Supply to Outweigh Oil Demand Over the Next 6 Months

August 02, 2012 /

The next six months should see over supply in the oil market with increased production from Libya, Iraq and US shale keeping oil prices flat according to Ernst & Young’s Quarterly Oil and Gas outlook. However, any new economic or political threat to supply that emerges, whether perceived or real, has the potential to shock oil prices.

The outlook predicts that fund-raising conditions are likely to remain challenging for many smaller, independent oil and gas companies and tightening credit markets may result in an increase in transaction activity in the oil and gas sector, as smaller players are forced to bring in partners in order to sustain development, or simply look for an exit strategy.

Dale Nijoka, Global Oil & Gas Leader for Ernst & Young explains, “There is a diverse range of international investment opportunities available for well-capitalized national oil companies (NOCs) and international oil companies (IOCs). Continued interest in unconventional resources is one of the areas we see driving a higher level of NOC M&A activity for the remainder of 2012.”

2012 – The story so far

The first half of 2012 was marked by oil price volatility and shifting fundamentals. Q1 saw Brent crude prices surging close to US$130 per barrel, driven primarily by supply concerns over Iran’s reaction to tighter sanctions on its oil exports and the status of its nuclear program.

The upward price pressure was further underpinned by the territorial dispute between Sudan and South Sudan and signs that the US economy was on the road to recovery. However, prices retreated in the second quarter as demand doubts grew with the rising international economic uncertainty and Iranian supply worries diminished.

Dale comments, “Early optimism over the health of the global economy proved to be short-lived. Higher oil prices and weaker than expected economic growth have translated into fears of a slowdown in demand for oil.”

Despite concerns over weakening oil demand, OPEC decided to leave production levels unchanged at its June meeting. The same month, the price of Brent crude fell below US$100 per barrel for the first time since early 2011. Brent prices fell to below US$90 per barrel at the end of June, but have since climbed back up to over US$100 per barrel following the escalation of the conflict in Syria and renewed worries about Iran.

If prices were to remain below US$100 per barrel for a prolonged period, this could be good news for struggling refiners as it will provide some temporary relief by reducing feedstock costs. However, over-capacity in European refineries, which are also facing competition from new, more complex refineries in Asia, continues to keep margins under pressure.

Outlook for the rest of 2012

For the next six months however, oil markets should remain well-supplied.

As Dale explains, “We expect additional supplies will be made available to the market through the return of Libyan production to pre-conflict levels, increased production from Iraq and an increase in oil production from shale plays in the US, as producers switch their investment focus from natural gas to liquids.

“However, any new threat to supply emerges – whether perceived or real – has the potential to shock oil prices.”

The Ernst & Young outlook suggests that stock markets are likely to remain volatile for the remainder of 2012 as they respond to economic news from the Eurozone and the wider global economy.

Fund-raising conditions are likely to remain challenging for many smaller, independent oil and gas companies. Tightening credit markets may result in an increase in transaction activity in the oil and gas sector, as smaller players are forced to bring in partners in order to sustain development, or simply look for an exit strategy.

Globally, gas is the growth story

The shale gas dash in the US has resulted in a supply glut that could turn the country into a net gas exporter. Despite the weak gas price outlook in the region, NOCs’ appetite for access to unconventional projects in North America remains undiminished.

The main driver of Asian NOCs’ pursuit of these unconventional assets is to gain knowledge of the underlying technology in order to apply that expertise to other areas of the globe, as well as to ensure the security of supply.

However, in Europe, early shale gas exploration results have been disappointing on the whole. Estimates of reserves have been revised down in Poland and the UK. As a result, companies are re-evaluating and shifting their investment focus to other areas such as the Neuquen Basin in Argentina.

The US Department of Energy estimates that Argentina has 774 trillion cubic feet of risked recoverable shale gas resources, of which the Neuquen Basin is home to over half. However the threat of resource nationalization, such as in Argentina, continues to be a risk factor for oil companies.

A new liquefied natural gas (LNG) frontier is emerging in East Africa after a string of recent gas discoveries in Mozambique and Tanzania.

Although only initial estimates of reserves have been announced, there is believed to be sufficient gas in place to support several large-scale LNG projects. East Africa is geographically well placed to meet the LNG demand in Asian markets. The discoveries have sparked investment interest from both IOCs and NOCs.

While some LNG projects in these emerging regions will not proceed to final investment decisions immediately, there will be increased global competition for access to gas-hungry markets.

Dale concludes, “Longer-term, LNG from East Africa could become more competitive than unsanctioned Australian LNG projects, causing them to be delayed, re-worked or possibly cancelled. In Australia, the pace of LNG development has resulted in mounting cost pressures for operators.

“There have been cost over-runs on a number of Australian LNG projects due to inflationary pressures in the local market and appreciation of the Australian dollar relative to the US dollar. Cost control on these capital projects is also likely to be a key focus area for oil executives in the next six months.”


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