Natural gas and oil industry fundamentals are improving "in stride" with the global economy, and with rising economic expectations, energy market sentiment remains "relatively positive," industry consultant Ernst & Young LLP reported last week.

"The markets are coming back into balance," said Marcela Donadio, the consultant's Americas Oil & Gas Center leader. "The industry, in particular oilfield service companies, is cautiously optimistic about the proposed steps to open sections of the Outer Continental Shelf to oil and gas exploration. However, the environment could change significantly with the passage of new energy policy legislation or setbacks in the global economic recovery."

Although the natural gas industry got a short-lived boost in prices following some cold winter days early this year, Ernst & Young said "prices have since retreated as shale gas production has continued to expand, despite relatively low prices and weak demand. In this environment, the incentives for pulling liquids out of the gas stream have increased dramatically."

The long-term outlook for gas "is very strong, particularly in the unconventional plays, and producers are moving forward," said Donadio. "The potential upside is attracting the larger, financially stronger international companies, and [it] will have substantial implications for natural gas and energy strategies."

However, possible obstacles could hinder gas growth. Notably, said the report, the U.S. Environmental Protection Agency has singled out energy extraction activities, including hydraulic fracturing, as a top enforcement priority for 2011 to 2013 (see NGI, March 15).

Most energy analysts expect the oil market to come into balance this year, "with ample spare capacity to meet increases in demand," said Ernst & Young. "Prices steadily increased at a comfortable pace over the past quarter and this trend will continue as demand grows."

However, the consultant warned that with oil prices above $80/bbl and a recovering economy, "concerns are being raised with respect to a tipping point -- where high oil prices may negatively impact manufacturers and consumers and slow economic recovery."

More exploration and production spending is beginning to trickle down to the bottom line of oilfield services, said Ernst & Young. "The past quarter witnessed improvements in rig counts, largely as a result of growth in horizontal drilling. This positive trend is likely to continue into Q2."

Several oilfield service operators, including Halliburton, Nabors Industries Ltd. and Schlumberger Ltd., last week reported that their North American activity, led by shale plays, jumped in the first three months of this year (see related story).

In addition, transaction activity "was reasonably strong" in 1Q2010," climbing above $70 billion in deal value, according to the report.

"While the global financial crisis is still impacting deal flow, there is evidence of loosening in capital markets. While there are fewer deals made, they have been greater in value than [in] recent quarters," the report noted.

"Activity is starting to increase in the deal markets," said Jon McCarter, the consultant's Transaction Advisory Services leader for the Americas Oil & Gas Center. "And we can expect to see more activity in unconventional shale plays and consolidation in the oilfield services segment."

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