With uncertainty about the future of carbon emission regulations, many producers view natural gas development as a long-term hedge against any prospective legislation, an Ernst & Young LLP executive said last week.

Marcela Donadio, Ernst & Young's Americas Oil and Gas sector leader, offered her take on the energy sector in the consultant's 2010 outlook report. Among other things, the report said it was noteworthy that ExxonMobil Corp. was buying domestic gas producer XTO Energy Inc. (see NGI, Dec. 21, 2009).

"As Copenhagen demonstrated, environmental concerns and the focus on carbon management are clearly going to affect the future of this industry," said Donadio, referring to last month's United Nations climate change conference in Denmark (see NGI, Dec. 14, 2009). "In addition, there is still uncertainty around the future of energy policy. This has opened the door for natural gas. Recent transactions indicate that gas development is seen as a long-term hedge against prospective carbon emission regulations."

Companies are making "strategic acquisitions, particularly for long-term North American unconventional gas," the report noted. "In addition, a recent shallow water discovery off the coast of Louisiana may pave the way for additional exploration in this area."

Earlier this month McMoRan Exploration Co. and its partners announced success at their Davy Jones discovery well, which may be one of the largest gas and oil discoveries in decades in the shallow Gulf of Mexico (see NGI, Jan. 18). Energy analysts said the discovery could bring more explorers back to shallow waters.

Overall, the Ernst & Young report found that energy market sentiment is "relatively positive amid rising economic expectations. While global economic growth has turned positive, the recovery is, however, slow and fragile." However, despite some uncertainty with regard to the strength of the economic recovery and the shape and impact of forthcoming policy decisions, the oil and gas industry should be able to sustain its recovery, according to the consultant.

The "short-term fundamentals...remain relatively weak," said the report. "Until very recently, strong supply, largely from growth in unconventional gas, particularly shale gas, in the face of sluggish demand and high storage levels, kept natural gas prices depressed. But demand and prices have picked up strongly with the colder weather."

Oil demand also is showing some signs of improvement, especially in developing economies, according to Ernst & Young. "Additionally, there is some anticipation that the economic recovery will be an 'oil-less' recovery, meaning that the developed economies will not return to previous high levels of fossil fuel consumption due to gains in energy efficiency, substitution and behavioral change."

Meanwhile, the expectations for oilfield services are mixed for 2010.

"The global rig recovery began in the third quarter of last year, and those numbers continue to improve. While some downward pricing pressures remain for the oilfield services sector as a whole, Ernst & Young expects to see some early progress in the subsectors that deal with consumable goods, such as bits, pumps and tubular goods. Most companies slashed inventories for these consumables during the recession and are slowly rebuilding, which is a positive sign for the broader sector."

Offshore markets also offer a mixed picture, according to Ernst & Young. The ultra-deep markets are staying strong and the shallower jack-up markets are "still very weak. Survival in the sector may involve consolidation; therefore, additional mergers in the sector are expected in the next year or so. While there has been some slight improvement, the credit market constraints continue to be particularly important for medium-to-smaller companies."

Excluding the ExxonMobil-XTO transaction and the now completed mega-merger between Canada's Suncor Energy Inc. and Petro-Canada (see NGI, March 30, 2009), transactions last year were down substantially, but there are signs that the global financial markets may be loosening.

"In 2010 well funded and capitalized companies will have the opportunity to fill strategic needs," said Jon McCarter, Ernst & Young's Transaction Advisory Services leader. "We will continue to see both 'offensive' and 'defensive' deals in the sector in the near term, but as the economy and other oil and gas industry metrics improve, we will hopefully see a shift away from a defensive focus to a more offensive approach."

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