North America Maintains Large Upstream-Downstream Lead

BMI View: Canada retains the top position in our Developed States Oil & Gas Upstream Risk/Rewards Ratings (RRR) although infrastructure obstacles in Canada and the unconventional oil and gas boom in the US could see Canada lose this top position in our regional rankings to the US. Meanwhile, upstream scores for the UK and Norway in particular have been pulled down by high project costs stemming from labour and, specifically for Norway, fiscal policy. In the downstream, we expect the US to extend its lead in this category over the longer term as its refining sector is given second life by domestic upstream growth. The US' re-emergence, however, will further hit the competitiveness of Western Europe's and Canada's refining sectors further, contributing to our negative outlook for these downstream markets.

The key themes from BMI's North America & Western Europe Oil & Gas Risk/Reward Ratings (RRRs) are:

  • North America clearly remains at the top of our overall RRRs, far above Western Europe, with a strong upstream and downstream outlook.

  • US Catches Up As Canada Risks To The Downside
    US and Canada Upstream RRR

BMI View: Canada retains the top position in our Developed States Oil & Gas Upstream Risk/Rewards Ratings (RRR) although infrastructure obstacles in Canada and the unconventional oil and gas boom in the US could see Canada lose this top position in our regional rankings to the US. Meanwhile, upstream scores for the UK and Norway in particular have been pulled down by high project costs stemming from labour and, specifically for Norway, fiscal policy. In the downstream, we expect the US to extend its lead in this category over the longer term as its refining sector is given second life by domestic upstream growth. The US' re-emergence, however, will further hit the competitiveness of Western Europe's and Canada's refining sectors further, contributing to our negative outlook for these downstream markets.

The key themes from BMI's North America & Western Europe Oil & Gas Risk/Reward Ratings (RRRs) are:

  • North America clearly remains at the top of our overall RRRs, far above Western Europe, with a strong upstream and downstream outlook.

  • While Canada retains the top position in the our Developed States Upstream Oil & Gas Risk/Rewards Ratings (RRR), downside risk such as infrastructure obstacles for Canada and the unconventional oil and gas boom in the US could see Canada lose this position to the US.

  • Outside of the top two spots held by North America, our overall rankings have remained largely stable. Germany, with its large and open market (and sizable refining sector), continues to hold on to third place in our overall rankings while the North Sea producers - the UK and Norway - round out the top five.

  • Nonetheless, we warn that rising production costs - owing to high labour costs, questionable fiscal terms in the case of Norway, and the increasingly challenging nature of developments in the North Sea - could further eat into Industry Rewards in the UK and Norway. Policy changes to re-incentivise exploration and project development provide limited upside risks to these markets.

  • The remaining European countries' upstream scores are generally underwhelming due to limited resource potential upside and a lack of E&P. A change in government policy and public sentiment towards hydraulic fracturing (fracking) could see dramatic shifts in Western Europe's upstream scores. Nonetheless, the sizeable challenges facing a reversal in public wariness against fracking makes this a long-term prospect.

  • The US' downstream renaissance - which is backed by its upstream production growth - will continue to have ripple effects on Western Europe and Canada's downstream segment. The lack of competitiveness in Europe and Canada relative to the US is likely to see these markets' downstream RRR remain low, with closures and consolidations to shrink Western Europe's refining sector in particular.

North America & Western Europe States Oil & Gas Risk/Reward Ratings
Upstream R/R Ratings Downstream R/R Ratings Oil & Gas R/R Ratings Rank
Canada 75.2 64.7 70.0 1
US 70.7 66.9 68.8 2
Germany 53.9 60.6 57.2 3
UK 53.2 58.2 55.7 4
Norway 55.7 42.5 49.1 5
Spain 46.8 49.3 48.0 6
Denmark 40.0 45.4 42.7 7
Belgium 28.0 54.6 41.3 8
Italy 36.1 45.9 41.0 9
France 32.6 46.3 39.5 10
Greece 23.6 36.1 29.8 11
Average 46.9 51.9 49.4
NB Scores out of 100. Source: BMI

Upstream: US Catches Up To Canada

There are few shuffles in our Upstream RRR for North America and Western Europe. The US and Canada remain at the top of our upstream ratings as the boom in unconventional oil and gas continues to fuel production in North America, while upstream growth prospects remain weak in Western European countries.

Oil & Gas Upstream Risk/Reward Ratings
Upstream Industry Rewards Upstream Country Rewards Upstream Rewards Upstream Industry Risks Up-stream Country Risks Upstream Risks Up-stream R/R Ratings Rank Previous Rank
Canada 59 100 69 95 86 92 76 1 1
US 58 100 68 90 83 88 74 2 2
Norway 33 85 46 80 91 84 57 3 3
Germany 31 70 41 90 86 88 55 4 5
UK 19 100 39 90 79 86 53 5 4
Spain 21 55 30 85 77 82 45 6 6
Italy 34 45 37 60 70 64 45 6 7
Denmark 16 50 25 80 87 82 42 8 8
Belgium 6 45 16 60 80 67 31 9 9
France 8 40 15.63 60 76 66 31 9 10
Greece 0 5 1 40 61 47 15 11 11
Average 26 63 35 75 80 77 48 - -
*Lower Score = higher risk; *NB Scores out of 100. Source: BMI

Canada currently sits at the top of the table. While comparable to the US in terms of an open business environment with friendly oil and gas investment climate, what clearly gives Canada the edge in the region is its excellent oil and gas resource prospects, notably with large oil sand deposits. The country has an abundance of proven oil and gas reserves, which keeps it among the world's top hydrocarbons producers.

However, we do highlight that a main downside risk to Canada's hydrocarbon production is the slow development of the sufficient oil and gas infrastructure. Continued regulatory delays in key crude pipeline projects such as Keystone XL, Northern Gateway and Energy East will likely see investments into oil sands projects moderate. Canada will therefore likely remain below its full development potential. In addition, we have also adjusted downward our forecasts for gas developments such as the major liquefied natural gas (LNG) projects which have recently been approved by Canada's NEB owing to expectations that difficult project economics could make such projects less attractive. As such, while Canada clearly has the resource advantage compared to the US, downside risk to production due to infrastructure bottlenecks could see the country's upstream ratings trend to the downside in coming quarters.

US Catches Up As Canada Risks To The Downside
US and Canada Upstream RRR

Meanwhile, the US has been performing increasingly well in its upstream ratings: the shale gas revolution and growing tight oil production has lifted the country's ratings. While the US does not benefit from the large proved oil reserves base which has pulled Canada upwards in our ratings, the country could catch up with Canada in our upstream ratings should the federal government continue to make more leases available for Exploration and Production (E&P) both offshore and onshore. Gas could also be the big winner for the US, as unlike Canadian LNG export projects which have be developed from scratch, US LNG export projects are largely brownfield developments that would incur fewer costs.

Another upside risk for the US' upstream ratings is if the country further relaxes its policy on crude oil and natural gas exports. If greater volumes of crude oil and gas can flow out of the US market, this could significantly boost its upstream Industry Rewards ratings.

Reserves Is To Canada As Production Is To The US
US and Canada Crude Production (000b/d; LHS) and Proved Oil Reserves (bn bbl; RHS)

Western Europe Upstream Languishes Without Shale Outlook

Western European countries continue to see underwhelming ratings relative to their North American counterparts, with unattractive production growth outlooks.

Although there appears have been a renaissance in E&P in the North Sea over the past few years, especially on the back of the large Johan Sverdrup discovery made in Norway, upstream ratings in both Norway and the UK have been heading downwards in past quarters, pulled down by weakening industry rewards reflecting declining outlook for oil and gas production in the short-to-medium term.

Developments in both countries will incur high costs, with reserves increasingly difficult to extract, and with high labour costs and taxation issues key concerns, notably in Norway. The tax increase under the former government in Norway particularly affected its upstream score. However, as the taxation system is currently under review, there is scope for upside improvement in the country's fiscal policy. In the UK, despite tax breaks, the high-pressure high-temperature (HPHT) environment in which undeveloped reserves are located also raises the cost of investment. Companies have scaled back investment plans on the back of these concerns.

While Norway managed to retain its position in third place, the UK has fallen to fifth place. Shale gas E&P could pose upside risk to this outlook, though we note that difficult below-ground conditions and public wariness of hydraulic fracturing (fracking) could slow exploration despite government efforts to build an encouraging regulatory regime for shale gas developments to take off. A change in public sentiment could see us revise this outlook.

Stemming Decline But Long-Term Outlook Remains Bleak
UK and Norway Oil, 000b/d (LHS) and Gas, bcm (RHS) Production

Prospects for upstream improvement are limited in areas aside from North America and the North Sea unless Western Europe relaxes its stance on shale gas E&P. Similarly to the UK however, even if there is government support at the national level, much work would have to be done to persuade local communities to the benefits of shale gas before drilling can take place (see 'Jurisdiction In Question Despite Progress On Fracking', December 10). If this is overcome, however, the upside could be large. France, which currently performs particularly poorly in Industry Rewards, could see a large upswing in ratings provided the country lifts its moratorium on fracking to allow a large-scale exploration of potential shale plays.

Downstream: US Comes Out Tops

Oil & Gas Downstream Risk/Reward Ratings
Downstream Industry Rewards Downstream Country Rewards Downstream Rewards Downstream Industry Risks Downstream Country Risks Downstream Risks Downstream R/R Ratings Rank
US 52 84 60 85 79 83 67 1
Canada 52 68 56 90 76 85 65 2
Germany 39 76 48 100 74 90 61 3
UK 40 80 50 80 73 77 58 4
Belgium 40 52 43 95 61 82 55 5
Spain 30 56 37 90 63 79 49 6
France 33 56 39 60 69 63 46 7
Italy 33 58 40 60 62 61 46 7
Denmark 22 46 28 90 79 86 45 9
Norway 27 36 29 70 80 74 42 10
Greece 22 40 27 60 55 58 36 11
Average 36 59 41 80 70 76 52
*NB Scores out of 100. Source: BMI

Downstream ratings remain stable with little change from last quarter and it is no surprise that the US tops our downstream RRR table. The country has the largest refining capacity in the world and we see further upside risks to its downstream score. Its renaissance in crude oil production has also boosted its downstream segment. While East and West Coast refiners had previously struggled to gain access to advantaged feedstock, we note that there has been a substantial build-out of new infrastructure in recent quarters. Margins have improved relative to peers in other regions, with districts such as the East Coast seeing the refining segment gain a second life.

Rising domestic crude production in the years ahead combined with the current ban on exporting crude oil suggests room for fuels growth to continue, and we see the US becoming an increasingly important supplier to the Latin American and European markets. That said, we are keeping a close watch on the crude-by-rail evolution, as greater regulations could lead to a bottlenecking of available tank cars and could yield downside risk to the US' downstream sector.

New projects have also been planned in non-traditional refining areas like North Dakota, while several refineries in the Gulf Coast have also planned some upgrades to accommodate greater influx of cheap sweet crude sourced from the Eagle Ford shale play.

However, the US' downstream renaissance has also come at a cost to Western European refiners in particular. In contrast to the US, our outlook for refining capacity in Europe paints a bleak picture and the downside risks to Downstream RRRs for Western Europe are high.

The five major western European economies of France, Germany, Italy, Spain and the UK, have already seen refining capacity fall from 9.8mn b/d in 2008 to 8.5mn b/d in 2013, and it is expected to fall further to 8.0mn b/d by 2018. Risk to this outlook is only to the downside with the ageing European refineries unable to compete with the scale and efficiency of new capacity being built around the world. Developments in the Middle East will make a particular impact over the coming years as considerable capacity from large modern facilities will add further refined products to the global market. Over 1.7mn b/d of new capacity is expected by 2018 from just five facilities in four Middle Eastern countries.

Weak macroeconomic conditions has squeezed domestic demand, and energy efficiency gains and limited growth in vehicle sales are also likely to reduce the benefits that economic recovery could bring to total oil consumption of refined products in the medium-to-long term. The particularly weak demand outlook in countries such as Norway and Italy will likely maintain downstream RRR ratings low, with little room for upside.

Muted Consumption Growth Offers Limited Downstream Rewards
Refined Product Consumption (000b/d)

We expect to see further rationalisation of downstream capacity in Western Europe as refiners consolidate operations to cut losses and compete with more efficient challengers from other parts of the world. The biggest risk we see comes from the incompatibility between labour demands and Western Europe's poor downstream outlook. Workers across parts of Europe have gone on strike to push for better labour conditions - exemplified first in labour protests at the UK's Grangemouth refinery in October and in Total's La Mede, Gonfreville and Feyzin plants in France in December 2013. However, worker unrest would most likely decrease interest in sustaining operations at these plants instead. Governments are also likely to lack the power to prevent further refinery shutdowns in view of their poor fiscal positions.

Shrinking Capacity
Western European Refining Capacity (000b/d)

While Canada has maintained its second position in our Downstream RRRs, we highlight significant downside risks to its downstream segment, under the same pressures as those hitting Europe. Limited demand for oil and gas demand growth in particular drag down Canada's downstream RRR.

Despite the country's large volume of oil production, its East Coast refiners face logistical difficulties in accessing this crude. At present, they are mostly either importing crude oil along the East Coast, or taking Western Canadian crudes via rail deliveries. A tightening of crude delivery regulations in the wake of a string of crude oil derailments and a failure to push through with TransCanada's Energy East pipeline enabling lower cost western Canadian crude to be transported to the Eastern refining heartland could see the region switch to more competitive imports than domestic products.

Troubled Times Could Lie Ahead
Canada Refined Products Output - % chg y-o-y

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This article is tagged to:
Related sectors of this article: Oil & Gas, Upstream, Exploration, Refining/Marketing, Development, Production, Unconventional
Geography: Global, Belgium, Canada, Germany, Denmark, France, United Kingdom, Greece, Italy, Norway, United States
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