It’s evident that the UK oil and gas market is going through adjustment following a period of substantial investment growth.
As stated in July’s Energy, a correction has been long overdue and ultimately will be beneficial to the long-term prosperity of the basin.
E&P companies and the service community need to focus on operational efficiency and cost reduction to ensure we maximise UKCS resources. Assuming they do, we still see a positive long-term outlook.
It is difficult to predict how long the correction will last and the extent of the downward pressure it may exert on Capex and Opex in the short term. But, looking to the medium term (or next five years) the overall picture is still quite healthy in some sectors of the market.
One big problem with oil and gas is that it’s not rational and inherently cyclical. What we see is that in times when optimism is high on the back of strong commodity prices and good returns on investment, the industry moves into a growth cycle which fuels demand.
This demand increase almost always creates issues as service companies are unprepared and scramble for new assets, equipment and people which inflates prices and creates operational inefficiency as all stakeholders try to do too much, too quickly.
What then happens which compounds the problem further is that E&P firms see that the market is tight, that availability of equipment is lessening and prices are rising. They then try to secure availability for future programmes early, adding extra demand to the market which leads to further overheating.
Allied to this cycle, in order for service companies to allocate their limited resources, they seek to lock in longer term contracts which secure their services at a favourable rate for a longer period of time.
This further reduces future capacity and impacts pricing and availability for E&P, albeit it secures workload for sometimes years ahead for the contractor.
Right now we are post the recognition stage of overheating and into a correction, which in turn will lead to reductions in activity before the cycle starts again. And it will start again.
The UKCS is still very attractive given the infrastructure, potential recoverable reserves, commodity price outlook and relative political stability. Yes, we have some “uncertainty” with the Scottish Independence election due and its aftermath, but either way the vote goes it’s in nobody’s interest to stifle UKCS activity.
With this backdrop, we can also see that key sectors of the UK oil and gas market are holding up quite well. If we turn to drilling specifically as one of the largest from both an activity and expenditure perspective, the outlook is quite robust.
Douglas-Westwood analysis of the UKCS drilling market centres around a number of cases. I shall focus on our “base” case here which considers current drilling programmes and commitments, future developments we view as likely to progress, in addition to historical trends and future production potential.
When considering the exploration and appraisal position there is no doubt that historical trends have not been positive. In the UK around 60 E&A wells were drilled during the last peak year in 2007.
This steadily reduced and bottomed at 24 in 2012 before recovering in 2013. Our expectations are that E&A drilling will likely stabilise around the 30 wells per year mark through to 2020 reflecting the basin’s maturity.
While E&A has effectively plateaued in the base case, the outlook for development drilling is more favourable.
Since 2009, the market has been relatively flat with between 120-130 wells being drilled per year. We anticipate that in spite of reduced E&A the prospect backlog for further development is quite strong, albeit a higher number of smaller opportunities.
From 2014 through to 2020 we expect that around 1,300 wells will be drilled moving to a new average of around 180 per year. Our current peak is forecast in 2017 based upon our outlook on present development and infill opportunities, with marginal declines through to 2020.
Underpinning this activity will be the traditional shallow water (less than 250 metres) basins with very minimal activity in the 250 – 1,000m range. A small number of developments in the deeper water areas will progress albeit it will constitute only 6% of total wells drilled.
Considering investment around commodity type, our base forecast highlights that oil-based activity will dominate, although only just. Over the forecast period some 55% of wells will be oil directed.
Activity levels are looking favourable going forward, albeit there is some risk from an operator perspective. When we look at drilling demand by operator type there is a high concentration of independent companies which will be responsible for driving development.
Smaller companies without a larger portfolio to generate cash flow can find themselves “betting the farm” on one development with little room for any complication. We have seen in the past that funding issues have caused delay or halted programmes altogether, which may factor going forward.
Of course, E&P fragmentation is also a positive in that it provides diversity and means there are a higher number of smaller operators very focused on maximum recovery of their assets – potentially pushing forward with new investment not otherwise committed by their larger competitors.
This situation is a reflection of the maturity of the UKCS and it must be pointed out that being dominated by the majors isn’t necessarily healthy either.
Reorganisations now going on across this group of operators may present some risks to future investment and associated drilling programs.
As far as dayrates and drilling rig commitments are concerned, our view is that the market should hold up reasonably well albeit it will remain under short-term pressure.
Currently, dayrates across most asset classes are at historically high levels. If we focus on the semi-submersible market utilisation of plus 80% has driven dayrates up to an average $360,000 per day this year.
It’s recognised that downward pressure will be exerted on new fixtures in the market going forward, however, given that a high proportion of the fleet is already contracted through 2015, there may be limited opportunity for this to happen.
This will help protect to an extent part of the drilling market and associated services including the marine support market. Given the materiality of this area, Aberdeen may still have some life in it yet.
Andrew Reid is MD at Douglas-Westwood
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