China, India, Japan hamper Asia oil demand growth, efforts to balance market

As the global oil market frets about a stubborn supply glut, faltering demand growth in key Asian crude importers is further hampering efforts to restore market balance.

A fuel glut in China, a hangover from demonetization in India, and an ageing, declining population in Japan are holding back crude oil demand growth in three of the world's top four oil buyers.

The three countries make up a fifth of 97 million barrels per day (bpd) in global oil consumption, and any hiccups among them will mean lower-than-expected oil demand growth in Asia, helping to undercut the OPEC-led effort to support prices.

"We are indeed seeing lower demand from more than a few clients - air, marine, road, industrial ... They are actually consuming less fuel than anticipated," said Michael Corley, managing director of Mercatus Energy Advisors.

In China, vying with the United States as the world's biggest oil importer, imports in May were still at a near record of 9 million bpd, but a looming cut in refinery operations is set to hit demand for crude oil in the third quarter.

In India, which overtook Japan as the world's third-biggest oil importer last year, crude imports fell by more than 4 percent between April and May to around 4.2 million bpd C-INIMP, as after-effects of the country's recent demonetization program hit consumption.

For the first five months of the year, India's imports are about flat to the same period last year, following an annual rise of 7.4 percent last year.

In Japan, Asia's most advanced economy, oil demand has been in structural decline for years due to a declining, ageing population, and the rise of cars with better mileage or that use alternative fuels.

Japan in April imported around 3.5 million bpd C-JPIMPTOT, down from a peak of 5.9 million bpd hit in 2005.

Coupled with plentiful supplies, the stuttering demand in Asia has contributed to a 20 percent price fall for Brent crude oil LCOc1 to around $45 per barrel, in what is the biggest slump in a first half of a year since 1997.

FLOATING STORAGE

In the latest indicator of a supply overhang, traders said that five very large crude carriers (VLCCs) have been chartered in recent days to store unsold oil.

Each VLCC can hold around 2 million barrels of oil, and the five chartered for storage add to around 25 supertankers already sitting in southern Malaysian waters.

In a market condition known as contango, where spot crude oil prices are cheaper than those for future delivery, it is profitable to store oil for a later sales.

Currently, spot Brent is almost $1.50 a barrel cheaper than that for delivery in early 2018. <0#LCO:>

"If oil prices head lower, floating storage will get more traction," said Ashok Sharma, managing director of ship broker BRS Baxi in Singapore.

The cheap spot price comes despite the effort led by the Organization of the Petroleum Exporting Countries (OPEC) to cut production by 1.8 bpd that has been in place since January.

Doubts over OPEC's compliance with its own targets and soaring U.S. output have led to scepticism that markets will re-balance soon.

"The slide in oil prices continues ... as markets remain skeptical of OPEC's ability to balance supplies," ANZ bank said on Friday.

Source: Reuters

Milestones on the oil market's road to rebalancing

Crude oil stockpiles are expected to empty significantly during the third quarter as continued production restraint from OPEC interacts with the seasonal increase in consumption.

OPEC and non-OPEC countries are committed to reducing production by an average of nearly 1.8 million barrels per day in the first six months of 2017, with an option to extend cuts for a further six months.

Production assessments by independent agencies suggest compliance with the agreement has so far been high from OPEC especially from Saudi Arabia and its allies.

Further reductions from non-OPEC could be phased in over the next few months, with Russia in particular committed to increase its production cuts progressively during the compliance period.

Set against this is the risk of "compliance fatigue" if OPEC and non-OPEC countries become complacent and allow production to rise toward the end of the period.

Past experience suggests compliance tends to weaken over time as prices rise and the panic which made an agreement possible in the first place fades.

To preserve their flexibility, OPEC and non-OPEC countries have declined to commit themselves on whether the agreements will be extended.

But the consensus within the crude market seems to be that the cuts will be continued for a further six months, at least in modified form.

The alternative would be to flood the market with more 1 million barrels of extra crude from the start of July which would likely increase stockpiles again.

Assuming production cuts are extended in some form, the biggest impact is likely to come during the three months from July to September.

U.S. refineries normally increase their crude consumption sharply during the third quarter to meet strong demand from motorists during the summer driving season.

Over the last decade, net crude inputs into U.S. refineries have risen by an average of 840,000 barrels per day in the third quarter compared with the first.

The third quarter is also when Saudi Arabia and Iraq increase their own internal consumption of crude to meet air-conditioning demand.

Direct crude combustion in power plants will cut the amount of crude available for export by several hundred thousand barrels per day from both countries.

Finally, the third quarter is when most North Sea producers undertake maintenance, which cuts output of Brent and other grades during the summer.

In sum, the seasonal increase in consumption and reduction in output could combine to produce a particularly sharp draw down in crude stocks over the three months from July to September.

SPREAD WATCHING

Traders are currently betting storage tanks will empty significantly during the third quarter based on the structure of Brent calendar spreads (tmsnrt.rs/2lLqoNg).

The Brent spread for April-May is currently trading around 35 cents per barrel contango, which makes storage on land profitable under most assumptions.

But the spread for June-July is only 19 cents per barrel contango, which makes storage only marginally profitable, depending on assumptions about the cost of financing and leasing tank space.

And the contango for September-October is currently just 2 cents per barrel which would make storage unprofitable under all assumptions.

While the June-July spread has not changed much for the last 12 months the spread for September-October has tightened significantly.

The scenario encapsulated in futures prices is that the market will move into a significant supply deficit over the third quarter.

Physical traders will gradually lift their inventory hedges and sell stocks to refiners to help meet the shortfall in supplies from producing nations.

This scenario is only one possible outcome and there are a number of risks to the expected rate of market rebalancing.

Stocks could draw down faster than currently expected, in which case the supply-demand situation would become very tight in the third quarter. OPEC might respond by allowing production to rise.

On the other hand, growing U.S. shale output, weakening compliance from OPEC and non-OPEC, and any slowdown in consumption growth could all push back the draw down in stocks and cause spreads to weaken.

The movement of the Brent spreads for June-July, September-October and December-January should therefore provide a real-time indicator of whether traders think rebalancing is still on track or slipping.

Source: Reuters