General optimism and a weakening US dollar are creating strong commodity prices, despite sluggish short-term demand and high inventories. To a large extent, oil prices continue to be higher than market fundamentals justify, according to analysis by Ernst & Young.

"The key question in the months ahead is, once government-delivered stimulus efforts run dry, will private and corporate dollars step in to carry on the economic recovery and create growth in energy demand?" said Marcela Donadio, Ernst & Young LLP, Americas Oil and Gas Sector Leader. "But perhaps the even bigger question is the future of energy policy in the US."

Natural gas

Historically, oil and natural gas mirrored each other, but presently they do not appear to be connected. With a strong natural gas supply, largely from unconventional sources, anticipation of warmer winters and a weak economy, there is little to indicate that this trend will reverse in the near future. However, increased regulatory pressure to decrease carbon emissions could open the door for greater natural gas demand.

"With storage and supply at an all-time high, short-term fundamentals for natural gas are very weak," said Donadio. "However, natural gas has promising potential as the clean-burning bridge to alternative and renewable energy."

Downstream

The downstream oil and gas segment is still feeling the economic downturn acutely, much more than the upstream segment. The issues driving the outlook for downstream are low demand brought about by the depressed economy, a shift to more fuel-efficient vehicles and greater biofuels use and domestic and international refining capacity increases, planned in a different economic climate.

Oilfield services

While spending on oilfield services by the upstream players is likely to continue in a downward pattern for the near future, rig counts seem to have turned a corner. After bottoming out in early Q3 2009, counts are slowly increasing, particularly in the US and Canada. The strength in this sector lies in oil drilling. Oil drilling has led the US upturn. While offshore markets are relatively stronger than onshore markets, deep and ultra-deep offshore exploration and development are the strongest. Given current credit constraints, survival for some medium-to-smaller oilfield services companies may require consolidation.

Transactions

Compared to the first three quarters of 2008, global oil and gas transaction activity so far in 2009 is down about 20% in terms of deal value, and about twice that in terms of deal volume. In contrast to the fairly stagnant US transactions environment, China continues to shore up its energy production capabilities, and has completed a number of major asset acquisitions in 2009. There are some indications in the US and elsewhere that a new wave of oil and gas transactions is building. These deals will likely take the form of M&A, joint ventures, strategic and tactical alliances, and other forms of restructuring.

Energy companies will be well served to continue to be nimble during these tumultuous times. The outlook for each sub-sector could change dramatically depending on a number of political and economic factors.

About Ernst & Young's Americas Oil & Gas Center

The oil and gas industry is faced with complex issues and constant change. Volatile prices, business consolidation, difficult operating environments, ever-increasing customer demand, continuously evolving regulatory environments and the reliability of supply all present significant challenges. The Ernst & Young Americas Oil & Gas Center can draw upon a network of energy professionals in the Americas and around the world to work closely with clients to facilitate the development of coordinated approaches to managing risk, improving performance and increasing operational effectiveness. The Center works to anticipate market trends, identify the implications of and develop points of view on relevant industry issues. Our deep energy industry focus helps Ernst & Young make a difference.

About Ernst & Young

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This news release has been issued by Ernst & Young LLP, a client-serving member firm of Ernst & Young Global Limited located in the U.S.