North American infrastructure expansions easing crude price distortions

According to EY's Oil & Gas Center's US quarterly outlook

Jul 25, 2013, 09:00 ET from EY

HOUSTON, July 25, 2013 /PRNewswire/ -- While crude oil supply in the Midcontinent continues to increase, infrastructure expansions are easing crude price distortions. New pipeline construction, reversals and repurposing, along with a surge in new crude-by-rail capacity and shipments, have relieved much of the logistical pressures that caused crudes like WTI to be substantially undervalued in relation to comparable global crudes.

The global supply/demand balance is seen as relatively weak, with only modest oil demand growth, in the face of rather strong non-OPEC crude supply growth, with most of that growth coming from North America. Lackluster global economic growth and continuing uncertainty have resulted in global crude prices generally weakening over the second quarter. However, high levels of geopolitical tension, particularly in the Middle East and North Africa, are keeping a floor under oil prices. Nonetheless, pressures continue on OPEC to restrain its production in order to keep global prices from sliding below members' targets.

In North America, on the other hand, the pricing of WTI, which had been selling at a substantial discount to other global crudes, has strengthened. We are seeing significant infrastructure expansions, in particular, increases in rail shipments of crude oil, with substantial volumes of oil now moving by rail from the Midcontinent region to all three coasts. While generally more costly than pipelines, rail provides flexibility and optionality for both producers and refiners — allowing producers to access higher-value markets that are often inaccessible by pipeline, and allowing refiners to source the most cost-effective feedstocks.

Ernst & Young's Americas Oil & Gas leader Marcela Donadio noted, "We don't see rail as just a temporary phenomenon in the oil market; rather, we expect that it will remain a valuable piece of the logistics puzzle. However, in the wake of the recent catastrophe in Quebec, we do expect to see increased attention to operational safety and oversight, both in Canada and the US."

Despite a seasonal retreat in prices, US gas market fundamentals remain fairly balanced as producer restraint has kept gas storage at near normal levels for this time of year, and producers look hopefully forward to a strong gas-fired cooling season.

A second proposed US LNG export facility has received full export permits from the US Department of Energy rekindling hopes that exports of natural gas will be the answer for the substantial amount of gas production that is possible. Still only a handful of companies have full rights to export LNG to buyers in countries without free-trade agreements (FTAs) with the US, as well as to countries with FTAs. Underpinning the increasing number of proposed LNG export projects is the fact that buyers, particularly Asian buyers, have become increasingly attracted by the potential for lower-cost LNG supply from the US and Canada.

While some of the structural crude supply imbalances are waning, refining margins remained quite strong in the second quarter, particularly for refiners in the Midcontinent region with access to the discounted crudes. Those margins are however sliding back.

Oilfield services
Total global rig counts continue to trend below year-earlier levels, primarily due to relatively weak drilling activity in the US. Global upstream spending is still increasing, but growth is slowing, particularly so in North America, where operators have been re-directing capex spending from dry-gas plays to oil and/or liquids-rich gas plays. At the same time, oilfield services cost pressures are rising, as is service intensity. There is an increasing focus on deepwater, and the new plays are deeper, more remote and more complex. Going forward, EY expects to see North American rig activity to begin to improve through growth in deepwater spending.

After a strong year in 2012, global oil and gas transactions activity slowed significantly in the first quarter of 2013, but rebounded sharply in the second quarter. For the first half of 2013, global reported deal value was up almost 40% compared to the first half of 2012, while the number of deals was down by almost 10%. However, strong transaction activity outside North America in the first half of the year has been overshadowed by weak activity in North America.

Ernst & Young LLP's Oil & Gas Transaction Advisory Services leader in the US, Jon McCarter noted, "We've been disappointed with the recent deal environment as reported deal value in North America for the first half of 2013, was 33% below the year earlier, while the number of deals was off by 15%. However, we do think the second half of the year will have a strong come back in activity given the current pipeline of opportunities and ample availability of capital from various sources."

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