Higher output from Saudi Arabia will help offset faltering non-Opec supplies.
But more crude is needed to satisfy rising diesel demand and reverse the upward trend
in oil prices.
Saudi Arabia is taking a step in the right direction. More crude can only be good for the market, helping to slow the relentless rise in prices. But its increase of 400,000 b/d from April levels is not enough. Industry stocks remain low after last year’s deep global draw-down and non-Opec supply fell last quarter, opening up a gap that only Opec can fill. Yet the organisation is still in denial — blaming a weak dollar and speculators for high oil prices and claiming that there is no need to boost crude supply.
Opec is wrong. Oil demand continues to grow — especially for diesel — despite rising prices and an economic slowdown. Diesel demand in the 14 countries monitored by Argus — which represent 60pc of world oil consumption — grew by 7pc or 800,000 b/d last quarter compared with a year earlier. Refiners are struggling to keep up with surging diesel consumption and stocks of middle distillates are down sharply, supporting wide crack spreads for these products. But with refinery upgrading capacity already fully utilised, the only way to make more diesel is to run more crude.
The industry’s problem is that demand for other refinery products is not growing as strongly as diesel, so running more crude to boost diesel output will yield unwanted gasoline, heating oil and fuel oil. Total demand in the 14 countries monitored by Argus rose by 1pc in the first quarter compared with a year earlier, but gasoline demand was flat, heating oil use fell by 12pc and residual fuel oil use was down by 7pc. Spreads for gasoline and fuel oil against crude are weak, depressing refinery margins and undermining crude demand. Only sophisticated refiners with enough upgrading capacity to produce high diesel yields can afford to buy crude at current prices, apparently confirming Opec’s view that the market is well supplied.
This mismatch between growing demand for diesel and weak or declining demand for other products means that the oil market has become unstable. Until refiners build enough upgrading capacity to improve the mix of products they can make, they will face either a persistent shortage of diesel or a surplus of other products. At present, a shortage of diesel supports the upward trend in oil prices. But running more crude to satisfy diesel demand risks provoking a sharp downward correction in prices.
Opec needs to supply more crude in the sort term, because non-Opec supply is not growing as expected. Non-Opec supply fell in the first quarter as output slumped in Mexico, Russia and the North Sea. Non-Opec crude supply, excluding Ecuador, was down by 550,000 b/d on the same period a year earlier and total non-Opec oil supply — including NGLs, biofuels and processing gains — fell by 250,000 b/d, according to Argus estimates. A decline in non-Opec supply this year is a real risk, rather than the 750,000 b/d growth assumed in Opec’s latest Monthly Oil Market Report.
But, in the longer-term, it seems unlikely that Opec is willing to supply enough extra crude to solve the diesel problem. High oil prices undermine the global economy, but Opec is not prepared to engineer a price fall that would reduce its oil revenues. Unless the global economy suddenly slides into recession or non-Opec supply recovers unexpectedly, oil prices will keep rising, fuelled by strong diesel demand and Opec output restraint.
