Political risks keep oil prices high, despite rising non-OPEC crude supply

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London, 19 April 2012 — Increased oil production in non-OPEC countries, which more than offsets increases in global demand, is keeping pressure on OPEC to limit crude output according to EY’s latest oil & gas quarterly outlook.

The global oil market balance over time alternates between OPEC increasing and decreasing production. With significant production growth from South America, Russia and Canada, along with the US producing more, OPEC needs to reduce production for the remainder of this year.

Increased supply typically creates lower oil prices, but currently this is being outweighed by possible supply interruptions from Iran, though their nuclear program talks may help temper this in the near term. Other supply interruptions are also being seen from Syria, Yemen, the Sudans, and the North Sea. These supply concerns are further compounded by continuing fairly low level of OPEC spare and EY expects Brent crude prices to remain around US$120/bbl through at least the next quarter.

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“Global oil supply and demand is currently broadly balanced in terms of barrels but not necessarily oil quality. Markets are concerned about how the Iranian issue will play out long term, as well as by the broader unrest throughout the Middle East. If an economic slowdown occurs in China and the US, the two largest economies, it could have a large impact on the demand numbers,” said Dale Nijoka, EY’s Global Oil and Gas Leader.

Oil
Oil demand in the developed economies in 2012 is expected to continue to decline, but on a global basis will rise by a modest 0.9%, given the expected relatively strong growth in the emerging economies. While the US benchmark crude WTI has become disconnected from globally-traded crudes, global crude prices are still high as a result of geopolitical supply uncertainty. With 60% of Iran’s oil exports currently flowing into Asia, Asian buyers are now looking to diminish purchases.

Gas
Regional differences in natural gas prices around the world are substantial and underpin the future necessity of having a flexible LNG supply coupled with the ability to shift cargoes to the most advantageous market. Asian gas demand has remained relatively strong, particularly boosted by the continued nuclear outages in Japan. In the US in recent months, natural gas has been increasingly displacing coal for power generation and EY predicts that this trend will continue. The East African gas frenzy has triggered a bidding war for assets, but the large projects will be challenged without further clarity around regulations and fiscal terms. The huge eastern Mediterranean gas discoveries similarly will present challenges in terms of oversupply within the region, as well as with the difficult regional political environment.

North American and European spot prices have diverged again, primarily reflecting the ample North American gas supply situation. There have been some recent disappointments in Polish shale gas development, but some successes reported in China. Meanwhile, Argentina looks likely to be next in line for major shale gas development.

Downstream
Refiners in the developed economies remain significantly challenged by declining oil demand and surplus refining capacity. With as much as two million barrels per day of Atlantic Basin crude capacity potentially slated to shutdown, margins could get some needed relief. But as was seen in recent months, some of those potential shutdowns could be avoided – with new owners and new investment metrics – and margin prospects again diminish. The biggest issue in the US will be how the East Coast product markets will be affected by the looming refinery closures. In Europe, the big question involves the fate of the Petroplus refineries – will they finally close or be re-opened, perpetuating the European capacity surplus.

Asian refining still marches to Chinese demand growth – potentially slowing, but still nonetheless strong. “Regional refiners still struggle with fuel subsidies in many countries. With more than 60% of Iran’s oil exports moving into Asia, it remains to be seen how successful Asian refiners will be in securing replacement supplies,” comments Nijoka.

Oilfield services
Rig counts are broadly holding steady across all geographies – with Africa and the Middle East showing the strongest growth. The total US rig count is near its last peak, reached in fall 2008, but the structure of the rig market is notably different. At the previous peak, gas-directed drilling accounted for about 80% of all rig activity; more recently, gas-directed drilling was only about 30% of the US total.

Global upstream spending is increasing, but decelerating with forecasted growth of 10 to 15% in 2012. John Avaldsnes, EY’s Global Oil and Gas Advisory Leader explains, “Oilfield service cost pressures have moderated somewhat, but game changers for oilfield service companies will be the next generation of oilfield technology, particularly those focused on reducing costs.”

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