Fundamentals is our monthly review of global oil data, this is the August edition.
End-product demand has started to recover following the trough in early Q2 18, supporting refining margins. For instance, Brazilian demand recovered from May’s strike-induced collapse to reach 2.44 mb/d in June, the highest since September 2017 and higher y/y by 51 thousand b/d. Some of this was probably pent-up demand as the strikes eased, but it confirms our view that even the drop in May was clearly exaggerated and did not represent a new baseline. The same is true for Saudi demand, which recovered in May and June following April’s dismal performance, rising by 0.5-0.6 mb/d compared to April’s levels. Iraq also raised diesel and fuel oil imports for power generation. Meanwhile, a low base is helping Indian and Chinese demand growth, and the measured stimulus package being undertaken by China is positive for future demand.
The broader demand picture also remains positive, despite the persistent worries about trade wars. Economic data out of the US has been exceptionally strong and while Eurozone GDP growth was soft for a second straight quarter at 1.4%, the reality is that this is a far more sustainable pace of growth than seen in 2016/17, when Europe was growing at close to double its sustainable potential. A full-blown trade war would undoubtedly do severe damage to economic growth, but current economic activity remains strong. We may be at the late stage of this current economic cycle, but the strength is still supportive for oil demand. Any slowdown from a trade war would take time to materialise. Demand worries are a bit premature and belie the available data.
The improvement in product demand has led to a sharp recovery in refining margins, which had slumped in June. But also contributing to the strength in products has been the weakness in refinery runs. Hot weather in Europe and the US has played havoc with refinery operations by straining power grids and reducing the effectiveness of refinery cooling systems. Moreover, turnarounds have also been longer than expected as refiners tweaked their kit and tested new crudes during scheduled maintenance ahead of IMO 2020. Some European refineries said runs have been cut by up to 10%. German refiners have confirmed that output fell by just 3% nationwide as some plants were able to avoid the cooling issues that have hobbled others. Overall, we think European runs may have fallen by 0.6 mb/d (~5% of operable capacity) from planned levels at times in July and August. For crude markets, these refinery outages go a long way towards explaining why the physical market remains soft despite the sharp 1.5 mb/d m/m drop in OPEC exports in July, which almost entirely reversed the 1.7 mb/d m/m rise in June exports.
But with products demand recovering, refineries will run once they return from maintenance. So crude buying is already starting. Moreover, with Iranian exports already starting to decline, the market will start to get tight in the coming month. We maintain our projection for 1 mb/d of stockdraws for Q4 18. The decline in Iranian exports has also helped tighten sour crude markets significantly, incentivising switching to sweet crudes in some parts of the world already. As a result, Brent spreads have found find a floor as sweet-sour switching in the Atlantic basin kicks in. Once the October contract is off the board and if the sour crude strength persists, Brent spreads should be able to rally, especially if Chinese buying returns to restock.