New Oil Price Shock Threatens Economic Growth

HOUSTON April 21, 2011 /PRNewswire/ -- Unrest in North Africa and the Middle East, coupled with the disaster in Japan, threatens the sustainability of the global economic recovery, but the momentum of growth is thought to be strong enough in most regions to absorb the shocks. However, global economic growth projections are being reduced, dropping to around 4% for 2011. Despite the fact that short-term oil and gas supply and demand remains relatively balanced, oil prices have gone up in anticipation of supply shocks.

"We are dealing with a new kind of 'oil shock'," said Marcela Donadio, Americas Oil and Gas Leader for Ernst & Young. "Driven by angst over broad geopolitical concerns, markets are proactively reacting to a potential supply problem. When Saudi Arabia increases production, as they just did, it is clear that oil supplies are plentiful and that the current pricing volatility is driven by market psychology and not necessarily real-time fundamentals."

Oil

For most of 2010, crude oil prices (WTI basis) hovered in the $70 to $80 per barrel range. But as the global economy grew, global oil demand recovered and prices began to move higher in the last quarter of 2010. The WTI price broke through the $100/barrel mark in early March 2011, as Libyan supplies were cut off. While a disconnect has emerged between WTI prices and the more globally-traded crude oils, continued political upheaval in the Middle East and Africa will prolong upward pressures on oil prices.

Gas

A confluence of factors has created a more positive outlook for natural gas. The crisis at Japan's Fukushima Daiichi nuclear power plant and the loss of Libyan gas supply have established a "floor" for global gas prices. In the short-term, additional LNG will be needed to replace the damaged nuclear generation, but the nuclear power generation risks brought to light in Japan could also renew a push for greater long-term use of natural gas for electricity generation in the US and other countries. Another positive for natural gas, in response to higher gasoline prices and unease over foreign oil dependence, is a federal bill supported by both parties creating tax incentives to expand the use of natural gas vehicles in the US.  

Downstream (see data charts at: https://filexchange.fleishmanhillard.com/confirmedaspx/1217164585f42cc0d45b8a9f2ce3ebab/EY_Charts_201104201556461.zip)

Despite the strong rise in crude oil prices, refiners generally had a good first quarter. Capacity tightened with the loss of some of Japan's refining capability. At the same time, loss of high-quality Libyan crude oil is creating some short-term supply problems, particularly for middle distillates. Despite the higher cost of crude oil, average cracking margins have moved over $20/bbl. Refiners with access to the relatively "cheaper" crude oils, like WTI and Canadian heavy, generally saw stronger gains than those more exposed to global crude oil markets. However, recent investments in additional capacity continue to come online and could overwhelm demand growth, creating weaker conditions for margins in the medium term.

Oilfield services

The oilfield services segment, so heavily dependent on upstream spending, is encouraged by movement in offshore permitting. It is a significant bright spot on the horizon. Seven deepwater permits were issued in the first quarter of 2011 by Bureau of Ocean Energy Management, Regulation and Enforcement, compared to none in the last half of 2010. Onshore shale development both for oil and natural gas continues to be another significant driver of business for oilfield services companies.

Spending rose in 2008 by about 20%, but declined in 2009 by about 25%. Spending increased by about 15 to 20% in 2010, and that pace is expected to continue in 2011, bringing the industry back to 2008 spending levels.

Transactions

The first quarter of 2011 marked the sixth strong quarter in a row, with almost $90 billion in transaction value. Notably, BP has returned as a buyer after several quarters of primarily selling assets. And there is still significant foreign inbound investment in North American unconventional gas. Transaction activity, including joint ventures, is expected to be similarly brisk throughout the rest of the year.

Global economic growth remains robust, but is challenged by political unrest and the natural disaster in Japan, making the outcomes unpredictable. The markets have reacted quickly by pushing prices higher. Higher prices are expected to impact the global economic recovery and restrain oil demand growth. Notably, these events and their potential impact have captured political attention in the US, and energy policy is back on the agenda.

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SOURCE Ernst & Young