Kayrros Energy Digest 21 August 2019

Time is of the Essence

Amid mounting market concerns about a slowdown in economic and oil-demand growth, it might come as
a surprise that crude oil inventories have actually been plunging. Yet that is exactly what satellite imaging
has been showing for two months now. Since mid-June, Kayrros has measured a drop of more than 100 million
barrels in global crude oil stocks, wiping out this year’s earlier builds. This decline has been as broad-based as it
has been steep, has spanned all key regions, and while initially focused on crude-oil importing countries, it has now
spread to producers.

The counter-intuitive strength of crude fundamentals underpinned by these draws does not suggest that
recent reports of slowing demand have been overstated. But it goes a long way to shed light on the complex
ways in which the ups and downs of end-user product demand work their way through the supply chain
and impact both crude and product prices. Typical oil market balances compare crude supply on the one hand,
and product demand on the other — the proverbial apples and oranges — and miss the middle link. Non-OECD
crude stocks have long been a blind spot, as has global refinery demand, which is a key piece missing from most
oil market analyses. New inventory data unlocked by satellite imaging are changing all that. Not only are oil-industry
participants now able to track crude stocks worldwide in near realtime, but their knowledge is yielding new insights
into the dynamics of crude oil demand, refining activity, and crude price dynamics.

Recent near-realtime measurements show a mix of factors behind the latest crude draws including a strong
demand uptick, driven by the seasonal cyclicality of refinery throughputs that has been further exacerbated
this year by structural capacity expansions. On the supply side, the delayed impact of US sanctions on Iran
has only partly offset by higher Iraqi supply. It would be tempting to speak of a perfect storm if the expression
had not been so overused. Global refinery throughputs spiked in June and July in line with seasonal trends, pulling
down crude inventories that were simultaneously pinched by a dip in Iranian exports after the US ended sanctions
waivers in early May and got serious about pursuing its ‘zero export’ policy target. At the same time, structural crude
distillation capacity edged higher. China looms large on all counts. As a key Iranian oil buyer it brought its imports
to a near halt even as it started two new refineries. Not surprisingly, China has led the destocking.

Tightness in crude physical markets goes a long way to explain the resilience of crude markets in terms of
their time structure despite recent flat price weakness. Overall oil prices have come under pressure from
worries about the China-US trade war, signs of slowing economic activity, evidence of slowing end-user oil demand,
and reports of counter-seasonal OECD product inventories. Yet the time structure of crude futures with prompt
prices surprisingly robust relative to those of barrels for later delivery, speaks of a tighter market than meets the
eye. These seemingly discordant signals make perfect sense in view of crude inventories when seen in time.

While demand has risen seasonally, annual demand growth has, however, slowed. Year-on-year increases
in implied crude demand slowed to a trickle in Q2. This decline mirrors that observed in end-user product demand
and corroborates it. The year-on-year slowdown in refinery demand for crude – despite the effect of new capacity
coming on line – suggests the slowdown in end-user consumption may in fact by even steeper than currently
captured in the time-lagged estimates of the publicly available sources.

The seasonality of refinery demand also cuts both ways, suggesting that the support it has provided to
crude markets may have already peaked. What goes up must come down. Global refining activity cools off in the
fall as summer driving demand winds down and Northern Hemisphere plants head into seasonal maintenance. This
can go a long way to slow down future crude stock draws. Refinery-margin pressure from counter-seasonal builds
in product stocks may compound this trend, though higher distillate demand due to new product requirements for
marine fuels from the International Maritime Organization may provide something of an offset. Geopolitical tensions
in the Gulf also remain high and raise the perception of supply disruption risks. While there is considerable
unpredictability surrounding these geopolitical factors, they serve to highlight the benefit of greater market
transparency provided by new data technologies—particularly when viewed on the same time horizon. Keeping
close tabs on the market conditions in which these developments play out in near realtime will help manage the
potential of the effects that they might cause. Time really is of the essence.