FTSE 350 oil & gas producers: A major defection to Kurdistan in 2012

The geopolitical issues that have destabilised the region are as yet unresolved, but there are some industry analysts who believe that the price of crude will be driven predominantly by physical supply and demand over the coming year, with traders eschewing long or short strategies in favour of a more conventional emphasis on relative value trades. Though daily prices for Brent crude averaged out at record high of $111.27 (£68.69) a barrel in 2012, price volatility remained relatively subdued, with a peak-to-trough range of $126-$90 recorded in a 10-week period through to the end of June. Nevertheless, a narrow focus on physical drivers seems slightly disingenuous given the possibility that Tel Aviv’s response to Iran’s nuclear programme could well be dictated by a new rightwing religious coalition following Israel’s elections this month.

While we’re all hostage to events on the global stage, last year showed that oil companies can still make their own luck. In August, Heritage Oil (HOIL) finally managed to monetise its Miran gas discovery in the Kurdish region of Northern Iraq through a $450m deal with Tony Hayward’s Genel Energy (GENL). Though the geology of the find always stacked-up, the fractious relationship between Iraqi officials and the Kurdistan Regional Government (KRG) had always presented a stumbling block to any sale. However, by the end of the third quarter, it became apparent that Baghdad’s influence over the oil & gas majors was on the wane. The likes of Total SA, Gazprom and Chevron had followed the lead provided by ExxonMobil and Marathon in establishing a presence in the region. Rumours followed that other global energy players – such as Norway's Statoil – were considering a foray into the Kurdistan oil & gasfields. And by the year-end, it emerged that Exxon intended to exit the 8.6bn barrel Qurna Phase I project in Iraq, leaving Shell as the junior partner at the site.

It’s hardly surprising that the majors are now prepared to risk the ire of Baghdad given that the KRG’s profit sharing deals are potentially far more lucrative than many of the static royalty arrangements put in place by the Iraqi administration. We can certainly expect increased activity in the Kurdish oilfields through this year, including a step-up in M&A deals. However, it’s worth noting that none of this would have been achieved without the initial efforts of smaller, nimbler explorers such as FTSE 350 constituents Heritage Oil and Afren (AFR), not to our mention longstanding favourite Gulf Keystone Petroleum (GKP).

Perhaps one of the most significant – and certainly the most talked about – sectoral news stories to emerge this year formed part of the World Energy Outlook published by the International Energy Agency. This report predicted that US oil production would outstrip that of Saudi Arabia's by the end of the current decade due to the rapid growth of hydraulic fracturing technologies. Though some analysts initially scotched the claim, the subsequent publication of data for 2012 confirmed that US production had expanded at its fastest rate since records began, with domestic output growing by a record 766,000 barrels a day to its highest level since 1995. US net imports of petroleum have fallen by more than 38 per cent since their 2005 high water mark. So the latest figures do, indeed, suggest that the US could leapfrog both Russia and Saudi Arabia in the production league.

The implications for the US, both in terms of the trade deficit and manufacturing costs, are obviously positive, but the growth of the unconventional oil & gas segment in North America has also opened up opportunities for FTSE 350 constituents. In recent years, Shell has acquired strategic stakes in the Texas Eagle Ford and Marcellus Shale deposits, in addition to substantial unconventional plays in British Columbia. The Anglo-Dutch giant also recently forked out around $1.94bn for acreage owned by Chesapeake Energy Corp in Texas' Permian Basin.

Moves to establish a uniform pricing mechanism in liquefied natural gas (LNG) export markets could gather momentum this year. The share of LNG as a proportion of the overall gas market is set to rise markedly by the end of the decade as new production comes on-stream, particularly from Australia where Shell and a number of domestic operators have ploughed around $165bn to build an LNG infrastructure base to rival that of the Qataris. There will be no shortage of near-term demand given Japan’s decision to phase out its nuclear facilities. But the global export balance – and subsequent pricing – over the long run will be predicated largely on the growth rate of Chinese demand, and to a lesser extent whether the US pushes ahead with plans to transform its existing east coast LNG facilities into export terminals.