While little evidence exists to demonstrate marked increases in demand driven by an improving economy, general optimism and signs of recovery in key US indicators such as housing prices, car sales, business investment and consumer confidence have driven oil prices steadily higher over the past quarter, according to Ernst & Young's Americas Oil & Gas Center.
"In the past few years, there was a $20 to $25 per barrel 'risk premium' added to oil prices. That premium has been replaced by a 'hope premium', as markets believe an improving economy will spur significant demand increase," said Marcela Donadio, Ernst & Young LLP, Americas Oil & Gas Industry Leader. "Major players in the energy industry are preparing for the upturn."
While oil has more recently settled in the low $60 per barrel price range, the run up to $70 per barrel last quarter made oil prices $20 to $25 higher than market demand supported. With relatively weak demand and no marked change in production, it is believed that the run up was attributable to anticipated recovery.
"While recovery will be slow and gradual, there is a great deal more optimism in the markets going into the third quarter and that is reflected in oil and gas industry activity," said Marcela Donadio.
Other areas of the energy sector have yet to be impacted by the ''hope premium."
Big increases in upstream spending, drilling activity and infrastructure expansion created major growth in natural gas production in recent years. Now, due to a depressed economy, demand is weak.
When commodity prices collapsed at the end of 2008, leaving gas at $6 per million BTUs, oil and gas prices were aligned in the $30 per barrel of oil equivalent (boe) range. While oil prices have bounced off the bottom and climbed as high as $70 per barrel, natural gas prices have continued the downward march and are currently around $3.50 per million BTUs or $21/boe. On a barrel of oil equivalent basis, oil is now approximately three times the value of natural gas.
Refining and marketing
The outlook for the refining and marketing industry is still quite bleak. Several refinery expansions, planned in a high commodity price environment, were completed last year and more capacity is coming soon. Global refining capacity increased by about 1 million barrels per day in 2008. Another 1.5 to 2 million barrels per day are anticipated to be online this year with another 1 to 2 million next year.
The oilfield services sector -- traditionally last to feel the effects of a down economy -- is feeling the brunt of the credit crunch now. They also are experiencing the effects of exploration and production spending cuts and pressure to renegotiate contract rates for all drilling and production services. However, there is some optimism for oilfield services companies. Rig counts have increased the last three consecutive weeks.
"There is a trickle down effect for oilfield services. The volatility or ups and downs hit this sector hard and last," explained Charles Swanson, Houston Office Managing Partner for Ernst & Young LLP. "Earnings go through the roof in the good times, when demand for equipment and services is high, driving up the price. Likewise, earnings bottom out when E&P companies cut back spending."
The transactions landscape appears to be stable. Arguably, things are improving and the start of the recovery may be at hand. Deal activity is down only slightly over first half of last year when prices averaged $125 per barrel. For the first half of 2009, transaction value was only about 7.5 percent lower than the first half of 2008 when commodity prices were twice as high. Deal volume is almost identical. The fact that transactions values are only slightly lower than the same time last year, demonstrates continuity, consistency and long term vision on the part of industry.
"We anticipate the next wave of transactions coming soon," said Jon McCarter, Ernst & Young LLP, Transaction Advisory Services Leader for Ernst & Young's Americas Oil & Gas Center. "There are weakened companies out there, ripe for the picking and companies with strong balance sheets looking for quick growth opportunities."
About Ernst & Young's Americas Oil & Gas Center
The oil and gas industry is faced with complex issues and constant change. Volatile prices, business consolidation, difficult operating environments, ever-increasing customer demand, continuously evolving regulatory environments and the reliability of supply all present significant challenges. The Ernst & Young Americas Oil & Gas Center can draw upon a network of energy professionals in the Americas and around the world to work closely with clients to facilitate the development of coordinated approaches to managing risk, improving performance and increasing operational effectiveness. The Center works to anticipate market trends, identify the implications of and develop points of view on relevant industry issues. Our deep energy industry focus helps Ernst & Young make a difference.
About Ernst & Young
Ernst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our 135,000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve their potential.
For more information, please visit www.ey.com.