Outlook for oil and gas sector remains positive for 2010
London, 27 January 2010 — Energy market sentiment remains relatively positive amid rising economic expectations, according to the Ernst & Young’s Global Oil & Gas Centers’ latest quarterly market outlook. Highlights of the outlook released today include:
- Sector is likely to fare better than most in the year ahead, given the sustained demand for oil.
- Junior companies with few or no producing assets will find it harder to raise sufficient funds.
- By contrast, larger companies in the sector, supported by strong oil prices and more robust balance sheets, are on the lookout for opportunities to expand their asset base.
- More consolidation in the sector is inevitable as larger companies take advantage of the strategic opportunities presented by their junior counterparts.
- A number of IPOs are planned for 2010 and, if successful, we can expect to see increasing investor interest in the sector.
- Lessons have been learned regarding the risks of investing in single-asset, pure exploration companies, so we anticipate that companies successfully coming to market will have larger portfolios, probably spread from exploration into production operations.
Conditions for increased M&A activity building
In total, 837 oil and gas deals were announced in 2009, with upstream accounting for 72% of these. The volume of deals was down 24% compared to the previous year. The total value of oil and gas transactions announced globally stood at US$198bn, up some 10% compared to the previous year. This is perhaps surprising given lower-than-average commodity prices in 2009, although the statistics have been dominated by a few large transactions. If ExxonMobil had not announced its US$41b acquisition of XTO in December, the figures would have looked very different.
M&A activity was much stronger in the second of half of 2009, reflecting the improving capital-market conditions and growing consensus on the oil price outlook. The positive trends that we have seen in recent months are likely to continue into 2010, and the outlook for oil and gas transactions is healthy in upstream and oilfield services. In the downstream world, over-capacity in some regions is likely to drive a longer period of uncertainty and transactional challenges. But the experience of the last year shows that one person’s challenge represents another’s opportunity.
“There is a broad consensus that deal activity will pick up again in 2010. We have seen some investment in US shale gas and anticipate more activity in this area, as well as the development of shale gas in other parts of the world,” said Dale Nijoka, Ernst & Young’s Oil and Gas global leader.
Oil demand uncertainty
Oil prices have become somewhat divorced from fundamentals and are looking to movements in wider equity markets and changes to economic indicators in key consuming nations for direction. The level of future oil demand is highly uncertain, which translates into a volatile short-to medium-term outlook for oil prices. Demand in 2009 was underpinned by economic stimulus measures undertaken by governments.
However, in spite of the largest decline in demand for oil in almost 30 years, demand is showing some signs of improvement, especially in developing economies. But there is some concern that the economic recovery will be an “oil-less” one, meaning that the developed economies will not return to the previous high levels of fossil fuel consumption due to gains in energy efficiency, substitution and behavioral change. Upward cost pressures are starting to relent, paving the way for growth, and potentially improving margins for producers. Oil companies require security of demand and a stable oil price environment to underpin long-term investments.
Investment in unconventional gas
Natural gas is regarded as abundant and reliable and companies have recently been making strategic acquisitions as a result, particularly for long-term North American unconventional gas. Nijoka comments, “As Copenhagen demonstrated, environmental concerns and the focus on carbon management are clearly going to impact the future of this industry. In addition, fears of security of supply, particularly for natural gas could emerge again this winter. These concerns will impact energy policy changes.”
The short-term fundamentals for gas remain relatively weak. Until very recently, strong supply, largely from growth in unconventional gas, particularly shale gas, in the face of sluggish demand and high storage levels, kept natural gas prices depressed. “In 2010 we expect to see more investment commitments around liquefied natural gas. The development of Gorgon in Australia will spur more activity in this area,” explains Raymond Ng, Ernst & Young Oil and Gas Far East Leader.
Tough times for refiners
The downstream sector remains under pressure. Refiners are likely to continue to be squeezed by upward crude price pressures and very limited demand pressures. At the same time, refining expansions, planned during times of high demand growth and strong economics, are coming online – implying weak margins over the next few years. Depressed light/heavy spreads are further punishing complex/sophisticated refiners.
“Over capacity in refining will be the biggest issue facing integrated oil and gas companies globally and particularly in Asia,” adds Ng, “We are seeing a massive modernization and expansion of the Chinese refining system, which includes closing numerous smaller, inefficient simple plants and replacing them with newer, larger, complex refineries that are more able to process heavier, more-sour and acidic crude oil. This will further depress margins for other refiners, who are already struggling.”
Oilfield services preparing for the upturn
Expectations for oilfield services in 2010 are mixed. The global rig recovery began in the third quarter of last year, and those numbers continue to improve. While some downward pricing pressures remain for the oilfield services sector as a whole, early progress is expected in the sub-sectors that deal with consumable goods, such as bits, pumps and tubular goods. Most companies slashed inventories for these items during the recession and are slowly rebuilding; a positive sign for the broader sector.
Offshore markets are mixed, with the ultra-deep markets staying strong and shallower jack-up markets still very weak. Survival in the sector may involve consolidation; therefore, additional mergers in the sector are expected in the next year or so. While there has been some slight improvement, the credit market constraints continue to be particularly important for the medium to smaller companies.
Despite some uncertainty with regard to the strength of the economic recovery and the shape and impact of forthcoming policy decisions, Nijoka is confident that the oil and gas industry will be able to sustain its recovery. He concludes, “The oil price has strengthened, equity capital is starting to flow back into the sector, development projects are coming back on stream with increasing frequency, and stronger exploration budgets are being set for 2010.”
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