Oil Market Report: 12 October 2018

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Highlights

  • The forecast for demand growth in 2018 and 2019 has been reduced for both years by 110 kb/d to 1.3 mb/d and 1.4 mb/d, respectively. This is due to a weaker economic outlook, trade concerns, higher oil prices and a revision to Chinese data.
  • OECD demand, supported by a strong 1Q18 and robust US growth, will expand by 300 kb/d in 2018, slowing to 130 kb/d in 2019. Non-OECD demand will grow by 1 mb/d in 2018, led by China and India, which together account for 60% of the global increase.
  • Global oil supply is growing fast; in September, world oil production, at around 100 mb/d, was 2.6 mb/d higher than a year ago. Non-OPEC output is forecast to expand by 2.2 mb/d and 1.8 mb/d in 2018 and 2019, respectively, led by the United States.
  • OPEC crude oil production rose by 100 kb/d in September to a one-year high of 32.78 mb/d. Since May, OPEC output has increased by 735 kb/d, led by the main Gulf producers and supported by Nigeria and Libya, offsetting falls in Iran and Venezuela.
  • Refiners are facing increased competition as capacity additions surge between now and end-2019. After increasing by 0.9 mb/d this year, refinery runs will grow by 1.3 mb/d in 2019, while refined product demand growth is only 1 mb/d.
  • OECD commercial stocks rose 15.7 mb in August to 2 854 mb, their highest level since February, on strong refinery output and LPG restocking. OECD inventories are likely to have risen by 43 mb (470 kb/d) in 3Q18, the largest quarterly increase in stocks since 1Q16.
  • ICE Brent prices reached four-year highs above $85/bbl in early October. The Brent-WTI differential has widened to $9/bbl as US price increases were weaker. Product prices failed to match the gains made by crude.

Twin peaks

Both global oil demand and supply are now close to new, historically significant peaks at 100 mb/d, and neither show signs of ceasing to grow any time soon. Fifteen years ago, forecasts of peak supply were all the rage, with production from non-OPEC countries supposed to have started declining by now. In fact, production has surged, led by the US shale revolution, and supported by big increases in Brazil, Canada and elsewhere. In future, a lot of potential supply could come to the market from places like Iran, Iraq, Libya, Nigeria and Venezuela, if their various challenges can be overcome. There is no peak in sight for demand either. The drivers of demand remain very powerful, with petrochemicals being a major factor. In a new IEA study "The Future of Petrochemicals", the Agency points out that rising living standards, particularly in developing countries, are already underpinning strong demand growth for plastics and this will continue for many years to come.

As the oil market reaches the landmark 100 mb/d level, prices are rising steadily. Brent crude oil is now established above $80/bbl, with infrastructure constraints causing North American prices to lag somewhat. Nonetheless, our position is that expensive energy is back, with oil, gas and coal trading at multi-year highs, and it poses a threat to economic growth. For many developing countries, higher international prices coincide with currencies depreciating against the US dollar, so the threat of economic damage is more acute. The global economy is also at risk from trade disputes. In this Report, our revised demand outlook reflects these concerns: growth in both 2018 and 2019 will be 110 kb/d lower than our earlier forecast. As explained in the demand section of this Report, there is also an impact from methodological changes to Chinese estimates.

Today's elevated oil prices partly reflect very high crude runs during recent months and also supply fears as sanctions against Iran draw near. In fact, since May, when the US announced its withdrawal from the JCPOA and its decision to impose sanctions, the Vienna Agreement parties, plus Libya and Nigeria but excluding Iran, Mexico and Venezuela, have increased total oil production by a combined 1.6 mb/d. At the same time, total US supply has increased by 390 kb/d. Even China has seen the first year-on-year production growth in nearly three years in response to higher prices. Official statements from Saudi Arabia suggest that October exports are back to the high levels seen in June and that more oil is available for those who wish to buy it. Meanwhile, output in Iran, Mexico, and Venezuela has fallen by 575 kb/d. New data for OECD stocks show that in August they increased by a more-than-normal 16 mb and have been relatively stable for several months after falling significantly following the implementation of the original Vienna Agreement.

The increase in net production from key suppliers since May of approximately 1.4 mb/d, led by Saudi Arabia, and the fact that oil stocks built by 0.5 mb/d in 2Q18 and look likely to have done the same in 3Q18, lends weight to the argument that the oil market is adequately supplied for now. The IEA welcomes this boost to supply; however, with Iran's exports likely to fall by significantly more than the 800 kb/d seen so far, and the ever-present threat of supply disruptions in Libya and a collapse in Venezuela, we cannot be complacent and the market is clearly signalling its concerns that more supply might be needed.

It is an extraordinary achievement for the global oil industry to meet the needs of a 100 mb/d market, but today, in 4Q18, we have reached new twin peaks for demand and supply by straining parts of the system to the limit. Recent production increases come at the expense of spare capacity, which is already down to only 2% of global demand, with further reductions likely to come. This strain could be with us for some time and it will likely be accompanied by higher prices, however much we regret them and their potential negative impact on the global economy.

Demand

Summary

In this Report, a combination of higher prices, a less optimistic outlook for the global economy and a downward revision to Chinese data has reduced our expectation for oil demand growth. US demand remains strong, supported by robust diesel deliveries but other regions are starting to show signs of faltering. European oil demand rose above last year levels in July but fell back again in August, heavily influenced by weak German demand. Non-OECD demand remained robust in July but started to reflect the impact of high oil prices in August. Non-OECD Asia oil demand, supported by China and India, continues to be the main contributor to global growth. Overall, world oil demand is now expected to grow by 1.3 mb/d in 2018 and 1.4 mb/d in 2019. 



OECD Americas oil demand is projected to increase by 370 kb/d in 2018, supported by harsh weather conditions in 1Q18 and the start-up of petrochemical projects in the US. However, the strong year-on-year (y-o-y) increase in oil prices is slowing gasoline demand. More ethane crackers coming on stream should support OECD Americas growth at 145 kb/d in 2019. OECD Europe oil demand posted a decline of 90 kb/d y-o-y in 2Q18 and is projected to be 80 kb/d below last year's level in 3Q18. For the year as a whole demand will be down by a very small 15 kb/d in 2018 on very weak gasoil deliveries, but it will rebound by 70 kb/d in 2019. OECD Asia Oceania demand will post small declines in both 2018 and 2019. Overall, total OECD growth is projected at 300 kb/d in 2018 and 130 kb/d in 2019.



Non-OECD oil consumption should increase by 1 mb/d in 2018 supported by growth in Asian demand. In 2019, growth is set to accelerate to 1.23 mb/d. Asia will continue to be the main source of growth (0.91 mb/d in 2018 and 0.87 mb/d in 2019).



Supply

Global oil supply is growing at a relentless pace, even as Venezuelan production deteriorates and Iranian flows decline ahead of US sanctions. In September, world oil production was little changed from a month earlier at 100.3 mb/d, but more significantly, was up 2.6 mb/d on a year ago with non-OPEC countries accounting for almost the entire increase. Indeed, the recent breakneck pace of supply growth has led us to boost our non-OPEC supply growth estimate for this year to 2.2 mb/d. Next year's growth is unchanged at 1.8 mb/d. In OPEC, higher output from Saudi Arabia and other key Middle East producers has so far offset decreases from Venezuela and Iran.



In fact, since May, the month before OPEC and non-OPEC countries agreed to ease supply curbs, the 24 Vienna Agreement producers have raised output by a net 640 kb/d. Excluding Venezuela and Iran, the increase is 1.2 mb/d. Of this, Saudi Arabia has contributed almost 500 kb/d and record-breaking Russian producers have added nearly 400 kb/d. Supplies are also reaching record levels in the US and Canada despite infrastructure constraints and heavily discounted local crude prices.



In September, although non-OPEC supply was significantly above year-ago levels, it actually declined by 140 kb/d from August, as seasonal drops in Canada and Norway outweighed higher Russian flows. Higher supplies from OPEC offset this to keep global oil supplies steady at 100 mb/d. OPEC crude oil production rose to a one-year high of 32.78 mb/d with Saudi Arabia, African producers and the UAE more than making up for a further decline in Iran.

Looking ahead, more supply might be forthcoming. Saudi Arabia has stated it already raised output to 10.7 mb/d in October, although at the cost of reducing spare capacity to 1.3 mb/d. Russia has also signaled it could increase production further if the market needs more oil. Their anticipated response, along with continued growth from the US, might be enough to meet demand in the fourth quarter. However, spare capacity would fall to extremely low levels as a percentage of global demand, leaving the oil market vulnerable to major disruptions elsewhere.

Refining

Summary

With oil demand growth revised lower in this Report, a more pessimistic picture is now emerging for refiners worldwide. This is not helped by the recent surge in crude prices, driven by seasonally tighter crude markets in 3Q18. Even though incremental output from Saudi Arabia, Russia, Iraq and elsewhere has so far offset the declines in Iranian and Venezuelan flows, crude balances were tight, with draws estimated at about 650 kb/d in 3Q18. Refining margins instantly gave in to feedstock pressure, and in late September/early October they fell to their lowest levels since the beginning of the year.

We have extended our refinery runs forecast through end-2019 in this report, using a three-year average for maintenance shutdowns to define seasonality. This has revealed yet another looming challenge for refiners: competition from new refineries that will come online starting from 4Q18. Capacity additions of more than 2 mb/d are higher than the forecast demand growth for refined products in 2019. The bulk of additions, however, are likely to start or ramp up operations in the second half of the year. This is happening at a time when refining margins will enter a truly unpredictable period. The uncertainties are augmented by possible developments of Iranian and Venezuelan flows on one hand, and the countdown to the IMO 2020 marine fuels specification change on the other hand, that can possibly push diesel cracks to levels where they can carry refining margins independently. Overall, we forecast refinery runs increasing by 1.3 mb/d in 2019, compared to refined product demand growth of just 1 mb/d.



In terms of geography, the pattern of recent years continues. East of Suez will account for the lion's share of new additions, with two 400 kb/d complexes coming online in China and Saudi Arabia's 400 kb/d refinery, in Jazan. Malaysia is also bringing online the 300 kb/d first phase of RAPID, with several smaller-sized additions elsewhere in Asia. The only significant addition in the Atlantic Basin is the 200 kb/d STAR complex in Turkey that is currently being commissioned.

What is a departure from recent history, however, is the strong petrochemical orientation of the new refineries. Almost 1 mb/d of next year's new capacity is being built by Chinese textile conglomerates - Rongsheng, Hengli and Hengyi - that have taken the upstream integration (from the perspective of the downstream petrochemical sector) to new levels. China already has the highest degree of refining/petrochemical integration, with 75% of naphtha crackers owned and operated by refineries. The next phase of the integration process is driven by the petrochemical industry's clients, who want to capture the whole value chain. This is a strategy very much consistent with the future of oil demand growth, projected in the IEA's first comprehensive study "The Future of Petrochemicals", released on 5th October 2018. The sector is expected to become the main driver of oil demand growth, as transport goes through a transformative phase with stricter energy efficiency standards, penetration of alternative fuels and technologies and modal changes.



Stocks

Summary

OECD commercial stocks rose 15.7 mb month-on-month (m-o-m) in August to 2 854 mb, their highest level since February. On a regional basis, inventories built strongly in the Americas as refinery output and seasonal LPG restocking outpaced crude production gains, and to a lesser extent in Asia Oceania. However, they fell sharply in Europe. Stock gains in August ran ahead of the five-year average increase of 14 mb. Overall, inventories were around 34 mb below the average at the end of the month. This metric has been relatively stable since May, as stocks have moved in line with historical patterns.



Product categories moved in a predictable way: crude stocks declined 20.7 mb, in line with the five-year average, and oil products built due to higher refinery throughput and seasonal restocking of propane. For September, preliminary data show a similar pattern, with crude stocks declining further (-14 mb) and oil products building sizeably in Japan and the US. Overall, when September preliminary figures are added to August data, we estimate that OECD industry stocks increased by 43 mb (470 kb/d) in 3Q18, the second straight quarterly stock increase and the largest since 1Q16.

Data show that global crude inventories have reduced over the last few months, and that they continued to do so in early October. However, oil products stocks have built sizeably in the OECD since May due to record refinery runs. Refining margins declined sharply in the northern hemisphere in August.



Revised data showed a sizeable stock increase of 13.9 mb versus initial estimates for the OECD in July, prompted by upward modifications in Asia Oceania (+7.6 mb), Europe (+3.7 mb) and the Americas (+2.6 mb). There was also a data revision recorded for June, but, at 1 mb, it was small.



Prices

Market overview

Despite recent increases in global supply, prices have reached four-year highs as the date for Iranian sanctions draws near, Venezuelan output dwindles and available spare production capacity declines. ICE Brent has gained more than NYMEX WTI, improving the export economics of US crude. On 10 October Hurricane Michael made landfall on the US Gulf Coast. There has been little impact on prices even though a significant amount of Gulf of Mexico production has been shut-in. In the Middle East, the anticipation of lower Iranian exports saw differentials for key grades, with the exception of those from Iran, strengthen. In product markets, the seasonal reduction in demand for transport fuels weighed on refining margins. However, gasoil markets gained on strong Asia Pacific demand and disruptions to supply.