Global oil glut continues despite increasing demand

July 6, 2015
A year since crude prices plunged, oversupply lingers, evident in a record-setting stock build, as production by members of the Organization of Petroleum Exporting Countries remains far above the group target, squeezing high-cost producers elsewhere.

Conglin Xu
Senior Editor-Economics

Laura Bell
Statistics Editor

A year since crude prices plunged, oversupply lingers, evident in a record-setting stock build, as production by members of the Organization of Petroleum Exporting Countries remains far above the group target, squeezing high-cost producers elsewhere.

This oversupply, however, is seeing signs of easing, stemming from rising global oil demand growth and the slowdown in non-OPEC supply, notably in the US.

Global oil demand, after bottoming out to a 5-year low in second-quarter 2014, has steadily increased, supported by lower oil prices, cold weather in Europe, and additional economic gains. Demand from the Organization for Economic Cooperation and Development, after a long-standing decline, has started to show a rising trend.

A drop in drilling activity is gradually starting to take its toll on US production, and the growth of non-OPEC supply is expected to slow.

In the US natural gas market, supply growth will exceed the level needed to balance the market, leading to hefty inventories and lower prices.

World economic outlook

After hitting a soft patch at the start of the year, global activity is expected to finally achieve a higher growth trajectory, helped by low commodity prices and accommodative financial market conditions.

US economic activity stalled in this year's first quarter as the result of another cold winter, port labor disputes, and cutbacks in capital expenditures by oil and gas companies. US real gross domestic product decreased 0.2% in the first quarter, according to the third estimate of the Bureau of Economic Analysis.

As weather and strike-related disruptions receded, the US economy is showing signs of rebounding, led by consumer spending and housing activity. The Federal Reserve projected US real GDP growth this year to reach 1.8-2%.

The eurozone's economic recovery has been unexpectedly swift since late 2014. This is mainly thanks to the decline in oil prices, the weaker euro, and the European Central Bank's stimulus policies. Growth remains fragile, however, with high debt levels and political uncertainty. The sovereign debt crisis in Greece also is a source of great concern.

In Japan, the consumption tax hike in April 2014 is still hurting consumer demand. But domestic spending is benefiting from the Bank of Japan's expansionary monetary policy. A weaker yen also makes exports more competitive.

While the recovery in developed countries is gathering momentum, growth in developing countries, especially oil exporters, is slowing down. A strengthening US dollar also is raising concerns about balance-sheet exposures in developing countries with weakened local currencies and sizable dollar-denominated liabilities.

In China, cyclical deceleration continues, led by the downward trend in investment and the slower pace of exports.

The stagnation of the Latin American economies will continue as well, with persistent inflation, larger current account deficits, and foreign debts. Brazil remains in the grip of recession.

World oil demand

Global oil demand in 2015's first half outperformed due to additional economic gains, lower oil prices, and cold winter weather conditions in Europe. According to the latest Oil Market Report from the International Energy Agency, global oil demand averaged 93.3 million b/d in this year's first half, up 1.6 million b/d on the year.

Demand in the developed countries of OECD has been much more volatile than non-OECD demand, contributing to major shifts in market balances. The biggest change in oil markets recently, from a demand perspective, has been the evolution of OECD demand from a long declining trend to a rising one, according to IEA. OECD demand, which last year fell 460,000 b/d, was up 800,000 b/d to 46.5 million b/d in this year's first quarter, year-over-year.

Because of low motor fuel taxes and no negative effect from a strengthening US dollar, the spillover effect of low crude prices on private consumption has been most significant in the US. In 2015's first 3 months, with West Texas Intermediate averaging below $50/bbl, total US oil demand rose 480,000 b/d year-on-year to 19.29 million b/d, accounting for one third of the world's gain in oil demand in that quarter, according to EIA data.

However, as both lower price supports and additional winter heating demand fall out of the outlook, IEA forecasts OECD demand growth to decelerate through the end of the year.

Crude oil demand throughout Asia has been exceptionally strong over the first quarter of 2015, as the Chinese refineries increased run rates and strategic reserves.

For the full year, IEA forecasts global oil demand to climb to 94 million b/d from the 2014 average of 92.6 million b/d. Demand will increase 400,000 b/d this year to 46 million b/d in the OECD group and rise 1 million b/d in non-OECD countries to 47.9 million b/d, with the largest increases in China and other Asian countries. Non-OECD countries will continue to be the main contributor to global oil demand gains.

World oil supply

OPEC has continued to surpass its collective production output quota on a monthly basis over the course of this year's first and second quarters, aiming to squeeze out competitors and regain market share.

At the organization's June 5 meeting in Vienna, members decided to maintain their collective output quota of 30 million b/d for the next 6 months, although actual production has surpassed that level by upwards of 1.3 million b/d.

Elevated production could persist for at least the next few months, considering the desire to defend market share, recent rig count activity in key countries, and rising local summer demand, according to Simmons Energy Research. Iraq is expected to be the largest contributor to OPEC production growth in 2015.

If sanctions on Iran are removed, Tehran could boost exports by 1 million b/d roughly 7 months afterwards, Iranian Oil Minister said in early June.

OGJ forecasts that following this year's first quarter supply of 30.5 million b/d, crude output by the organization will average 31.3 million b/d in the second and third quarters and then ease to 30.8 million b/d in this year's fourth quarter.

Non-OPEC production is forecast to increase to 58 million b/d in 2015 from 57 million b/d a year earlier. IEA expects non-OPEC supply to decline in the second half of the year compared with an increase in the first half, leading to yearly growth of 1 million b/d, which is one third of growth witnessed in 2014.

OECD commercial inventories built up 38 million bbl in April, ending at a 147-million bbl surplus vs. the 5-year average level, the widest since April 2009.

Crude oil prices

Crude oil prices have started to recover from the low levels witnessed at the beginning of the year, driven by increasing demand, stock draws in the US, conflict in the Middle East, and expectations for an easing of US light, tight oil output growth. In May, North Sea Brent and WTI crude oil spot prices averaged $64.08/bbl and $59.26/bbl, respectively, up from a respective average of $47.76/bbl and $47.22/bbl in January. However, the upside was limited by still plentiful supplies and OPEC's decision of not cutting production.

In the futures market, speculators are increasing net long positions, indicating expectations for higher prices.

The Brent premium to WTI decreased to 53¢/bbl in late June from above $11/bbl in late February. In the US, higher refinery runs to meet gasoline demand during peak driving season have helped to support WTI.

WTI futures contracts for September 2015 delivery traded during the 5-day period ending June 4 averaged $60/bbl while implied volatility averaged 33%. Last year at this time, WTI for September 2014 delivery averaged $101/bbl, and implied volatility averaged 14%.

US energy demand

Total US energy demand will rise 0.4% to 98.88 quadrillion btu (quads), and energy efficiency will improve to 6,027 btu/dollar of GDP from last year's rate of 6,121 btu/dollar of GDP.

Oil will still comprise the largest share of the US energy mix, accounting for 35.8% of the market. Total use will be 35.426 quads, a 1.8% increase from last year. Demand for all major petroleum products will increase this year as a result of low prices.

With demand at 28.34 quads, gas will account for 28.7% of the energy mix this year. In 2014, US demand for gas totaled 27.59 quads. In light of low gas prices, rising demand for gas in electric power generation and by industrial users will drive this year's climb in gas use.

OGJ forecasts that coal demand will decrease sharply by 6.7% to 16.79 quads, and comprise 17% of this year's energy consumption. Preliminary estimates show that demand for coal by electric power producers dropped 15% in this year's first quarter vs. a year ago.

Nuclear power's share of electricity net generation has been increasing this year. OGJ forecasts that total demand for nuclear energy will be 8.5 quads this year vs. 8.33 quads last year, and nuclear power's share of the energy market will be 8.6%.

All forms of renewable energy used in the US this year will meet 9.9% of total energy demand, up from 9.8% last year.

US oil demand

Total US liquid fuels consumption rose 70,000 b/d in 2014 to 19.03 million b/d. In 2015, total liquid fuels consumption is forecast to rise 1.8% to 19.38 million b/d, boosted by low prices and economic gains.

US vehicle miles traveled are rising at the fastest pace in 15 years. In this year's first half, gasoline demand is estimated to have been 2.1% higher than during first-half 2014. As the effects of employment growth and lower gasoline prices outweigh increases in vehicle fleet efficiency, gasoline consumption for the whole year increases 1% to 9 million b/d.

Average US gasoline prices fell by one-third between June 2014 and April 2015. Since then, the average price of gasoline has continued to climb, catalyzed by short-term gasoline supply tightness in the US Midcontinent. OGJ forecasts that the pump price for all types of gasoline in the US will average $2.51/gal this year.

Lower jet fuel prices have translated into lower passenger fares and also increased numbers of flights and routes. In its annual summer air travel forecast, the Air Transport Association of America, the industry trade association for leading US-based airlines, forecasts that US airlines will carry a total of 223 million passengers from June through August, about 4.7% more passengers than during the corresponding 2014 period. OGJ forecasts that jet fuel demand will increase 2.2% to 1.5 million b/d this year due to more flights.

Strong diesel fuel consumption will continue this year because of heavy trucking and rail use. Distillate demand will average 4.1 million b/d, up 2.2% from last year.

Residual fuel oil demand has declined over time as less is used in electric power generation and by industrial customers. This year, OGJ expects a 14.4% decline in demand for residual fuel to average 220,000 b/d.

Liquefied petroleum gas and ethane demand will increase 6.9% this year across industrial, residential, commercial, and transportation users, averaging 2.52 million b/d.

US oil supply

In this year's first half, US crude and condensate production averaged 9.48 million b/d. This was an increase from 8.38 million b/d in 2014's first half. OGJ forecasts that crude and condensate production will average 9.45 million b/d this year, up from last year's 8.71 million b/d.

The number of oil-directed rigs in the US has declined for the 29th straight week to 628 in late-June since a recent peak during the week ended Oct. 10, 2014. Despite of the steep decline in oil rig count, production has increased as producers work through the backlog of uncompleted wells and achieve potentially better completions with higher initial production rates.

Drilling costs are also declining. According to data from the US Energy Information Administration, from June 2014 to May 2015, rates for drilling activities, which primarily represent service fees for contractors to drill oil and gas wells, declined 19.6%. Rates for support activities, which include the surveying, cementing, casing, and otherwise treating wells, declined 1.4%. The price of sands primarily used for hydraulic fracturing declined 12.5%.

Nevertheless, cuts in upstream spending and lower drilling activity levels have started to impact output. US crude oil production will begin to decline in June, with continuing declines through early 2016, EIA said.

In a most recent report, EIA forecasts crude production from seven major US shale plays to fall 91,000 b/d in July to 5.49 million b/d, including a 49,000 b/d drop in the Eagle Ford to 1.59 million and 29,000 b/d drop in the Bakken to 1.24 million b/d.

Natural gas liquids output will increase 7.3% to 3.18 million b/d. Most of this growth is expected to come from additional ethane and propane production.

Imports, exports

Total US imports of crude and products will average 9.2 million b/d this year, down slightly (0.2%) from last year. Product imports will increase 8.8%, and crude imports will decrease 2.5%.

During this year's first quarter, US total petroleum imports increased 2% over the same period the prior year to average nearly 9.4 million b/d. Crude oil imports were down 0.9% from the prior year, falling to 7.27 million b/d. Imports of refined products were up 13% to nearly 2.1 million b/d.

Canada is the No. 1 crude oil exporter to the US, representing 39% of all exports in 2014 with 2.885 million b/d. During this year's first quarter, crude imports from Canada averaged 3.223 million b/d, up 11.7% from the 2014 annual average.

With the startup of two major pipelines that move Canadian heavy crude to the Gulf Coast, Enbridge Inc.'s 600,000-b/d Illinois-to-Oklahoma Flanagan South Pipeline, and Enterprise Products Partners' 450,000-b/d Oklahoma-to-Texas Seaway Twin, more crude from Canada is expected to arrive and compete with other imports on the Gulf Coast.

Crude imports from Saudi Arabia, the No. 2 exporter, were down 21.1% to 915,000 b/d. This follows a 12.5% decrease in 2014. Total crude imports from OPEC member countries dropped 16.5% in this year's first quarter, following a 14.3% decrease last year.

The growth in refined product imports was mainly driven by motor gasoline imports. According to data from the American Petroleum Institute, total motor gasoline imports increased 11.2% year-over-year for the first 5 months of 2015. Product imports from Canada surged 39.6% in the first quarter to 702,000 b/d.

OGJ forecasts that the US will export 4.68 million b/d of crude oil and petroleum products, up 12% from last year. Crude oil exports averaged 445,000 b/d in the first quarter of 2015, up from 243,700 b/d in the first quarter of last year. Product exports averaged 4.02 million b/d in the first quarter vs. 3.6 million b/d a year earlier.

US crude exports have included modest amounts of Canadian-produced crude that was moved through the US and reexported.

US oil inventories

At midyear, industry crude oil stocks stood at 468 million bbl, up from 383.8 million bbl at the same time in 2014. Crude in the Strategic Petroleum Reserve totaled 692 million bbl.

According to OGJ's estimates, at the close of this year's first half, distillate stocks were up almost 10% from a year earlier to 133.7 million bbl. Total gasoline stocks were up 1.1% from mid-2014 to 221.3 million bbl. Jet fuel and residual fuel oil stocks were up from year-ago levels while stocks of unfinished oils fell.

Volumes of crude and oil products in storage will finish 2015 higher than a year earlier. OGJ forecasts that crude in industry stocks will be 439 million bbl, and products will total 776 million bbl compared with a respective 394 million bbl and 772 million bbl at yearend 2014.

Refining

Increased refinery runs, capacity, and utilization have helped accommodate increases in US crude oil production.

For year to date, refinery gross inputs were up 1.8% compared with year to date 2014. Gross inputs to refineries averaged a record 16.1 million b/d in 2014 compared with 15.1 million b/d in 2010. According to EIA's recently released annual Refinery Capacity Report, nearly 75% of the 1 million b/d increase in refinery gross inputs is the result of a four percentage point increase in refinery utilization compared with 2010. The rest of the increase is attributable to capacity expansions.

Operable refining capacity averaged 17.88 million b/d during this year's first half and is expected to increase though the remainder of the year, based on further investment in refinery expansion projects. Dakota Prairie Refining recently completed construction of one of the few new refineries built in the US in the past 30 years. Delek US plans to increase crude distillation unit capacity by 10,000 b/d at its Tyler, Tex., refinery, and Marathon Petroleum Corp. reported that it plans to add 35,000 b/d in condensate splitter capacity at its Catlettsburg, Ky., refinery by yearend.

Refinery utilization will average 90.8% this year on operable capacity of 17.92 million b/d, OGJ forecasts. Last year, refineries ran at 90.4% of capacity on average. A combination of factors is holding utilization high, including a strong rise in gasoline demand, high margins in the face of low input costs, and good exports opportunities.

For the first 5 months of this year, the Gulf Coast cash refining margin averaged $11.81/bbl, up 22% from a year earlier, according to Muse, Stancil & Co. And East Coast and West Coast margins averaged $5.87/bbl and $22.88/bbl, respectively, compared with a respective $2.74/bbl and $15.12/bbl during the first 5 months of 2014. However, as infrastructure builds out, some of the crude price advantages for Midcontinent refiners erode, resulting in less excessive margins from a year earlier.

The average composite cost of crude oil for US refiners in this year's first half was estimated at $51.05/bbl, down from $98.70/bbl a year earlier.

Natural gas market

Record-high US gas production will be more than enough to meet growing demand, leaving larger gas inventory in storage than 2014 and putting downward pressure on prices. Meanwhile, abundant US production and lower prices are displacing demand for gas imports and boosting exports.

OGJ's forecast of US total gas consumption is revised up to 27.53 tcf in 2015 vs. 26.82 tcf in 2014. The growth in demand is mainly promoted by the switch from the use of coal to gas in generating electric power, coal plant retirements, and to a smaller extent the increased gas consumption by industry, particularly in petrochemical production. According to Bentek Energy, year-to-date gas-power burn is up 3.1 bcfd, or 12%. Residental and commercial demand will decline this year compared with a 4% increase last year.

The total count of rigs targeting gas fell to 223 for the week ending June 19, according to Baker Hughes Inc. data. Since the start of 2015, the number of gas rigs fell 105 units. However, gas rigs seem to have stabilized in the past 2 months.

Despite of the drop in drilling activity, market production of gas continues to climb, reflecting increases in drilling efficiency and new systems coming online to move gas out of producing shale areas. Output from the Marcellus shale will contribute to a large portion of 2015 production growth.

The pace of gas production growth, however, is to decelerate slightly in 2015, driven by lower associated gas production combined with reduced activity.

From 2010 to 2014, US gas exports to Mexico doubled in response to declining Mexican production, increasing Mexican demand for gas, and rising US production. Mexico's energy ministry projects imports to continue increasing, reaching an annual average of 3.8 bcfd by 2018. According to Bente Energy, recent gas exports to Mexico have reached record levels of around 3 bcfd.

Cheniere's Sabine Pass LNG Train 1 is expected to start up as early as late this year, which should add 0.6 bcfd incremental gas demand when at full capacity, according to Simmons Energy Research.

This year, 2.62 tcf of gas from overseas will reach the US, a 2.6% decline from last year, according to OGJ. Imports by pipeline from Canada, accounting for nearly 97% of all US gas imports, is main driver of the decrease in total imports.

Due to high levels of gas production, this year's injection season is expected to one of the largest on record. Summer weather has been warmer than both last year and normal, which may mitigate surplus levels. EIA projects end-of-October inventories will total 3,912 bcf, 115 bcf above the 5-year average for that time.

The Henry Hub gas prices are expected to remain low throughout 2015, as OGJ forecasts an average spot price of $3.02/MMbtu for the year. This compares to last year's $4.36/MMbtu average.