Oil demand likely to climb, but supply remains less certain - report

Source: Ernst & Young

According to a quarterly report from Ernst & Young, oil demand and prices should continue to rise in the third quarter of 2011 according to indicators, even with ongoing uncertainty with respect to the economic recovery, deficit reduction initiatives in the US and the debt crisis in Europe. 

In the first quarter of this year, with expectations for continued economic improvement and as a result of the supply disruptions from the Middle East, oil prices rose to over $100/barrel. But after peaking in the second quarter, crude prices fell back slightly, in spite of the announced stock release by the International Energy Agency (IEA), as the economic recovery lost some steam. 

Oil 

The bright spot in the oil outlook is the increasing activity in the Gulf of Mexico since the oil spill last year, with the first new production out of the Gulf coming in the second quarter. While overall production remains below pre-2010 levels, the application and permitting process is substantially improved, and increasing production will create jobs and increase domestic energy supplies at a time of expected strong demand growth. Oil production elsewhere in the Americas continued to increase as well, notably from the Bakken formation in the Upper Midwest, as well as from the Canadian oil sands and Brazil. 

The big unknowns for oil producers are the short-term effects of the IEA's release of 60 million barrels from emergency supplies and OPEC members' disagreement over supply increases. The IEA's release announcement brought prices down temporarily and is expected to fill the void of Libyan supplies. However, as the market moves into the high-demand season, the IEA release will not meet that increased demand, and the market will need more supply from OPEC at a time when its spare capacity is at its lowest level in more than 20 years. Beyond the short-term, over the next three to five years, pressures on OPEC to increase capacity and production are expected to increase substantially. 

"Oil prices are dictated by supply and demand, and all signs point to modest oil demand growth and uncertain supply," said Marcela Donadio, Americas Oil and Gas Leader, Ernst & Young LLP. "Barring a strong economic shock, continued strong oil prices seem to be in order over the next three to five years." 

Gas 

US natural gas production continues to grow, with the latest production figures reaching the highest point in almost 40 years. Shale gas is driving the growth and is now approaching about 30% of US total gas production, even as gas-directed drilling has slowed and issues surrounding the economic feasibility and potential environmental impacts of the resource are raised. 

"We maintain that natural gas is a sound solution to the nation's need for domestic, cleaner-burning fuel," said Donadio. "We have the resource in abundance and we know how to produce it safely. We need to put any questions around that to rest and focus on creating more opportunities to increase natural gas demand." 

Downstream 

With softening crude prices during the second quarter, the US downstream sector had a relatively strong quarter, with average cracking margins moving close to $30/bbl. Refiners with access to the relatively "undervalued" crude oils, like WTI and Canadian crude, continued to see stronger margins than did coastal refiners, which are more exposed to global crude oil markets. 

Investments in new refining capacity made in recent years are now coming to fruition, and are expected to overwhelm growth in oil demand in the short-to-medium term. This means weakening conditions for margins over the next few years. 

Oilfield Services 

Oilfield service activity is dictated by upstream spending. Spending is expected to continue to grow by about 15 to 20% in 2011, returning close to the peak 2008 levels. Service capacity is being strained by the unconventionals boom. Cost increases and staffing shortages are appearing. This resurgence of the oilfield service segment is being driven by fit-for-purposes technology such as rotary steerable rigs and directional/horizontal drilling; strong oil prices; and the efficient application of shale gas technologies including multi-stage fracking and horizontal drilling. 

Transactions 

The second quarter was another fairly strong quarter for oil and gas transaction activity, marking seven consecutive quarters of deal growth. Deal activity in Americas continues to dominate the global transactions landscape. 

Looking into the second half of year, transaction activity should stay fairly strong, boosted by the expected continued high oil prices and the ever-high geopolitical risk, tempered only by the still reasonably high levels of economic uncertainty, particularly in the US and Europe.



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