioning further declined to lows unseen since July 2012, when Brent prices slipped below $90/bbl. Hedge funds slashed their long stance in NYMEX WTI as well, on the back of prices retreating to around $95/bbl. The 'long-to-short' contracts ratio now stands below 1.4, the lowest in 18 months.



Overall open contracts in the North Sea based benchmark had a modest 3.7% recovery on the month, albeit are now sitting at their lowest since January 2013. Conversely, NYMEX WTI open interest retreated monthly, and stands 16% lower than a year ago. Trading activity came off the historical peak in Brent contracts, down 25% on the month and 3.6% year-on-year. WTI volumes seem to have lost their momentum they got in late 2013 and are back on a downtrend, down about 17% on the year.





On the products side, hedge funds strengthened their short positioning in New York ultra-low sulphur diesel (ULSD, the former heating oil contract) throughout the month, as prices came under pressure from a well-supplied market. Funds also thinned their net long exposure to Rotterdam gasoil futures. As of 2 September, ICE gasoil funds are only 5 000 contracts away from short selling.





Financial Regulation

The US Federal Reserve board met on 3 September, easing proposed collateral requirements for swaps between banks, manufacturers and other firms.

On August 19, the US Commodity Futures Trading Commission (CFTC) issued limited two weeks no-action relief regarding documentation of confirmation of uncleared swap transactions. The agency is also preparing rules for position limits and is currently working on addressing energy firms' concerns that rules might harm their hedging activity. The rule is expected to be finalised towards the end of the year.

The European Securities and Markets Authority (ESMA) is poised to submit draft regulatory technical standards (RTS) on the swaps clearing obligation on 18 September, under the framework of the European Market Infrastructure Regulation (EMIR).

Spot Crude Oil Prices

Spot crude oil prices slumped in August, pressured by rising Libyan exports, excess West African crude - resulting from steadily lower US imports - and sluggish demand from refiners in Europe and Asia. The weight of the surplus barrels pushed North Sea Dated Brent below $100/bbl for the first time in more than a year in mid-August. It recovered slightly to average $101.56/bbl for the month, down $5.07 versus July. Middle East Dubai was more robust, shedding $4.36/bbl to average $101.43/bbl. WTI lost the most, falling $6.55/bbl to $96.38/bbl. Urals, supported by stronger fuel oil margins, held up best - losing $4.09/bbl to average $101.43/bbl.

As West African grades struggled to find homes, the premium for Nigerian grades shrank versus Dated Brent. North Africa also added to the surplus, with an improvement in Libyan output lifting exports to 550 kb/d in August - more than double July volumes (see Supply).



Higher shipments of about 570 kb/d are expected this month. The extra barrels weighed on the market for Caspian light sweet CPC blend and pushed North Sea Oseberg and Ekofisk during August to the lowest values versus Dated Brent in over seven years.



Higher volumes from Libya, Iraq, the North Sea and Russia are expected to arrive in September as refiners in the US and Europe start maintenance work that will temper demand (see Refining). Larger shipments of sour Russian Urals are expected as domestic refinery maintenance gets underway and rising volumes of KRG crude arrive at the Turkish Mediterranean port of Ceyhan. About 170 kb/d of KRG crude loaded in August and flows through the Kurdistan Regional Government pipeline to Turkey are now running at roughly 200 kb/d. Exports of Basra Light from Iraq's Gulf terminal, depressed in August due partly to bad weather and loading glitches, are expected to rise. With maintenance finished, loadings from the UK North Sea are also set to increase (see Supply).



The narrow gap between North Sea Brent and sour Dubai has meanwhile created favourable trade economics that allowed Dated Brent-linked crudes to move east - shifting much of the Atlantic Basin overhang to Asia. The arrival of the West African barrels into Asia, however, has pressured differentials for Middle East and Russian grades such as ESPO and Sokol to multi-year lows. Spot Dubai barrels fell briefly below $100/bbl for the first time in a more than a year.

Declining crude inventories in the US trading hub Cushing, Oklahoma, helped lock in the backwardation of WTI. But the landlocked US benchmark appears to be responding more to regional fundamentals such as the prospect of excess supply from new inbound pipeline capacity coming online later this year. Inland crudes moved at deep discounts, with spot WTI traded at Midland, Texas, falling to more than $15/bbl below Cushing prices before recovering towards the end of August (see Supply). Rising domestic supply also kept a lid on LLS premiums to WTI.


Spot Product Prices

Spot product prices weakened across the board in August although while prices at the posted steep declines, outpacing weakening crude prices, declines in middle distillates prices were relatively moderate. Consequently, gasoline and naphtha cracks generally weakened while those for middle distillates firmed. 





Naphtha cracks fell across the board as spot prices continued on their downward trajectory during early August with spot prices weakening more than crude prices. Spot prices slipped below year-earlier levels amid weak petrochemical demand as LPG, especially in Europe, remains a cheaper feedstock. Prices finally bottomed out mid-month as buyers entered the market. However, crude prices continued to slide which saw cracks rebound in late-month so that by early-September, despite remaining embedded in negative territory, they remained above year-ago levels across all markets. In Europe, some strength was also garnered as demand from gasoline blenders picked up while in Asia healthy supply, notably from the Middle East, India and Malaysia capped gains.

Gasoline spot prices retreated across all markets in August on a monthly average basis as plentiful supply weighed heavy. Losses outstripped crude price falls and consequently gasoline cracks retreated in Europe and Asia. In Europe cracks were hit early-month by underwhelming domestic demand and a lack of interest from West African buyers while the arbitrage window to ship product from Europe across the Atlantic remained shut. However, cracks changed course from mid-August onwards as a number of unscheduled US refinery outages reopened the transatlantic arbitrage. In Asia, prices remained under pressure from high inventories in Singapore while regional demand also remained low. In the US the picture was better where the crack for unleaded improved by $2.28/bbl on average over the month after the aforementioned refinery outages buttressed spot prices while US crudes weakened against other global benchmarks.



European gasoil futures remained in contango throughout August as prompt month prices were pressured lower by anaemic regional demand, plentiful arrivals from the US and Russia and Northwest European stock builds while the back end of the futures curve remained firm in anticipation of higher winter demand and increased shipping demand with forthcoming new bunker fuel regulations. Despite this, gasoil cracks rose on a monthly average basis as regional crude price losses outstripped those of spot prices. In Singapore, gasoil spot prices were somewhat buttressed by low on-shore inventories while supply from Asian refiners remained constrained. However, the crack versus Dubai strengthened less than for Northwest European refiners as the grade strengthened against Brent. US diesel cracks continued to rebound from July's nadir as LLS weakened against other global benchmarks. Spot prices also received some strength from abundant opportunities to ship product to Europe and Latin America and stock draws on the Gulf Coast (PADD 3).



At the bottom of the barrel, fuel oil cracks in the US and Singapore posted month-on-month gains while in Europe HSFO outperformed LSFO. Spot prices weakened across the board as demand remained thin amid plentiful supply. In Singapore low demand from Japan and from the shipping sector pressured prompt prices lower. This has reportedly led a number of traders to charter tankers to store product in the region amid anticipation of higher demand going forward. In Europe, LSFO spot prices slipped by $4.40/bbl on a monthly average basis compared to a more moderate $1.70/bbl for HSFO after the latter was supported by bunker demand and an open arbitrage to ship product to Asia while high regional supply pressured the former lower.

Freight

Rates for crude carriers had a volatile month, albeit settling around prior month's levels. Very large crude carriers (VLCC) tankers activity picked up in the second and third week of August, as solid demand and weather delays lifted the Middle East Gulf-Asia benchmark rate to near $14/mt, its highest since February, before it eased to around $10.50/mt on lower loadings at end-August.

The Suezmax West Africa-US benchmark route softened throughout the month, as loadings from the region sat at their lowest since February. Vessels coming from the east are expected in early September, putting further pressure on prices.

In the North Sea, the Aframax rate seesawed between $6/mt and $10/mt, closing the month on a subdued note as cargoes got covered. Aframax rates in the Baltic had similar ups and downs, amidst a very active second week of August, finally settling around $6/mt.



Product tankers also had a mixed month. The Aframax Middle East Gulf - Japan route grew further after having surged in late July, surpassing October 2013 highs and reaching $33.19/mt, a level unseen in one year. Monthly loadings reached their highest since August 2010, on still subdued Japanese refinery runs and growing Saudi throughputs.

The 38 Kt Caribbean - US Atlantic Coast route reverted to June levels, hovering around $10/mt, after that the gasoline arbitrage window that prompted July's gains had closed. Rates for 30 Kt Singapore - Japan remained subdued as the region has still plenty of prompt ships available.

Refining

Summary

  • Global refinery crude demand rose by more than 2 mb/d over July and August to peak at 78.7 mb/d before seasonal maintenance likely curbed activity again from September. Surging OECD throughputs in July were offset by a drop in non-OECD runs, while both OECD and non-OECD runs moved higher in August.
  • Global crude runs projections for 2H14 are largely unchanged since last month's Report, averaging 77.9 mb/d in 3Q14 and 77.5 mb/d in 4Q14. Annual gains look set to average 0.7 mb/d for 3Q14, rising to 1.3 mb/d in 4Q14. New capacity in the Middle East, an expected rebound in Chinese runs and a more positive outlook for European refiners in 4Q14, compared with exceptionally steep contractions in regional runs at the tail end of 2013, support growth at end-year.
  • OECD crude throughputs surged by 2.1 mb/d in July, to average 37.6 mb/d, narrowing the year-on-year deficit to 330 kb/d, from more than 2 mb/d in June. Refinery runs rose in all OECD regions in line with expectations. Preliminary data suggest OECD throughputs rose slightly in August to 37.7 mb/d.
  • Refinery margins rebounded in August as benchmark crude prices weakened across the board while the ability to produce more of the most profitable products determined refiners' fortunes versus their regional rivals. Simple refiners in Europe benefitted from buoyant HSFO cracks while more complex refiners in Singapore took advantage of their high middle distillate yields.

Global Refinery Overview

After posting its first year-on-year (y-o-y) deficit in eight months in June, global refinery activity recovered over July and August, rising by an estimated 2.1 mb/d to hit a likely peak for the year of 78.7 mb/d in August. In July, a dip in non-OECD runs stemmed the increase, with both China and India reporting sharply lower runs from a month earlier. Unplanned outages and maintenance curbed runs in India and Vietnam, respectively, while Chinese refinery activity plunged by almost 0.5 mb/d from record high June rates, taking non-OECD Asian throughputs (including China) 150 kb/d below year-earlier levels. Also Russian refinery runs eased in July following a fire at Rosneft's Achinsk plant. Surging Saudi Arabian throughputs provided some offset, as Satorp's Jubail refinery pushed rates higher.

In contrast, July OECD throughput increased by more than 2 mb/d, with gains more or less evenly spread across the three regions. OECD throughputs had fallen counter-seasonally in June, following planned and unplanned outages in the US and Pacific, while weak margins likely caused European refiners to curb runs beyond scheduled maintenance. As the slump in refinery activity caused product markets to tighten and left the Atlantic Basin with ample crude supplies, refinery margins improved. Refiners took advantage of the higher returns where possible, underpinning the seasonal gains. Despite the sharp increase from June, both OECD and global refinery runs stood below year earlier levels. 



In August, an expected recovery in non-OECD refinery activity drove global runs higher, while OECD throughputs were largely unchanged. Global runs were nevertheless on track to resume annual gains, after a two-month hiatus. In all, global runs are forecast to rise by 0.7 mb/d in 3Q14 and a steeper 1.3 mb/d in 4Q14 y-o-y, though the latter gain is inflated by a very low base at the end of 2013. Gains will be particularly steep in the Middle East, where Saudi Arabia is on track to start up its second greenfield 400 kb/d refinery in less than a year, with Yasref's Yanbu refinery reportedly having started test runs in early September. By end-year, the 300 kb/d Paradip refinery in India and the 400 kb/d Ruwais refinery in the UAE are also set to be completed.

Refinery Margins

Refinery margins rebounded across surveyed markets in August as benchmark crude prices weakened across the board, although widening crude price differentials had a significant impact on refiners' fortunes. As US crudes softened against other global benchmarks, refiners there saw their margins rise by $3.90/bbl on average compared with increases of $1.10/bbl and $0.80/bbl for refiners in Europe and Singapore, respectively. Producing more of the most profitable products also helped simple refiners in Europe, who took advantage of buoyant HSFO cracks, and more complex refiners in Singapore, who benefitted from high middle distillates yields, outperform their regional competitors.

After arresting their steep declines in the first week of August, European margins rapidly increased so that by early-September they were once again approaching their recent highs to stand well above year-ago levels. The catalysts for this were weakening feedstock prices, while product prices, notably in the middle of the barrel, remained relatively firm. On a monthly average basis, refiners running Russian Urals saw their margins rise more than those processing Brent as Urals weakened against Brent. In a rare move, simple refiners in Northwest Europe posted steeper rises than more complex ones due to their high fuel oil yields, which saw margins boosted by surging HSFO cracks. Margins for simple refiners in Northwest Europe briefly entered positive territory in late August.



Margins for US refiners rose by $3.90/bbl on average in August, well above those posted in other surveyed markets, after US benchmark crudes weakened against other global grades. Refiners in the Midcontinent saw their margins rise by $4.80/bbl on average after Midcontinent grades such as WTI and Bakken softened against seaborne grades used on the Gulf Coast. This followed reduced regional crude demand in the wake of several refinery outages in the Midcontinent, notably at CVR's 115 kb/d Kansas, Tennessee plant and BP's 410 kb/d Whiting, Indiana refinery. These supply outages also supported spot product prices relative to the Gulf Coast, which further improved refiners' margins.

On the Gulf Coast, crude prices were supported by the mid-month closure of the LOOP terminal in response to a possible oil spill, which reportedly blocked crude imports into the region as well as disrupting seaborne crude shipments from West Texas. Product prices also decreased at a steeper rate as product supply remained plentiful amid record-high regional refinery runs.



In Singapore the choice of feedstock had a larger impact on refiner's fortunes than elsewhere. Those running light, sweet Tapis saw their margins improve by $1.10/bbl on average over the month while those refining sour Dubai posted gains of only $0.60/bbl on average after Tapis weakened against Dubai amid a glut of light, sweet crudes in Asia. Complex refiners also saw margins rise by more than simple refiners due to their increased yields of the more profitable products in middle of the barrel.

The table on IEA/KBC Global Indicator Refining Margins is available as Table 15 in the full tables section on the OMR website. See http://www.oilmarketreport.org/

OECD Refinery Throughput

OECD refinery crude throughputs surged by more than 2 mb/d in July, to 37.6 mb/d on average. Refinery runs rose in all regions, curbing the y-o-y deficit of total OECD throughputs to 330 kb/d from over 2 mb/d a month earlier. OECD throughputs declined counter seasonally in June, on a number of planned and unplanned outages, compounded by weak margins and discretionary run cuts. In July, however, North American refinery runs resumed annual growth of some 400 kb/d, while OECD Europe and Asia Oceania contracted by 570 kb/d and 160 kb/d, respectively.



Preliminary data for August indicate that OECD runs moved slightly higher from July levels and remained at seasonally high rates around 37.7 mb/d. In particular, improved margins look to have boosted European runs to their highest in a year. While OECD throughputs are set to fall steeply through October on seasonal maintenance, the outages are expected to be less important than last year. In fact, on a quarterly basis, in 4Q14, OECD refinery runs could post their first annual increase since 4Q12.



Refinery throughputs in the OECD Americas surged 650 kb/d in July, to 19.6 mb/d, after outages curtailed regional runs a month earlier. US refiners accounted for all of the gain. Gulf Coast refiners, in particular, raised their crude oil intake by 550 kb/d, to an average 8.6 mb/d for the month, an all-time high. Midcontinent runs were also at record highs of more than 3.7 mb/d, taking total US throughputs to 16.5 mb/d, 470 kb/d above the year-earlier levels.



US throughputs remained generally high in August, around 16.4 mb/d. US Gulf Coast runs reached yet another monthly high, of 8.7 mb/d, or almost 96% utilisation. Significantly improved Gulf Coast refinery margins since the last week of July supported maximum throughput rates. While margins also improved in the Midcontinent, a fire at CVR's 115 kb/d Kansas City refinery in late July forced the plant to shut for most of August. Operations at BP's 413 kb/d Whiting refinery in Indiana were only minimally affected by a blaze on 27 August. The fire, which was reportedly confined to a hydrotreater for gasoline producing FCC, caused a spike in wholesale gasoline prices in the Chicago area.



US Refiners Adjust to Changing Feedstocks

As US light tight oil (LTO) production continues to surge, refiners are investing to absorb the increasingly lighter API gravity feedstocks, and the impact on refinery yields is starting to be felt. As outlined in the 2014 Medium-Term Oil Market Report (MTOMR), surging US NGL and LTO oil production, and increased intake of light refinery feedstocks, has the potential to significantly raise the production of light distillates (naphtha and gasoline), as well as LPGs. Indeed, in the most recent data for which a full refinery balance is available, US gasoline yields, here calculated as the share of total gasoline production of total inputs, rose to almost 53%, more than 2 percentage points higher than both the previous year and the five-year average. As domestic demand for gasoline is expected to resume its structural decline due to improved vehicle fuel efficiency and increased biofuel supplies, the US gasoline balance will continue its transformation.

US crude oil production continues to exceed expectations, rising 3.2 mb/d over the last five years, to average 8.5 mb/d in August 2014. In particular, production of Eagle Ford LTO, the fastest growing shale play at

present, is expected to reach 1.5 mb/d by end-2014 and 1.7 mb/d a year later. Expectations for future growth already exceed those published in our last medium term outlook (see Eagle Ford Booming in OMR dated 11 July 2014), which saw total US production rising to 13.1 mb/d in 2019, from 10.3 mb/d in 2013 on average. 

As a result of LTO's increased share of US crude oil output and the US refining markets, the weighted average API gravity of crude oil input into US refineries has increased from around 30.0 degrees in 2009 to 31.2 degrees on average in the first six months of this year according to the US EIA data. This comes even as volumes of Canadian oil sands headed to the US market increase almost as rapidly. Canadian oil sands, or diluted bitumen blends, typically have an API gravity in the range of 19 to 22 degrees, compared with a range of 42 to 58 for Eagle Ford liquids for example. Canadian oil production, including synthetics, condensate, NGLs and conventional crude, is expected to increase to 5.2 mb/d in 2019, from 4.2 mb/d currently, and 3.2 mb/d in 2009. US imports of Canadian crude oil and refinery feedstocks had already surpassed 3.0 mb/d this summer. This is an increase of more than 30% in five years.



To deal with the increasingly bifurcated feedstock slate, of very heavy Canadian grades and light US crude and condensates, refiners are investing in new units, expanding or tweaking existing equipment to accommodate these new realities. As the majority of US existing refineries were mostly designed to process discounted heavy crudes, the focus for refiners has shifted to absorb the increasing light crude and condensate volumes, discounted compared with similar imported crudes.

Several large US refiners, including Valero and Marathon, have announced plans to increase light crude oil processing capacity. This involves adding equipment such as simple hydroskimmers, or topping units, and pre-flash towers, which extract some naphtha from the oil before it is processed in a crude distillation unit (CDU). Valero plans to add simple topping units at its Houston and Corpus Christi refineries on the Gulf Coast to process Eagle Ford crude with an API up to 50. It is also planning to expand CDU capacity by 25 kb/d at its McKee refinery to absorb higher Permian crude production. Marathon is building condensate splitters at its Canton and Cattletsburg refineries in the Midcontinent to process Utica Shale crude. Delek is adding pre-flash towers at its Tyler and El Dorado plants, while Calumet, Flint Hills and Tesoro are investing to increase capacity to process domestic crudes. Kinder Morgan, Magellan and Martin Midstream are building dedicated condensate splitters on the Gulf Coast. In all, more than 600 kb/d of new light tight oil and condensate processing capacity could be added in the next few years. Light product outputs are on track to rise further.

US net gasoline imports have already declined from over 900 kb/d in 2005 to 100 kb/d so far in 2014, with the US actually having been a net exporter in certain months. In coming years, as the feedstock slate continues to change and processing capacity keeps adjusting, US light distillate exports will reach increasingly far-flung markets. The OECD Americas could be left with a surplus of naphtha and gasoline of around 1.3 mb/d by 2019. The need to find a market outlet for this surging output of light distillates may be the greatest constraint on the refining industry's capacity to absorb new supplies and to meet demand for products that the market really needs, such as middle distillates.

For regional OECD refinery yields, please see Table 16 in the full set of OMR tables, available on our website http://www.oilmarketreport.org/

European refinery runs recovered in July, rising by a slightly steeper-than-expected 750 kb/d from June levels. If confirmed by final monthly statistics, regional runs of 11.6 mb/d were at their highest level since August 2013. Preliminary data from Euroilstocks indicate regional refiners increased runs further in August, due to improved profitability. Benchmark refining margins, both on the Mediterranean and in Northwest Europe, improved markedly since early June, on ample crude supplies and tightening product markets resulting from the weak refinery activity. Simple margins even turned positive at the end of August on higher HSFO cracks, even as refiners were preparing for another round of maintenance cuts.

Amongst others, Shell was planning maintenance on several units of its Pernis refinery in the Netherlands and on parts of its Godorf plant in Germany for most of September. Ireland's sole refinery, the 75 kb/d Whitegate plant, was expected to be fully shut for most of September due to maintenance, and Statoil's Mongstad refinery in Norway was planning to undertake partial turnarounds in September. Despite a brief shutdown of Total's La Mede refinery (148 kb/d) in July, French refinery runs rose by more than 110 kb/d month-on-month (m-o-m), to 1 170 kb/d on average, the highest level in almost a year. The company's 220 kb/d Donges refinery shut on 1 September for about a week. In the UK, Essar shut a 148 kb/d crude unit at its Stanlow refinery for about a week at the end of July. Essar announced it would mothball the plant's smallest crude unit, which has a nameplate capacity of 50 kb/d, by October.



Refinery throughputs in the OECD Asia Oceania also rebounded in July, by 650 kb/d from June, to average 6.46 mb/d. Refinery activity in both Japan and Korea picked up after maintenance following exceptionally weak runs in June. Japanese refiners lifted runs by a steep 480 kb/d, from 25-year lows hit in June. Based on preliminary data from the Petroleum Association of Japan, we estimate that Japanese crude runs rose by a further 110 kb/d in August, to 3.1 mb/d (adjusting for NGL intake included in weekly data). August is the low season for maintenance in Japan, with autumn turnarounds already curbing runs from September.

South Korean crude runs rose to an eight-month high of 2.6 mb/d in July, 160 kb/d higher than a month earlier. Oil product exports saw even stronger gains, averaging 1.2 mb/d, as refiners also drew down inventories. Gasoil exports rose 33% y-o-y, to an average of 445 kb/d, while gasoline exports rose 31% to 171 kb/d on average. In Australia, Caltex will start shutting its 135 kb/d Kurnell plant in October. The company had announced in 2012 that it would convert the refinery site into an oil import terminal, leaving the Sydney area without an operating refinery. Australian throughputs averaged 540 kb/d in July, up from 510 kb/d in June and 450 kb/d in May, when two of the country's refineries were undertaking maintenance.

Non-OECD Refinery Throughput

Non-OECD refinery crude demand eased in July, on lower throughputs in China and India, in particular. After posting record high rates in June, Chinese refinery runs plunged almost 500 kb/d m-o-m. Unscheduled outages in India and Russia, also contributed to the m-o-m decline, which totalled some 830 kb/d. Preliminary indications for August suggest throughputs recovered, though maintenance should again curb runs from September onwards. New refinery capacity in the Middle East and Asia will further lift runs in 4Q14 and early next year. In all, non-OECD crude demand is set to expand by 730 kb/d in 3Q14 and 1.0 mb/d in 4Q14, to reach 41.1 mb/d in 4Q14, following annual growth of some 1.3 mb/d over the first six months of the year.



After processing a record 10.2 mb/d of crude in June, Chinese refiners scaled back runs sharply in July, to 9.67 mb/d on average. Maintenance at PetroChina's 260 kb/d Lanzhou refinery from end-June and Sinopec's Yangzi and Shanghai Petrochem refineries contributed to the decline. Weak domestic demand, in particular for gasoil, has also been putting a damper on Chinese refinery activity. Apparent demand, calculated as refinery output plus net product imports and stock change, contracted in July, due to a sharp drop in product imports. This latter plunged by 33.1% y-o-y, the steepest decline on record. Refinery throughputs, meanwhile, were up 2% compared with the same month a year earlier. Industry surveys suggest refiners raised runs again in August, as some refiners restarted after maintenance.



In India, refinery throughputs also fell in July by 170 kb/d, on unscheduled outages. Following a fire and subsequent closure of HMEL's Bathinda refinery, Indian refinery runs slipped below year-earlier levels in July, to average 4.3 mb/d. The 180 kb/d plant in northern India processed only 13 kb/d in July, compared with 200 kb/d on average over the previous six months. The fire at the plant's vacuum gasoil unit in mid-June led the company to advance planned maintenance and shut the refinery. An unplanned outage at Chennai's Manali refinery also reduced throughputs. Higher throughputs from IOC's Panipat and Koyali refineries as they completed maintenance provided a partial offset.

Vietnam's sole refinery, the Dung Quat plant, was shut in June and through mid-July for scheduled turnarounds. In Taiwan, Formosa restarted a 180 kb/d crude unit in June, after a 45-day shutdown, with an 84 kb/d RFCC restarted in July after a three-month shutdown.

Russian refinery throughputs surged to a new record high in August, hitting the 6.0 mb/d mark for the first time. Throughputs were 200 kb/d higher than a month earlier and 250 kb/d above the same month in 2013. Russian refinery runs had fallen back slightly in July, following a deadly fire, which shut Rosneft's Achinsk refinery from mid-June until early September. The plant normally processes around 160 kb/d of crude. Rosneft was expected to lift production at its recently expanded Tupase refinery on the Black Sea in September, to its 240 kb/d nameplate capacity, after receiving clearance to use a new crude pipeline. After completing an expansion last year, which nearly tripled its capacity, the plant has been running at low utilisation rates. The plant processed an average 165 kb/d in the first seven months of this year, compared with 90 kb/d over the same period in 2013.

In Ukraine, fuel suppliers have reportedly increased oil product imports from the Baltic Sea, through the Lithuanian port of Klapeida and then by rail, as product shipments from Russia and Belarus have dwindled. Ukrainian refinery runs slipped to only 54 kb/d in June, as most of the country's refineries stand idle. Only the 363 kb/d Kremenchug plant, running significantly below capacity and the smaller Shebelinsky condensate refinery seem to be operating. In June, domestic supplies of gasoline and diesel only met 22% and 12% of domestic demand, with the remainder imported from neighbouring countries. Ukraine normally sources 20% of its gasoline imports and 60% of its diesel imports from Belarus, though maintenance at the latter's Naftan and Mozyr plants over August and September led Ukraine to seek supplies from further afield.

In the Middle East, Saudi Arabian refinery runs averaged 2 055 kb/d in June according to JODI data, 80 kb/d less than in May and 100 kb/d below our expectations. Saudi throughputs were nevertheless 400 kb/d higher than a year earlier and set to rise further in coming months as the new Yanbu Aramco Sinopec Refining Co (Yasref) refinery starts up. News agencies reported that the 400 kb/d Yanbu refinery started trial runs in early September. The plant, located on the Red Sea, is reportedly processing Arab Light crude in the test period, before eventually shifting to Arab Heavy from the nearby Manifa oil field. The timing of the test runs is in line with earlier company statements suggesting that first commercial shipments of refined products would occur by November.



Iraqi crude processing is estimated to have fallen to 560 kb/d in July, with just under 400 kb/d processed at the main refineries. The 330 kb/d Baiji refinery, still under militant control, remains closed with no prospects of reopening in the near future. According to KRG Natural Resources Minister, Ashti Hawrami, it will take at least a year to repair the plant after it was damaged in an attack by ISIS militants in June. Crude processed at refineries and simple topping units in Kurdistan, currently estimated at 160 kb/d, is not included in official Iraqi Ministry data. While the latest KRG Ministry data only includes data up until January 2014, current throughputs at the three main KRG refineries - Tawke (DNO), Kalak (Kar Group) and Bazian (Bezan Pet) - are estimated at just above 100 kb/d. Another 60 kb/d of crude is estimated to be sold to local buyers for processing in small topping plants for domestic consumption.