Midyear Forecast Oil Supply Increase Due In 1996's Second Half

Robert J. Beck
Associate Managing Editor-Economics

The crucial oil-market issue for this year's second half is new supply.

Production will increase again outside the Organization of Petroleum Exporting Countries. And Iraq has general approval to resume exports under limits set by the United Nations, although start of the exports has been delayed by at least 60 days.

The big question is the market's ability to absorb the supply gains. To the extent it doesn't need all potential supply, OPEC must choose between limiting its members' production levels and defending market share at the expense of price.

It's a never-ending choice for OPEC, several members of which account for most of the world's spare capacity to produce crude. The job of market balance becomes especially difficult when new supplies loom and demand growth is uncertain.

As usual, the market's need for oil in the second half will depend on economies. So far in 1996, economic growth has pushed consumption to levels unexpected a year ago.

Demand the rest of the year depends heavily on economic performances of the industrialized nations that make up the Organisation for Economic Cooperation and Development (OECD) and the rapidly growing nations of the Asia-Pacific region. Growth in countries elsewhere in the developing world, especially Latin America, remains a wild card.

The U.S. economy is expanding slowly but steadily. In the first half, oil demand received an extra lift from a cold and protracted winter. As economic expansion continues in the second half, demand for oil and gas should continue to rise.

Real (inflation-adjusted) gross domestic product (GDP) in OECD Europe is forecast at 2.6% in 1996, compared with 2.9% in 1995 and 2.4% in 1994. Real GDP in the Asian developing countries is projected to increase 7.9% in 1996 vs. 8.7% in 1995.

In line with these projections, International Energy Agency (IEA) expects oil consumption to increase in OECD Europe and the Asian developing countries through yearend. For the Commonwealth of Independent States (C.I.S.), IEA expects demand to level after several years of sharp decline.

OPEC will need all the help it can get from demand. In June, the group raised its quota in anticipation of the 700,000-800,000 b/d expected from Iraq under the UN's program to allow exports for humanitarian purposes.

The increase, to 25.033 million b/d, amounted to 513,000 b/d from the earlier quota. But with Gabon no longer subject to the quota, the real increment amounted to only 226,000 b/d.

The adjustments were academic. Before they were made, group members were producing more than the new, elevated level. The important question in the second half is whether overproducing members bring their output in line with new quotas or whether they cling to market share and let prices fall.

If they follow precedent, they will do some of both, and prices will weaken but not crash.

The market

In the first half, worldwide oil demand as gauged by IEA averaged 71.3 million b/d, up from 69.6 million b/d for the same period a year earlier. Strong gains came in OECD countries, Asia, China, the Middle East, and Latin America. They more than offset a small drop in C.I.S. consumption, much less than it has been in recent years.

Estimated total worldwide oil supply in the first half averaged 71.7 million b/d, up from 69.6 million b/d for first half 1995. Non-OPEC supply moved up to 43.1 million b/d from 41.9 million b/d. C.I.S. production slipped to 7.1 million b/d from 7.15 million b/d.

Output in OECD Europe, mainly the North Sea, jumped by 350,000 b/d from the first half of 1995 to 18.25 million b/d in this year's first half.

Despite those output gains, the call on OPEC oil increased due to the large increase in overall consumption. Average demand for OPEC oil rose to 26 million b/d during the first half from 25.2 million b/d a year earlier. In addition, OPEC NGL output averaged 2.55 million b/d, up from 2.4 million b/d in 1995.

Total OPEC liquids production during the first half was up 1 million b/d from the same period last year at 28.55 million b/d.

Stocks fell at a rate of 1.1 million b/d during the first quarter of the year but rose in the second quarter at about 2 million b/d. The second quarter stock build sustained demand for OPEC oil in the face of seasonally declining consumption.

In total, OPEC members produced 680,000 b/d more than the pre-June quota of 24.52 million b/d, and the market needed the oil.

Worldwide outlook

IEA expects average worldwide demand to increase 1.7 million b/d to 71.6 million b/d for 1996, reaching 73.6 million b/d in the fourth quarter.

For the OECD, demand is forecast at 41.1 million b/d in 1996, up 800,000 b/d from 1995's average. In non-OECD Asia, demand will move up 500,000 b/d to average 8.5 million b/d.

Supply of crude oil from OECD will leap by 700,000 b/d in 1996 to 18.7 million b/d, IEA projects, largely on the strength of North Sea production gains. In the fourth quarter, OECD output will average 19.6 million b/d.

In the C.I.S., production has been falling since 1988, when it exceeded 12 million b/d. Production is expected to average 7.2 million b/d this year, the same as 1995.

With non-OPEC output surging, demand for OPEC oil will change little this year and may fall in the second half, depending greatly on stock behavior.

IEA estimates there was no net addition to worldwide stocks last year. Even if stocks rise, demand for OPEC liquids will slip to 27.2 million b/d in the third quarter this year from 28.6 million b/d in the second quarter. With a seasonal rise in demand in the fourth quarter, the need for OPEC liquids will move up to 27.8 million b/d.

OPEC NGL output is estimated to be 2.7 million b/d in the third quarter and 2.8 million b/d in the fourth. Therefore, demand for OPEC crude oil-the quantity to which the group's quota applies-is projected to be only 24.5 million b/d in the third quarter and 25 million b/d in the fourth quarter.

That would be a second-half reduction in demand for OPEC oil of more than 1 million b/d.

Crude oil prices

On average, world crude oil prices during the first half of this year were up from the first half last year and significantly higher than the latter part of 1995.

World export crude oil prices for the first half of 1996 averaged $18.60/bbl, up 7% from the average in the first half of 1995. The price peaked at $20.50/bbl in April then slumped to an estimated $18.15/bbl in June.

The pattern was similar for both OPEC and non-OPEC crudes. The average price for OPEC exports was $18.12/bbl for the first half of 1996, up 6% from the same period of 1995. The price for the OPEC reference basket of seven leading export crude oils averaged an estimated $18.99/bbl for the first half of 1996, up 8%. The price for non-OPEC crude oil was up 9% at $19.27/bbl.

Because of the first-half price rise, the average crude price for the year may exceed last year's level, despite the chance for weakness in the second half.

On the New York Mercantile Exchange, the futures price for light sweet crude oil began moving up in the fourth quarter last year and continued into the first week of January, rising from an average of $17.37/bbl in October 1995 to $19.97/bbl. The price slipped to $17.65/bbl in the first week of February but rose to a high of $24.39/bbl in mid-April. Prices remained above $20/bbl in May and June. For the first half of the year the Nymex price, an average $20.59/bbl, was up 9% from first half 1995.

The average posted price for West Texas Intermediate (WTI) crude oil followed a similar pattern: averaging an estimated $19.65/bbl for the first half of the year, up 8.5% from the same period last year.

The U.S. average wellhead price averaged $15.50/bbl for January and February this year, the latest data available, up 8% from the same period a year earlier.

OGJ projects an average annual U.S. wellhead price of $15.35/bbl for 1996, up 5% from 1995.

U.S. product prices

Rising demand and crude costs will boost product prices in the U.S. this year.

According to OGJ's survey, the average price of self-service unleaded motor gasoline at the pump rose to $1.201/gal in the first half from $1.15/gal last year. The average motor gasoline price excluding all federal, state, and local taxes was 89.7¢/gal, up 4.5¢/gal from the level a year earlier.

Motor gasoline pump prices rose slowly at the start of the year and swiftly in April and May. The pump price averaged $1.10/gal the first week of January and $1.112/gal for the month. It peaked at $1.31/gal in the middle of May, its highest level since December 1990. By the week of June 19, the price had receded to $1.293/gal.

Federal, state, and local gasoline taxes averaged 39.5¢/gal for the first half of this year vs. 38.9¢/gal in the same period a year ago.

OGJ expects the pump price for all types of motor gasoline, including premium grades, to average $1.269/gal for 1996, up from $1.205/gal for 1995. The peak annual average pump price for motor gasoline was $1.353/gal in 1981.

Residential heating oil prices for the first 3 months of 1996 averaged $0.932/gal, up 6.4% from the same period last year, when prices averaged $0.876/gal. The increase was primarily due to demand increases related to weather. OGJ expects heating oil prices to average $0.919/gal for the year vs. $0.871/gal last year.

Natural gas prices

Rising demand, mostly related to cold weather, raised prices for natural gas in the U.S., beginning in the fourth quarter of 1995.

Spot natural gas prices averaged $2.23/Mcf for the first half and were as high as $2.57/Mcf in January. In first half 1995, spot gas prices averaged $1.45/Mcf. The spot price slipped to $1.99/Mcf in May but bounced back to $2.16/Mcf in June.

The Nymex gas futures price also was well above year ago levels, averaging $2.41/MMBTU for the first half, up 54% from the same period of 1995. It averaged $2.53/MMBTU in January, slipped to $2.29/MMBTU in May, then moved back up to an estimated $2.49/MMBTU in June.

The average U.S. wellhead price for natural gas rose to $2.02/Mcf during the first 2 months of this year from $1.56/Mcf in the same period last year.

Gas prices peaked in 1984 at $2.66/Mcf, then dropped to $1.67/Mcf in 1987. The average annual gas price was $1.71/Mcf in 1990, $1.64/Mcf in 1991, and $1.74/Mcf in 1992. In 1993 the price jumped to $2.03/Mcf before falling to $1.83/Mcf in 1994.

Natural gas demand during the first 3 months of this year, the latest data available, was up 6.3% from the same period of 1995. Working gas in storage fell from 2.148 tcf at the end of December 1995 to 752 bcf at the end of March.

Gas prices will come under pressure in the second half, particularly in markets where natural gas competes with heavy fuel oil. For all of 1996, OGJ projects an average U.S. wellhead price of $1.90/Mcf, compared with $1.59/Mcf in 1995. This is based on an expected 1% increase in U.S. gas consumption this year.

The U.S. economy

OGJ expects the U.S. economy to expand in 1996 at about the same rate as last year. Inflation appears to be under control so the Federal Reserve is not likely to raise interest rates. The level of industrial production is expected to be down marginally, but auto sales and housing starts are expected to move up from year-ago levels.

The U.S. economy has been growing slowly but steadily since the latest recession in late 1990 and early 1991. OGJ projects annual 1996 GDP will be up 2% from the 1995 level-the same growth rate as last year.

Measured growth rates appear more moderate than they did before the federal government adopted what is called the chain-weighted system of calculating real GDP. The new system does a better job of adjusting for large price swings, such as the sharp drop in the cost of computing power, and measuring true growth in goods and services. The new method is more accurate but reduces apparent growth from what the old method reflected by about 0.5%/year.

GDP in the U.S. increased by 2.7% in 1992, 2.2% in 1993, and 3.5% in 1994.

This year industrial production is expected to increase an estimated 2.6% following an increase of 3.3% in 1995. New car sales are expected to increase to 8.8 million in 1996 from 8.7 million last year. Housing starts are projected to rise to 1.4 million units from 1.36 million in 1995.

U.S. energy demand

Energy consumption will rise to fuel the expected economic growth, although continuing improvements in energy use efficiency will keep the energy growth rate below that of the economy.

Total U.S. energy consumption will increase 1.7% this year after a 1.9% gain in 1995. Energy consumption will rise to 88.72 quadrillion BTU (quads) from 87.245 quads in 1995.

After declining in the early 1980s, energy consumption grew at an average rate of 1.7%/year during the long economic expansion of 1982-90, when GDP grew at an average rate of 3.6%/year.

When the economy slowed, energy consumption fell by 0.1% in 1990 and 0.2% in 1991. As the economy recovered, energy demand rose by 1.3% in 1992 and 2.1% in 1993.

Since 1970, improvements in energy consumption efficiency have kept energy use from growing as fast as economic output. Energy consumption per unit of GDP was 35% lower in 1995 than in 1970. The measure fell from 19,800 BTU/$ of GDP in 1970 to 12,950 BTU/$ in 1995.

OGJ projects energy consumption per unit of GDP to continue to drop to 12,900 BTU/$ in 1996. The rate of growth in energy consumption tracks closer to GDP growth during periods of rapid economic expansion and periods of low energy costs.

Oil energy demand will move up 2% in 1996 to 35.32 quads after slipping 0.3% in 1995. Strong demand during the cold first quarter of the year and oil prices more competitive relative to natural gas should help stimulate demand growth.

Oil's share of total energy demand will increase to 39.8% from 39.7% last year. It was 40.6% in 1994. In 1978, the year of peak consumption, oil's market share was 48.6%.

Demand for energy from natural gas will also increase in 1995 but at a slower rate: 1%, to 22.47 quads, vs. a 4.3% increase last year. Elevated prices will slow demand growth. The natural gas market share will slip to 25.3% in 1996 from 25.5% in 1995. It was 24.9% in 1994. Together, oil and natural gas will account for 65.1% of the energy consumed in 1996 vs. 65.2% in 1995.

Increased electricity consumption will boost demand for coal energy by 2% in 1996 to 20.01 quads. This follows an increase of 0.4% in 1995. Coal's market share will be 22.6% in 1996 vs. 22.5% last year.

Energy from hydroelectric and other energy sources will increase 1.3% in 1996 to 3.62 quads after a 12.2% increase last year. The market share of hydro and other sources will remain at 4.1% in 1996, the same as 1995 but up from 3.7% in 1994. Hydro power output had been well below capacity for several years because of drought in the western U.S. Other energy sources such as geothermal, wind, wood, and solar provided only 0.2% of total energy consumed in the U.S. in 1995.

Nuclear energy output is expected to increase 1.5% this year to 7.189 quads. This follows an increase of 5.1% last year. Nuclear's market share is expected to remain at 8.2%. Nuclear energy output had been moving up gradually in recent years due to an increase in the capacity utilization rate, which reached a record 77.5% in 1995. There are no plans to add nuclear units, and total industry capacity is leveling off. Expectations are for modest growth in nuclear energy output for a few years as the industry continues to boost capacity utilization.

This slowing of growth in nuclear power generation will force the electric power industry to turn to other fuel sources, probably coal and natural gas.

Natural gas in the U.S.

Consumption of natural gas in the U.S. is expected to increase 1% in 1996 to 21.85 tcf following increases of 4.3% in 1995 and 2.4% in 1994. The recent low in gas use came in 1986 at 16.221 tcf. The record high for natural gas consumption was 22.049 tcf in 1973.

Through 1989, prices and uses of natural gas were subject to varying degrees of federal control.

During 1987-91, wellhead prices averaged $1.68/Mcf, well below the peak of $2.66/Mcf in 1984.

Lower prices and relaxation of end-use controls enabled gas to compete with other fuels, primarily residual fuel oil and coal.

The industrial sector accounted for 54% of the increase in gas demand that occurred during 1986-95. Industrial demand for gas increased from 5.579 tcf in 1986 to 8.52 tcf last year. The industrial category includes nonutility, gas-fired power generation.

Demand also moved up in other major economic sectors. Over that same period commercial demand increased 23.6% to 3.096 tcf, residential demand moved up 13.1% to 4.881 tcf, and utility demand rose 22.9% to 3.197 tcf. Demand for natural gas as a pipeline fuel and a lease and plant fuel increased 38.2% to 1.946 tcf.

Drops in gas prices in 1994 and 1995 boosted consumption last year. Utilities and industrial facilities with multifuel capability favored natural gas. The electric utility sector recorded the sharpest increase in gas use last year.

In 1996 modest increases in natural gas consumption are expected in the industrial, commercial, and residential sectors. Utility demand will decline.

In the utility sector, natural gas will face competition from lower coal and fuel oil prices, and there will be increased nuclear and hydroelectric output. According to the U.S. Energy Information Administration (EIA), the cost of coal for steam electric utilities dropped from $1.455/MMBTU in 1990 to $1.318/MMBTU in 1995. The cost of natural gas for these utilities was $2.321/MMBTU in 1990, $2.56/

MMBTU in 1993, and $1.984/MMBTU in 1995. In January the gas cost to utilities jumped to $2.812/MMBTU.

U.S. marketed production of natural gas is expected to increase faster this year than in 1995 as the industry refills storage. Domestic production is projected to move up 2.2% to 20.09 tcf in 1996. This follows an increase of 0.2% in 1995.

In recent years U.S. production has risen in response to growing demand and a higher average price level.

Domestic output hit a peak of 22.648 tcf in 1972 but slipped to a recent low of 16.859 tcf in 1986. Since then output has moved up at an average rate of 1.7%/year to the 1995 level of 19.665 tcf. This compares with an average increase in natural gas consumption of 3.3%/year over the same period.

Imports, mainly from Canada, have met a major part of the increase in demand, increasing from 750 bcf in 1986 to 2.753 tcf last year. Imports of natural gas are projected to increase to 2.89 tcf this year-2.87 tcf from Canada. Imports from Canada were up 6.4% last year at 2.729 tcf. LNG, mainly from Algeria, will total 15 bcf this year, compared with 17 bcf in 1995 and 51 bcf in 1994.

Since the recent demand low in 1986, consumption has moved up 5.419 tcf, domestic dry gas production 2.69 tcf, and total imports 2.003 tcf.

U.S. oil demand

U.S. demand for petroleum products moved up significantly in the first half this year, with elevated need for heating oil augmenting the demand effects of economic growth.

First-half demand averaged an estimated 17.93 million b/d, up 1.9% from the same period a year earlier.

All the major products except residual fuel oil posted increases. Resid demand was strong in the first quarter due to weather and the sharp rise in natural gas prices. Resid demand slumped in the second quarter, pulling the first-half average to 1% below that of a year earlier.

First-half consumption increases of other major products were motor gasoline 0.3%, jet fuel 4.1%, LPG and ethane 3.8%, and distillate 3%.

Heating degree days for the first 4 months of 1996 were up 10.8% from the same period in 1995 and 3% from normal levels.

Continued economic growth and stable, if not lower, product prices will increase U.S. demand for oil products in the second half by 2% from first-half 1995 to an average of 18.22 million b/d.

For all of 1996, domestic demand will average 18.075 million b/d, up 2% from 1995's level. It will be the fifth consecutive year of increased product consumption. Demand moved up only 0.04% last year after gains of 2.8% in 1994, 1.2% in 1993, and 1.9% in 1992.

Demand hit an all time high of 18.847 million b/d in 1978, at the end of the period of price and allocation controls, then fell to 15.231 million b/d in 1983 as prices rose to market levels.

A record period of sustained economic growth in 1982-90 increased product demand through 1989 before a weak recession that began in 1990 suppressed consumption for 2 years.

Gasoline up slightly

Motor gasoline demand's slight increase in the first half took average consumption to 7.72 million b/d.

Through the first half of the year pump prices on average were 4.4% higher than their level of a year earlier, largely as a reflection of the weather-related jump in general petroleum prices.

With crude prices under pressure from growing supplies, motor gasoline pump prices will remain at current levels or decline further in the second half, lifting demand.

For the year motor gasoline demand is projected to average a record high 7.895 million b/d, up 1.4% from 1995. Gasoline demand has set records in each of the past 3 years and increased in each of the last 5 years despite improvements in the efficiency of U.S. autos. Increments were 2.4% in 1995, 1.7% in 1994, 2.9% in 1993, and 1.1% in 1992.

The current upswing in gasoline demand follows a low of 6.539 million b/d in 1982. The earlier cycle's peak came in 1978 at 7.412 million b/d.

In recent years, the vehicle fleet and miles driven per vehicle have increased, and efficiencies have suffered from a trend toward purchases of midweight vehicles.

EIA says average mileage peaked in 1991 at 21.69 mpg, slipped to 21.68 mpg in 1992 and 21.04 mpg in 1993, and rose to 21.48 mpg in 1994. In 1973, the average was only 13.3 mpg.

Driving has increased from 9,141 miles/vehicle/year in 1980 to 11,839 miles/vehicle/year in 1994.

Distillate gains

The gain in demand for distillate fuel oil in the first half resulted largely from the cold winter and also from increases in business shipments and use of transport fuels.

For all of 1996, OGJ projects distillate demand of 3.295 million b/d, up 2.7% from 1995. Increases in demand are expected in all economic sectors.

Demand for distillate used as transportation fuel will lead the gains.

Resid slumps

Demand for residual fuel oil fell to 850,000 b/d in the first half from 859,000 b/d in first half 1995, although the first-quarter surge from fuel-switching moderated a decline that's part of a long trend.

According to the EIA, the residual fuel oil wholesale price for January and February this year was up 16% from the same period a year earlier. The average price for natural gas was up 60-75%, depending on location, making resid attractive to consumers able to switch, especially electric utilities needed to meet heavy heating needs.

Electric utility consumption of petroleum, primarily resid, for the first 2 months of 1996 was up 49% from the same months of 1995.

Resid demand for all of 1996 will remain at the first-half average of 850,000 b/d, with heavy fuel oil remaining competitive with natural gas through yearend.

LPG, ethane, others

Demand for LPG and ethane is projected to average 1.95 million b/d in 1996, up 2.7% from 1995.

Demand for the light products during the first half was up 3.8% at 1.97 million b/d as increased chemical manufacture added to cold weather to boost consumption.

Demand for all of the other petroleum products will increase 2.7% to 2.53 million b/d in 1996. During the first half of 1996 demand averaged 2.47 million b/d, up 3.9% from 1995. Demand is expected to be up due to increased construction activity, more driving and industrial activity, and greater spending on highways.

This category includes petrochemical feedstocks other than LPG and ethane, special naphthas, lubricants, waxes, petroleum coke, asphalt and road oil, still gas, and miscellaneous products.

U.S. supply

U.S. production of crude oil and lease condensate continued its slide during first half 1996, averaging 6.465 million b/d, down 2.8% from the first half of 1995.

Alaskan North Slope production is now in steady decline, no longer able to provide partial offsets to the long slide in Lower 48 output.

During the first half, average Alaskan output fell to 1.44 million b/d from 1.532 million b/d in the first half of 1995. Alaskan production reached 2.031 million b/d during first half 1988 and averaged 2.017 million b/d that year.

Lower 48 production fell 1.8% in the first half this year to average 5.025 million b/d. Annual average Lower 48 output has fallen from 9.01 million b/d in 1973 to 5.046 million b/d in 1995.

The decline in U.S. output is expected to continue in the second half of the year. However, steady crude oil prices would stimulate investment in secondary recovery projects, workovers, and other methods of slowing the decline. A resurgence of exploration and development activity in the Gulf of Mexico promises future production from fields now under development.

OGJ projects second half U.S. output of 6.335 million b/d. For the year crude output is projected at an average 6.4 million b/d, down 2.4% from 1995.

Total U.S. crude and condensate output this year will be at its lowest level since 1954 and down 29% from the recent high of 8.971 million b/d in 1985.

Production patterns

U.S. production peaked in 1970 at 9.637 million b/d then slipped to 8.132 million b/d in 1976, just before Prudhoe Bay oil field on the North Slope came on stream. Increases in Alaska coupled with a boom in Lower 48 drilling pushed production to 8.971 million b/d in 1985. The price collapse of 1986 slashed drilling and made production gains in the U.S. look impossible, although there was a slight increase in 1991 associated with the Persian Gulf war.

As crude prices remained generally below $20/bbl, however, producers concentrated on efficiency and cost-cutting. They have developed seismic, drilling, completion, and production technologies that enable them to find and develop more oil per rig, per well, and per dollar of investment. Future production is no longer a function of the rig count.

Improvements in technical and economic efficiency have revitalized key regions of the U.S., such as the Gulf of Mexico, leading some analysts to suggest that isolated increases in U.S. production may be possible before 2000.

Production of natural gas liquids and other hydrocarbon liquids averaged 2.06 million b/d in the first half of 1996, down 1% from the year before. Production of non-crude liquids is projected to average 2.08 million b/d for the year, up 0.7% from 1995. Since 1993 this production category has included oxygenate production from MTBE plants and fuel ethanol. Output, therefore, is closely tied to motor gasoline demand.

U.S. total liquids production is projected to average 8.48 million b/d in 1996, a decline of 1.7% from 1995. Total liquids production this year will be down 20.3% from the recent high of 10.636 million b/d in 1985.

Refining capacity rises

Average U.S. operable refining capacity increased during 1995, following several years of decline. For the year, crude capacity averaged 15.346 million b/d vs. 15.15 million b/d in 1994.

The increase in product demand has encouraged refiners to raise capacities of existing facilities. Grassroots refinery construction is unlikely.

Operable capacity averaged 15.4 million b/d during the first half of 1996 and is projected to remain at about this level through yearend.

During 1984-92, capacity fluctuated in a range of 15.5-15.9 million b/d. With product demand rising, capacity utilization rates increased.

Total capacity fell to 15.143 million b/d in 1993 and 15.15 million b/d in 1994 as the utilization rate climbed to 92.6% in 1994. That is close to full sustainable capacity, since some capacity is required for maintenance downtime and contingencies.

The utilization rate averaged 92% last year.

Crude input to refineries is projected to be up only 0.2% this year at 14.005 million b/d, and total input to distillation units will move up 0.3% to 14.16 million b/d. The increase in capacity will be slightly higher than the increase in throughput so the average utilization rate will slip to 91.9%. The utilization rate will be up to 94.3% in the third quarter.

With product demand rising and refining capacity stagnant, U.S. imports of petroleum products must rise.

Imports

Total oil imports will set a record high in 1996.

For the first half total industry imports were up 5.6% at 9.17 million b/d. This was partly due to a 16.6% increase in product imports.

Industry imports are expected to be even higher in the latter half of the year due to increased product demand, lower domestic liquids production, and the need to replenish stocks.

Imports will average 9.78 million b/d during the second half of 1996. For the year total imports are forecast at 9.475 million b/d, compared with 8.835 million b/d last year.

Last year imports fell 1.8% from the previous record high of 8.996 million b/d in 1994. Refiners met much of the year's flat demand by reducing stocks. With stocks beginning this year at minimum operating levels, the pattern can't be repeated.

The previous peak year for industry imports was 1977 with average industry imports at 8.786 million b/d. Imports dipped to a recent low of 4.949 million b/d in 1985.

U.S. petroleum imports will represent a record high 52.4% of consumption this year, compared with 49.8% last year and 50.7% in 1994, the previous record.

Crude imports are projected to increase 5.3% in 1996 to 7.61 million b/d. Crude imports increased 2.5% last year.

During the first half of this year crude oil imports averaged 7.35 million b/d, up 3.2% from first half 1995. There have been no imports for the Strategic Petroleum Reserve (SPR) since June 1994, and OGJ expects none this year. The SPR holds 586 million bbl of crude.

Petroleum product imports will jump this year after falling in 1995, when they were partly displaced by stock withdrawals.

The stock draw continued during the first half of this year but couldn't meet rising demand without help from an increase in product imports, which were up 16.6% from a year earlier at 1.82 million b/d.

Product restocking in the second half will add to the need for imports, which will average 1.91 million b/d in the second half. OGJ projects product imports at 1.865 million b/d for the year, up 16.2% from 1995.

The leading source of U.S. crude imports during the first quarter of this year was Saudi Arabia with 1.239 million b/d, 17.7% of the total. Crude imports from Saudi Arabia averaged 1.26 million b/d for all of last year. They have been as low as 131,000 b/d in 1985.

Other countries supplying large volumes of crude to the U.S. during the first quarter were Venezuela 1.22 million b/d, Mexico 1.159 million b/d, and Canada 1.026 million b/d. Total crude imports from OPEC members averaged 3.482 million b/d for the first quarter, 49.8% of total crude imports. Crude imports from OPEC averaged 3.569 million b/d during all of 1995.

Stocks

Total industry stocks finished 1995 at 971 million bbl, compared with 1.061 billion bbl at yearend 1994.

During the first half of this year stocks were reduced even further, with the total falling to 953 million bbl at the end of June. The stock draw provided 99,000 b/d to the supply stream during the first half.

But low motor gasoline stocks were a reason for the sharp increase in pump prices during the second quarter.

A portion of these stocks will be replenished during the remainder of 1996. Refiners are trying to time stock additions to take advantage of any slump in crude oil prices. But additions will have to be made to stocks before the next winter heating season.

Total industry stocks are projected to move up to 981 million bbl at yearend, 1% ahead of a year earlier. Crude oil stocks are expected to move up to finish the year at 310 million bbl, up 2.3% from yearend 1995. This level allows refiners some additional flexibility in meeting changing patterns of product demand. Product stocks are also expected to be increased in the second half and finish the year at 671 million bbl, vs. 668 million bbl at yearend 1995.

At the end of the first half, crude oil stocks were reduced to an estimated 306 million bbl. The EIA has listed 300 million bbl as the observed minimum level for crude stocks, established in March 1996. The EIA no longer defines this as a minimum operating level, but it does represent the lowest stock level registered over the last 36 months.

At the end of the first half, product stocks were estimated at 647 million bbl, down from the 668 million bbl at yearend 1994. The observed minimum level for product stocks was about 593 million bbl, also at the end of March this year.

Although the minimums are not defined as levels where there are operating problems, the motor gasoline price reaction in the second quarter of 1996 indicates the tightness of supply at these low stock levels.

Refiners have generally been more willing to deplete product stocks than crude oil stocks. Crude stocks provide refiners with the flexibility to meet changes in demand for any product. However, with distillation capacity in full use, refiners have little room to meet unexpected surges in demand by increasing runs.

Stock coverage

At yearend 1994, total industry stocks represented 59.9 days of supply at 1994 demand levels. Last year, due to the sharp drop in stocks, this ratio fell to 54.8 days of supply at yearend. This is the lowest stock level, in terms of days' supply, on record.

In the 1960s forward demand coverage of total crude and product stocks ranged from 68 to 82 days. In the 1970s the range dropped to 58-70 days. In the 1980s forward coverage peaked at 78 days in 1981 and fell to 58 days by yearend 1989.

This year the modest increase in stock levels and increased demand will result in yearend 1996 stocks at only 54.3 days of supply.

Refiners now manage inventories less on the basis of operating strategies and more as financial assets. Forward trading instruments and other new flexibilities in the market enable them to do so without imperiling their abilities to meet demand.