Fundamentals is our monthly review of global oil data, this is the December edition.
The stand out feature of this month's data review is the recovery in demand across the board, including in Europe (albeit y/y growth remained in negative territory). Indeed, the latest data for OECD oil demand in October showed the first y/y increase (90 thousand b/d or 0.2%) since May this year and was only the second y/y increase in 14 months. Of course, the recovery of China together with the continued strength in oil demand in other non-OECD countries has served to boost non-OECD demand y/y growth in October to nearly 1.8 mb/d, the strongest pace of growth since January 2011. Chinese oil demand in November breached 10 mb/d for the first time ever and growth rate in September through to November picked up from an average 1.5% in the prior months to 9%, while Middle Eastern, Indian, Russian and Brazilian demand together increasing y/y by 1 mb/d in October. Should November's data show a continuation in the improvement seen in Europe in October, and the persistent strength in Canadian and Mexican oil demand, global oil demand is likely to have increased y/y by nearly 1.5 mb/d in November.
Looking forward, sustaining this trend is not a foregone conclusion. Europe still remains a source of macroeconomic worry, despite having stabilised (at extremely weak economic growth levels), but it is the US and negotiations surrounding the fiscal cliff that is the greatest downside risk to demand. Should negotiations stall, which is not our base case, US economic growth is likely to take a significant hit, potentially moving into sharply negative territory, with knock-on effects on the export environment of key trading partners like China and Europe.
Nonetheless, although non-OPEC supply is rebounding seasonally, we expect demand to be the surprise element heading into next year, with the call on OPEC crude remaining high. Moreover, it is actually OPEC where the risks to supply are high, with the backdrop in Iraq, Iran, Nigeria and Libya all taking a turn for the worse in recent weeks. Thus, while the market fixates on OPEC's ability to reduce production in order to curb oversupply, should the improvement in demand continue at this pace, then the call on OPEC crude next year could well be higher than this year, rather than lower as consensus currently expects. Then, should the situation in any of the OPEC countries mentioned above worsen, the risk of OPEC failing to deliver on the higher call on its crude should not be underestimated.
In particular, market optimism about the upswing in Iraqi and Libyan oil output next year may not materialise, given the recent developments in both countries. In Iraq, Kurdish exports have recently fallen to just 5 thousand b/d, due to a mix of technical issues and disputes with Baghdad over revenue payments, while tensions seem to be rising concerning the Exxon's deal with the Kurdish Regional Government (KRG), adding to an existing military stand-off between Baghdad and the KRG.
In a market where crude inventories outside the US remain low, any deterioration in the supply situation or a continued improvement in demand is likely to lend itself to upside risk to prices, although we believe that the upward progression will be capped until the fiscal cliff is entirely resolved. Like crude, global distillate inventories, too, remain low and despite fairly subdued demand, cold spells can result in price spikes in both heating oil and gasoil. Moreover, while the start-up of new refineries and the return of refining capacity from maintenance have both resulted in improved product supplies that have forced down refinery margins, especially in the Gulf Coast (USGC) and in Europe, which in turn incentivises run cuts that we believe are likely in the coming weeks.