Looking back on 2012, it is hard to discern the biggest story in the oil and gas sector. The reshuffling of assets is certainly a contender, as is the huge growth in U.S. oil production. Here at 24/7 Wall Street, we want to see how the old year might tell us something about the coming year.
Major oil and gas companies spent quite a lot of effort shedding assets for one reason or another. BP PLC (NYSE: BP) has parted with $32 billion in assets as it builds a cash reserve of $38 billion to pay claims resulting from the sinking of the Deepwater Horizon and the deaths of 11 workers in the disaster. Chesapeake Energy Corp. (NYSE: CHK) has sold nearly $14 billion in assets as it tries to reduce its debt and find deep-pocketed partners to help fund future exploration. ConocoPhillips (NYSE: COP) spun off its refining and marketing business into Phillips 66 (NYSE: PSX), and refining company Valero Energy Corp. (NYSE: VLO) plans to spin off its downstream retail business next year.
Another big story was the $15.1 billion acquisition of Nexen Inc. (NYSE: NXY) by China’s Cnooc Ltd. (NYSE: CEO). The Canadian government recently approved the deal, but the United States still needs to weigh in because about 10% of Nexen’s assets are in the U.S. This deal is being watched closely for precedent — Canada already has said that this sale will cause the country to reevaluate its policies on the sale of natural resource assets to companies controlled by foreign governments.
The other candidate for big story of the year is the jump in U.S. oil production, now estimated to reach 6.4 million barrels a day in 2012. Thanks to oil-rich shale formations and hydraulic fracturing (fracking), the International Energy Agency expects the U.S. to pull even with Saudi Arabia as the world leader in oil production by 2017 and to surpass the Saudis by 2022.
There is more at stake than simple bragging rights. While the U.S. will still rely on oil imports to maintain its ability to meet demand, the continuing boom in U.S. oil production could lower the price consumers pay at the pump, especially if the industry can develop transportation projects to get the oil to one of the coasts. The key here is a pending decision by the Obama administration on the Keystone XL pipeline, a 1,700-mile conduit proposed by TransCanada Corp. (NYSE: TRP) that would have capacity to carry 1.1 million barrels a day from Canada’s oil sands to the U.S. Gulf Coast.
Refiners with access to domestic crude oil should continue to see good margins in the coming year. Marathon Petroleum Corp. (NYSE: MPC), HollyFrontier Corp. (NYSE: HFC) and Tesoro Corp. (NYSE: TSO) are well positioned to take advantage of the price differential between West Texas Intermediate (WTI) and Brent, which was about $22 a barrel last night. As U.S. production grows again next year, that differential probably will not close much.
In the same vein, the switch to Brent crude prices as the international benchmark for crude prices is nearly complete. WTI, virtually none of which is available outside the U.S., will lose its benchmark status to Brent, which is traded far more widely. This is not likely to affect actual pump prices for gasoline, but it is the sort of change that can cause a lot of ink to be spilled about not much. Just be warned.
Gasoline pump prices average around $3.21 in the U.S. today, below the year-ago price of $3.22 and the month-ago price of $3.49. Prices rose to more than $5 a gallon in some places in California this summer, and were near $4 at times last year. Prices have fallen below $3 a gallon in a handful of states already, and we could be headed toward the two-year low of $2.97 — or even lower.
If U.S. political leaders fail to negotiate an end to the threat of the fiscal cliff, crude prices will dive further on the belief that economic growth will stagnate even more. The declines will not be as far or as fast as the decline in 2008 following the collapse of Lehman Brothers. Brent crude sold for about $97 a barrel in September of that year, and by December had collapsed to around $36 a barrel. The recovery was just as quick.
Crude prices could decline well below $80 a barrel if the U.S. does not avoid the cliff, but at some point U.S. and Canadian producers would have to shut-in production because they would not be able to cover their costs at prices below $60 a barrel, assuming a similar discount to Brent. In fact, Bakken crude and Western Canadian Select already sell for a discount of about $20 to the WTI price, or a whopping $40 a barrel discount to Brent.
Finally a word about natural gas prices. The average price for natural gas fell from $4 per thousand cubic feet in 2011 to $2.78 in 2012, and the EIA expects the price to average $3.68 in 2013. At that price, coal again becomes competitive as a fuel source for power generation and gas producers still realize very little margin. Next year will be another tough year for natural gas producers, but perhaps not as tough as this year has been.
Also hard hit by low natural gas prices and potentially even harder hit by a U.S. tumble off the fiscal cliff are the field services companies like Schlumberger Ltd. (NYSE: SLB), Halliburton Co. (NYSE: HAL) and Baker Hughes Inc. (NYSE: BHI), all of which have been hurt by the decline in onshore drilling in the U.S. and Canada. Offshore drilling companies like Transocean Ltd. (NYSE: RIG) and Diamond Offshore Drilling Inc. (NYSE: DO) should perform better in 2013 as demand for rigs, particularly mid-depth rigs, and day rates are rising.
Fiscal cliffs, rising production and slow global economic growth all conspire to make energy production a pretty risky business in 2013. That will keep prices down for consumers, but perhaps we’d all be willing to pay more for a better and faster growing economy. That is the trade-off we will be confronting next year.
Check out other sector outlook pieces from 24/7 Wall St. for 2013:
- A Turnaround for Coal?
- Some Potential Turnarounds and Losers in Cleantech and Alternative Energy
- Semiconductors Look to Be All About Mobile
- Will Base Metals Make a Comeback?
- Next Year’s Biotech Winners