Rising North American oil supply continues to reveal infrastructure mismatches

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Houston, 30 July 2012 –Growing oil supplies from unconventional fields in the U.S. and Canada have created significant logistics constraints, bottlenecks and considerable investment needs. In addition, new supply and demand trends/patterns have revealed widespread infrastructure mismatches, with pipelines being in the “wrong place,” carrying crude in the “wrong direction” and/or transporting the “wrong products.” These infrastructure constraints and mismatches are clearly reflected in the price disconnects in the Midwestern region over the last 18 months.

The US crude pipeline network was primarily designed to move crude from the Gulf Coast to the north. While much of the discussion about pipeline dislocations has focused on the oversupply at Cushing, Oklahoma, - a critical oil pipeline hub and the delivery point for West Texas Intermediate oil, the U.S. benchmark – getting supplies out more broadly across the country is also crucial. Supplies from the US midcontinent and Canada need diverse infrastructure to reach areas of demand.

EY - US Midwest Crude Oil Price Graph

“The magnitude of the problem is much greater than reversing one pipeline,” said Marcela Donadio, Americas Oil and Gas Leader, Ernst & Young LLP. “Not only do we need more infrastructure, we need different infrastructure.”

Oil
The global supply/demand balance continues to be uneasy due to heightened tensions between Iran and the West as well as to economic weakness and uncertainty. The threat of a full-scale strike in July by Norwegian offshore workers could have quickly tightened the balance, but government intervention seems to have averted the production halt.

In the US, rising new supplies of tight oil continue to put pressure on WTI and Canadian oil prices. Going forward, oil markets appear to remain skittish; with demand growth dependent on the economic recovery and geopolitical risk still high.

Gas
Natural gas prices recently reached their lowest level in a decade, as supply surged while strong growth in demand in the industrial and power generation sectors has been partially offset by a broadly weak economy and by abnormal weather. Natural-gas storage volumes remain high, with no relief in sight. Globally, new LNG supplies from the Eastern Mediterranean, Eastern Africa, and expected export capacity from the US and Canada are likely to result in significant shifts in long-term global supply/demand fundamentals. The booming Australian LNG sector will be the most pressured by the new supplies.

Downstream
The big challenge for the U.S. and European refining industry continues to be what has been called the “zombie refineries.” Just when it appeared that some of the surplus capacity may be permanently shut down, improving margins for other refiners, the uneconomical plants live on. The expected East Coast product deficits are now less likely to happen after the announced sale of refineries on the East Coast and Aruba. With those plants’ capacity still online, refining margins for US plants across the board will feel downward pressure. On the consumer side, gasoline demand has continued to decline in the US, where consumers appear to have reached the tipping point. This is in contrast with Latin America’s strong demand growth.

Oilfield services
Rig counts are generally holding-up across all geographies, with strongest growth in Africa and the Middle East. Cost pressures are slowing somewhat across all services, including labor and materials, increasing roughly at a general inflation rate of about 2-3%. Global upstream spending is still increasing, but growth is decelerating. Upstream spending is expected to be up 10-15% in 2012. In North America, operators are continuing to redirect capital expenditure from dry-gas plays to oil and/or liquids-rich areas.

Transactions
Oil and gas transaction activity was up slightly in the second quarter. Deal activity increased slightly in North America while activity was strong in Europe, the Middle East and Africa, driven primarily by the non-upstream segments. Asia-Pacific activity trended slightly downward. Interest in US and European refining assets remained reasonably strong, while midstream interest has also continued strong, particularly in North America.

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