Oil & Gas Markets

Oil and gas prices remain cyclical and both have recently fallen from the heights seen in 2005-6, although oil has risen again during 2007. Price movements have both contributed to and constrained activity in the oil and gas sector in 2006; while the rapid rise in 2004-5 encouraged investment, costs have now risen on the back of those higher prices, making many investments less attractive now, to a lesser extent in oil but a greater extent in gas.

Oil Prices

Figure 17: Daily Brent Crude Price 2005-2007

Many commentators had predicted that the rate of increase in the oil price since 2002 was unsustainable. Indeed, during 2004, the average price rose by a third, in 2005 by another 42%, but in 2006 by only a fifth to $65/bbl, peaking in that summer, as shown in Figure 17. It then fell sharply, but has bounced back up again in the first five months of 2007, reaching $70/bbl at the time of writing (end of May).

Figure 18: Annual Brent Crude Price 1965-2006

During the second half of 2006 and early 2007, the US dollar has weakened against sterling. For companies whose revenue is in dollars but whose costs are mainly in sterling, a stronger pound means that the expense of developing and operating on the UKCS absorbs a larger share of revenues than previously.

In the combined circumstances of volatile commodity prices, a stronger pound and increasing costs, the vulnerability of the industry’s cash flow and its investors’ confidence to fiscal uncertainty is being exposed. In particular, the recent tax increases which significantly reduce global competitiveness are undermining this confidence, itself founded previously on a clear understanding of the UK’s fiscal and regulatory predictability. When prices are high, the temptation to garner more of the available economic rent in the short term has to be matched by both a wariness of the effects of subsequently falling prices and an appreciation of the potential damage which could be done in the longer term.