Geopolitical unrest is impacting global oil markets, this time bringing a sigh of relief from North American unconventional oil producers – Ernst & Young has found.
As the industry moved out of a relatively strong winter season, fears had been building in an already cash-strapped unconventional environment, that supply growth – not only from North America, but also in particular from Libya and Iraq – would put downward pressure on oil prices. But signs of political progress in Libya have proved fleeting at best, and oil exports remain severely constricted, with few signs of progress in the near-term future. At the same time, Sunni jihadists threaten a new civil war in Iraq, putting the aggressive production growth assumptions for the Iraqi oil industry at risk.
North American natural gas markets remain bolstered by the recent very cold winter that brought gas storage levels to record lows. Despite the seasonal fall-off in demand, below normal storage levels continue to support production growth and prices. In the recent quarter, the North American gas industry also recognized the US Supreme Court’s support for EPA’s carbon reduction strategy, and the efforts of Congress and the US Department of Energy to speed the approval of US LNG projects.
Mexico’s road to energy reform continues, but delays in the Mexican Congress are likely to impact the implementation of the historic reforms. “This is an exciting time for the energy industry with a lot of investment opportunities being pursued by players from across the industry and beyond,” said Deborah Byers, the Oil & Gas Leader for Ernst & Young LLP in the US. “The industry remains confident and upbeat around the potential opportunities.”
Global oil prices moved higher in the second quarter, supported by increasing geopolitical risk – particularly in the Middle East and North Africa (MENA) – despite continuing strong North American supply gains. Markets have tightened in the recent quarter, as supply growth outside of North America has been minimal, while global oil demand growth is expected to remain modestly strong with the rebound in economic growth.
Byers notes that “We are seeing a ratcheting up of most price forecasts, reflecting not just the increasing costs of development and production, but also a more robust view of oil demand growth, and most-critically, the deteriorating outlook for Libyan and Iraqi production growth.” Importantly, Iraq has been forecasted to be the largest source of oil production growth over the period to 2025. With the increasing unrest and uncertainty, those growth expectations are now being challenged.
US gas producers are still taking support from the large storage deficit, despite continuing strong gains in production from the Marcellus and Utica Shale formations in the US Northeast. Gas prices will likely need to remain reasonably high in order to incentivize the necessary storage build over the summer, but at the same time, the higher gas prices will slow the switch from coal to gas in the power sector.
With gasoline prices moving up seasonally and distillate prices moderating only slightly, refiner margins generally increased in the second quarter, despite the upward crude price pressures. Notional cracking margins on a NYMEX 3-2-1 basis averaged almost $22.50 per barrel in 2Q14, up by almost $1 per barrel from the 1Q average. Average margins were up for the quarter across all of the refining regions, with margins in the Midwest once again continuing to be the strongest.
Led by international drilling, total global rig counts continue to show year-over-year gains. US rig activity, which has been the global laggard in recent years, is now also showing reasonably strong growth once again. Upstream operators are however, becoming more cautious in their spending plans, and while spending is expected to continue to increase in 2014, the increases (5-7%) are expected to be less than those estimated for 2013 (8-10%). At the same time, pressures on operators’ cash flows are being reflected as pressures on service companies to control costs.
Global oil and gas transaction activity in the second quarter 2014 turned up rather sharply, driven largely by US midstream transactions. The US midstream, and in particular the MLP segment, remains the most dynamic part of the North American oil and gas landscape. But apart the strong performance in the midstream segment, North American oil and gas transaction activity continues to be rather weak.
However, Byers, remarked, “We are clearly seeing that capital discipline and operating cash flow growth are driving the strategic agendas of oil and gas companies. We are seeing a shift from value-destructive acquisitions to value-accretive divestments, and we think that portfolio simplification and more strategic focus will trigger a rebound in North American transaction activity.”
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