Rising Oil prices will drag Asian economic growth: Ernst & Young

The firm warns of a "new kind of oil shock" we haven't see before.

Ernst & Young’s quarterly global Oil & Gas

forecast, highlights that, despite the fact that short-term

oil and gas supply and demand remains relatively balanced, oil prices have

gone up in anticipation of supply shocks. This is against a background of

unrest in North Africa and the Middle East, coupled with the disaster in

Japan. As a result, global economic growth projections are being reduced

and are dropping to around 4% for 2011.

Dale Nijoka, Global Oil & Gas Leader for Ernst & Young, says: “We are

dealing with a new kind of ‘oil shock’. Past oil shocks have been caused by

embargoes, war or demand growth, this pricing shock is being driven by

broader geopolitical factors across a larger geographic area. More simply

put, markets are proactively reacting to a potential supply problem, not

necessarily real-time fundamentals.”

Oil

For most of 2010, crude oil prices (West Texas Intermediate, (WTI)) hovered

in the US$70 to $80 per barrel range. But as the global economy grew,

global oil demand recovered and prices began to move higher in the last

quarter of 2010. The WTI price broke through the US$100/barrel mark in

early March 2011, as Libyan supplies were cut off. While a disconnect has

emerged between WTI prices and the more globally-traded crude oils,

continued political upheaval in the Middle East and Africa will prolong

upward pressures on oil prices.

Gas

A combination of factors has created a more positive outlook for natural

gas. The crisis at Japan's Fukushima Daiichi nuclear power plant and the

loss of Libyan gas supply have established a “floor” for global gas prices.

In the short-term, additional LNG will be needed to replace the damaged

nuclear generation, but the nuclear power generation risks brought to light

in Japan could also renew a push for greater long-term use of natural gas

for electricity generation in the US and other countries.

Downstream

Despite the strong rise in crude oil prices, refiners generally had a good

first quarter. Capacity tightened with the loss of some of Japan’s refining

capability. At the same time, loss of high-quality Libyan crude oil is

creating supply problems, particularly for middle distillates. Despite the

higher cost of crude oil, average cracking margins have moved above US

$20/bbl. Refiners with access to the relatively “undervalued” crude oils,

like WTI and Canadian heavy, generally saw stronger gains than those more

exposed to global crude oil markets. However, recent investments in

additional capacity continue to come online and could overwhelm demand

growth, creating weaker conditions for margins in the medium term.

Oilfield services

The oilfield services segment, which is heavily dependent on upstream

spending, is encouraged by movement in offshore permitting. The first seven

deepwater permits since the moratorium were issued in the first quarter of

2011 by Bureau of Ocean Energy Management, Regulation and Enforcement.

Spending rose in 2008 by about 20%, but declined in 2009 by about 25%.

Spending increased by about 15 to 20% in 2010, and that pace is expected to

continue in 2011, bringing the industry back to 2008 spending levels.

Transactions

The first quarter of 2011 marked the sixth strong quarter in a row, with

almost US$90 billion in transaction value. Notably, BP has returned as a

buyer after several quarters of primarily selling assets. And there is

still significant foreign inbound investment in North American

unconventional gas. Transaction activity, including joint ventures, is

expected to be similarly brisk throughout the rest of the year.

Nijoka concludes: “Global economic growth remains robust, but is challenged

by political unrest and the natural disaster in Japan, making the outcomes

unpredictable. The markets have reacted quickly by pushing oil prices

higher. Higher prices are expected to weaken the global economic recovery

and restrain oil demand growth.”