Industry impacts of oil price collapse

January 26, 2015 | By Barbara Vergetis Lundin

After more than three years of oil prices at between $100 and $110 per barrel, prices collapsed by nearly 50 percent in late 2014 after OPEC refused to cut production. Combined with modest oil demand growth since 2010, restored production in countries like Libya and Iraq and the huge increase of U.S. light tight oil production, OPEC's decision has contributed to a massive supply/demand imbalance and the resulting price drop, according to Ernst & Young.

The sharp decline in prices has impacted global gas markets, as oil-linked liquid natural gas (LNG) has fallen to levels on par with hypothetical U.S. LNG export prices. The concern is no longer peak oil as it was five years ago, but peak demand.

"Unless there is an unexpected change in the supply/demand balance, a substantial oil surplus — and hence low oil prices — could continue through the first half of 2015," said Deborah Byers, U.S. Oil & Gas Leader for Ernst & Young LLP.

The International Energy Administration (IEA) predicts oil demand growth to be lower in 2014 -- less than 0.8 percent or less than 1 million barrels per day with growth in 2015 expected to be only slightly higher. At the same time, IEA forecasts continued strong gains in non-OPEC oil production, primarily led by the Americas.

Based on current forecasts of oil demand and non-OPEC supply, in the first half of 2015, the market is expected to need substantially less than 30+ million barrels per day of crude from OPEC, the amount the cartel has been producing and vowed to keep producing. If OPEC holds to its vow and continues to produce more than 30 million barrels per day and there are no unexpected supply outages, the market could see a surplus of as much as 1.5-2 million barrels per day in the first half of 2015.

By the second half of the year, the price collapse is expected to cause US production growth to slow somewhat, but critically, not to reverse. Seasonal demand increases will also play a factor in the slightly improving supply/demand fundamentals.

Although U.S. natural gas prices have weakened less than oil prices, they are still declining due to continued high production, weak early-winter demand, relatively high gas storage levels and the decline in LNG prices. As a result of their link to oil prices, global gas prices also declined in Q4. Most notably, the oil price collapse has minimized the advantage of spot-priced gas since oil-linked LNG trading prices are now essentially on par with hypothetical U.S. LNG exports.

"Despite the weakening price spread, U.S. LNG projects are still very competitive due to their low capital costs and the supply is attractive for flexibility and diversity," Byers said. "However, the LNG projects that don't yet have contracts for their outbound gas will face much more pressure, as Asian buyers have less incentive to sign new contracts."

Looking forward, the oil price collapse will spur increased transaction activity during 2015 for a couple of reasons.

As Mitch Fane, U.S. Oil & Gas Transaction Advisory Services leader for Ernst & Young LLP, explained, "On one hand, upstream companies with strong balance sheets operating in low-cost basins will be well-positioned to not only weather the dip in prices, but also scoop up assets from those with less liquidity or more capital intensive assets. At the same time, companies across the O&G segment will be pressured to review and reshape their portfolios to optimize capital and create higher returns."

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