Distillate demand driving market

Sam Fletcher
Senior Writer

Growing demand for middle distillate fuels in Asia and Europe has created a world shortage that can only be resolved by processing more crude to produce these straight-run products. But because additional crude supplies are not forthcoming, the result has been a sharp escalation of crude prices, said analysts at the Centre for Global Energy Studies (CGES), London.

If members of the Organization of Petroleum Exporting Countries increased their total production by 500,000 b/d, world oil prices would begin to retreat, CGES claims. However, the price of OPEC's basket of 13 benchmark crudes averaged $95.27/bbl through late April, with no indication of any interest among cartel members in increasing production and reducing prices.

In its Monthly Oil Report, CGES said: "OPEC's view of a 'fair' price for oil has continued to rise in tandem with actual prices, and there is no sign that the organization intends to take any action whatsoever to try to bring oil prices down. Indeed, the OPEC oil ministers . . . . continue to argue that their actions have had no bearing on oil prices, which, in their view, are being driven higher by a weakening US dollar, geopolitical tensions, non-OPEC production problems, refinery bottlenecks, speculative trading on the futures markets—in fact, just about everything imaginable, with the one glaring exception of their own production policies. OPEC's member-countries consistently produced less oil than the world needed from its residual suppliers in 2007, leading to a massive global stockdraw that averaged 750,000 b/d."

The oil industry began this year with just 67 days' worth of forward stock cover, 5 days less than at the start of 2007, CGES observed. Global oil inventories were drawn down last year "as OPEC first tightened supply to avert falling prices and then failed to boost it again in the face of another year of less-than-expected non-OPEC production," CGES said. The first quarter of 2008 witnessed a
further draw of 500,000 b/d, making it the sixth consecutive quarter of falling global oil inventories.

"Worryingly, OPEC once again expects strong growth in non-OPEC output this year, just as it did in 2007," said CGES. OPEC expects non-OPEC output (excluding Ecuador throughout) to increase by 900,000 b/d between 2007 and 2008, compared with the 600,000 b/d forecast by the CGES. This may not seem a huge discrepancy in relation to the 86 million b/d of global oil demand, but, given OPEC's caution since the Jakarta meeting of 1997, the impact of any underestimate of the amount OPEC needs to produce tends to get magnified.

"The world needs OPEC to err on the side of overproduction, not output restraint, if last year's massive stockdraw is to be reversed and oil prices are to be brought down from the heights they have reached in the first months of 2008," said CGES. "At the moment, the organization shows no sign that it recognizes that the world needs more of its oil and that inventories need to be replenished through large-scale restocking. On the contrary, OPEC gives every indication that its pursuit of high oil prices will continue. Faced with what looks like a one-way bet, it is little wonder that financial investors see oil as a safe haven for their funds as the US dollar weakens and yields on more traditional investments disappoint."

Production boost
CGES warned, "If forecasts of robust oil demand growth in 2008 are borne out, OPEC will need to boost its production to prevent oil prices from continuing to rise over the coming months. Even if global oil demand follows the CGES's far more pessimistic forecast, increasing by just 600,000 b/d this year compared with the IEA's [estimate of] 1.3 million b/d, OPEC will still need to maintain output at its current level for the rest of the year just to ease the upward pressure on oil prices and allow global oil inventories to be replenished at a rate similar to the one at which they were drawn down last year."

CGES said market points to watch include:

-- US economic growth and the impact of any slowdown in the US on China and the rest of Asia.

-- Any widening of the discounts offered by Saudi Arabia for its heavier export grades, signaling higher output.

-- Eastbound flows of oil as an indicator of Asian Pacific oil demand.

-- US crude and product inventory levels in the second quarter of 2008.

-- And the level of global refinery runs during and beyond the turnaround season.

(Online Apr. 28, 2008; author's e-mail: samf@ogjonline.com)

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