Weaker price shows further slump of China oil demand

Petroleum products demand in China seems to be worse.
Media report that wholesale prices of diesel oil in fifteen provinces and major cities are slipped from the official limit level.

In China, domestic retail petroleum products prices are decided by the government based on international market prices. Wholesale prices and refiners' sales prices are set on the basis of the official retail prices.

Previously, supply of petroleum products could not catch up with the rapid growth of demand, thus wholesale prices were usually stayed at the high limit level. Even higher prices were accepted among buyers in the black market.
Diesel oil is the most popular petroleum product in China. The fuel is used for agriculture, fishery, transportation and on-site electricity generation. A lack of diesel oil supply caused turmoil in the market during 2010.

However, the petroleum demand in China are weaker since the beginning of this year due to the lower rate of economic growth and the strict regulations over the real estate market. China's diesel oil production in March was at 14.1 million tons, only 2.0% increase from a year ago, according to the National Bureau of Statistics. The year-on-year growth was 9.3% in March last year and annual growth rate in 2011 was 5.4%.

China's domestic diesel oil sales in the first quarter 2012 was flat from a year ago, according to the National Development and Reform Commission.

Chinese refineries have suffered losses because local petroleum products official sales prices could not catch up with higher international crude oil prices since early 2011. They were hesitant to increase production but any significant shortage of petroleum products have not been reported. It also suggests sluggish demand.

Does China's crude oil futures succeed?

China Securities Regulatory Commission recently announced to launch the domestic crude oil futures by the end of this year. The authority hopes to make the futures market to be the global crude oil price index which allows China taking advantage to set oil prices.

The authorities have not decided which type of crude oil will be traded yet. They may choose domestic produced crude oil. Alternatively may select middle eastern oil, since more than half of China's crude oil imports are coming from the region.
Also the Chinese crude oil futures contracts may be traded in US dollar. The authority seems to think influence on international markets is much more important than usability for local Chinese players.

Commodity futures in China started in 1990. The first futures market was set up in Zhengzhou to trade grains. Then large number of futures markets and brokers were appeared during the first half of 1990's.  Because unregulated rapid expansion of Chinese futures market caused confusion, the government regulated the market strictly after mid-90's.
Currently, about 25 commodities futures are traded at three exchanges in Shanghai, Zhengzhou and Dalian following the consolidation.

Since industrial products such as non-ferrous metals and natural rubber are traded in Shanghai Futures Exchange, crude oil is likely to be launched there.
The following table shows annual trading volume in each futures exchanges. Trading volume of CME Group that holds CME and NYMEX is much greater than any others, but Shanhai market has already exceeded ICE that has Brent crude oil.

Chinese market was rapidly expanded during 2009 and 2010 when huge amount of speculative money due to the quantative easing flowed into the country's commodity futures.
However, Chinese government increased trading commissions, margins and trading size of contracts in November 2010 to cool down the market. Trading volume in 2011 shrinked to about half of the previous year's level following the regulation.
Even if the trading volume declined, Chinese markets still have huge transactions and the nation's increasing commodity demand keep global market players' eyes into China's futures market.

Meanwhile, arbitrage between China's futures markets and overseas markets is difficult due to strict regulation on currency exchange.
A lack of arbitrage impair price linkage between Chinese market and international markets. But it also means speculative turmoil in the Chinese market does not affect international markets directly.

The Chinese crude oil futures market is likely to be the domestic index since big state-owned firms like PetroChina will use it.
Gigantic trading volume will attract global market players eyes. Thus price movement in the Chinese market may affect global crude oil prices.
However, the limited overseas participants and the lack of arbitrage may prevent China's crude oil futures from being global price index.

China diesel oil demand slows clearly

Diesel oil demand in China seems to be declining.

Diesel oil is the most intensive petroleum fuel in China. The country's diesel oil production is almost double of gasoline. Gasoline production is almost equal to diesel oil (gas oil + A fuel oil) in Japan. Middle distillate output in the U.S. is about half of gasoline.

Diesel oil is used for transportation, agriculture, fishery and electricity generation etc. in whole over China. The country's apparent diesel oil demand in February was 14 million ton, according to media reports. The volume rose only 5.2% higher than a year ago, while 5.1% lower from the previous month.
Number of days in February are less than January, but there was Lunar new year holidays in January.

China's diesel oil production during January and February was 478,000 ton per day, rose 0.8% from December, according to the National Bureau of Statistics.
Meanwhile, industry sources said that the country's diesel oil stocks as of the end of February rose 12.3% from a month ago.

Moreover, industry sources estimate that China's apparent diesel oil demand in March decreased by 6.4% from the previous month.
Since diesel oil consumption by farmers is very active in early spring, the lower demand suggests significant weak demand from transportation and industrial sectors.

The National Bureau of Statistics also announced earlier that China's January-February electric power generation was 719 billion kWh. The figures was 7.1% higher than a year ago, the first single digit year-on-year growth after 2009.

Recent energy consumption suggests that China's economic growth is slowing apparently. Is Chinese economy able to soft landing?

Nuclear shut doesn't boost oil use in western Japan

Kansai Electric Power Company (KEPCO), that supplies electricity to big cities in western part of Japan such as Osaka and Kyoto, avoided power outage successfully during winter despite a lack of nuclear power supply. The company, however, is very eager to restart its nuclear power plants. Because its electricity supply capacity without nuclear power is likely to be smaller by 14% than expected demand during coming summer.

KEPCO's maximum electricity supply in August 2011 was 22.59 million kilowatts. About 3.43 million kw was provided by nuclear power plants. Thermal power will have to compensate the lack of nuclear power supply in coming summer season.

KEPCO has thermal power generation capacity of 16.91 million kw in total. But regular maintenance and unexpected troubles usually reduce its utilization to about 80% of the rated capacity. Hydroelectricity is able to provide maximum 5.3 million kw. Although the sum total of thermal power supply and hydroelectricity is 18.88 million kw, it is lower by 17% than the maximum demand in last August.

Even if the company can expect some relief by other electricity suppliers, it is difficult to avoid power outage without asking to consumers to reduce electricity use by 15% compared to the previous year.

The following chart shows KEPCO's maximum electricity supply and its power generation capacity over the past couple of years. Monthly supply by sum total of thermal power and hydroelectricity have always exceeded thermal power generation capacity. It means that KEPCO always must reduce electricity supply when it shuts all of its nuclear plants.

Electricity consumption in Kansai area may be required to reduce by 15% from a year ago during the active demand season. About 5-10% power saving is also necessary in other period.

If the power-saving to depress thermal power generation, petroleum consumption by KEPCO is unlikely to increase significantly.
 A 15% reduction of electric power use will limit KEPCO's monthly electricity supply to 10 billion kWh during summer period. Hydroelectricity can supply 1.6 billion kWh per month, while liquefied natural gas and coal are likely to generate 6 billion kWh. Therefore, petroleum-burning thermal power plants are required to supply only 2.4 billion kWh.

Monthly petroleum consumption by KEPCO is likely to remain at about 550,000 kiloliters, or 110,000 barrels per day. It seems to be a small quantity despite a serious situation of the shut of entire nuclear power plant in the megalopolis area.

Meanwhile, KEPCO seems to have boosted operations at its LNG-burning thermal power plants. The company's montly LNG consumption has almost reached to the physical limit of 700,000 metric tonnes.

If KEPCO continues to use monthly 700,000 mt of LNG to make up for a lack of nuclear power supply, its natural gas consumption in 2012 will rise 45% from a year ago.
Failure of additional LNG purchase may force the company to use more petroleum.

US sucks excess Saudi oil

Recently, media reported that Saudi Arabia is boosting crude oil exports to the U.S.

Members of the Organization of Petroleum Exporting Countries have been increasing crude oil production following the western sanction against Iran. Their outputs have rebounded to the pre-Lehman shock level.

Especially, Saudi Arabia that has the largest spare production capacity lifts its crude oil production significantly. OPEC evaluates the Kingdom's February output at 9.66 million barrels per day, meanwhile International Energy Agency estimates that Saudi production has already reached to the 10 million bpd level.

Japan and China has reduced Iranian crude oil import since the beginning of this year, while France and U.K. has stopped buying Iranian oil. These nations have increased purchase from Saudi Arabia.

But media reported U.S. also had boosted Saudi crude oil imports by 38% from a year ago in the first 10 weeks of 2012. The kingdom's crude oil shipments to U.S. was reported rising about 25%.
Import of Saudi crude oil by U.S. seems to have recovered 1.5 million bpd, the same level as the pre-Lehman shock. U.S. imported 1.3 million bpd of Saudi crude oil in December 2011.

However, the U.S. has not imported Iranian crude oil for a long time. Thus American refineries should not require any alternative crude oil to Iran.
On the other hand, petroleum consumption in the U.S. is declining despite recent indicators suggesting economic recovery.
Why U.S. needs to boost Saudi oil import?

Crude oil import statistics over the past three months show that total U.S. imports surged in February. Import from Canada, that had increased significantly after the Keystone pipeline started business operations in February 2011, was capped in 2012.

Crude oil stocks figures show that crude oil inventories in the Gulf of Mexico area are not increasing significantly despite the surging imports. But stocks in the Midwest area is rising despite reduction of Canadian oil flow.
Imported crude oil carried by tankers seems to be transported into Midwest through pipelines.

Iranian crude oil outputs are expected to be falling in March but are still avoiding large amount of reduction. It means other OPEC members' extra production may cause excess supply in the global market.

Saudi Arabia has decided to increase production levels further in July when EU's import ban against Iran is scheduled to be effected, because of request by the Obama administration.
U.S. is responsible to over-supply which may happen. Is that the reason why U.S. lifts Saudi crude oil import with cutting Canadian oil purchase despite sluggish domestic demand?

These imports may be suitable for supplement to the strategic petroleum reserve that was reduced by 30 million barrels last year for urgent release. But absorbing commercial stocks is likely to stimulate the crude oil market and that is not desirable for recent rising gasoline prices.

Is Japan able to cut LNG prices?

Recently, only two of total 54 nuclear power units are operated in Japan. Thus thermal power generation has been boosted to make up for the nuclear power shortage.

Petroleum consumption by Japanese ten major electric power companies in 2011 surged 80% from a year ago to 17.76 million kiloliters, while liquefied natural gas (LNG) consumption rose 20% on year to 49.13 million tonnes, according to the federation of electric power companies of Japan.

Fuel costs for thermal power generation spent by ten major firms during April and December 2011 increased by 950 billion yen ($12 billion) from a year ago.

Expanded fuel costs were mainly caused by the volume of consumption, but higher fuel prices pushed the costs up as well.

Increased petroleum demand from Japanese electric power generation seemed to do little to lift crude oil prices. Japan has been a negative factor against the crude oil market because of its declining total demand. Tensions over Iranian nuclear development have been supporting crude oil prices for past several months.

However, petroleum is not main fuel for Japanese thermal power generation. Volume of electricity generated by LNG is 2.5 times larger than that generated by petroleum.
If LNG prices have not soared in step with crude oil, power companies' spending could be much smaller.

Since Asian LNG prices have been set by formulas based on Japan's average crude oil import prices, LNG traces price movements in the crude oil market.
The following chart shows Japan's average import prices of LNG and petroleum. LNG prices exceeded petroleum last year since electric power companies bought many expensive spot cargoes added to usual long-term contracts.

LNG prices are usually higher than petroleum prices when crude oil markets decrease sharply such as later half of 2008, but higher LNG prices compared to petroleum when crude oil markets are rising seems to be abnormal condition.

World LNG market is apparently over-supply. Even if International Energy Agency forecasts that global LNG demand will increase to 540 billion cubic meters by 2020 from 265 billion cubic meters in 2011, surplus is also predicted to expand to 90 billion cubic meters from 80 billion cubic meters during the same period.

Natural gas prices in North America, that has declined significantly after the shale gas revolution, are less than one sixth of Asian LNG prices.Aggressive supply from North America to Asia may reduce Asian LNG prices considerably as Qatar has expanded its supply capacity.

To boost supply from North America, huge investments are required to both suppliers and consumers. Also number of LNG tankers are not enough for increasing supply of spot cargoes, because LNG carriers have been built based on long-term projects.

Japanese government and power companies have to decide to choose natural gas as the future main energy source to start such investments. But many people still do not give up nuclear power and concerns over the global warming make them hesitate to boost use of fossil fuel.

No one can provide alternative to Saudi oil

Crude oil prices fluctuated turbulently in the first couple of days in March following a report about an explosion on Saudi Arabian pipeline. NYMEX WTI April crude oil futures contract surged above $110 per barrel for the first time since May 2011, but started falling after Saudi officials denied the news. Crude oil prices eventually ended the week at negative range compared to previous week.

Recently, South Sudan halted its 350,000 barrels per day crude oil production because of conflicts on sharing oil revenue with neighboring Sudan. Then Sudan's bombing attack against oil fields in South Sudan was reported. However, these situations failed to lift crude oil prices.

The reason why only Saudi Arabia has special influence to the market is not only the country's large crude oil output volume but also its ample spare production capacity.

Saudi Arabia increased its crude oil production level from around 9.0 million bpd to the second half of 9 million bpd after the civil war entirely hampered Libyan output.

Libyan civil war boosted WTI crude oil prices to $150/bbl in April last year, but urgent release of strategic petroleum reserve by Organization for Economic Co-operation and Development member nations and Saudi Arabian apparent output hike led the market to below $80/bbl later.

Libya's crude oil production is recovering sharply since Q4 2011, while Iraqi output is increasing steadily as well. Iraq has also started operations at its 400,000 bpd new oil export terminal at Persian Gulf.

Iraqi crude oil output is expected to grow from present 2.7 million bpd to 4 million bpd by mid-2014. Libyan production, which is estimated at 1.3 million bpd in February, is also projected to rise to 2 million bpd within five years.

Tensions on Iran is supporting the crude oil market presently, but decrease of Iranian oil supply is unlikely to affect the market seriously except for war case. Even though increasing refinery costs caused by different type of alternative crude oil supply may affect petroleum products markets.

Currently, most members of Organization of Petroleum Exporting Countries including Iraq and Libya are being estimated to produce crude oil close to their capacity limit. Russia, which is currently producing about 10.3 million bpd, is unlikely to have enough spare capacity as well.

Saudi Arabia was estimated to be pumping 9.8 million bpd of crude oil in February maintaining nearly 2.5 million bpd spare capacity. The kingdom is the sole supplier that has an enough spare capacity for boosting crude oil production in case of emergency. Conversely, no one can provide plenty of alternative crude oil if Saudi Arabia fails to supply.
Crude oil prices are likely to show a crazy surge if the U.S. and other nations do not decide urgent and massive release of oil reserve.