Arguably, the bull market in oil began with the recovery from the price
collapse in 1999, but there is no doubt that the rally truly kicked off in
2004, following an unexpected surge in global demand. A year of supply-side
woes followed, due to slowing Russian production growth and the hurricane
damage from Rita and Katrina.

The year 2006 was a year of dramatic inventory shifts. The 33mb rise in OECD
total oil stocks in September was more than reversed by a 40mb stock draw in
October, despite exceptionally mild weather in Europe at the start of the
fourth quarter and relatively normal weather in the US. To this, we can add
November’s near 20mb draw on US stocks, a 3.7mb fall in Japanese inventories
and a decline in independent storage in northwest Europe.

Heavy and protracted refinery maintenance in the US resulted in a sharp
decline in product inventories, but the accompanying fall in global crude
production appears to have dampened the usual offsetting rise in crude stocks.
Admittedly, some of October’s primary inventory draw may have been exaggerated
by consumer and wholesale restocking but the draws would appear to confirm
recent trends in the primary balance.


There is considerable uncertainty over the levels of supply and demand over
coming months. Global GDP, Iraqi and Nigerian output, and OPEC discipline are
all unpredictable. But it is still a useful exercise to try to estimate the
impact of recent changes in OPEC output on future stock levels. Figure 1 shows
the cumulative stock change implied by three scenarios for OPEC production,
based on:

  • September OPEC production and the current ‘call on OPEC and stock change’
    (call) (light blue)
  • November OPEC production and the call (dark blue)
  • November OPEC production and the call, plus an adjustment for statistical
    difference (green)

The light blue area shows the outcome had September production been
maintained. The dark blue and green areas represent the cumulative stock build
/ draw implied by the current OPEC cuts, based (respectively) on the call and
the call together with an adjustment for the miscellaneous-to-balance.

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By GlobalData
“There are offsetting downside risks to global GDP, and thus oil demand growth.”

Although the miscellaneous-to-balance could represent either under-reported
demand, over-reported supply or unreported stock builds, including it in the
calculation shows a more realistic range of outcomes. It could be argued that a
further adjustment should be made for known risks to non-OPEC supply, which can
average 300–400kbpd, but for now we feel that there are offsetting
downside risks to global GDP, and thus oil demand growth.

Without doubt, November’s output cuts could tighten the oil market this
winter, and offer little prospect, allowing for demand growth, of a recovery in
stock cover above the current 54 days – cold comfort for a risk-prone
global economy already facing another winter with high oil prices.


Global oil product demand growth remained unchanged at +1.1% in 2006
(84.5mbpd) and +1.7% in 2007 (85.9mbpd), as minor downward adjustments in OECD
countries were offset by upward revisions in non-OECD countries. The 2007
forecast, though, faces downside risks, given uncertainties surrounding the US

OECD oil product demand projections have been more or less maintained at
49.4mbpd in 2006 and 49.6mbpd in 2007. Support from strong US demand continues,
even after accounting for last year’s hurricane-affected baseline. OECD Europe
and the Pacific, meanwhile, will likely continue to see a gradual fall in

Non-OECD oil product demand was also unchanged at 35.1mbpd in 2006 and
36.3mbpd in 2007, despite a slight downward adjustment in China’s oil product
demand growth rate for 2006 (from 6.2% to 5.6% annually). This revision is
related to the country’s relatively lower apparent demand growth over the past
three months, possibly due to the drawdown of stocks. This could justify
revising Chinese demand upwards in 2007, but the IEA is waiting for
confirmation of the stock hypothesis.

“The year 2006 was a year of dramatic inventory shifts.”


The IEA has kept unchanged its global growth forecast for 2006 (+1.1% to
84.5mbpd) and 2007 (+1.7% to 85.9mbpd), as downward adjustments in OECD
countries were largely offset by upward revisions in the rest of the world.

There is, however, a big question mark over US economic growth prospects in
2007, which could have a powerful influence on the oil market. Although most
observers concur that economic activity is slowing, the jury is still out
regarding the magnitude and timing of the slowdown, amid a host of
contradictory signals.

As a result, the IEA has decided to continue to base its forecast on the
IMF’s US GDP projection for 2007 (+2.9%, compared with an emerging current
consensus of 2.5%), but it will review this figure. Moreover, it can be argued
that slower US economic expansion will not translate into much lower domestic
oil demand next year. US citizens are likely to maintain their driving and
flying habits in the short term.

The oil price fall after last summer’s highs encouraged the marginal
substitution of hitherto cheaper natural gas with naphtha and fuel oil in the
US. However, this effect has diminished following the rebound in oil prices
over the past month. As a result, demand for the heavy end of the barrel has
resumed its long-term downward trend.


World oil supply slipped by 50kbpd in November to 85.4mbpd, with lower OPEC
crude supply outstripping an OECD-inspired rise from non-OPEC. August and
September production estimates have been revised down by close to 90kbpd, based
on a lower baseline for non-OPEC Africa and the North Sea. October supply has
been revised up by 120kbpd, on the strength of higher FSU and OPEC crude
availability. A yearly comparison shows 3Q06 global output 1.3mbpd above
disrupted year-ago levels.

Non-OPEC supply estimates have been revised down by 40kbpd for 2006 and by
115kbpd for 2007. Next year’s adjustments are focused in the 1Q–3Q
period, when Australia, Russia, Brazil, Sudan, Egypt and Mauritania now appear
headed for lower than previously expected output. A partial offset comes from
higher expectations for North America and China.

“Heavy and protracted refinery maintenance in the US resulted in a sharp decline in product inventories.”

All told, non-OPEC supply rose by 650kbp d in 2006 (constrained by weak 2Q
performance) and could rise by1.7mbpd in 2007, reaching 52.6mbpd. OPEC NGL
supply growth is expected to remain unchanged at 0.2mbpd both years, averaging
4.7mbpd and 4.9mbpd respectively for 2006 and 2007.

Total OPEC crude supply fell by 555kbpd in November, after a 225kbpd
reduction in October. November supply averaged 28.9mbpd, after substantial
reductions from Saudi Arabia, the UAE, Venezuela and Iran. There were ongoing
disruptions to supply from Iraq and Nigeria.

OPEC-10 (excluding Iraq) output fell 500kbpd in November to 27.1mbpd. In
all, OPEC-10 production is running 610kbpd below September, compared with a cut
of 1.2mbpd pledged at the October OPEC meeting. Notional spare capacity reached
3.8mbpd, but effective spare capacity (excluding Iraq, Nigeria, Venezuela and
Indonesia) rose only modestly to 2.4mbpd.

The call on OPEC is revised up by 0.1mbpd to 28.4mbpd for 2007, based on
lower expectations for non-OPEC supply in the first three quarters of the year.
The current quarter’s call stands at 29.8mbpd, nearly 1mbpd above prevailing
OPEC supply, suggesting the potential for a substantial 4Q stock draw unless
winter weather proves markedly milder than normal. Similarly, the 1Q07 call
stands marginally above recent OPEC output, at 29.0mbpd.