Q4: Oil and gas services: A bridge over troubled waters?

The final quarter of 2011 served up one economic shock after another, which impacted global demand for hydrocarbons and confidence in the sector.

However, the underlying industry drivers have stood to maintain high oil and gas prices compared to historic levels, while the inherent need for operators to continually increase recovery factors and renew both conventional and unconventional reserves points to further appetite for innovative upstream services in 2012.

As investors in these potentially game changing technologies, we continue to track the positive and negative forces in the global oil and gas sector in order to effectively identify and capitalise on market opportunities.

Eurozone uncertainty spreads

With European economies already heavily destabilised, the situation on the continent reached melting point in October, forcing leaders to agree further measures designed to prevent the collapse of member economies. These included an agreement with banks to accept a 50 per cent write-off of Greek debt owed to private creditors, increasing the European Financial Stability Facility (EFSF) to approximately €1 trillion and requiring major European institutions to maintain nine per cent capitalisation.

To restore confidence in Europe, EU leaders also suggested creating a common fiscal union with enforceable rules embedded in EU treaties.

Growth in key states is now slowing at a concerning rate, with the latest IMF predictions suggesting that the Eurozone will suffer a "mild recession" in 2012, with GDP expected to shrink by 0.5 per cent compared with a previous forecast of 1.1 per cent growth. There is also rising concern that slower economic activity in Europe will have a knock-on effect around the world, decreasing the development of both OECD and non-OECD economies.

During Q4, both OPEC and the IEA predicted that global economic growth in 2012 would decrease to 3.7 per cent, while a number of the world's developed economies would see growth at levels less than 2011.

Positive market dynamics

In contrast to the European economic climate, tensions in the Middle East around Iran's nuclear ambitions and instability in Syria, alongside continued high signal-digit growth in China and India, have continued to push up oil prices globally.

The US continues to exploit its unconventional shale oil and gas resources aggressively, resulting in relatively cheap gas as supply temporarily exceeds demand. In the case of oil, the U.S. also seems positioned for improved energy security.

Technology has been critical in initially unlocking the potential of the US' vast unconventional reserves, and will continue to play a central role as the country's operators seek more efficient fracking processes which deliver significant cost benefits.

Growth levels in developing countries, in contrast to the Eurozone states and other developed nations, will remain relatively high, OPEC reported. The body sees China remaining unchanged at nine per cent for 2011 and 8.5 per cent for 2012. India's forecast was revised down to 7.6 percent for both 2011 and 2012.

Demand growth still exceeding supply growth

As a consequence of reduced global economic growth it is believed that demand for energy in 2012 will be lower than prior forecasts. The outlook for world oil demand growth this year has been revised down to between1.2 and 1.3 million bpd.

Global oil supply fell by 0.3 million bpd to 88.7 million bpd between September and August 2011 due to non-OPEC outages, indicating that swing capacity remains tight. Annual growth in oil supply will be 0.9 million bpd in 2012, this being less than the demand growth of 1.2 to1.3 million bpd.

Oil prices fluctuated widely in Q4, after falls in October due to Eurozone concerns were offset by rising tensions in the Middle East. West Texas Intermediate (WTI) traded for a short period in October at less than $80/bbl, finishing the quarter at about $100. Brent crude prices remained higher, finishing the year at $110/bbl. Observers believe that Brent gives a more realistic representation of global pricing, and this Brent to WTI discount reflects the shortage of US pipeline capacity.

Forecasting oil prices for 2012 may be difficult as bearish views over reduced OECD growth are offset by concerns over Iran and lack of spare OPEC capacity. However, a range of $100 to $110 seems realistic, a price segment at which OPEC and other producers will be comfortable. Operators will continue to be profitable despite the increased oil services intensity required to extract the crude.

US natural gas prices have sunk to the lowest point in a decade as the shale-drilling boom continues and the North American winter remains benign. Storage levels are high and the NYMEX Henry-Hub price at the end of December was just below $3/mmbtu. In Europe natural gas prices continue to track oil prices and, as the quarter came to a close, they increased alongside crude to close at more than $12/mmbtu, three times the cost of US natural gas.

Strong prospects in an uncertain global economy

At the outset of 2012, it seems that the global economic recovery is far from underway. There is, perhaps, even more uncertainty than there was at the outset of 2011.

Nevertheless, oil prices remain high, spare oil capacity is tight, crude prices suggest increased industry outlay from operators and, despite low US natural gas prices, activity in the US shale basins remains high.

These current market dynamics, coupled with the underlying requirement for operators to increase recovery factors and renew both conventional and unconventional reserves, suggest that appetite for innovative technologies which contribute to efficient completions and provide the capacity to bring wells online more quickly will remain stable.

Investing in the future of oil and gas completions

These technology-led companies are vital to the industry but, in order to make the significant commercial leap from young innovation to full industry adoption, these businesses require significant funding and strategic guidance. However, in the constrained debt and investment markets, there are few avenues for those that require backing for research and development, and support to bring innovations to market.

We continue to provide investment to firms in this position, working with our portfolio companies to develop and establish the completions specialists of the future, providing managerial support and commercial expertise to help them break into the highly competitive global upstream services market.

We also closely monitor market conditions to inform the strategies of our investee firms, and to help us identify the sector's strategic requirements and, in turn, game changing industry technologies.