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The past year has been a boon for exploration and production (E&P) companies, thanks to higher crude oil prices. Oil companies -- especially Big Oil -- were able to garner comparatively higher profits despite a general drop in production. However, things might not look as rosy in 2012.
Gloom on the horizon
The World Bank has come up with a bleak 2012 outlook for developing countries due to the European debt crisis. The bank warned that an escalation in the euro-area debt crisis could tilt the world into a recession on par with the financial meltdown three years ago. The bank goes on to outline the consequences on crude oil prices, and this might mean a reduction in margins for those E&P companies that booked greater profits by relying more on higher crude oil prices than production growth.
In the report (PDF file, Adobe Acrobat required), the bank notes that "fiscal pressures could be particularly intense for oil and metal exporting countries. Falling commodity prices could cut into government revenues, causing government balances in oil exporting countries to deteriorate by more than 4 percent of GDP." The international lender also predicts that average crude oil prices will fall by 5.5% from 2011 levels.
In simpler terms, the weak economic environment in developed nations could seemingly reduce demand for crude oil, which could badly impact those countries that primarily depend on crude oil exports.
The net result: A drop in global oil prices
The World Bank average price -- which is a simple average of the crude oil benchmarks WTI, Dubai, and Brent -- is forecast to be around $98/barrel in 2012. This is a drop from $104/barrel in 2011. Not surprisingly, the report also mentions the additional risk of "a hard landing in one or more economically important middle-income countries" (read: China and India) that could further act as a catalyst for a fall in demand and lower prices.
What effect will this have on major E&P companies in the next 12 months? It depends. However, if one has to go by the production trends of 2011, then you can expect a substantive drop in margins.
Not an enviable 2011
The list starts with BP (NYSE: BP ) , whose production levels fell 9% in the first nine months of 2011 compared to the previous year. ConocoPhillips' (NYSE: COP ) production fell 7%, while Statoil (NYSE: STO ) and Total (NYSE: TOT ) saw a 3% and 2% decline, respectively. The reason cited by these companies is a general decline from currently producing fields. Only ExxonMobil (NYSE: XOM ) registered decent growth in terms of production. Additionally, the current focus has shifted more toward natural gas production. As fellow Fool Abantika Chatterjee has noted, capital expenditures for most of these companies are slated to go up, but the major portion would be allotted to finding and developing natural gas reserves.
Thirdly, crude oil production from these companies could further witness a dip, and that might be dangerous. The geopolitical situation in the Middle East and disruptions in supply in North Africa are perfect catalysts to that. Of course, such events have the potential to push up prices, but that still might not result in a free run like E&P companies enjoyed during the Libyan crisis. The European debt crisis, after all, has consequences that are more far-reaching and difficult to resolve. The balance looks dicey. In short, the downside for 2012 looks much more prominent than the upside if oil production levels are to take a beating.