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What Is Standard & Poor's Outlook For Oil Prices In 2013?
What Is Standard & Poor's Outlook For Oil-Refining Margins Globally?
Where Are U.S. Natural Gas Prices Headed?
What Is Standard & Poor's Outlook For Long-Term Secular Demand For
Natural Gas In The Electricity Sector?
What's The Outlook For LNG And The Prospects For Global Gas Price
Convergence?
How Do We Expect Prices For Natural Gas Liquids (NGLs) To Trend In
2013?
What Impact Have Foreign Investors Had On North American Oil And Gas
Companies' Expansion Plans And Operating Efficiency?
What Is The Outlook For Midstream Energy Construction Projects In North
America?
Will There Be Any Ratings Impact From Weakening Margins In The Oilfield
Services And Contract Drilling Sectors?
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European refineries are not well suited to meet distillate-focused product demand without significant investment.
Assuming continued dependency on Brent-based crude slates and their low complexity relative to facilities in the U.S.
Gulf Coast and newer refineries in the Middle East and Asia that are able to process disadvantaged slates, we do not
expect long-term margin prospects to improve. European and Caribbean refiners also have an energy cost structure
directly or indirectly reliant on crude oil prices, a further disadvantage relative to U.S. refiners that can utilize much
cheaper natural gas fuel.
Trends for refiners in the Asia-Pacific region are diverse and depend on the regulatory environment in which they
operate. Refining margins for domestic suppliers in India, China, and Indonesia are hurt by government-regulated
product prices designed to control inflation and protect continued economic growth. However, there is increasing
pressure to move toward a more market-driven pricing mechanism, which could be favorable for refiners. Our
medium-term (2013-2014) outlook for refining margins has a negative bias reflecting additional capacity from newer
refineries in the region, mostly China. This will overshadow expected demand growth from emerging economies and
lead to downward pressure on refining margins. Nevertheless, Asia-Pacific refiners continue to invest to enhance the
efficiency and complexity of their refineries and to improve downstream integration into petrochemical manufacturing,
as in South Korea.
What Is Standard & Poor's Outlook For Long-Term Secular Demand For
Natural Gas In The Electricity Sector?
Coal-to-gas switching remains significant in the U.S., though not enough to materially affect natural gas prices. The
U.S. Energy Information Administration (EIA) expects that natural gas consumption will average 69.7 billion cubic feet
per day (Bcf/d) in 2012, an increase of 3.2 Bcf/d (about 5%) from 2011. Large gains in electric power use more than
offset declines in residential and commercial use. Projected consumption of natural gas in the electric power sector
averages 25.4 Bcf/d in 2012, 22% higher than in 2011. This increase in fuel share stemmed from natural gas costs that
were very low relative to coal costs. We note that coal-to-gas switching is more intense in the middle of the supply
stack and is usually along a sliding scale--first between inefficient coal and efficient CCGT units and then progressively
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between efficient coal units and mid-merit CCGT as gas prices decline relative to coal prices. Efficient coal units that
burn cheaper Powder River Basin (PRB) coal has a lower equivalent gas price (i.e., converting coal and gas prices on a
comparable dollar per million Btu basis) compared with inefficient units that burn Central Appalachian (CAPP) coal.
Because CAPP coal is more expensive than PRB coal, switching competition has occurred even between mid-merit
combined-cycle gas units and efficient coal-fired units using CAPP coal. However, in July 2012, the average Henry
Hub natural gas spot price surpassed the average spot price for Central Appalachian coal for the first time since
October 2011, indicating that the recent trend of substituting coal-fired generation with natural gas-fired generation
could be slowing.
So far, much of the switching has occurred due to economic factors and not from environmental considerations. As the
EPA implements its environmental agenda (such as Mercury and Toxin standards), there would be more permanent
shifts to gas usage. CCGT units were utilized an average 37% in 2011. If the capacity factors for CCGTs were to
increase to 50%, we expect natural gas demand by the electricity sector to increase by an incremental 5 Bcf/d relative
to consumption today. However, in addition to the economics, there is a logistical constraint driven by availability of
gas-fired units. It is not a coincidence that the Southeast Electric Reliability Council, the Southwest Power Pool, and
the Northeast and Mid-Atlantic regions are reporting the highest coal displacement. These regions use higher-priced
CAPP coal and have spare CCGT capacity available.
What's The Outlook For LNG And The Prospects For Global Gas Price
Convergence?
Our outlook for LNG producers is positive for the short term (two to three years). They should largely maintain
favorable pricing power for the next few years, both in long-term contracts and spot pricing. This is because of
continued growth in natural gas consumption, particularly in Asia. At the same time, domestic gas supplies in Asia will
remain constrained and the use of imported gas, namely LNG, will increase. We expect tight LNG supplies and the
short-term forecast for demand to outpace new liquefaction capacity until at least 2014.
In the medium-term however (2015 and onwards), LNG producers face risks in the form of higher global gas supply
from additional LNG capacity and the possible development of unconventional gas resources. These conditions could
force changes to current long-term, oil-indexed offtake contractual conventions and encourage the convergence of
global gas prices through downward pressure on LNG prices and upward pressure on domestic gas prices from
increasing use of higher cost gas imports.
We view the following developments for the global gas market over the longer term (post 2018) for a variety of
reasons:
Potential delays in Australian LNG projects from cost overruns and a shortage of equipment and labor.
Continuing debate in North America of the benefits and future impacts of exporting shale gas production.
Infrastructure and regulatory impediments to the development of other unconventional resources globally.
Lastly and more importantly, existing regulatory frameworks and contractual conventions in Asia-Pacific
economies, which affect domestic gas prices that are either heavily government controlled/influenced or negotiated
under long-term bilateral supply contracts with gas prices either linked to crude oil prices or linked to domestic
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How Do We Expect Prices For Natural Gas Liquids (NGLs) To Trend In 2013?
NGLs production has increased significantly in the U.S. over the past few years while E&P companies, seeking to boost
low returns from dry-gas plays, have aggressively pursued unconventional natural gas and oil shale plays rich in NGLs.
Not unlike the natural gas markets in years past, this rampant production increase is leading to oversupply concerns.
We forecast that the total supply of NGLs could increase about 30% to 3.3 million barrels per day (bpd) by 2015-2016,
based on our view that the crude-to-gas pricing ratio remains between 30x and 40x (the 2012 average was 39x) and
relatively high crude prices and the NGL uplift will motivate producers to continue drilling in these liquid-rich regions.
Demand, while increasing, has not kept pace.
The two main markets, or trading hubs, for NGLs are Mont Belvieu, Texas, and Conway, Kansas. Mont Belvieu is the
more liquid hub and fetches higher prices for NGLs because it's close to the Louisiana Gulf Coast and a key end-user
for NGL feedstocks--the U.S. petrochemical industry. Conway prices usually are discounted relative to Mont Belvieu
prices because of the cost to transport y-grade (a mix of NGLs) to so-called fractionators that separate the NGLs into
purity products for consumption as feedstocks for other products or resale. This discount has widened considerably
since 2009 and recently reached a high of more than 20 cents/gallon for a composite barrel of NGLs. We believe there
is a current oversupply of NGLs into Conway due to active drilling in the MidContinent region. Once additional
takeaway capacity comes online in 2013, we believe that this differential could narrow to about 10 cents, which is our
estimate of the average transportation cost of shipping a barrel of NGLs from Conway to Mont Belvieu.
Ethane and propane prices at the main U.S. trading hub of Mt. Belvieu, Texas, have been the hardest hit of any NGLs.
Collectively, these two purity products generally constitute at least two-thirds of the typical NGL battle. Since the
beginning of 2012, ethane's value has dropped about 60% to the low-30 cent per-gallon area. Meanwhile, the price of
propane has slid 35% to about 90 cents per gallon. Prices at Conway, Kan., the Mid-Continent region's pricing hub,
have decreased even further. Although ethane's price decline has been mainly due to ongoing maintenance and
turnarounds (when a plant is taken offline for a certain period of time to revamp) of petrochemical facilities on the U.S.
Gulf Coast, we think at least some of the decline stems from rising supply from the production of NGLs. In 2012,
domestic supply and demand of ethane has been roughly in balance at about 1 million bpd. However, because the
petrochemical industry consumes almost 100% of the ethane produced as a feedstock to make other products, any
reduction in demand will result in a sharp, if only temporary, price decline. In recent years, the petrochemical industry
has been adept at increasing ethylene cracker capacity levels. However, we believe it will be difficult to sustain rising
demand. Although expanding capacity at existing plants can be done more quickly, building new ethane crackers costs
billions of dollars and can take several years. We think supply could outpace demand until petrochemical companies
complete several large ethane crackers in 2016 and 2017. What this means for prices is not entirely clear, but we
believe ethane prices could be subdued for a prolonged period.
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What Impact Have Foreign Investors Had On North American Oil And Gas
Companies' Expansion Plans And Operating Efficiency?
As foreign national oil companies (NOCs) are increasingly looking beyond their borders to bolster their oil and gas
resources, investment activity in North America's oil and gas sector has been accelerating since 2008.
Standard & Poor's believes foreign NOCs' interest and investments in Canadian and U.S. oil and gas assets will likely
continue. China's NOCs have featured prominently in North American acquisition and joint venture arrangements to
date. NOCs from other Asian countries--such as South Korea, Japan, and Malaysia, which have the same interest in
securing access to energy resources to offset future domestic requirements--are also competing for North American
unconventional oil and gas assets. These government-owned companies are willing to pay increasing premiums to
acquire these assets, so many nongovernment-owned companies would likely find the return prospects at the
NOC-offered prices insufficient to meet their minimum required internal investment hurdle rates.
Nevertheless, as ExxonMobil Corp. (AAA/Stable/A-1+) demonstrated with its October 2012 C$3.1 billion bid to
acquire Alberta-based Celtic Exploration Ltd. (not rated), the international oil companies also appear prepared to
compete for these assets. ExxonMobil's offered price equates to about C$120,000/barrel of oil equivalent daily
production (excluding land), which is a significant premium to current oil and gas transaction values. Very few
companies have ExxonMobil's financial capacity; therefore, the companies that are unable to compete at these
transaction values to supplement their organic reserve replacement with cost-effective acquisitions might have to
assume greater exploration risk to keep pace with reserve replacement requirements.
For the E&P companies contributing acreage to a joint venture and managing their development as operators, the
partnerships offer attractive benefits. Growth-oriented companies such as Chesapeake Energy Corp.
(BB-/Negative/--), which have limited capacity to take on additional debt, can finance the huge costs associated with
shale development while retaining a portion of potential upside to properties. Investors typically provide cash at the
close of the transaction and a share of the cost as drilling and development progresses (often a disproportionate share
of the cost during the initial development period). Not surprisingly, Chesapeake has been the most active participant in
such ventures in recent years. Even for companies with more financial flexibility, joint ventures offer a way to diversify
risk.
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Will There Be Any Ratings Impact From Weakening Margins In The Oilfield
Services And Contract Drilling Sectors?
The overall outlook for ratings in the oilfield services and contract drilling sectors remains stable, though with some
caveats. The North American onshore oilfield services and contract drilling markets continue to experience declining
margins and utilization. We expect low natural gas drilling levels and the once-unthinkable oversupply of service
equipment and rigs to continue to hurt margins and utilization in 2013.
Nevertheless, we don't expect this to hurt most credit ratings because of E&P companies' generally strong balance
sheets and adequate liquidity. Strong crude oil prices, currently averaging about $90/barrel in 2013, should provide
strong returns on liquids production. As a result, we expect North American drilling levels to remain stable despite the
decline in natural gas drilling levels.
We believe most ratings can sustain a modest weakening in conditions, as our positive outlooks on Key Energy
Services Inc. and Basic Energy Services Inc. demonstrate. In particular, companies with significant international
diversity--such as Schlumberger, Halliburton, Baker Hughes, and National Oilwell Varco--should have improving
international operations to buffer the effect of the weakening North American markets. In addition, we expect the
offshore contract drilling market to continue to enjoy strengthening utilization and day rates. Nevertheless, ratings on
smaller companies with a combination of limited market and product diversity and weak financial performance could
come under pressure. However, we currently do not expect a significant amount of negative rating actions (like those
we took in 2009) in the near term.
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What Are The Prospects For Brazil's Oilfield Services And Equipment Sector
For 2013?
Oilfield services and equipment and contract drillers activity is tied to the projected capital spending levels of E&P
companies, and Brazil is not an exception. With very large investment plans ahead (mainly to be conducted by
government-controlled Petroleo Brasileiro Petrobras S.A.), the oil and gas industry in the country presents robust
growth prospects. In tandem with such growth, production plans would require a substantial number of
specialized--mostly offshore--drilling equipment and multiple services to carry out the perforation plans.
The large level of projected investments in the oil and gas sector also creates an opportunity to help foster industrial
and economic development in the country. Taking advantage of that, the government has included in E&P concession
contracts a clause requiring operators to purchase a certain percentage of goods and services from local suppliers. We
believe that the combination of large expected investments in the sector and the local content regulatory requirements
is having and will continue to have a significant impact on the development and growth of the oilfield services and
equipment sector in the country. Besides Petrobras' and Brazil's overall recognized expertise in offshore E&P, the
country is rapidly importing technology and knowledge through partnerships or by international players establishing or
expanding operations in the country.
A common factor among drillships in Brazil is the existence of medium to long-term (five to 20 years) charter
agreements with Petrobras. In our view, the long-term charter agreements with a creditworthy counterparty provide
relatively high stability and predictable cash-flows, though they mainly depend on dayrates-setting mechanisms. We
view the contracts' tenors as favorable when compared with the usually shorter tenor of contracts for less-complex and
easier-to-move onshore rigs. In addition, despite the differences between dayrates-setting clauses in each of the
contracts, we see some upward trend in those due to greater demand for drilling rigs, which is largely attributable to
Petrobras' expansion plan ($236.5 billion capital expenditures plan for the 2012-2016 period, including about $141
billion in its E&P segment).
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