What Next for Oil?

4 February 2009 (Last Updated February 4th, 2009 18:30)

After a seesaw 2008, how will the offshore industry react to volatile oil prices in 2009? Paul French investigates.

What Next for Oil?

Oil prices swung more violently in 2008 than a professional boxer’s right hook. After reaching record $147 per barrel ($/b) levels in July, analysts predicted prices would break the $200 barrier, yet only three months later they’d crashed to $60/b.

The International Monetary Fund (IMF) lowered its 2009 oil price forecast by $32/b to $68/b, predicting that markets will remain volatile as they respond "quickly to shifting perceptions of demand and supply trends".

So what’s causing the volatility? How will the industry react? And what does it mean for the future of the world’s black gold producers?

Demand and supply

Oil prices are determined by the basic economic principles of supply and demand. The wild fluctuations in 2008 were caused by a sharp downturn in demand resulting from the global credit crisis, the slowdown in demand for commodities from India and China and the rising value of the US dollar.

This was mostly in the second half of 2008, according to Simon Wardell, director of the global oil energy markets group at Global Insight. "Supply was tight but not declining that much and the falling US dollar meant that India and China didn’t see any evidence of a downturn," Wardell says.

"However as soon as the credit crunch really hit and Lehman Brothers collapsed, all the factors that had been propping up prices went into full reverse. When the very first rumblings of credit trouble began there was a decline in the equities market and capital flowed into commodities. That capital came out quickly once confidence dropped, accelerating down the price of oil."

"The falling US dollar meant that India and China didn’t see any evidence of a downturn.”

To bring some equilibrium to the price of oil, the Organization of Petroleum Exporting Countries (Opec) announced in October 2008 it would cut production by 1.2m barrels a day to try to compensate for falling demand. But how successful will this be in bringing oil prices under control in 2009?

"The jury’s out," says Simon Wardell. "It should help to prevent things getting worse but we’ll have to see how tough Opec is on quota compliance. New supply is about to come into the market and contracting demand, which means there will be a surplus of oil.

"Opec will need to make further cuts if it wants to see the price of oil increase but, with prices low, companies will look to increase revenue through volume and it is unlikely there will be 100% compliance."

Exploration and technology investment

For those still intent on seeking new resources, the global economic crisis means a shift in exploration and production away from unproven prospects towards areas of proven resources. For big oil companies wanting to reduce investment risks and national oil companies with goals to conserve resources, enhanced oil recovery compression technology could have a big impact on 2009.

"Improved oil recovery will account for up to 15% of annual oil additions worldwide," says Flavio Tosi, upstream equipment manager for GE Oil & Gas. "Recent advances in drilling technologies and fracturing techniques are being extensively employed and, coupled with water alternating gas re-injection techniques, this means the recovery ratio could increase by as much as an additional 20 to 40%."

Norway’s statistics agency announced in September 2008 that investment in the country’s oil and gas sector would reach record levels in 2009, with NKr31.4bn being pumped into exploration compared to 25.1bn in 2008.

"International oil companies [IOCs] will continue to fund capital expenditure as they have an ongoing need to find new resources," says Simon Wardell. "The problem will be within Opec, where most of the industry is state controlled. After budgeting for high oil prices there won’t be much money left for investment, which could cause a shortage of oil further down the line."

With major oil companies sitting on big piles of cash following record profit hauls earlier in 2008 and smaller companies struggling to finance exploration and production activity because of the credit crunch, mergers and acquisitions are expected to be rife in 2009 as the industry seeks to trim the fat.

"Due to the current delays in investment, we could end up with an acute supply crunch.”

Brian Youngberg, energy analyst at Edward Jones, says that although numerous smaller producers have a lot of property, many are constrained at the moment. "You also have the major integrated companies with deep pockets that could potentially buy these reserves at relatively attractive prices. You’re probably going to see this happen as we move through 2009."

"It is possibly a good time for mergers and acquisitions," agrees Simon Wardell, but he says that the problem is funding them. "Although the big oil companies are cash rich, they like to finance deals using traditional funding methods, which have dried up. I expect we’ll see an upsurge in speculation if not actual deals."

Politics and oil – Russia, Obama and Mexico

The international landscape is expected to change next year, with Russia indicating that it will leave previous turbulent relationships behind and work more closely with Opec. But will this help eradicate fears about energy supply and bring global oil prices under control?

"I wouldn’t put a huge amount of faith in it," says Simon Wardell. "Russia’s output is falling, or it will at least remain steady. It’s convenient for Russia to talk about moving closer to Opec but in reality you will just see a fig leaf cut in production equivalent to what they would lose anyway."

Another big change in the international landscape comes in the shape of Barack Obama. The new president has made no secret of his desire to slash the tax breaks that have helped big oil companies post record profits in the US.

"He’s talked about the need for investment in alternative energy and improving fuel efficiency," says Simon Wardell. "Long term I think there will be a drop in US consumption growth patterns but, because the oil price has fallen so sharply, I think there will be less immediate impetus. He understands the need to produce low-cost liquid fuel."

Next door, Mexico will open its waters to outside companies for the first time. Petroleos Mexicanos (Pemex), the only company allowed to explore or produce oil on domestic soil or water for the past 70 years, says that it hopes to award its first contract in 2009.

"We expect to be ready to release the first tender by the middle of the year and award it by the end of the year," says Pemex chief of exploration and production Carlos Morales. "We can learn the most from working with big oil companies such as Petrobras, Statoil, Exxon, BP, Shell, Total and Chevron."

Taking all these factors into account, how do things look for the offshore industry in 2009? Will Opec’s production cuts, smarter technology and new international alliances and opportunities help to arrest the slide? Or is the gloom too thick to permeate?

"Oil prices will get lower still," says Global Insight’s Wardell. "We are predicting that the average oil price will come down to $40 a barrel, maybe even the high 30s. Longer term, though, the price will increase gradually as we come out of recession. The major concern is what happens in 2011/12. There will be an upsurge in demand but, due to the current delays in investment, we could end up with an acute supply crunch."