Ernst & Young-Dynamics of Oil Demand are Changing

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Sharp differences in economic strength or weakness between regions, new development opportunities, a changing environmental landscape and upcoming mid-term elections are creating an uncertain environment for the oil and gas industry.

“The industry, which has been portrayed negatively in the recent past, needs to be an active collaborator and have a clear voice in developing new policies. Clarity around the future of energy policy would go a long way toward helping companies adapt and respond to this period of transformation,” said Marcela Donadio, Americas Oil and Gas Leader for Ernst & Young LLP.

The dynamics of oil demand are changing. Natural gas is full of promise, but key pieces of the puzzle, such as adequate infrastructure and strong demand, are missing. The downstream sector is faced with the challenge of too much capacity, as well as uncertainty about regulation and fuels. Oilfield service companies are facing a geographic shift. And transactions are being scrutinized following the Gulf of Mexico spill.

Oil (see data graphs in news release at: http://www.ey.com/US/en/Newsroom/News-releases )

Oil demand continues to be driven largely by emerging economies. Advanced countries’ continued low demand is attributable primarily to the economic recession, but gains in efficiency may be permanent. Following years of record high prices and with businesses working to reduce their carbon footprints, less oil-intensive economies are emerging. Upstream producers are also facing rising costs as a result of a tighter regulatory environment and are facing the potential loss of key tax advantages. Nevertheless, if the economy continues to improve, oil demand will inevitably increase.

Natural gas

With the North American unconventional gas boom and new liquefied natural gas capacity coming online, natural gas supply remains strong and storage levels remain high. As more of the majors move into the shale space and validate the unconventional gas strategy, Ernst & Young expects growth in supply to accelerate.

“The natural gas resource potential is incredible,” said Donadio. “Currently, demand is not keeping up with supply growth however, a supportive public policy could go a long way toward increasing demand.”

Downstream

Third quarter refining margins largely retreated to pre-boom levels as a result of modest utilization in the US and Europe, sluggish demand and relatively high crude prices. In addition, while excess  capacity abounds, new capacity is coming from the Middle East and Asia, which will further strain margins. There are ongoing questions as to the prospects for sustained transportation fuel growth in advanced economies and possible public policy shifts resulting from the Deepwater Horizon incident to support greater utilization of alternative fuels. All of this creates a very difficult operating environment and uncertainty for refiners.

Oilfield services

Global upstream spending declined by 25 percent in 2009, but is expected to be up 15-20 percent in 2010. While the Gulf of Mexico moratorium has created sharp downward pressures on rig utilization and day rates, new opportunities in South America and offshore Africa are emerging. The boom in unconventional oil and gas drilling has resulted in rising service intensity and has fed the demand for new, high-complexity rigs. Enforcement of “Idle Iron” regulations — which will require full decommissioning of wells, platforms and pipelines that are no longer producing or providing operational support — will provide opportunities for some oilfield service companies.

Transactions

Continued loosening of credit markets, strong oil prices and evidence of a financial recovery, even though somewhat mixed, have driven a clear uptick in upstream transactions over the past few quarters. While confidence in the economic recovery has waned some over the past few months, Ernst & Young believes that, in the oil and gas industry, companies are willing to make investments. International and National Oil Companies are beginning to invest heavily in unconventional gas. With gas prices depressed, investors are looking for gas plays with high liquid content, such as the Eagle Ford, Bakken and Granite Wash. In addition to a potential increase in oilfield services consolidations, many companies are re-examining how they structure deals.

“Looking forward, we expect deals that may differ from historic trends, with legacy structures being re-evaluated. The ongoing regulatory and legislative uncertainty has potential to slow the pace of negotiations,” said Jon McCarter, Transaction Advisory Services Leader, Americas Oil & Gas Center, Ernst & Young LLP.

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 ( www.ey.com/us/oilandgas ) can draw upon a network of Ernst & Young 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 141,000 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 .

Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. This news release has been issued by Ernst & Young LLP, a client-serving member firm of Ernst & Young Global Limited located in the US.

SOURCE Ernst & Young

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