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Leaner oilfield services sector could support recovery in offshore activity

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Essential Energy Insights - September 17, 2020

Essential Energy Insights September 2020

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Leaner oilfield services sector could support recovery in offshore activity

Offshore oil and gas exploration and production is expected to become increasingly important in 2019 and beyond, as companies look to expand operations or diversify their portfolios after focusing elsewhere during the recent market downturn.

Companies like Royal Dutch Shell PLC and Exxon Mobil Corp. that remained vested in various markets through the downturn will lead the recovery, IHS Markit analyst Keith King said in a July 28 podcast. Companies pulling back to unconventionals, specializing on certain basins and "not playing the deepwater game" could be in jeopardy if their single chosen resource investment type fails to remain competitive, he said.

Exploration and production companies that plan to continue or expand offshore operations in an improved economic environment will benefit from an oilfield services sector that has been made leaner and more cost-efficient due to technology and operating advancements propelled by limited opportunities during the price downturn.

Offshore costs have declined significantly over the past four years. Prior to 2014, offshore projects in the North Sea and even in the U.S. Gulf of Mexico had a break-even price between $60 per barrel and $80 per barrel. Today, data from the International Energy Agency show the cost at $25/bbl to $40/bbl.

The lower-cost environment is quietly renewing interest offshore, even as shale dominates the current focus for most oil and gas companies, according to market analysts, as the need for baseline production growth is driving exploration and production companies back to the offshore sector.

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According to a report released Aug. 14 by Wood Mackenzie, Shell's announcement in late May that it had commenced production at its deepwater Gulf of Mexico Kaikias field nearly one year ahead of schedule "epitomizes how the deepwater sector has — for now transitioned to a simpler, lower-cost business model."

The new environment has brought more collaboration between exploration and production companies and the services sector, especially in northern Europe and the North Sea, which "has led to greater simplification and standardization of projects," the report's author, Angus Rodger, said.

This renewal of offshore activity could also mean an increase in business for struggling segments of major oilfield service companies such as Schlumberger Ltd. and Baker Hughes, as well as for niche drilling and equipment companies. However, this does not necessarily equate to higher revenue, as the oilfield service and drilling sectors continue to struggle with pricing, cautious investments and a continued focus on short-cycle projects, Keith said.

Reporting a 1% sequential decline in revenue to $1.3 billion for its Cameron unit in the second quarter, Schlumberger pointed to lower OneSubsea revenue on a declining project backlog. Baker Hughes' oilfield equipment segment reported a 7% sequential decline in revenue to $617 million and a 5% drop in its turbomachinery and process solutions unit to $1.4 million.

Despite segment losses, Baker Hughes said its oilfield equipment business had its largest orders-quarter since 2015, winning significant subsea production awards across six different projects, and its turbomachinery and process solutions segment secured important commercial wins in LNG and on- and offshore production, two of the largest drivers of the business.

While reporting segment losses, Schlumberger noted that during the quarter Cameron International Corp. won new contracts from Transocean Ltd. for work in the Gulf of Mexico and the North Sea, from PJSC LUKOIL for work in the Caspian Sea and from Murphy Sabah Oil Co., Ltd. for work offshore Malaysia.

Among the niche drillers, Transocean was busy awarding well contracts in the second quarter. It announced in July that 11 contracts for its GSF Development Driller I offshore Australia will commence in the first half 2019 and that 13 well contracts for the midwater semisubmersible Transocean 712 will commence in March 2019 in the U.K. North Sea. Tudor Pickering and Holt Co. analysts July 24 said Transocean has plans to reactivate its ultra-deepwater drilling rig Development Drill III for a 180-day contract, plus three six-month options, with Exxon in Equatorial Guinea, providing a "very early" sign of an ultra-deepwater recovery.

While supported by the lower costs associated with efficiencies and new technologies in the oilfield services, equipment and drilling sectors, the scope and strength of the offshore market resurgence will be driven by supply and demand trends.

"An improving macro environment evidenced by indicators, such as oil price stabilization and continued growth in demand, along with economic discipline by OPEC and non-OPEC members, has raised confidence in oil and gas executives over the past six months," according to the latest Capital Confidence Barometer from Ernst & Young.

The International Energy Agency forecasts a tightening supply/demand balance in the second half of the year and into 2019 that could drive the price of crude oil higher, the agency said in its latest Oil Market Report.

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While forecasting an increase in demand growth from 1.4 million barrels per day in 2018 to 1.5 MMbbl/d in 2019, the IEA said geopolitical uncertainties and escalating trade disputes present downside risks to supply.

While rising crude oil prices would support an offshore market recovery, the Ernst and Young survey cited rising inflation and market volatility as the biggest risks to investment plans, as oil prices rise and oilfield services companies look to renegotiate contracts at higher rates.

At the same time, executives view political uncertainty and geopolitical tensions as their biggest risks to growth, the study showed. "Policy is becoming harder to predict, and any increases in protectionism could have an impact on the efficient flow of goods and services among companies," Ernst & Young analyst Andy Brogan said.

IHS Markit's King said that while an offshore recovery is underway, this recovery is going to be different from previous cycle recoveries when companies went back to doing what they were doing prior to the down cycle. He said there is an investment dilemma arising from competitive resource types and a concern about what the energy future is going to be in 10 to 20 years.

"People are talking about peak demand, people are talking about renewables, solar and wind replacing hydrocarbons, and all of this leads to a lack of certainty and a lack of certainty leads to a lack of investments," King said.