Oil and Gas Outlook 2013: Costs Could Put Upward Pressure on Prices

Oil price fall graphic
Oil price fall graphic

Looking back on 2012, it is hard to discern the biggest story in the oil and gas sector. The reshuffling of assets was certainly a contender, as was the huge growth in U.S. oil production. Here at 24/7 Wall St., we want to see how the old year might tell us something about what is in store for 2013.

Major oil and gas companies spent quite a lot of effort shedding assets for one reason or another in 2012. BP PLC (NYSE: BP) 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 Gulf of Mexico disaster that occurred in April 2010. Chesapeake Energy Corp. (NYSE: CHK) 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 this 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 approved the deal last month, but the United States still needs to weigh in because about 10% of Nexen's assets are located 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 2012 is the surge in U.S. oil production, estimated to have reached 6.4 million barrels a day in 2012. Thanks to oil-rich shale formations and hydraulic fracturing (fracking), the International Energy Agency expects the United States 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 United States still will 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 2013. 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 crude, which was about $19 a barrel last night. As U.S. production grows again this 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's 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 $3.27 a gallon in the U.S. today, below the year ago price of $3.22 and the month ago price of $3.30. Prices rose to more than $5 a gallon in some places in California last summer, and were near $4 at times in most other states. Prices remain below $3 a gallon in a handful of states through the first few days of the new year, although reaction to the fiscal cliff deal sent crude prices higher this week. Crude prices are expected to be somewhat lower this year, and that should keep a rein on pump prices for gasoline.

Crude prices might have fallen well below $80 a barrel if the United States had not dodged the fiscal cliff, and U.S. and Canadian producers may be forced to reduce new drilling for oil because they will not be able to cover their costs at prices much below $80 a barrel, assuming a similar discount to Brent. The average breakeven cost for a new well in the Bakken play is about $80 to $90 a barrel. 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. This turn of events cannot continue for long.

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. This year will be another tough year for natural gas producers, but perhaps not as tough as 2012.

Also hard hit by low natural gas prices were the field services companies like Schlumberger Ltd. (NYSE: SLB), Halliburton Co. (NYSE: HAL) and Baker Hughes Inc. (NYSE: BHI), all of which got 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 this year as demand for rigs, particularly mid-depth rigs, and day rates are rising.

Remaining fiscal issues in the U.S., rising production and slow global economic growth all conspire to make energy production a pretty risky business in 2013. These will keep prices down for consumers, but perhaps we would all be willing to pay more for a better and faster growing economy. That is the trade-off we will confront in the coming year.

Filed under: 24/7 Wall St. Wire, Commodities, Economy, Oil & Gas Tagged: BHI, BP, CEO, CHK, COP, DO, HAL, HFC, MPC, NXY, PSX, RIG, SLB, TRP, TSO, VLO