Downstream refinery bottlenecks make it impossible for Opec to stabilise oil
prices at current levels. More crude is needed to halt the rise in prices, but
Opec rightly fears a price fall.
Opec is in a bind. It recognises that oil prices are now too high but is reluctant to take the necessary action for fear of precipitating a price collapse. The organisation surprised the market this month by agreeing to boost output by 500,000 b/d from November, but this was not enough to halt the relentless rise in oil prices, which are setting new records as the winter heating season approaches.
The growing gap between supply and demand is undeniable. Stocks are falling when they should be rising, disturbing traditional seasonal patterns. At the end of August, total industry stocks monitored by Argus were over 100mn bl down on the same month last year after falling for two months in succession. Crude supplies are not keeping pace with refinery demand and product stocks remain unseasonably low. Crude and product markets are all in backwardation, signalling a shortage of prompt supplies.
Opec has kept a tight grip on crude supply for the past year, while oil consumption has continued to rise, forcing the industry to draw on stocks to meet demand. Global oil supply was unchanged in the first half of this year compared with the same period a year earlier, but global demand increased by nearly 1mn b/d (1pc), according to Argus estimates. Now the stockdraw is starting to hurt, with most analysts — including Opec — expecting a further draw of around 1mn b/d this quarter at a time when the industry should be building stocks to meet the seasonal peak in demand.
Downstream refinery constraints mean that Opec is going to find it difficult to relax its grip without triggering the price collapse that it fears. High oil prices are changing the composition of demand faster than the refinery system can handle it, putting a strain on upgrading capacity. Demand for transport fuels continues to expand despite rising oil prices, but demand for heating fuels is in decline, forcing refiners to upgrade more of their product output. But the shortage of upgrading capacity means that the oil market is permanently off-balance.
Demand for transport fuels in the largest oil consuming economies monitored by Argus has grown by nearly 2mn b/d over the past three years, while demand for heating fuels has fallen by over 1mn b/d (see upper graph). With upgrading capacity fully-utilised, crude supply at the margin now yields too much heating fuel and not enough transport fuel. Running more crude in a simple distillation unit would ease the shortage of transport fuel, but add to the surplus of heating fuel — putting downward pressure on oil prices.
Oil prices can only go up or down — there is no equilibrium at current levels. As long as there is a fundamental mismatch between the mix of products that refineries can make and the mix of products that consumers are prepared to buy, Opec faces a difficult choice. If it boosts crude output further, prices will fall to clear the inevitable surplus of heating fuels. But if it continues to hold output at its new level, prices will rise to limit demand for transport fuels. Unless the global economy slows abruptly — which looks less likely now that the US Federal Reserve has cut interest rates — oil prices will have to rise further before Opec is prepared to risk a price fall.
