Overview of the environment

The global economy’s recovery continued in most major economies (with the exception of the disaster-hit Japan) – at least based on available data. But recent evidence points to a serious global slowdown. The Eurozone’s sovereign debt crisis continued with full swing as Greece could barely steer away from a disorderly default.  The eventual outcome was a second international bailout worth an additional EUR 109 bn and the voluntary involvement of private investors in Greek debt restructuring that will likely amount to a selective default. At the same time, rating agencies cut all three European bailout countries’ credit ratings to below junk status, effectively barring them from debt markets for a prolonged period, while fears that the contagion may bring down Spain, Italy or even France flared up with renewed force in Q2 2011. The US economy presented the most obvious illustration of slowing economic activity as GDP growth showed at an annualized growth rate of 1.3% in Q2 2011 (after a downwardly-revised 0.4%  in Q1). The slowdown was partly attributable to the supply chain disruptions caused by the Japanese earthquake, the negative effect of booming commodity prices on consumption and the definitive end of the second round of quantitative easing (QE2) with no additional stimulus measures in sight. China’s economic growth slowed to a still robust 10.3% y-o-y in Q2 2011, but Chinese industrial activity was headed for a potential contraction towards the end of Q2, while rapidly growing inflation (at 6.4% in June), fuelled by rising global commodity prices, showed no signs of abating. This mixed picture about the health of the Chinese economy, which so far has been the primary driver of the global recovery, creates yet more uncertainties about the outlook for the global economy as a whole.

Oil prices followed a volatile trading pattern, overall showing a decline in Q2 2011 from the peak levels of above USD 125 seed during April to around USD 110 by the end of the period. The Dated Brent averaged at 117 USD/bbl in Q2 2011, 11% higher q-o-q and 50% higher y-o-y. The first price drop came with a sudden USD 12 “flash crash” in early-May, which was seen by most analysts as a significant correction after geopolitical concerns related to the Arab spring started to ebb away, global economic activity showed ever more signs of weakness and the US Fed made clear that QE2 will end on schedule, implying a strengthening dollar. The second notable weakening occurred in mid-June as Saudi Arabia began pumping an additional 650,000 bbl/day to the market, in spite of OPEC’s failure to agree on a quota increase at its June 8 meeting in Vienna. Prices fell temporarily further (to around USD 110) in late June following the IEA’s decision to release 60 mn bbl of oil from OECD emergency stockpiles to address the shortage of quality sweet crude created by the Libyan civil war. The measure had only a very short-lived impact over the oil price, but it apparently had a more lasting effect in tightening light/heavy spreads (including the Brent-Ural spread) and in removing the backwardation (meaning higher spot than futures prices) from the crude markets. Despite the temporary easing of oil prices during Q2, fundamentals remain largely supportive, as OPEC spare capacity dropped further (due to the Saudi output increase) to the alarming region of between 2.5 to 3.5 mn bbl/day, while OECD commercial stocks (at 58.6 days of forward demand cover in May) slowly receded to the 5-year average level. The demand outlook is also bullish as the IEA expects that the seasonally weak Q2 demand of 88.2 mn bbl/day will be followed by record demand levels of 90.3 and 90.6 mn bbl/day in Q3 and Q4 2011, respectively.   

Refining margins remained well below historic average levels during Q2 2011. Both diesel and jet fuel crack spreads remained relatively flat during Q2 2011 and slightly below their Q1 levels, as a combined result of slowing but still continuing Asian demand growth, ample middle distillate inventories and seasonal weakness. Overall, diesel was significantly weaker than the 5-year average, while jet fuel crack spreads surpassed historic average levels. Gasoline far exceeded 5-year average levels in Q2 due to sudden but temporary spike around May, which was driven by a sharp drawdown in US gasoline inventories and market anxiety about the potential impact of the Mississippi River flooding on several large US refineries. Naphtha was much weaker in Q2 2011 compared to Q1, partly reflecting the slowdown of industrial activity in both Europe and Asia. Negative fuel oil crack spreads responded to gradually decreasing crude prices and strengthened substantially from well below to slightly above the 5-year average during Q2 2011, but the quarterly average was bellow Q1 2011.

The Brent-Urals spread followed a declining pattern in Q2 2011 from near 4 USD/bbl in May down to just below 1 USD/bbl by early-July. The first significant drop between late-April and late-May was the result of the gradual strengthening of fuel oil crack spreads from their historically weak levels, which appreciated the heavier Urals (with a higher fuel oil yield) and subsequently narrowed the Brent-Urals spread. The second drop came after the IEA emergency stockpile release, which mainly poured light sweet crude onto the market (to make up for the missing Libyan barrels), which reduced the premium on the similarly light Brent type relative to the Urals, further narrowing their price differential.

The CEE region’s recovery likely moderated during Q2 2011 in line with the slowdown of the global and the Eurozone economy. The small export-oriented economies in the region (particularly Hungary, Slovakia and to a lesser extent Croatia as well) still rely mostly on manufacturing exports for their recovery, and thus remain highly vulnerable to any such loss of momentum in global and Western European demand that seemed apparent during Q2 2011. At the same time, domestic demand in most CEE economies remain subdued by weak labor markets, shrinking or stagnating real wages and high inflation. Additional fiscal tightening is also inevitable in most CEE economies to bring down budget deficits, which is likely to constrain domestic demand in the years ahead. The continuing Eurozone debt crisis remains another downside risk to the region, as a general flight of capital from the EU periphery may easily spill over to those “emerging” economies of the region that seem to share some of the structural weaknesses  as the distressed Eurozone economies.