Oil Sketches Its Oh So Quiet

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COMMODITIES RESEARCH 26 April 20

PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES STARTING AFTER PAGE 69

OIL SKETCHES

Its, oh, so quiet

Oil prices have come off the highs seen earlier in the year, and price action thus far inQ2 has been in line with our view of a very calm quarter. Oil market volatility is at itslowest level since 1995, and US retail gasoline prices are now lower y/y for the first timesince October 2009. Consumer government proactivity in discussing strategic stockreleases, the success in achieving something of a time-out on Iranian nuclear issues,high oil prices keeping demand in the western world in check, OPEC volumes movingsignificantly higher y/y and a lack of momentum and risk appetite have, incombination, gone a considerable distance in calming markets. This has taken the stingout of the upward pressure that was building in Q1.

In contrast to this time last year, when the plunge in OPEC output created a large deficitat the margin of the market and any weakness in OECD demand was overshadowed bysurging non-OECD demand, the dynamics are different now. OECD demand, outsideJapan, has been extremely weak, exacerbated by unseasonably warm weather, whilemomentum in non-OECD oil demand has slowed in line with softer economic growth.At the same time, with a recovery in Libyan volumes, most holders of spare capacitynow producing at their maximum capabilities and Saudi Arabian output at 10 mb/d,OPEC crude production is near record levels. This results in quarters of inventory buildsfollowing nine consecutive quarters of stockdraw.

However, OPEC production at these levels comes at a cost. Spare capacity is dwindling,with Saudi Arabia the only country able to boost production in the short term. The callon OPEC crude is set to rise in the coming quarters due to the combined effect of aseasonal pick up in non-OECD demand, an improvement in the global, in particular theChinese, economic backdrop in H2, improving US oil demand, and, at best, a flat-liningof non-OPEC supply. The recent pull-back in prices should be supportive for non-OECDoil demand growth. Should inventories fail to build even with OPEC producing near 32mb/d, spare capacity is likely to come straight back to the limelight and will likely be thekey determinant of prices. Iran is then almost tangential to this equation, althoughexpectations of a loss of almost 1 mb/d of Iranian export, which were largely priced inearlier in the year, are probably no longer so. Were one to again throw in a potential lossof Iranian supplies in Q3 against a backdrop of improving demand, the slim bufferwould be diminished further, thereby supporting prices.

Miswin Mahesh

+44 (0)20 7773 4291

[email protected]

Amrita Sen

+44 (0)20 3134 2266

[email protected]

www.barcap.com


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Barclays | Oil Sketches

26 April 2012 2

TABLE OF CONTENTS

DEMAND AND SUPPLY HIGHLIGHTS 3FOCUS 12Fuel oil: Saudi demand and Iranian supplies...................................................................................... 12MONTHLY DATA RELEASES 24OPEC production estimates................................................................................................................... 25US crude oil imports ................................................................................................................................ 28US data revisions ...................................................................................................................................... 30Japan............................................................................................................................................................ 34Europe continental big 4 ..................................................................................................................... 37South Korea ............................................................................................................................................... 38Middle East ................................................................................................................................................ 39India............................................................................................................................................................. 40China........................................................................................................................................................... 41Air traffic..................................................................................................................................................... 43US trucking and rail data ........................................................................................................................ 44Russia.......................................................................................................................................................... 45United Kingdom........................................................................................................................................ 46Mexico ........................................................................................................................................................ 48Brazil............................................................................................................................................................ 50International rig counts........................................................................................................................... 51Norway ....................................................................................................................................................... 53US oil production...................................................................................................................................... 54Canada........................................................................................................................................................ 56MARKETS AND PRICES 58Brent price differentials........................................................................................................................... 58WTI price differentials ............................................................................................................................. 59Price ranges and crude oil forward curves......................................................................................... 60Saudi Arabian crude oil pricing............................................................................................................. 61SUPPLY-DEMAND PROJECTIONS 62NON-OPEC SUPPLY 63DEMAND 64MACROECONOMIC FORECASTS 65TRADE RECOMMENDATIONS 66PRICE FORECASTS 68Data in this report comes from the following sources unless otherwise noted, and from Barclays Capital calculations.Pages 25 to 27: Energy Information Administration Short Term Energy Outlook, International Energy Agency OilMarket Report, Middle East Economic Survey, OPEC Monthly Oil Market Report, Reuters, Bloomberg. Pages 28 to 29:US Energy Information Administration. Pages 46 to 47: UK Department for Business, Enterprise and RegulatoryReform. Pages 48 to 49: Petroleos Mexicanos Indicadores Petroleros. Pages 51 to 52: Baker-Hughes. Pages 35 to 36:Ministry of Economy Trade and Industry, Preliminary Report on Petroleum Statistics.Page 53: Norwegian PetroleumDirectorate. Page 41: China Customs. Page 42 to 43: Energy Information Administration Petroleum Supply Monthly.Page 62 to 64: International Energy Agency Oil Market Report, OPEC Monthly Oil Market Report, Energy InformationAdministration Short Term Energy Outlook.

Sources


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26 April 2012 3

DEMAND AND SUPPLY HIGHLIGHTS

Demand

The latest global oil demand data for February and March are hardly inspiring, continuing toshow weak US and European demand offset by strong OECD Pacific and non-OECD

demand. Interestingly, though, the more up-to-date data are showing a remarkableimprovement, laying the groundwork for tightening in demand-supply balances in H2 12.

Part of the recent weakness in demand is clearly linked to the warmer-than-average winter inthe US and Europe. In the US, heating degree days during the first quarter were 23% lower.February was the coldest month of the winter so far in the US, yet it was still the warmestFebruary in 12 years. Similarly, the European winter has been very mild, with heating degreedays 6% lower than usual. March, in particular, was weak for US and European oil demand,with almost 45% fewer heating degree days in the US than normal, making it one of thewarmest Marchs on record, while in Europe it was the warmest March since 1990. Notsurprisingly, unrevised data show US demand down 831 thousand b/d in Q1, while Europeandemand is about 650 thousand b/d lower y/y. Despite the upward revision to Januarys

figures, US demand was lower by 853 thousand b/d y/y, while the latest European figuresfrom JODI pegged February as lower by 618 thousand b/d y/y. Even Mexican demand wasadversely affected by warmer weather, moving into negative territory y/y in February afternine months of solid growth, with all of the weakness concentrated in fuel oil.

With European temperatures now below normal levels, some of the demand weakness inQ1 may well be reversed. Similarly, in the US, not only does normalising temperatures aid inarresting some of the steep y/y declines, but there has also been an underlyingimprovement in demand. For the first time in more than a year, oil demand in April isrunning higher, by 309 thousand b/d y/y, with distillate demand snapping out of itsdeclines for the first time in five months and gasoline demand poised to move to positiveterritory after 14 straight months of decline. With retail gasoline prices having moved lower

y/y, albeit only slightly, for the first time since October 2009, gasoline demand could finallybe turning the corner.

Balanced now, tighter in H2

Weather-linked weakness

in the US and Europe

Some underlying improvement

in US demand

Figure 1: Asia-Pacific demand the brightest spot in the OECD

Figure 2: US oil demand shows signs of improvement

-3.8

-3.1

-2.4

-1.7

-1.0

-0.3

0.4

1.1

1.8

2.5

08 09 10 11 12

Europe

Asia-Pacific

NA

OECD oil demand (mb/d, y/y change)

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

Apr-07 Apr-08 Apr-09 Apr-10 Apr-11 Apr-12

US oil demand - y/y change mb/d

Source: JODI, Barclays Research Source: EIA, Barclays Research


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26 April 2012 4

OECD Pacific demand continues to stand out, as we highlighted in the previous Oil Sketches(23 March 2012), with the region adding more than 700 thousand b/d y/y. Japanese oildemand for February came in at 5.116 mb/d, the highest level in exactly three years,constituting a y/y increase of 483 thousand b/d, supported by strong direct crude burn andfuel oil demand. South Korean demand picked up strongly, too, by 173 thousand b/d y/y(one of the strongest growth rates ever) in February, buoyed by extremely cold weather.

Preliminary data for March show total oil input for electricity generation in Japan averaged527 thousand b/d, some 300 thousand b/d (150%) higher than a year earlier. Just onenuclear power plant was operating in Japan last month, and from early May, nuclear outputwill literally be zero. With the base comparisons becoming significantly easier over thecoming months, we expect Japanese oil demand to continue to register strong growth.Preliminary data from South Korea, however, show a fall of 67 thousand b/d as weatherturned warmer. Overall, we expect OECD Pacific demand in March to be up about250 thousand b/d y/y, with Japan continuing to shape the future of the region.

Figure 3: Japan views on nuclear power by region

JAPAN

Sea of Japan

Pacific Ocean

Kagoshima

Ehime

Saga

ShimaneFukui

Ishikawa

Niigata

Hokkaido

Aomori

Miyagi

Fukushima

Ibaraki

Tokyo

Shizuoka

Supports restartOpposes restartNeutral

Source: Argus Gas and Power, Barclays Research

The Japanese government has estimated that without nuclear generation, there could be a20% power shortage in the event of a hot summer. The test case in Japan focusses onrestarting Kansai Electrics (KEPCOs) no. 3 and 4 reactors at its Ooi power station. With thestress tests passed and the safety case judged compliant, the biggest remaining hurdle isconvincing a sceptical Japanese public that starting the plants poses no safety risk. Thegovernment has a self-imposed deadline of the beginning of May to make a decision on theOoi restarts. In the interim, the government is making the case for nuclear through a road-show to the affected provinces in an effort to increase public confidence to allow thoserestarts. With a recent Reuters poll suggesting that 57% of Japanese opposes the restarts,there remains considerable opposition to be overcome; having a decision on the first re-start in the coming weeks appears optimistic, and it is most likely that nuclear plant, to theextent they are restarted, will only come back slowly. The three largest power utilities TEPCO, Chubu Electric Power and Kansai Electric Power do not show signs of being able

Robust demand supported by

strong direct crude burn and fuel

oil demand

Japanese nuclear restarts:

lacking public confidence
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to restart their reactors any time soon. Thus, we expect oil demand to remain strong andpick up in the summer months, as air conditioning demand creates additional demand.

Among the non-OECD countries, the primary focus has been the slowdown in activity inChina. While the macroeconomic data improved slightly m/m yet remain broadly subdued,in line with our macroeconomists below-consensus views of GDP bottoming out in Q2, oildemand indications held up reasonably well in March, growing 400 thousand b/d y/y to

9.499 mb/d. Across Q1, demand averaged 9.612 mb/d, up 4.1% y/y, and while growthrates have slowed relative to last year, they continue to build on a high base, especiallyagainst an economic backdrop in which GDP growth was easing. In fact, real GDP grew8.1% y/y in Q1, below our forecast of 8.4%. Following some stockbuilds in January andFebruary, Chinas products stocks eased in March, with gasoline down 0.6% m/m, dieseldown 4.9% and kerosene down 5.1%, pointing to even stronger underlying demand onceadjusted for stockdraws. With record refinery turnarounds scheduled for this month andnext, we would expect China to continue to draw inventories as crude throughput remainslow. Given easing credit conditions, the fine-tuning property market measures andsupportive fiscal policy, activity should pick up slowly into H2, especially as loans andlending to small businesses pick up, and should boost petrochemical demand growth.

Demand in other non-OECD countries remained robust, with Indian demand up 2.1% y/y inFebruary and Brazilian demand 2.7% higher y/y. In India, growth in diesel sales picked up,increasing 8% y/y to 1.423 mb/d, the second-highest level ever, while gasoline demandgrowth recovered, too, increasing 4% y/y, as auto sales hit a record high. Brazilian demandwas also supported by gasoline sales at 0.661 mb/d, 16.2% higher y/y, and diesel demand3.7% higher y/y. While much of the increase in gasoline demand stemmed from a lowerratio of ethanol blending due to a poor sugar crop last year, current growth is largely afunction of strong economic activity and employment. March FSU demand ran higher y/yby a similar 2.5%. Demand in the Middle East, however, was tempered, due to significantlymilder weather. In February, the regions demand was lower by 232 thousand b/d y/y. Notsurprisingly, the weakest parts of the barrel were fuel oil (down 143 thousand b/d y/y) anddirect crude burn (down 157 thousand b/d y/y), while robust economic growth in theregion continued to buoy gasoline and diesel demand.

Supply

Oil supplies remain supported by high OPEC volumes, particularly from Saudi Arabia, UAEand Kuwait, as well as recovering Libyan production, helping to offset the reduction inIranian volumes, non-OPEC supply shortfalls and moderate demand growth. However, whileelevated OPEC volumes have helped balance the market, it has also thinned out availablebuffers of spare capacity. Non-OPEC supply remains weak despite the return of some of theweather-related and technical shortfalls. North America is the only region generating stronggrowth, although a series of technical problems have recently crippled Canadian output.

Non-OPEC

With the exception of the US, non-OPEC growth remains lacklustre. Although some of the

shortfalls in non-OPEC supply recently have recovered (eg, Australia, Canada), a wide rangeof shortfalls some perennial (North Sea) and some geopolitical (Sudan, Yemen) continueto plague several suppliers.

Output centres that have recovered recently include:

The bulk of Australian production has now returned online, having been shut duringtropical cyclone Iggy and Lua. The effect was varied with a total of 100 thousand b/d(one-third of Australias production) closed temporarily. Woodside Petroleum restartedproduction from its Enfield facility in late March, while the final 40 thousand b/d Vincentoilfield has only just restarted (mid April) following a one-month shutdown.

Chinese demand continues to

build on a high base

High refinery turnarounds

scheduled for this month

and next

Indian and Brazilian demand

remain strong

High OPEC volumes help offset

non-OPEC supply shortfalls

Some shortfalls fade,

others remain


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Canadas shortfalls have also eased, with Suncor restarting its 100 thousand b/dupgrader (U2) by mid-April, which had been shut for repairs since mid-March due to afractionator performance issue. Syncrudes 100 thousand b/d upgrader (Coker 8-1) is,however, still offline for extended maintenance, with no indications yet on its restartdate. The Syncrude upgrader has been shut in since a fire in early February. CNRLsoutput at Horizon was expected to restart full operations by the end of March, and while

there has been no official announcement confirming the restart, we expect it to resumeimminently. Shell, too, began restarting units at its Scotford unit in Alberta. Overall, Q1Canadian production faced severe shortfalls and is likely to come in lower y/y.

Elsewhere, the dispute between South Sudan and Sudan escalated into outright violenceover the month. South Sudan accused the north of bombing a disputed major oil field in theHeglig region, while the north then exchanged blame and even declared war on the south.Although South Sudan withdrew troops from the region, there have been severe damagescaused to the field. While South Sudans oil output of about 0.4 mb/d has already been shutin (due to transit fee dispute) for three months now, the damage to the Heglig region hastaken off half of Sudans 115 thousand b/d of oil production, reducing overall oil productionfrom the region to about 50 thousand b/d. Given that political rhetoric has evolved into

military action, any quick resolution to this situation is highly improbable, and we continueto expect more than 0.4 mb/d of output to remain curtailed in this region.

In the North Sea, ageing oilfields continue to weigh on growth rates, with UKs oilproduction down 337 thousand b/d in January, a much sharper decline than 2011s averageof 237 thousand b/d, at a time when Buzzard was fully operational. More recently, though,output at Buzzard was affected again as a bearing failure on one of the gas compressors onthe fields newest platform resulted in a shutdown. Repairs are under way according toNexen, and production is set to resume shortly. Separate to this, Forties cargoes that weredue to be loaded in April have already been delayed to the first week of May, highlightingthe widespread weakness in UKs oilfields.

Totals Elgin field was shut permanently following a leak, while Norwegian crude productionremains lacklustre, falling 166 thousand b/d y/y in February and 105 thousand b/d inMarch, as technical problems continue to cripple oilfields. While growth in NGLs has helpedoffset some of the crude declines, the overall outlook for North Sea remains grim.

While North Sea weakness is now a foregone conclusion, with the extent of decline thematter to debate, the FSU has seen contrasting fortunes for most of the past decade. WhileRussian production continues to grow y/y, output levels are plateauing at about 10.36mb/d. Meanwhile, the only oilfield to come online this year has now been pushed back,which could cripple the countrys growth rate towards the end of the year. Kazakhstansoutput growth is holding steady, but Azerbaijan recently announced that it was artificiallyreducing extraction rates to extend the production timeframe of its oil reserves. Azeriproduction fell 5.8% y/y (59 thousand b/d) in Q1 12, following a weak Q4 in which

production fell by 169 thousand b/d, hampered by repair work at some drilling platformsand refineries. The recent announcement on extraction rates is likely to not just temper2012 growth rates but possibly limit growth potential over the years to come, too.

Yemeni oil production has been reduced further this month due to an attack by militants onits second oil pipeline. The pipeline usually transports oil from the southern province ofShabwa to the 140 thousand b/d capacity Bir Ali terminal on the Gulf of Aden. This comesin addition to the series of attacks on the other pipeline, which had already kept half of thecountrys output offline for over a year. While the extent of the recent attack is not clear yet,it has certainly placed Yemens production below 140 thousand b/d for the time being.

Dispute escalates between South

Sudan and the North

North Sea shortfalls remain

Supplies from the FSU and

growth rates to plateau

More pipeline attacks in Yemen


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The brightest spot in all of non-OPEC remains the Americas, which has continued on astrong growth path. While Brazilian output has been affected somewhat by the latest oilspills and Canadian production by the shortfalls discussed above, output from bothcountries should recover as the year progresses. 2012 production may well disappoint tothe downside given the plethora of problems in Q1, but should still post positive growthoverall. US production, on the other hand, risks surprising to the upside. The contrast in

weather patterns between this year and last has had a pronounced effect on domestic oilliquids output, which increased at a record pace of 929 thousand b/d y/y in January. This issomewhat overstated given that most North Dakotan output was shut in by snow in January2011. Preliminary February data from North Dakota show continuation of the trend, withoutput higher 213 thousand b/d y/y. Even adjusting for weather effects, US oil productionhas increased by an average of 100 thousand b/d each month for the past six months, andUS crude production has risen 23% from 4.950 mb/d in 2008 to 6.094 mb/d currently. Thesuccess and growth of Bakken (which has made North Dakota the third-largest oil-producing state in the US) and Eagle Ford has fuelled the idea that similar results can beobtained in other shale plays across the country for instance, in the Permian and Uticabasins, where large areas of recoverable liquids play have been discovered. The problem,however, remains pipelines and appropriate infrastructure along with the quality issues,

which are likely to continue to weigh on light, sweet crude grade prices.

Figure 4: Status of unplanned non-OPEC supply outages

Country Impacted project/oilfield/unit and detailsOutage

(thousand b/d)Status

Canada Suncor Energy: Alberta oil-sands plant upgrader (March to April) 100 Mid April restart

Canada Syncrude upgrader (Coker 8-1) 100 Offline for extended maintenance

Canada CNRL's Horizon oil sands project (February to April) 110 Expected to resume

Brazil Chevron - Frade offshore oilfield 60 Offline

Brazil Petrobras - Albacora field (March) 91 Resumed

Colombia Protests and attacks on oil pipeline 45 Increasing frequency

South SudanDispute between Sudan and South Sudan over transit fees, now

escalating into military activity400 Intensified

UK Total's Elgin, Frankil and Bacton fields - gas leakage 70 Shutdown

UK Buzzard affected again due to bearing failure on gas compressor 200 Variable

Yemen New attacks on 2nd pipeline; 1st one remains offline 200 Ongoing

Norway Alvheim, Balder, Grane etc - technical problems >50 Recovered

SyriaOperating environment remains constrained with increasing

frequencies of pipelines attacks and sanctions restrict flows250 Still under pressure

Australia Cyclone Iggy affecting production (January to March) >100 One-off

Australia Cyclone Lua affecting production (March to April) ~40 Nearing full recovery Source: Barclays Research

Great expectations on supply

growth in the Americas

US production risks surprising

to the upside, but what

about infrastructure?


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OPEC

OPEC production at elevated levels has played a crucial role in balancing the market. Acombination of steadily recovering Libyan production, gains in Iraqi production, andelevated output from Saudi Arabia, the UAE and Kuwait have supported this surge.

Libyan production continues its steady recovery, gaining 110 thousand b/d over the month

to 1.346 mb/d. In April, output is set to receive a further boost from incremental productionof 30 thousand b/d from AGOCOs Sarir field and 20 thousand b/d from the Mesla field,taking both to producing almost at their pre-war capacity. Additionally, production at thesmaller Majid field that came onstream at the end of March is expected to ramp up to thefields 10-15 thousand b/d capacity. The ramp up has, of course, not been withoutchallenges. Germanys Wintershall, for instance, has its production at Blocks NC-96 and NC-97 of the Sirte basin stuck at about 60 thousand b/d, due to pipeline damage leading to theRas Lanuf export terminal. Production at the OMV/Occidental operated Zueitina field,which relies on the same pipeline, remains crippled at 75% of pre-war capacity. The largerissue surrounding Libya currently is the resumption of exploration drilling, particularly byforeign oil companies; without foreign companies, Libyan oil production may well stagnatejust below pre-crisis levels or, worse, risk slipping backward.

Most of the countrys output resumption has been offshore, while new activity onshore hasbeen relatively muted. Eastern Libya, home to the Sirte basin, which accounts for more thantwo-thirds of the countrys oil output and has close to 80% of Libyas proven reserves, is allonshore, and maintaining production at current levels never mind raising it further willbe much more of a challenge given the almost total lack of new upstream activity. In fact,less than 10% of Libyas output comes from offshore operations of the Pelegian Shelf Basin.Although foreign companies have restarted existing production, no new ground investmenthas been made with regards to personnel and equipments for exploration activity. (Repsolremains the only exception, issuing tenders to restart exploration drilling in Murzuq, whilePolands POGC sounds less pessimistic on the potential for return.) Libyas own companiesare crippled with a lack of exploration drilling. AGOCO, for instance, has several

infrastructure tenders in the pipeline that are essential to lay the groundwork for expandingcapacity further, but these cannot be awarded until the companys 2012 budget isapproved. Under the previous Gadhafi regime, the budget used to be awarded in April.However, currently there is a great deal of uncertainty in the ability of the countrystransitional government and NOCs Tripoli headquarters to finalise the oil sectors share ofthe national budget and allocate it to NOCs regional affiliates any time soon. With thetransitional government only managing to sanction emergency spending, the NOC hasfailed to secure enough funds for new drilling themselves and have been limited to far lesscapital-intensive activity than drilling such as shooting seismic.

Iraqi volumes have risen steadily since the start of the year, with March output increasing0.24 mb/d y/y, taking it to 2.84 mb/d. The start-up of the new export facility in the south,

allowing Iraqs southern fields to ramp up, has helped output inch closer to 3 mb/d in Aprilaccording to preliminary data. However, with the next big surge in output from thesouthern fields dependent on water reinjection, which has already been pushed back, weremain sceptical about Iraqs ability to grow production much further. Indeed, Exxons exitfrom the Common Sea Water Supply Project has pushed 4.2 mb/d of this critical project bytwo years to 2017 and has endangered output targets of four out of five of Basra provincescritical oil capacity expansion projects. Together with security issues and Baghdads disputewith KRG, various challenges remain for Iraq. In early April, KRG halted oil exports out of thenorth, claiming that Baghdad owes them $1.5bn in revenues for exports from the regionand stating that, without full payment, Kurdish exports would not restart. Further,

Libyan production gaining

ground, but in a fragile backdrop

Lack of exploration

drilling in Libya

Iraqi volumes receive a boost, but

politics continues to pose risk


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politicians have been trying since 2007 to pass legislation that would give badly neededlegal certainty to Iraqs oil sector, but last week the oil and energy committee rebuffed thedraft law put forward by the cabinet. The committees vote to table that draft sends a signalto Maliki that he cannot expect to pass oil legislation without returning to the negotiatingtable and puts the long-term prospects of Iraqi output in doubt.

While Irans output continues on its long downward trajectory separate from the sanctions,export volumes have started feeling the pinch from the sanctions and embargo stated tocome to full effect from 1 July. Irans oil officials recently stated that their exports stood at2.1 mb/d, down from the usual 2.3 mb/d last year. In reality, these export figures might belower still, as Europe, Japan, South Korea and even countries such Turkey and India, whichhad initially shown little signs of reducing Iranian imports, have started cutting purchasesfrom Iran. China may well be the only anomaly, with Iranian volumes dispersed aroundvarious Asian ports eventually finding its way to the country. While the March ChinaCustoms data showed a 54% y/y fall in Iranian imports, that was primarily a result of thepricing dispute from earlier in the year, and we expect Iranian imports to pick up in thecoming months. Overall, unless talks between Iran and the western countries held in fiveweeks time yield some conclusive results, the US sanctions and EU embargo effective 1 July

could curtail Iranian exports significantly, especially as shipping re-insurance returns to thefore. Please see Geopolitical Update: Overtime Iranian nuclear negotiations set to continuenext month, 17 April 2012, for more information.

Figure 5: OPEC crude output at near record levels Figure 6: OPEC spare capacity remains thin

-4

-3

-2

-1

0

1

2

3

06 07 08 09 10 11 12

OPEC 12 output, y/y change, mb/d

0 0.5 1 1.5 2

Iraq

LibyaNigeria

Ecuador

AlgeriaV'zuela

AngolaKuwait

UAE

QatarIran

Saudi

mb/dIranian spare -available in theory but

no buyers due tosanctions

Official Saudi spare vs.realisticspare (brought online in 30

days and sustained)

Source: EIA, MEES, IEA, EIG, Platts, Reuters, Bloomberg, Barclays Research Source: Barclays Research

Saudi Arabia continues to pump close to 10 mb/d, while increasing their assurance ofample supplies through various statements by oil minister Ali Naimi. Although Naimi placestotal Saudi capacity at 12.5 mb/d, we believe the sustainable spare capacity that can be

brought online in 30 days and sustained for 90 days is not much more than 1 mb/d in thecountry. We place global spare capacity at less than 1.5 mb/d. One of the other factorsdiscussed by Naimi is Saudi Arabias ability to meet its domestic swing up in demand overthe summer through natural gas generation. While natural gas generation may well behigher than last year, we still expect a swing in overall oil demand of about 0.5 mb/d. Whilehistorically increases in Saudi Arabias domestic crude production go towards meeting theirown demand in the summer, keeping exports constant, we believe that this year SaudiArabia will meet the bulk of its power generation through higher fuel oil burn, possibly eventurning into a net fuel oil importer in the summer (see Energy Flash: Fuel oil Saudi demand

Irans exports in the focus

Saudi Arabian power utilities

gearing up to burn more fuel oil
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and Iranian supplies, 24 April 2012). Together with the build up in crude inventories over Q1and power utilities gearing up to burn more fuel oil, Saudi Arabia seems prepared on thesurface to continue exporting crude when the loss of Iranian volumes could be substantial,giving off an impression of ample spare capacity. In reality, already thin spare capacity islikely to get slimmer in Q3 unless there is a resolution to the Iranian stand-off.

InventoriesOECD inventories built counter-seasonally in February and March, with stocks 5.6 mb abovethe five-year average for the first time since May 2011. This implies a 0.55 mb/d impliedstock build over Q1 after nine consecutive quarters of stock draw. Overall, European crudeinventories remain very low, as do stocks in the Asia-Pacific, with US the only region whereinventories are above the five-year average. However, there is more to the data than meetsthe eye. Although the market attention has focussed on the headline crude builds, whichare now 24.6 mb above the five-year average, product stocks have fallen sharply, andcurrently stand 19.2 mb below the seasonal average. Distillate inventories are almost 7 mbbelow the average while gasoline stocks are just 1 mb above the five-year level.

Globally, a large part of the stock build seems to have come from the non-OECD countries

(namely, China filling their SPR, Saudi Arabia filling inventories preparing for higher call ontheir crude, and even Iran stockpiling in Europe and Asia). Chinese commercial inventorieshave been building since the start of the year, mainly replenishing the stocks that weredrawn down sharply last year. However, the rate has been in line with the three-monthmoving average. The stockbuilds in January and February were followed by Chinasproducts stocks easing in March, with gasoline down 0.6% m/m, diesel down 4.9% andkerosene down 5.1%, pointing to even stronger underlying demand once adjusted for thesedraws. With record refinery turnarounds scheduled for this month and next, we wouldexpect China to count on these inventories since refinery throughput will likely be low.Finally, China has also been actively filling its SPR, and given the large tranche of Phase IISPR coming online this year, SPR buying of crude could easily average about 150-200thousand b/d through the year, supporting higher crude imports.

OECD inventories climb above

the five-year average in March

A large part of the global

stock builds have comefrom the non-OECD

Figure 7: OECD inventories above the five year average Figure 8: Chinese inventory builds

-75

0

75

150

225

Mar-08 Mar-09 Mar-10 Mar-11 Mar-12

OECD inventories relative to 5 year average (mb)

-400

-200

0

200

400

600

800

1000

Jan Mar May Jul Sep Nov

2008 20102011 5-year average2012

3mma

Rate of Chinese stock build, thousand b/d

Source: IEA, Barclays Research Source: China Customs, Barclays Research


11/72


26 April 2012 11

Summary of key consensus/agency monthly reports

IEA (Monthly Oil Market Report)

The IEA revised global oil demand growth marginally lower, by 50 thousand b/d to 0.77 mb/dfor 2012, due to a large downward revision to US demand (lower by 100 thousand b/d), whilenon-OPEC supply growth was reduced by a similar 40 thousand b/d to 0.7 mb/d. The call on

OPEC crude and stock change for 2012 was left unchanged at 30.1 mb/d, but was raised forQ2 12 and Q3 12, by 0.1 mb/d and 0.2 mb/d, respectively, due to further downward revisionsin non-OPEC supplies. A largely balanced market would then imply range-bound trading formost of this quarter before balances tighten in H2 12.

OPEC Secretariat (Monthly Oil Market Report)

OPECs monthly oil market report for April maintained its forecast for global oil demandgrowth for 2012 at 0.86 mb/d. There were marginal revisions, however, on a regional basisthat offset each other, with higher demand expectations for Japan cancelling out downwardrevisions to the US. Non-OPEC growth estimations for 2012 were trimmed by 0.03 mb/d,similar to the revisions this month by the IEA, while in contrast to the upward revision bythe EIA. The current growth estimate of 0.58 mb/d is higher than our own estimate of 0.28

mb/d, though it is less optimistic compared with the IEA and EIA forecasts, with NorthAmerica being the mainstay of growth. OPEC production estimates for March (based onsecondary sources) show production pegged at 31.3 mb/d, gaining 0.136 mb/d on a m/mbasis; on a y/y basis, the comparison is even starker at 2.46 mb/d y/y, with the Libyanoutage last year at this time providing a low base. This month, the report has introducedOPEC production estimates based on direct communication by member countries, and datafrom these numbers differ from the secondary source estimations primarily due todivergence in data from Iran. As a result, volumes in February are at 32.1 mb/d, a recordhigh. Overall, the call on OPEC crude and stock change for 2012 has only undergone aminor upward revision of 0.09 mb/d to 30.02 mb/d.

EIA (Short-Term Energy Outlook)

The EIAs latest short-term energy outlook made significant revisions to its demand and supplyestimates yet again. However, surprisingly, the change in non-OPEC supply was upwards, by 160thousand b/d to 0.84 mb/d for 2012, with an upward revision of 230 thousand b/d in the UScontributing to the bulk of the change. Indeed, this is the first time this year that EIA has revisedits estimates of non-OPEC supply higher. It now expects US production to increase 0.49 mb/d,bringing it in line with our own expectations of 0.41 mb/d. While we agree with the strength inUS output, we continue to believe the EIA remains overly optimistic on the rest of non-OPECproduction growth prospects, leaving them unaltered at a time when unplanned outages havetotalled almost 1 mb/d for a few months now. Even with the spectacular growth in US domesticproduction, global non-OPEC supply growth has been flat, at best, so far this year. Thus, thecurrent non-OPEC growth rate forecast of 0.84 mb/d for 2012 is now the highest among theforecasts of the IEA, OPEC Secretariat and our own expectation of 0.28 mb/d. For 2013, non-

OPEC supply was revised higher, albeit by a lesser extent (90 thousand b/d), and is now peggedat 0.85 mb/d, with Canadian production seeing an uptick, while Sudanese output is expected toresume. The EIA trimmed 2012 demand growth estimates by 170 thousand b/d to 0.89 mb/d,with the downward revisions over the two months now totalling 0.43 mb/d. This leaves themlower than our forecasts of 1.1 mb/d of demand growth, but brings them closer to the IEA andOPEC Secretariats growth expectations of 0.82 and 0.86 mb/d, respectively. Revisions wereconcentrated in the OECD, in particular Europe and the US, with overall growth trimmed by 0.19mb/d. 2013 demand growth was also revised marginally lower, by 7 thousand b/d, and is nowprojected at 1.3 mb/d.


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26 April 2012 12

FOCUS

Fuel oil: Saudi demand and Iranian supplies

Despite the sharp correction in fuel oil prices following the rally at the start of the year,we expect prices to rise through H2 and 2013, with a potential risk of a spike in Q3 thisyear. While there is a lot of focus in the market on the scale of Russian refineryupgrades, the tightening in the second half of the year is likely to come from changingdynamics in the Middle East, in our view.

We believe the up swing in power generation in Saudi Arabia this summer is likely to bemet by higher usage of fuel oil, as the kingdom aims to rely as little as possible on directcrude burn, at a time when global spare capacity is thin and the call on its crude exportsis set to remain high. Utilities have already started expanding the number of units able togenerate power from fuel oil. If the summer temperatures are high enough, there is astrong likelihood that Saudi Arabia could turn into a net importer of fuel oil instead ofexporting an average volume of 775 kt/month.

At the same time, fuel oil volumes out of Iran are likely to dry up, as sanctions tighten inQ3. Iran exports more than 500 kt/month of fuel oil, and while it is trying to push asmuch volume as possible to Asia currently, with the exception of China, financing andinsurance restrictions could limit severely the amount of fuel oil that can be taken out bymajor participants to East Asia. With the quality of Iranian fuel oil making it a vitalblending component for optimising thicker variants of the fuel in the consumptionchain, the effect is likely to be substantial and have important implications for the lowsulphur-high sulphur spread.

Russian supplies have surprised to the upside despite the implementation of the 60/66tax. The primary reason for this is that in a rising crude price environment, it remainsattractive to export fuel oil relative to crude, and the integrated companies have done

exactly that. With crude oil prices coming off, the effect of the tax changes on Russianfuel oil exports are finally likely to be felt.

Further, despite lagging behind, Russian refineries continue to upgrade, although thematerial effect on fuel oil supplies will only be felt in 2013, in our view. Near term,Indias Vadinar refinery, which accounts for a third of the countrys 650 kt/ monthexports, is set to cease fuel oil exports following the long-awaited upgrade. Indeed,globally, as refineries continue to upgrade steadily, fuel oil supplies will continue tocome under pressure.

Lower fuel prices are also likely to incentivise the return of Chinese teapot refineries, themarginal demand barrel in the market. With Japanese nuclear restarts extremely slow atbest and weather normalising in Europe and the US, OECD fuel oil demand should staywell supported in the coming months. Bunker demand remains strong, with theorderbook continuing to look large despite bankruptcies. With inventories sharply lowerthan the five-year average once again, the risk of a fuel oil price spike this summerremains high.


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26 April 2012 13

Fuel Oil to the foreThe fuel oil markets have charted a very volatile course this year. The year began withcracks turning positive, but prices have fallen by more than $5 since. Supply side pressureswere building for some time and as refinery upgrades, closure of simple refineries and thepassing of a Russian legislation discouraging production of low end products gathered

pace, sentiment around fuel oil turned extremely bullish. With prices picking up, teapotrefineries in China, the marginal consumer of fuel oil, started to face severely negativemargins, thereby cutting back demand. Equally, the long-expected reduction of Russian fueloil supplies failed to materialise, with exports actually running higher y/y, while springmaintenance in Venezuelan refinerys secondary units temporarily increased supply, too.While bunker demand and Japan remained positive, the loss of Chinese demand andcontinuation of Russian exports dampened prices. The key question then is: were theexpectations around fuel oil overdone and, if not, what went wrong in much of theprognosis earlier in the year?

Figure 9: Fuel oil cracks, Singapore and Rotterdam

($/bbl)

-24

-21

-18

-15

-12

-9

-6

-3

03

Jan-10 Jul-10 Jan-11 Jul-11 Jan-12

Fuel oil 180 cst Singapore - Dubai crack

Fuel oil 3.5% Rotterdam - Brent crack

Source: Bloomberg, Barclays Research

Supply risks of significant volume lost from H2?

Middle East

Saudi higher fuel burn to mask thin crude spare capacity?

While there is a lot of focus in the market on the scale of Russian refinery upgrades, thetightening in the second half of the year is likely to come on changing dynamics in theMiddle East. That Middle East fuel oil demand is particularly high in the summer is no news,yet trade flows are likely to change significantly this summer, in our view. Fuel oil demand in

the region has risen by about 2% annually over the past ten years, with Saudi Arabiaaccounting for a large part of that growth. However, in recent years, incremental powergeneration has been met by direct crude burn and, increasingly, diesel, lowering fuel oildemand growth significantly. In 2005, the gap between a low consumption point of 1.1mb/d and a high of 1.5 mb/d was 370 thousand b/d. By 2009, that seasonal gap had morethan doubled, from 1.5 mb/d to 2.4 mb/d, and by 2011, the gap had increased to anhistorical high of 750 thousand b/d. Three categories accounted for all summer demandgrowth: middle distillates (gas/diesel oil); residual fuel oil; and crude oil used for directburning all used as boiler fuel for power generation. Since 2002, the swing in reported

A volatile start to the year

Saudi summer demand has been

met by more direct crude burn

and diesel lately


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26 April 2012 14

Saudi gas/diesel oil demand (from trough to peak) has ranged widely, from 90 thousandb/d in 2002 to 286 thousand b/d in 2010. In residual fuel oil, the swing in demand widenedfrom 90 thousand b/d in 2002 to 190 thousand b/d in 2008, but narrowed in 2010 and2011 as Saudi Arabia phased out the use of residual fuel oil as boiler fuel. The swing indirect crude burn is by far the widest, averaging 370 thousand b/d during 2006-10, up from140 thousand b/d between 2002 and 2005, with 2011 alone seeing a swing of almost 500

thousand b/d. Thus, much of the base load, as well as the seasonal variation, in powergeneration demand is now increasingly being met by distillate and direct crude, likelysupplemented by small amounts of condensate.

However, the up swing in power generation in the country this summer is likely to be met byhigher fuel oil usage, as the kingdom aims to rely as little as possible on direct crude burn ata time when global spare capacity is thin and the call on its crude exports is likely to remainhigh. Utilities have already started getting ready, expanding the number of units able togenerate power from fuel oil. If the summer temperatures are high enough, there is a stronglikelihood that not only will Saudi exports of fuel oil fall to zero, but it may even turn into anet importer. This in itself is a major swing factor for the fuel oil market as Saudi exportshave averaged 775 kt/month over the past 14 months. Though Saudi Arabia is in the

process of adding almost 1 mb/d of refining capacity by the middle of this decade, Saudidemand for fuel oil will likely continue to rise despite the greater use of gas and solar inpower generation and desalinisation. Last month, Saudi Electricity (SEC) announced that itis looking to build and operate a 1.7 GW independent power plant (IPP) running on fuel oil,as the countrys power generation continues to grow steadily.

Figure 10: Saudi Arabian oil demand, y/y change Figure 11: Saudi and Iranian fuel oil exports

-300

-200

-100

0

100

200

300

400

500

07 08 09 10 11 12

Direct crude

Diesel

Fuel oil

y/y change, thousand b/d

-1.3

-0.8

-0.3

0.3

0.8

1.3

09 10 11 12

Saudi Iran

y/y change, mt/month

Source: JODI, Barclays Research Source: JODI, Barclays Research

Iran sanctions biting into fuel oil, too?

While the focus of the sanctions on Iran has been on the crude oil market, fuel oil volumesout of the country have started to be curtailed severely as well. In particular, Iranian exports,which made up close to 8% of the 7 mt monthly flow into East Asia, have started tomoderate somewhat. Currently, Iran seems to be trying to push out as much fuel oil aspossible to East Asia ahead of the sanctions, with flows being extremely erratic. The port ofFujairah in the United Arab Emirates, a key hub for bunkering (demand ~1 mt/month), hasstarted to face problems in accepting Iranian fuel oil cargoes already given its relative smallsize. However, Iranian volumes are finding it easier to enter the Singapore bunker pool, asthe 4 mt/month size could allow for a better chance of reclassification and sale. With

But this year, we expect it to be

fuel oil

Sanctions impact Iranian fuel oil

exports too


15/72


26 April 2012 15

sanctions taking effect on 1 July, financing and insurance restrictions could severely limitthe amount of fuel oil that can be taken out by major purchasers in East Asia. With thequality of Iranian fuel oil being a vital blending component for optimising thicker variants ofthe fuel in the consumption chain, the effect is likely to be substantial and has importantimplications for the low sulphur-high sulphur spread (see box 1). The Bandar Abbas refineryhas the potential to export as much as 300 kt/month of 380 cst fuel oil, while the Bandar

Mahshahr refinery has the capacity to export up to 600 kt/month of the 280 CST variant,which is used as refinery feedstock in Singapore and China. Already a few of Irans existingfuel oil lifters have been sanctioned by the US government, and as long as the sanctionsexist, these volumes are likely to find it difficult to access consumer markets in the Far East.Much like crude, we would expect some of the fuel oil barrels to move to China, but overall,there would still be a loss of some fuel oil exports from Iran in H2.

Saudi Arabia, Kuwait, Iraq and Iran account for 86% of the total Middle Eastern fuel oil usein power generation, with Saudi alone contributing to 45% of the Middle East total. While anabundance of simple refinery capacity so far had led to a regional surplus in the region (eg,A960 from Saudi Arabia), allowing for fuel oil exports, parts of the region are already fuel oilimporters. With Iranian volumes likely to curtailed severely following the sanctions and with

the risk that Saudi Arabia turns into a net importer of fuel oil, more than 1 mt of fuel oilexports are at risk of being lost from the market.

Figure 12: Iranian exports by destination Figure 13: Russian fuel oil exports

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

Jan-11 May-11 Sep-11 Jan-12

Asia Mi ddl e East

mt/month

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

Jan-09 Jan-10 Jan-11 Jan-12

y/y change, mt/month

Source: Barclays Research Source: JODI, Barclays Research

Box 1: Loss of Iranian fuel oil affects specification changes

The global sulphur limit was revised by the International Maritime Organizations International Convention from 1 January toprevent pollution from ships. It mandated that ships global sulphur emission limits should not exceed 3.5%. The Fujairah port

was widely expected to have difficulty adjusting to this change, but it has achieved a smooth transition, making availableconsistent quality since the beginning of the period. Anecdotal evidence suggests steady Iranian exports of fuel oil helped withthe blending at the start of the year. However, with the pressure from sanctions increasing over the past two months, moreIranian fuel oil is heading to Singapore, thereby reducing supplies to Fujairah. Fujairah normally sells an average of 1 mt/monthof fuel oil with almost one-third (300 kt/month) coming from Irans Bandar Abbas refinery. This implies higher blending costs forFujairah; as a result, the premium for the 380cst bunker fuel over Singapore peaked in February. With supplies building up inSingapore, however, Fujairah was able to source lower sulphur fuel oil to offset the loss of blending volumes from Iran. With theeffect of the sanctions likely to increase, especially in the form of shipping insurance, Iranian volumes are finding it easier to enterthe Singapore bunker pool, as the 4 mt/month size could allow for a better chance of reclassification and sale.

Over 1 mt of fuel oil exports at

risk between Saudi and Iran


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26 April 2012 16

Overall globally, the next big spec change is expected to kick in 2020 when sulphur content is expected to be reduced from 3.5%currently to 0.5%. Even with the use of on-board scrubbers, this would warrant a shift from high sulfur to low sulphur fuel oil andultimately lower sulphur gasoil.

However, the IMO bunker legislation is not only a post-2020 problem. The 1.5% sulphur grade has already been erased in Europe(now 1%). The main short-term effect will be when the North American SECA comes into force as of 1 August 2012, which

could widen the LS-HS differential in the region. This year, the Californian cap moves to 0.1% (within 24 nm of the coast).Australia, New Zealand and Hong Kong have voluntary measures that are l ikely to develop into ECAs by 2015.

Figure 14: Global fuel oil spec changes

Likely

Mexico/Panama:Possible by 2018

Unlikely

MalaccaStraits:Unlikelyby 2018

Hong Kong(voluntary)

Med: Part or all by 2018

NE Atlantic unlikely

Sulphur EmissionControl Area

Source: FGE, Barclays Research

Jordan and Israel remnants of the Arab SpringJordan has ramped up its fuel oil imports for power generation as continued attacks on thepipeline running through Egypt, Israel and Jordan have disrupted natural gas supply sinceFebruary 2011. Gas from Egypt covers 40% of Israels needs and 80% of Jordans. As aresult, Jordan, which has been an occasional importer of about 40 kt of fuel, has recentlystepped up its buying, pulling in more than 200 kt of fuel oil. Similarly, ahead of lastsummer, Jordanian officials said they were spending $28mn a week to import fuel oil toreplace the disrupted Egyptian gas. Given the fragile security situation in the region, wewould expect the effect on fuel oil to last through the year and possibly early 2013 as well.

Moreover, given the recent dispute between Egypt and Israel, where the former terminated itscontract to supply gas, this could boost fuel oil demand in Israel too. While the disruption in the

pipeline in the past has been met by higher gasoil demand (eg, 750 kt additional buying seen atthe end of the year), incremental summer demand could see some higher usage of fuel oil too.

India

Essar Oil in India is expected to cease fuel oil exports by early May following the recent startup of its new coker unit (DCU) at its Vadinar refinery. Total Indian fuel oil exports average645 kt/month; Vadinars share is one-third of that total. Thus, we expect a fall of 215kt/month in the coming months. This event is likely to leave a long-lasting impression in themarket, and even if Venezuela manages to push out more fuel oil in the short run due tofurther secondary unit maintenance, the loss of Essars volumes should tighten balances.

Gas pipeline bombings increases

Jordans fuel oil appetite

Indian refinery upgrades curtail

fuel oil supplies


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26 April 2012 17

Russia

As noted above, much of the positive sentiment about fuel oil concerned the export taxincreases in Russia and the subsequent planned upgrades to their existing refineries, whichwould also curtail fuel oil supplies. Russia currently exports 55 mt of fuel oil a year. In aglobally traded market of close to 105 mt, this makes Russias share equivalent to 53%. Thedestinations of these flows are split almost evenly between Western Europe and Southeast

Asia, making Russia crucial in the traded market for fuel oil in both basins.

Export duty

The 60/66 rule introduced in October last year brought the levy on light products (from 67%to 60% of the tax on crude oil), while that for heavy products (fuel oil) jumped from 46.7% to66%. The regime change was put in place to revamp Russias outdated refining landscape andto kick-start investment in more advanced refining. Not only was the regime intended to rakein future income from the export of high-end petroleum products, especially diesel exports toEurope, where imports continues to rise, the government also wanted to find a solution to theacute domestic gasoline shortages. Recently, there have even been talks about RussiasEconomy Ministry proposing an increase in the fuel oil export duty to 90% to solve Russiasburgeoning budget deficit. This would encourage Russian refineries to produce more clean

products at the expense of fuel oil. However, given the lacklustre margins already cripplingRussian refineries and with little outlet for fuel oil in the domestic market in contrast togasoline and diesel, we do not expect the 90% tax to be implemented in practice.

Nonetheless, even if the export duty hike to 90% does not materialise, the increase in taxesto 66% should curtail fuel oil exports. While the latest data for February show Russian fueloil exports down by 3.4% m/m, overall exports have broadly been in line with last yearslevels or slightly higher, much to the surprise of the market. Given that in absolute terms,with the current 66% export tax on fuel oil applied as a portion of the 60% tax on crude oil,as crude oil prices increase, it is beneficial to continue exporting fuel oil. For example, ifcrude oil prices are $100 per barrel, the tax on crude amounts to $60, while the tax on fueloil amounts to $39. If crude oil prices rise to $150, the crude export tax rises to $90, a $30

increase, while the increase in fuel oil tax takes it to $59, an increase of $20. Thus, theabsolute differential in fuel oil prices in a rising crude oil price environment narrows. Withprices having remained on an upward trajectory through most months since the taxchanges were implemented, it should not be surprising that Russian fuel oil exports havenot fallen, especially as Russias biggest fuel oil producers Rosneft, Surgutneftegas, Lukoil,TNK BP and Slavneft are integrated with upstream operations. As oil prices have started tocome off over the past few weeks and with our expectation that prices are set to remainbroadly range bound at these low levels, Russian fuel oil exports could come under pressurein the coming months. Thus, much like Chinas teapot refineries, a falling price environmentalso draws support from Russia due to the loss of fuel oil exports.

Figure 15: Russian refinery upgrades (unit wise breakdown), thousand b/d

2010 2011 2012 2013F 2014F 2015F

CDU 70 80 210 370 265 150

Cond. Splitter 4 4 0 20 105 0

Coking 0 0 20 15 30 30

FCC 15 92 5 40 65 140

Hydrocracking 0 0 10 140 60 90

Thermalcracking 5 0 0 0 0 0

Visbreaking 0 35 65 60 5 5

Source: Barclays Research

Russia increases export duty on

fuel oil to 66%

However, in a rising crude price

environment, still more attractive

to produce fuel oil


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26 April 2012 18

Refinery upgrades

To take advantage of the European shortages in diesel, Russian refineries have been gearingtowards large-scale refinery upgrades, including hydrocrackers that would enable them toproduce Euro-5 fuels for the European markets. In the past, Russias fiscal system stronglyencouraged exporting refined oil products compared with crude oil exports. This led tointegrated Russian refineries processing crude in low complexity refineries and exporting

large volumes of fuel oil into European markets. The latest changes in financial incentives(the 60/66 tax as detailed above) and the mandate by the government to produce light-endproducts for higher domestic consumption as well have provided a further catalyst forRussian refineries.

According to Lukoils Corporate Strategy of Intensive Growth for 2007-16, its oil refiningcapacity is set to expand as well as upgrade, with the average Nelson complexity index atthe refineries expected to touch 8.8 points, allowing it to produce twice as much highquality engine fuels from the same amount of crude oil than in 2007. The strategy alsoenvisages the output of products to be compliant with the Euro-5 standard. Furtherexamples include the upgrading of Rosnefts oil refinery located in Tuapse, which, by theend of this year, will have a capacity of 12 mt/year, up from 4.3 mt/year currently. Up to

80% of products are expected to be exported. Nonetheless, over the past five years, severalupgrading plans had been put forward but have been slow to materialise. While the taxchange has provided a catalyst to these upgrading programmes, with several projects nowscheduled to finish before their scheduled dates, the rate of upgrading may still be lower inpractice compared with what is implied on paper. While the pace of slowdown in fuel oilexports from Russia may not be as sharp in 2012, relative to expectations, we expectsignificantly lower fuel oil exports in 2013 as more refineries are upgraded.

Several visbreaking units are expected to come online over this year and next, reducing thequantity of residual oil produced while simultaneously increasing the yield of more valuablemiddle distillates. The y/y increase in visbreaking units was 8% in 2011; this is expected togrow by 15% this year and another 12% in 2013, taking the total close to 600 thousand

b/d. Several hydrocracking units are also expected to come online in 2013 (boostingRussias capacity by almost 50% to 450 thousand b/d), allowing them to process more fueloil as feedstock to produce lighter ends.

Figure 16: Russian refinery profile in 2008 Figure 17: Russian refinery profile in 2013

Coking

2%

FCC

7%

Visbreaking

3%

Thermal

Cracking

3%

Hydro

cracking

2%

CDU and

Cond.

Splitter

77%

Others

6%

Coking

2%

FCC7%

Others

8%

CDU and

Cond.

Splitter

73%

Hydro

cracking

2%

Thermal

Cracking

2%

Visbreaking

5%

Source: Company reports, Barclays Research Source: Company reports, Barclays Research

Refinery upgrades to curtail fuel

oil exports further

But upgrades have been slow

Supply impact to be felt in 2013


19/72


26 April 2012 19

Demand the weakness is behind us now

US and European demand where did the winter go?

Part of the recent weakness in fuel oil is clearly linked to the warmer-than-average winter inthe US and Europe. While the usage of fuel oil in power generation is minimal, the y/y fall wasstill a noticeable 212 thousand b/d (35%) in Q1 in the US and about 130 thousand b/d (10%)

in Europe. In the US, fuel oil currently plays a very small role in power generation and is limitedprimarily to the northeast markets and Florida and Hawaii. With natural gas prices grindingsteadily lower, any opportunistic use of fuel oil in the past due to local gas price spikes has alsodisappeared. Nonetheless, having fallen sharply since 2006, fuel oil demand stabilised, risingby 24 thousand b/d y/y in 2010 and falling by only 55 thousand b/d in 2011, with the coldwinter providing support. In sharp contrast, this year fuel oil demand has fallen sharply, asheating degree days during the first quarter were 23% lower. February was the coldest monthof the winter so far in the US, yet it was still the warmest February in 12 years. Similarly, theEuropean winter has been very mild, with heating degree days 6% lower than usual and fueloil demand, with the exception of February when temperatures turned cold, very weak. Astemperatures normalise and with some weather predictions pointing towards a cold summerin Europe, the weakness in fuel oil should start to abate in the coming months.

Figure 18: Heating degree days in Europe Figure 19: Heating degree days in the US

-50%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

Sep Oct Nov Dec Jan Feb Mar Apr May

2010/11

2011/12

5-yr Average

-50%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

Sep Oct Nov Dec Jan Feb Mar Apr May

2010/11

2011/12

5-yr Average

Source: FGE, Barclays Research Source: FGE, Barclays Research

Japan fuel oil guzzler

As a result of the lacklustre demand in the West, an increasing number of cargoes were divertedeastwards to accommodate the only solid growth centre for fuel oil, Japan, where usage y/y is up200 thousand b/d (61%) in the Dec-Feb period. While LNG has thus far seen the largest gainsamongst fossil fuels post the loss of nuclear power, the increase is oil consumption is also

noteworthy. Since Q4 11, Japanese oil demand has increased more than 320 thousand b/d y/y,led by higher crude burn (up by 222 thousand b/d y/y) and fuel oil consumption (up by 171thousand b/d y/y). Direct crude burn has moved above 300 thousand b/d for the first time sinceFebruary 2008 and has stayed above that level for three consecutive months for the first timesince 1997. Fuel oil has been the other key beneficiary, with demand moving past 0.5 mb/d forthe first time since March 2006. In the second half of 2011, the top ten Japanese power utilitiesconsumed a total of 205 thousand b/d of fuel oil, double the amount they used in the first half.Total inputs of crude and fuel oil into Japans main electric utilities have surged further sinceNovember to well above 600 thousand b/d, matching Feb 08s peak. For the current fiscal yearending 31 March, TEPCO now expects its total oil purchases to be the highest in over three years.

A very warm winter has weighed

on fuel oil demand

Loss of nuclear supports fuel oil

burn in Japan


20/72


26 April 2012 20

Indeed, preliminary data for March show total oil input for electricity generation in Japanaveraged 527 thousand b/d, some 300 thousand b/d (150%) higher than a year earlier. Justone nuclear power plant was operating in Japan last month, and from early May, nuclearoutput will literally be zero. While Japans prime minister and other cabinet ministers arecurrently attempting to persuade local residents of the need to restart nuclear facilities,Argus analysis of the stances of local politicians suggests that as much as 35.2 GW of

Japans 49.1 GW nuclear fleet could be blocked from restarting indefinitely.

Figure 20: Japan: views on nuclear power by region

JAPAN

Sea of Japan

Pacific Ocean

Kagoshima

Ehime

Saga

ShimaneFukui

Ishikawa

Niigata

Hokkaido

Aomori

Miyagi

Fukushima

Ibaraki

Tokyo

Shizuoka

Supports restartOpposes restartNeutral

Source: Argus Gas and Power

Two weeks ago, the Japanese government began what may be a long and difficult processto re-start its nuclear plants. With only one of its 54 nuclear power reactors working (andthat one going to close shortly), bringing nuclear plants back online is essential if Japan is toavoid another summer of power rationing. The Japanese government has estimated thatwithout nuclear generation, there could be a 20% power shortage in the event of a hotsummer. The test case in Japan focuses on restarting Kansai Electrics (KEPCOs) no. 3 and 4reactors at its Ooi power station. With the stress tests passed and the safety case judgedcompliant, the biggest remaining hurdle is convincing a sceptical Japanese public thatstarting the plants poses no safety risk. The government has a self-imposed deadline of thebeginning of May to make a decision on the Ooi restarts. In the interim, the government ismaking the case for nuclear through a road-show to the affected provinces in an effort toincrease public confidence to allow those restarts. With a recent Reuters poll suggestingthat 57% of Japanese opposes the restarts, there remains considerable opposition to beovercome; having a decision on the first re-start in the coming weeks appears optimistic,and it is most likely that nuclear plant, to the extent they are restarted, will only come backslowly. The three largest power utilities TEPCO, Chubu Electric Power and Kansai ElectricPower do not show signs of being able to restart their reactors any time soon. Thus, weexpect fuel oil demand to remain strong and pick up in the summer months, as airconditioning demand creates additional demand.

Restart of all nuclear facilities

seems unlikely

Summer demand likely to be met

by higher fuel oil burn among

other fossil fuels


21/72


26 April 2012 21

Figure 21: Japanese fuel oil burn Figure 22: Chinese fuel oil demand

-240

-200

-160

-120

-80

-40

0

40

80

120

160

200

240

07 08 09 10 11 12


-400

-300

-200

-100

0

100

200

300

08 09 10 11 12


Source: METI, Barclays Research Source: China Customs, Barclays Research

Chinese teapots swinging around

China is a key source of marginal fuel oil consumption, with Chinese teapot refineriesaccounting for the bulk of the countrys fuel oil demand of about 600-700 thousand b/d.While the National Development and Reform Commission has been closing teapot refinerieswith a capacity of less than 2 mt/year, thereby culling fuel oil imports over the past few years,high fuel oil prices lately have also weighed by taking their refining margin into the negative.Shangdong and Guangdong are the main hubs for these refineries. Almost all the teapots inthe southern province of Guangdong have closed, and output in Shandong, where the largerplants are located, is down to 20-30% as operators extend maintenance outages.

However, the pull back in fuel oil prices towards the end of Q1 should provide some respite,as runs at these refineries pick up, providing a soft floor to fuel oil prices. Moreover, whilethe NDRC aims to shut all refineries with less than 2 mt/year capacity by the end of 2013,product shortages in the country have slowed this process, as teapot refineries usually stepup to fill the gap. Further, total capacity for Shandong teapot refineries is rising by about 6-7mt annually and is likely to keep fuel oil imports at about 10 mt annually in the next two tothree years, about the same as now, helping to offset closures in the Guangdong region.

Ships ahoy newbuilds accumulating

Over the next nine months, the dry bulk orderbook shows a total of 1359 ships expected tobe added to the world fleet. The fuel oil usage heavy Capesizes total 225, while additions toPanamax are expected to total a massive 468. However, some of the vessels planned tocome online this year are getting pushed back, in particular because of the increasingbankruptcies. Financing constraints for shipowners as a result of low freight rates have alsomeant they are not in a position to make the final payment instalments necessary to takedelivery of the ship. Moreover, with the current environment of low freight rates and softdemand, some are sceptical of taking delivery of the ships for fear of making them idle.

Nonetheless, even after adjusting for the delays and cancellations and expecting only a 40%realisation of the orderbook, fleet additions still look large enough to warrant an increase indemand for bunker fuel. Even if the ships coming online do not necessarily operate at fullcapacity, the initial fuelling required to get these ships from the shipyards to the ownersports would add to significant fuel oil demand through this year and next.

High fuel oil prices crushed

teapot refinery margins

With a pull back in prices,

Chinese demand is resurfacing

Orderbook for ship additions are

very large


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26 April 2012 22

While the rising cases of bankruptcies may imply that the orderbooks could get smaller,there have been several instances in which, for example, the hull of the ships have beenmade but the original owner has defaulted on the payment date for the rest of theinstalments. This, along with distressed selling from bankrupt shipping companies, haslured non-traditional buyers (including utilities) into the market for ships, where they aremanaging to pay 60% of the ships value for delivery of the entire carrier.

Figure 23: Net change in the dry bulk fleet (no. of ships) Figure 24: Orderbook growth expected ( % of current fleet)

-60

-35-10

15

40

65

90

115

140

165

Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 Mar-12

Deletions

Additions

Net Change

0%

4%

8%

12%

16%

20%

Containership Multipurpose Tankers Dry bulk

2012 2013 2014+

Source: SSY, Barclays Research Source: Clarksons, Barclays Research

The dry bulk fleet is not alone in terms of expansion, with containerships as well as thetanker market all facing oversized orderbooks. Given that ships normally contribute close to40% of global fuel oil demand, the support from the newbuild getting their first fuel is awelcome sign for the market. However, low freight rates and higher fuel oil prices havedented operating margins, and the global fleet has responded by operating through slowsteaming, while the greater efficiencies of the relatively new fleet (ie, come online since

2010) have helped economise fuel usage further. Overall, we believe that a fair degree ofusage lost through demand destruction on the operational side is likely to be offset by theinitial fuelling required for the massive orderbook due to be realised.

Box 2: Slow steaming eroding bunker fuel demand, but very slowly

Slow steaming has reduced fuel oil demand from dry bulk carriers by close to 11% over the past two years. The biggestproportional decrease has come from container vessels (32% decline), although for general cargo, dry bulk carriers and tankers,the efficiency gains have been less significant. With dry bulk carriers accounting for more than 40% of the total shipping market(and hence the largest consumer of bunker fuel), this sector remains key for determining the effects of slow steaming on fuel oildemand. There are two reasons the dry bulk category has had no decline because of slow steaming. First, depressed freight ratesover the past two years have resulted in a level playing field among suppliers of iron ore and coal in terms of accessing markets,

which resulted in new longer routes being employed. A prime example of this is the increasing volumes of US coking and steamcoal cargoes into the Pacific Basin. The actual tonne miles for delivery of dry bulk cargo have increased over the past two yearsdespite demand for the underlying products remaining the same. Second, and linked to the first, is the fact that with these longlucrative routes (in a market scarce of cargoes on offer), there have been several cases in which ships that would have otherwisewaited for cargoes at the point of offloading have ballasted back empty (without cargo) to the original source. This wasparticularly prevalent on routes from the Atlantic to the Pacific, where negative freight rates have prevailed, with ship ownersagreeing to pay part of the rates to get their ships back to the Atlantic and take cargoes to the demand centre in the Pacific.These movements have supported the dry bulk market and have largely offset benefits from slow steaming. With chronicoversupply of ships likely to remain a feature of the market for a few years to come, we expect slow steaming to have a moretempered effect on the bunker fleet, thereby moderating the overall loss of fuel oil usage.

Initial fuelling requirements

are massive


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26 April 2012 23

Stocks buffers have all gone?With higher fuel oil prices slowing bunker demand temporarily and erasing Chinese teapotrefinery demand, inventories began to build steadily at the start of the year. However, afterpeaking in March, fuel oil stocks at Singapore and ARA have started falling. In Singapore,inventories are at five-year lows, while ARA stocks have fallen far below levels seen at this

time of the year over the past few years. In Europe, even as fresh supplies arrived fromFrance, Poland and Russia, there was a large drawdown as bunker demand picked up dueto fuel oil cargoes being pulled eastward. These volumes, which landed in Singapore in mid-April, were not enough to support inventories at Asias largest hub either, as lower priceslead to a sharp increase in bunker demand. Indeed, residual fuel oil stocks have been drawndown through healthy and dispersed regional demand, with about 115 kt shipped toIndonesia, 260 kt to China and Hong Kong, and 57.5 kt to New Caledonia.

Figure 25: Singapore fuel oil stocks Figure 26: ARA fuel oil stocks

thousand barrels

14

15

16

17

18

19

20

21

22

23

24

Jan Apr Jul Oct

2012 2011 Five year average

3

4

5

6

7

8

Jan Mar May Jul Sep Nov

2011 2012 2010

thousand barrels

Source: Bloomberg, Barclays Research Source: Bloomberg, Barclays Research

Much like the crude market, with limited buffers, fuel oil balances remain susceptible to aseries of potential supply disruption looming on the horizon. While Russia may well remainthe focus of the market, in our view, it is the Middle East that offers the most interestingdynamic in Q3, with the Russian upgrades substantially tightening the market only in 2013.With the potential loss of Iranian exports due to sanctions tightening the supply picture, theprimary swing comes from Saudi Arabia, which, in an attempt to keep crude exports high,could become a net importer of fuel oil this summer. Together with an improvingmacroeconomic backdrop in H2 supporting movement of dry bulk and container carriersand Japans needs for electricity remaining high this summer, we expect fuel oil tooutperform strongly in Q3.

Stocks that built earlier in

the year have been drawn

down again

Summer spikes in fuel oil likely


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26 April 2012 24

MONTHLY DATA RELEASES


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26 April 2012 25

OPEC production estimates

OPEC outputThe average of our third-party estimates for March placesOPEC output at 31.26 mb/d, higher m/m by 0.135 mb/d and

at the highest level since September 2008. Increased suppliesfrom Iraq and a further recovery in Libyan volumes were thekey contributors to the increase. Iraqi exports received a boostfrom the recently launched floating single-point mooringcoming into service, while the return of various damagedoilfields boosted Libyan volumes to 1.34 mb/d. Libyan outputis likely to inch up further in April, with AGOCOs Sarir fieldplanning to increase production by 0.03 mb/d and the Meslafield by 0.02 mb/d. Saudi Arabia continued to pump near10 mb/d, while UAE and Kuwait are producing at maximumcapacity, trimming available spare capacity further. Finally,Iranian production fell by 93 thousand b/d over the month, as

the long trend of declining output continues.

Figure 27: y/y change in OPEC crude oil production

-4

-3

-2

-1

0

1

2

3

06 07 08 09 10 11 12

Figure 28: Estimates of OPEC production, March 2012, mb/d

EIA IEA EIG MEES OPEC Platt's Reuters Bloomberg Average

Algeria 1.27 1.14 1.11 1.23 1.24 1.27 1.28 1.25 1.22Angola 1.85 1.68 1.66 1.70 1.71 1.70 1.65 1.78 1.72Ecuador 0.50 0.48 0.50 0.50 0.49 0.49 0.49 0.49 0.49Iran 3.40 3.30 3.25 3.40 3.35 3.40 3.15 3.39 3.33Iraq 2.65 2.84 2.88 2.95 2.78 2.85 2.83 2.81 2.83Kuwait 2.45 2.72 2.78 2.85 2.70 2.67 2.74 2.68 2.70Libya 1.20 1.32 1.39 1.40 1.37 1.35 1.40 1.25 1.33Nigeria 2.15 2.05 1.86 2.00 2.09 2.10 2.04 2.14 2.05

Qatar 0.85 0.81 0.72 0.79 0.81 0.82 0.81 0.81 0.80Saudi Arabia 9.60 10.00 9.98 9.85 9.83 9.90 9.90 9.71 9.85UAE 2.50 2.65 2.58 2.50 2.57 2.54 2.60 2.61 2.57Venezuela 2.20 2.44 2.44 2.36 2.38 2.30 2.37 2.32 2.35OPEC 30.82 31.43 31.14 31.53 31.31 31.39 31.26 31.22 31.26OPEC 11 28.17 28.59 28.26 28.58 28.53 28.54 28.43 28.42 28.43

Note: The estimates published by the OPEC Secretariat as shown above are the averages of third party sources. They are not included in the average of the othersources shown in the above and below tables.

Figure 29: Estimates of change in production over previous month, thousand b/d

EIA IEA EIG MEES OPEC Platt's Reuters Bloomberg Average

Algeria 0 0 -5 0 -1 0 10 -10 -1Angola 50 -80 -211 -90 -98 -100 -210 -35 -97Ecuador 0 0 -7 5 -4 0 10 0 1Iran -50 -50 -35 -60 -71 -100 -280 -65 -91Iraq 0 220 250 256 125 170 220 45 166Kuwait -100 20 0 -30 17 0 -10 15 -15Libya 200 30 90 80 112 100 300 125 132Nigeria 50 -50 95 -50 26 0 -40 -15 -1Qatar 0 0 -15 -5 -4 0 0 5 -2Saudi Arabia -100 0 -25 50 24 50 50 20 6UAE -100 60 25 30 11 0 60 15 13Venezuela 0 -20 -4 -10 -1 0 -10 10 -5OPEC 150 130 158 176 136 120 100 110 135OPEC 11 150 -90 -92 -80 11 -50 -120 65 -31


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26 April 2012 26

Range and average of OPEC output estimates

Figure 30: Estimates of Saudi Arabian output (mb/d)

7.6

8.0

8.4

8.8

9.2

9.6

10.0

10.4

06 07 08 09 10 11 12

Figure 31: Estimates of Iranian output (mb/d)

3.0

3.3

3.5

3.8

4.0

4.3

06 07 08 09 10 11 12

Figure 32: Estimates of Venezuelan output (m/d)

2.0

2.12.2

2.3

2.4

2.5

2.6

2.7

2.8

2.9

3.0

06 07 08 09 10 11 12

Figure 33: Estimates of UAE output (mb/d)

2.1

2.2

2.3

2.4

2.5

2.6

2.7

06 07 08 09 10 11 12

Figure 34: Estimates of Kuwaiti output (mb/d)

2.1

2.2

2.3

2.4

2.5

2.6

2.7

2.8

2.9

06 07 08 09 10 11 12

Figure 35: Estimates of Nigerian output (mb/d)

1.5

1.7

1.9

2.1

2.3

2.5

2.7

06 07 08 09 10 11 12


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26 April 2012 27

Range and average of OPEC output estimates

Figure 36: Estimates of Libyan output (mb/d)

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

1.60

1.80

06 07 08 09 10 11 12

Figure 37: Estimates of Algerian output (mb/d)

1.10

1.15

1.20

1.25

1.30

1.35

1.40

1.45

06 07 08 09 10 11 12

Figure 38: Estimates of Iraqi output (m/d)

1.4

1.6

1.8

2.0

2.2

2.4

2.6

2.8

3.0

06 07 08 09 10 11 12

Figure 39: Estimates of Qatari output (mb/d)

0.68

0.72

0.76

0.80

0.84

0.88

06 07 08 09 10 11 12

Figure 40: EIA estimates of Angolan output (mb/d)

1.2

1.4

1.6

1.8

2.0

06 07 08 09 10 11 12

Figure 41: EIA estimates of Ecuadorian output (mb/d)

0.44

0.46

0.48

0.50

0.52

0.54

0.56

06 07 08 09 10 11 12


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26 April 2012 28

US crude oil imports

US crude oil imports totaled 8.305 mb/d in January a m/mdecrease of 396 thousand b/d. The largest m/m decrease camefrom Venezuela (down by 132 thousand b/d), followed by Brazil(down by 112 thousand b/d) and Nigeria (down by 97

thousand b/d). Imports from Saudi Arabia edged higher (up by51 thousand b/d m/m) for the third straight month. Heavycrude oil volumes reduced the most over the month (down by398 thousand b/d), while imports of medium grades were alsodown by 48 thousand b/d. Light crude imports were the onlycategory in positive territory, gaining 52 thousand b/d m/m. Ona y/y basis, US crude oil imports were lower by 641 thousandb/d, with light sweet volumes displaced the most (imports fromNigeria were down by 567 thousand b/d) due to rising domesticproduction. Imports from Canada and Saudi Arabia were upstrongly, by 335 thousand b/d and 281 thousand b/d.

Figure 43: Source of crude oil imports, January 2012

Canada

30%

Saudi

Arabia

16%Mexico

11%

Ve

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