View from London: Price swings change industry on many fronts

Jan. 5, 2009
What a difference a year makes in the oil industry—or perhaps in this case 5 months.

What a difference a year makes in the oil industry—or perhaps in this case 5 months.

In July, crude oil prices peaked at $147/bbl and at this writing had plummeted to below $40/bbl. Questions have switched from How high can they go? to What is the new floor? Oil exporting countries such as Nigeria are reporting plunges in revenue, which have major repercussions for investments in health, education, and infrastructure.

Who remembers that oil product prices based on $40/bbl crude was unacceptably high to consumers a few years ago? Now operators complain that prices that low are unsustainable because operating costs have risen and that $70-80/bbl is necessary if they are to develop unconventional hydrocarbon and deepwater resources.

Spending cuts

Companies in 2009 are likely to slash capital spending, drill fewer wells, and delay or cancel investment decisions. Several companies, such as StatoilHydro and Royal Dutch Shell PLC, have postponed Canadian heavy oil projects, for example, because of price volatility. The worrying consequence of this is underinvestment that will limit future supply and possibly produce another violent price cycle.

Distinguishing features of the current slowdown are the drying up of finance and the extreme volatility of oil and gas prices, both of which hamper financing of projects and operations.

Companies that survive will be those that control costs, focus on core businesses, and respond quickly to opportunities. Operators considered mergers and acquisitions too expensive when oil prices were high. Now, as commodity prices fall, independents such as Tullow Oil PLC, Dana Petroleum, and Cairn Energy will become targets for companies able to finance deals.

Many new companies on the Alternative Investment Market (AIM) in London, particularly those that concentrate on exploration and lack cash flow from production, could cease to exist by this time next year. Deal financing, however, is difficult.

Under the Ernst & Young Oil & Gas Eye Index, which tracks AIM companies on the basis of revenue and fund-raising activity, companies saw a 44% fall over the third quarter of 2008. This was the most severe quarterly fall since the index’s inception in 2004.

European gas

Liberalization of gas markets in Europe continues to trouble companies, which complain about complexity and a lack of regulatory certainty. The European Commission’s third package offered European Union governments the choice of full ownership unbundling or introduction of independent system operators for electricity and natural gas.

Competing objectives regarding security of supply and carbon reduction are issues for policymakers and operators, particularly as Europe’s dependence on gas imports is likely to increase through its commitment to the EU trading system for carbon emissions.

In Europe, gas demand is falling due to the previous spate of high prices and the weak economic outlook. But the region also faces a potential of oversupply of gas with an unprecedented level of LNG projects coming on stream in the next 3 years, according to energy consultancy Wood Mackenzie. Between now and 2011, as much as 110 bcm of LNG will enter the market. Whether all planned projects come to fruition, however, remains uncertain.

During this weak economic period, relationships between national oil companies and the international majors will change. NOCs reduced their dependency on the IOCs during the period of high prices, but now many of them find themselves needing new participation from abroad.