Increasing global demand for energy and high prices have created a robust environment for oil and gas producers, but high prices have also driven up the cost of raw materials and impacted refining margins in the downstream sector, Ernst & Young said in a new report.
The firm's Global Oil & Gas Center said demand is expected to drive industry transformation for 2008. On the agenda for the coming year:
The cost of exploration and production (E&P) continues to rise sharply, the firm found. Heightened resource nationalism and geopolitical issues are increasing costs and decreasing access to reserves for international oil companies. Investment opportunities are becoming less lucrative and returns are decreasing. On a positive note, access restrictions may be lifted in the Gulf of Mexico, creating new opportunities for upstream activity. Ernst & Young said it expects that companies will take a slower, more cautious approach to upstream spending in 2008.
New midstream opportunities are emerging in support of Canadian oil sands, Rocky Mountain natural gas, Barnett Shale and liquefied natural gas. New technologies, like carbon sequestration, may prompt major changes in the way midstream companies conduct business in the coming year.
And in the downstream segment the industry continues to walk a tight rope, balancing capacity and margins. Global refining capacity continues to be tight and margins are expected to remain volatile. Ernst & Young said it expects that margin averages may fall from recent highs but remain above longer-term historical levels until new capacity is added. Upgrades later this decade should alleviate the strain.
Investors seeking attractive growth and high-margin acquisition opportunities will look to the oil and gas industry's significant, sustained and growing cash flows. Just as outside investors are investing in oil and gas, large oil and gas companies flush with cash will look for opportunities to enhance technology capabilities and reserve bases through acquisition. Smaller E&P companies will be of particular interest to such investors.
In the United States, master limited partnerships (MLP) have emerged as the dominant deal structure in oil and gas and will gain more ground in the coming year, according to Ernst & Young. The MLP structure, however, is creating companies with unbalanced portfolios as specific areas or divisions of a company are bought up and developed as stand-alone entities. Private Equity continues to have a keen interest in energy, with a particular focus on refining.
European Union countries have all adopted IFRS, almost 100 other countries require or allow the use of IFRS, and other countries -- including the United States -- are moving to do the same. If implemented by the U.S. Securities and Exchange Commission, IFRS could transform global financial operations. IFRS standards, which could go into effect as early as the first half of 2008, would streamline financial operations by creating one set of international accounting rules. IFRS could be a watershed event for global oil and gas companies.
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