As we get to May each year a significant number of UK-based business leaders will make the annual pilgrimage to OTC in Houston. And it’s with good cause.
The US market is unquestionably the largest and most influential centre in the global oil and gas world, not only because it’s the single largest investment market, but due to its influence in the energy world.
The majority of the world’s largest E&P firms and service companies are either headquartered or have material operations in Houston and UK organisations that will become increasingly reliant on overseas trade need to be there.
In 2014, it is expected that around $156billion will be invested in the country, accounting for 22% of all global spending.
We can see from various recent reports that exploration in the UK is declining and that large capital investment projects that have buoyed the sector are dwindling. With operating costs rising and production declining, coupled with little visibility on new investment, the need to internationalise is a priority for most service firms.
When one looks at the US market in comparison to the North Sea environment there are a number of significant differences in the way the market works and is segmented. Those firms that have taken time to understand the differences and adapt their business models accordingly have been successful.
Firstly, the US market is predominately land-based which in turn makes drilling and associated services the largest segment of spending. While there is a material offshore sector in the Gulf of Mexico and associated construction and subsea industry, its materiality is less.
The US market is also far more attuned to change and has the ability to react quickly. Budgets are still set on an annual basis but can change during the course of the year. This can make the market contract very quickly if commodity prices change downwards, however, it can also increase investment to take advantage of improved economics just as quickly. Consequently, the service community needs to be as nimble and reactive as its client base to take advantage of opportunity.
The US is also segmented by operating basin. Within the onshore market there are a number of areas which have different operating models including the Permian, Eagle Ford, Barnett, Woodford . . . to name but a few. Each basin has its own technical requirements, concentration of E&P companies and developed supply chains. As such, firms don’t enter the US market, they enter a basin.
In the past, the US market was relatively uncomplicated. Most of the wells that were drilled were simple, vertical wells using basic rigs and completion techniques. Due to the service intensity required to drill complicated and often expensive wells to exploit unconventional oil and gas reservoirs we are starting to see a more technology-led approach to the market similar to that of offshore.
Today, the land rig fleet has been materially upgraded and around 80% of all wells are horizontal or directional. Added to this the completions are much more complicated and thus we can see that technology adoption to improve operations, reduce cost and enhance productivity is a primary driver in selecting service partners. This is a model more familiar to UK firms and one they can prosper in.
It hasn’t been a constant growth story however. During 2013, the US markets paused for breath post a number of years of accelerated capex spending. The investment in unconventional resources which fuelled activity levels and spending due the higher levels of service intensity per well, created a huge boom for the service sector and operational challenges for the E&P companies.
The pause in activity in addition to greater efficiencies being achieved in drilling operations witnessed overcapacity of service equipment as new assets started to enter the market at a time of reduced activity, leading to pricing declines and some of the “gloss” coming off the market.
During early 2014, there have been many negative messages surrounding industry spending mainly by the international oil companies (IOC) such as Shell, BP, Chevron and others. Costs globally have been increasing in the oilfield at a compound rate of over 10% for the past four or five years. This has effectively doubled the costs of engineering, drilling and construction activity.
At the same time, production gains have not been forthcoming which has meant lower profitability. A wave of shareholder activism to protect returns has led to “Capex Compression” or the reduction and greater scrutiny on higher risk investment projects which are now being delayed or cancelled.
The rebalancing of demand to reduce cost inflation is welcome for the industry and ultimately the service community as well. The rampant inflation due to high demand levels couldn’t be sustained and created operational challenge and major inefficiently within the E&P and service community.
Reversing this trend by focusing on reducing high cost operations is critical to ensure sustainable investment and operational performance levels in the long term.
Market segments or regions where there is balance in supply and demand exhibit less risk and thus are likely to witness more sustained investment. The US land market in our view is in this situation and thus may be less prone to Capex Compression in the short term.
The IOCs are important although we need to remember that they are not as influential in the global energy market as they once were. While they dominate activity in many offshore and deepwater environments, they collectively account for around 16% of global spending.
National oil companies (or NOCs) are increasingly material including Petrobras, Pemex, Saudi Aramco, Petronas, CNOOC, and PDVSA all spending more than $15billion each. The largest single investor in the market is no longer Exxon. It has fallen to second place behind PetroChina, which is set to spend a whopping $43billion this year.
Collectively, the group of large spending organisations referenced account for around 50% of global spending; however, in the US they amount to 27% of the forecast spend.
The most material E&P category is the medium to large scale independent companies that really drive and influence activity in the US market such as Anadarko, Apache, Devon Energy, Noble Energy and Continental Resources. These independent firms have a different, arguably more entrepreneurial approach to operations and investment which is quite different from the structured IOC and NOC models.
We expect that 2014 will start to see improvements in activity levels as many undrilled prospects are executed and there is balance in the market allowing E&P companies to manage cost and realise operational improvement.
Andrew Reid is MD of analysts Douglas-Westwood
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