What will it take to re-start offshore drilling? | Fuel for Thought

As global crude oil has hit the $80/b mark, the industry is now wondering if there is a magic price that would jump-start the offshore sector which is lagging an otherwise steadily recovering oil patch.

Higher crude prices near-term may not be enough to entice operators back to the risky business of greenfield offshore projects—as opposed to the warm fuzzies and quick payoff provided by North American shale.

“Offshore is starting to look a bit better” as onshore breakevens rise due to high activity, S&P Global Analytics analyst Rene Santos said.

“For offshore, due to relatively low activity, service provider costs [for] rigs and fabrication yards continue to decrease, Santos said. “However, shale breakevens are still around $10/b lower than offshore—low $40s/b versus high $40s/b WTI.”

Other encouraging signs are afoot that could make offshore look better. A few more final investment decisions than expected were taken this year on medium-sized projects and more of them involve liquids—both potential harbingers of an offshore uptick, brokerage firm Bernstein said.

Consultants Rystad Energy earlier this month estimated 40 more offshore projects globally will be sanctioned this year than the 60 in 2017.

MORE THAN HIGHER PRICES NEEDED

Yet those who are close to that sector say these signs are not enough for many industry operators to warrant plunging back into an offshore business that remains risky and expensive, when onshore shale plays continue to beckon with quicker returns and less uncertainty.

“With 10 major oil companies accounting for 70% of total deepwater activity, the list of active names is short and none are likely to step up meaningfully as long as they have unconventional acreage in the US,” Credit Suisse analyst James Wicklund said in a recent investor note.

It will take more than higher oil prices to move the needle on more offshore drilling, Bernstein analyst Nicholas Green said in a recent investor note.

Green, who in March performed an extensive analysis of the state of global offshore, sees at least eight metrics that may help gauge if and when the sector is in authentic recovery and not just in fingercrossing mode.

They include: * A conviction that an offshore supply deficit is crystal-clear. *  “Substantially” better field economics for the average offshore project. * More oil projects sanctioned. * A greater number of contract awards spread out globally. * Investors’ desire for output growth and reserve replacement. * Corporate price decks adjusted to a higher oil price.

His conclusion is that the current set of conditions “lacks the proof we are looking for.”

“Oil price looks great and optimism is returning [but] oil companies are in no hurry to increase their capex,” Green said. “Crucially, the activity of one basin—Norway—single-handedly underpins the recovery in our datasets and the dollar value of order intake remains poor.”

US GULF LEASE SALE OFFERS CLUE

One clue to the state of the offshore industry may lie in the most recent US Gulf of Mexico lease sale last March. Many called the event lackluster since it captured just $125 million in high bids—less than half the $275 million in March 2017, and far less than the $500 million average of the three years before that.

But the reasons for the low bids is an indication of current oil company thinking, based on the reality of new market conditions, Tommy Beaudreau, former BOEM director and now a partner at law firm Latham & Watkins said.

Since early 2015, offshore companies have relentlessly reduced costs and lowered breakeven prices for oil—a “painful” process which has made that arena’s activity more competitive in the long run, Beaudreau said in a paper for Columbia University’s Center on Global Energy Policy.

“The offshore industry has [taken a] more strategic, value-driven approach to leasing decisions” in the Gulf of Mexico, resulting in fewer tracts receiving bids, he said. But “when... a particular tract makes strategic sense and offers value, companies still will spend millions for a single lease block.”

The industry will need to reach a “psychological point,” passing through several stages, before operators naturally gravitate to offshore exploration and development make sense again and offers value, Keith Myers, president of research for Westwood Global Energy Group said.

Myers suggested getting to that point will involve an evolution: oil prices staying above $60/b over time, which in turn provides operators enough funds to cover capital spending and dividends, so shareholders and the board are satisfied and begin calling for the next level of expansion.

“It’s the point where management teams and ... investors start saying, ‘Where’s your growth? Where is your high-impact drilling? How do you sustain yourself into the future and grow your top line’?” Myers said.

“Above $60/b is a crucial number,” he added. “When you ... are confident that the long-term price of oil will be above $60/b, that will unlock a lot more investment.”