Is the Oil & Gas business set to enter a new paradigm?

Recent reports about the future of the UK’s North Sea oil & gas fields has raised alarm, compounding already present worries about the industry at large. A low oil price that doesn’t appear too keen to move higher any time soon, lower demand from an apparently slowing China and competition in the form of Shaleand its potential to bring energy self-sufficiency ever closer to the US and UK have conspired to open up a war on multiple fronts.

Stubborn oil producers are now fighting to maintain their share of the global market, but with crude prices where they are the fight will almost certainly fail to produce any winners. There’s little point in things carrying on the way they are and the competitors know it. The question is who will back down first?

One of the reasons we’re in this situation is the sheer bloody mindedness of two of the major oil producers: OPEC and the USA. While OPEC has been pumping record amounts of crude into the market for some time, hoping to squeeze out global rivals, its main competitor – the US – has remained resilient and while OPEC’s so-called ‘fragile five’ will likely continue to produce at current prices, there’s only so far you can go without paying wages before workers start taking action. We’re unlikely to see $100/barrel oil any time soon but the current state of affairs in the Oil and Gas sector cannot continue, and there are two ways in which it could correct.

The acrimonious way or the amicable way?

A destructive scenario whereby Saudi Arabia simply allows the fragile five to fail could impact total OPEC output to the tune of up to 30% (the contribution of Saudi Arabia itself), and this would keep prices well above the $30s.

Alternatively, Saudi Arabia stops worrying about market shareand lets prices find their natural equilibrium via supply and demand – less output, less market share, higher prices.  Amicable or acrimonious, the oil price should find somebuoyancy, but the amicable way leaves Saudi Arabia with just that little bit more control – which is really what this whole thing is about.

North Sea Exodus

Industry body UK Oil & Gas said in a recent report that capital investment in North Sea exploration and production couldhalve in the next two years. We think this could be just the tip of the iceberg – already we’re seeing oil majors exiting, unwilling to put up with higher costs, and this is leaving fewer, smallercompanies to shoulder the burden. It’s only a matter of time before the rest give up too and the effect of that on UK supply is clear. If it’s not completely clear, know that the UK derives over a third of its energy from North Sea oil.

How have the UK’s Oilers been doing amid all this?

They’ve been under pressure – as expected in the current circumstances. It’s the smaller E&P stocks that have, perhaps unsurprisingly, suffered the most while the oil equipment and services subsector has outperformed with plenty of oil being pumped up, transported and refined the world over. Integrated oil & gas majors sit in between, tugged one way by E&P and the other by downstream activities, yet their dividend yields make them potentially attractive investments. Note Cairn Energy (CNE)outperforming its subsector while Hunting (HTG) is underperforming its own.