In the latest Ernst & Young Scottish ITEM Club economic forecast, it is predicted that Scotland is entering its first services sector-led recession, with its weakest performance since the early-1980s.
The forecast highlights a growth rate of 0.9% for the Scottish economy in 2008, compared with a trend rate of growth of about 2% over the last decade.
In 2009, ITEM expects Scottish GDP to contract for the first time since a marginal drop in 1991. At minus 0.4% for the year as a whole, the fall in output is expected to be the worst performance for the Scottish economy since 1980 – but one that comparatively outperforms the UK, which ITEM predicts to see a fall in output of minus 1%.
However, in 2010, Scottish growth could recover to 1.5% – compared with 1% growth for the UK – as the impact of lower interest rates, fiscal stimuli and sharp falls in inflation and competitiveness gains from a lower pound feed through to the economy.
Despite the recent downturn in oil price, ITEM also cites the performance of the oil&gas industry as another key reason why it expects Scotland to fare better than the rest of the UK in this recession.
September’s Scottish Engineering Quarterly Review provided some corroboration that manufacturing orders and expectations were holding up particularly well in the oil&gas sector. That said, the impact of the credit crunch is being felt beyond the financial sector and many oil&gas companies have not been immune to the recent turbulence.
Such unprecedented economic uncertainty is creating further ambiguity around the oil price. This has fallen to less than half its peak level of $144.07 recorded in July, 2008. Opec has moved to try to support oil prices at higher levels by agreeing at an extraordinary meeting in October to cut output by 1.5million barrels per day. However, early in the fourth quarter of 2008, prices continued to slide lower, edging below $60 per barrel for the first time since March, 2007, and slipping below $50 late-November.
A backdrop of such volatility makes decision-making very difficult, potentially leading to deferral of decisions and projects. Some developments will be postponed due to cash constraints as the banks will not lend, and others will be cancelled or postponed as the marginal cost is too high in relation to the current oil price.
At the same time, it is worth remembering that fundamental demand for energy remains very strong compared with current production. The major international oil companies (IOCs) and most national oil companies (NOCs) should be able to ride out the recession.
The crisis will also open up acquisition opportunities for larger companies in the sector with low debt.
However, many junior oil&gas companies are finding it increasingly challenging to secure funding from investors in the current environment. Without cash, a company cannot progress from exploration activities to the development and production phase (See Energy Eye – Page 12).
As such, credit-squeezed junior oil&gas companies that have attractive resource bases are likely to be more vulnerable to takeover in the current environment.
The majority of juniors listed on the three exchanges have seen their share prices fall throughout 2008. The latest Ernst & Young Oil & Gas Eye Index – a report that tracks the fortunes of oil&gas companies on AIM – highlights that a 44% fall was recorded over the third quarter of 2008 alone. This is the most severe quarterly fall since the inception of the index in 2004 and may accelerate the long-expected consolidation in the junior oil&gas sector.
The oil majors will be keeping a close eye on valuations during the crisis. In contrast to the 44% fall in the Ernst & Young Oil & Gas Eye Index, oil&gas companies still managed to raise a healthy £286million of funds from new and secondary issues in the third quarter of this year – demonstrating that finance is still available for the right projects.
New acquisition opportunities will open up for the cash-rich players – super-majors, NOCs and sovereign wealth funds (SWFS). These acquisitions are likely to include distressed companies that are reliant on debt or equity for funding.
Also, as market turbulence ebbs, there is likely to be more instances of public companies being taken private.
Institutional investors have played a crucial role in the success or failure of AIM oil&gas companies this year.
A number of institutions reportedly liquated their positions in some of AIM’s oil&gas stocks, exacerbating the huge falls in companies’ share prices. That said, juniors with a strong performance track record will be better placed to survive the credit crunch than peers who may already have been struggling.
Despite the turbulence in financial markets and a global economic downturn, the longer-term business fundamentals for the oil&gas sector remain positive.
The majors have reiterated their commitment to stick to spending plans announced before the credit crunch and financial turbulence really took hold.
IOC investment decisions are typically made on a long-term basis. Short-term volatility in financial markets is unlikely to impact their immediate spending plans.
Any slowdown in development activity now will only delay the investment that is required to satisfy the world’s need for long-term, reliable supplies of oil.
Of course, the crisis could help ameliorate some of the cost pressures that oil&gas companies have been facing due to double-digit inflation growth in the industry.
The challenge will be to demonstrate value and stimulate liquidity in market conditions where share prices have become increasingly detached from operational progress and future prospects.
The oil companies that are able to survive the credit crunch are likely to be those that are prepared to respond appropriately to the new market landscape.
Alec Carstairs is an Ernst & Young oil&gas partner
Recommended for you
