This year the oil market will see a few surprises. Commodity price volatility will continue, but it will moderate, and prices will move lower.
The US economy will grow at a much slower pace than during 2007, and there is still some risk of entering a recession this year. That risk is abated, though, by the strength of US exports. The weak dollar relative to other major currencies will drive strong export demand this year.
As motor gasoline prices decline, gasoline consumption will strengthen again following 2 years of flat demand. Demand growth will be muted, though, as inflation across consumer spending dents personal spending power.
Earnings
US company earnings this year will be less robust than last year. This eventually will hurt oil production, primarily US output. It also could further weaken chances for new refinery construction in the US.
Profits will continue to moderate for producers due to higher costs for exploration and field development. During 2007, US-based producers saw their quarterly earnings start to decline following a long string of gains.
Service and supply companies will also see earnings growth slow. As recently as the third quarter of 2007, these firms continued to enjoy strong growth in net income compared with year-earlier results. Revenues soared on high day rates for rigs.
This year, service and supply companies will also feel a downward shift in earnings growth as their supplies of equipment are pinched and due to leaner capital budgets set by producers.
Capital budgets
Oil prices will moderate this year from their run at $100/bbl on the futures exchanges in the fourth quarter of 2007.
Leaner profits from oil and gas producing companies will result in less cash being allocated to capital and exploration expenditures. Outside the US and Canada, capital budgets will climb at least 16% this year, according to the most recent exploration and production (E&P) spending survey from Lehman Bros.
But upstream capital spending will be nearly flat in the US and down in Canada this year. Deepwater operations will still command much of the available resources, but onshore activity will lessen. Uncertainty surrounding natural gas prices is the reason that Lehman forecasts only moderate US spending growth.
The combination of these factors will continue the decline in US oil output. The last year that US crude and condensate production climbed more than negligibly was 1984.
Consolidation
The climate looks conducive to more consolidation among oil and gas companies during 2008. Merger and acquisition activity slowed in the past couple of years but could spike this year.
OGJ’s annual look at oil and gas producers’ results, the OGJ200, shows a recent decline in consolidation among the US-based, publicly traded firms with reserves in the US. During 2006, only six of these firms were acquisition and merger targets, the same as in 2005 and down from seven in 2004. Recent mergers among the companies in this special report peaked at 12 in 2000 and 2001.
The number of respondents in the Lehman Bros. survey that indicated a preference for acquiring reserves through the drillbit rather than by purchasing reserves declined in 2007.
While the proportion viewing drilling as economically favorable has declined in the US and Canada, the reverse has been true internationally, according to the survey. In the US, the economics of drilling are viewed as preferable to purchasing by 83% of respondents, down from 90% last year; in Canada by 66%, down from 97% a year ago; and internationally by 86% vs. 79% last year.
