If someone ventured that global energy markets were becoming less predictable a few years back, it was safe to assume the view was linked to the doctrine of 'peak oil' - the point at which the maximum rate of petroleum extraction is reached. But it turns out global oil and gas markets are now becoming less predictable - at least in terms of pricing - not because we are running out of resources but because we are producing far more of the stuff than previously anticipated.
As the new millennium dawned, global crude production stood at 77.7m barrels of oil per day (bopd), according to the US Energy Information Administration. By the end of 2012, output had climbed to 89.3m bopd - a 15 per cent increase. And there’s no indication that this rate of growth won’t be sustained through to the end of the decade. The rapid expansion of the North American shale oil industry, and the related advances in hydraulic fracturing and directional drilling, may merely compel the Cassandras to re-calibrate their doomsday scenarios. After all, it's still true that many of the world’s biggest sources of conventional hydrocarbons are in terminal decline, and policy-makers would be foolish to assume that US shale oil will gush forth indefinitely.
For those investors with exposure to the oil and gas industry - and that's most of us - an important factor to take on board is that the historical correlation between economic growth and oil use is breaking down. This is certainly true of the world’s developed economies, and is even playing out in economies such as China’s, thanks to improving fuel efficiency, lower-priced alternative fuels and the combination of environmental degradation and a rapidly urbanised populace. This has major implications for big integrated players like BP (BP.) and Royal Dutch Shell (RDSB) in terms of their future production mix.
The oil-supply balance is critical because FTSE 350 oil and gas companies allocate development capital primarily on the basis of long-term expectations for the price of crude. For 2013, the global benchmark Brent Crude averaged $108.47 (£66.14) a barrel, but the latest aggregate median forecasts from Bloomberg give a rate of $103 per barrel for this year, falling away to $101.25 per barrel by 2017.
So despite the oversupply in the US market, which has pushed the spread between spot prices for West Texas Intermediate (WTI) and Brent Crude to $12.45 per barrel at the time of writing, projected global prices are sufficiently buoyant to underpin the existing development projects of the FTSE 350 oil producers. However, it can be said that rising well-head costs are reducing appetite for execution risk among explorers, particularly in mature regions like the North Sea. The decline in mature field output, combined with rising cost pressures, partially explains why major project developments for FTSE 350 constituent Tullow Oil (TLW) are located in frontier markets like Uganda and Ghana.
| Company name | Share price (p) | Market value (£m) | PE ratio | Dividend yield (%) | Share price change in 2012 (%) | Last IC view |
| Afren | 162 | 1,779 | 17 | 0.0 | 29.1 | Buy, 142p, 27 Aug 2013 |
| BG Group | 1,313 | 44,745 | 17 | 1.3 | 28.2 | Sell, 1,206p, 26 Jul 2013 |
| BP | 494 | 91,522 | 6 | 4.8 | 14.9 | Hold, 474p, 4 Dec 2013 |
| Cairn Energy | 265 | 1,575 | 35 | 0.0 | 1.9 | Buy, 277p, 20 Aug 2013 |
| Enquest | 137 | 1,096 | 5 | 0.0 | 12.2 | Buy, 124p, 14 Aug 2013 |
| Essar Energy | 64 | 837 | na | 0.0 | -39.3 | Hold, 99p, 25 Nov 2013 |
| Ophir Energy | 299 | 1,769 | na | 0.0 | -24.9 | Buy, 350p, 8 Nov 2013 |
| Premier Oil | 282 | 1,492 | 9 | 1.8 | -6.8 | Buy, 330p, 17 Oct 2013 |
| Royal Dutch Shell 'A' | 2,180 | 84,977 | 8 | 5.2 | 1.9 | Buy, 2,231p,17 Jan 2014 |
| Royal Dutch Shell 'B' (Lon) | 2,287 | 56,388 | 11 | 5.0 | 4.8 | Buy, 2,231p,17 Jan 2014 |
| Soco International | 413 | 1,370 | 11 | 0.0 | 21.8 | Hold, 431p, 25 Sep 2013 |
| Tullow Oil | 898 | 8,172 | 34 | 1.3 | -32.2 | Hold, 1,030p, 31 Jul 2013 |
There's been no show of timidity on the investment front in Australia's liquefied natural gas (LNG) industry. Around $200bn has been drawn in to fund schemes under development in Western Australia and Queensland, with the likes of BG Group (BG.) and Royal Dutch Shell (RDSB) prominent among the backers - though the latter has just sold off its Wheatstone LNG project to Kuwait Foreign Exploration Petroleum for $1.14bn (£687m), and other LNG divestments cannot be ruled out.
New production to fuel Asia's economic growth will start to ramp up though this year, and burgeoning demand (post Fukushima) means that wholesalers are now being asked to pay twice as much for LNG under new supply contracts than they have on average over the past decade, according to energy analyst Wood Mackenzie.
FAVOURITES:
Industry analysts will be looking on with interest as oil exports from the Kurdistan region of Iraq start to reach Turkey through a dedicated pipeline in 2014. Afren (AFR) currently has two interests in the region, including a 60 per cent stake in the Barda Rash licence that boasts proven and probable reserves of 190m barrels, with another 1.3m contingent. Tony Haywood's Genel Energy (GENL) has one of the biggest production profiles in the region, and will be working its way up the FTSE 350 if, as some suspect, it transfers from Aim later this year.
OUTSIDERS:
By mid-way through this year investors will know the US District Court ruling on the degree of BP's negligence in the Macondo spill. It's essentially a $13bn question - the difference between a ruling of 'negligence' and 'gross negligence'. Until then, all valuations are essentially guesswork.
