The oilfield services (OFS) industry was enjoying one of its most prolonged up-cycles in memory until the global recession reared its ugly head. After adjusting to the new financial environment and beginning to show positive signs again, the blowout on the Deepwater Horizon on April 20, 2010, happened.
Despite this, we believe the prospects for the overall OFS sector are set to remain fair for some time yet, albeit there will be winners and losers.
The current ban for the remainder of 2010 on deepwater drilling in the Gulf of Mexico (GoM) is likely to have repercussions throughout the global OFS market.
The fortunes of likely short-term winners and losers will depend on their geographical spread, sub-sector specialisation, customer base and order book.
Those firms that concentrate on the US Gulf are likely to be the ones to suffer the greatest in the short term. The larger and global players will absorb the pain and continue to march onwards.
The impacts so far include:
Alaskan offshore drilling has been delayed until at least 2011 and the lease sale for offshore Virginia has been cancelled.
The UK Department of Energy and Climate Change has instructed increased inspection of rigs and monitoring of offshore compliance with greater regulation.
For the moment, no suspension in deepwater exploration drilling has been brought into UK waters, although this has been suggested by the EU. This would have a destabilising effect at a time when deepwater activities are playing an increasing role, given the opportunities West of Shetland. It would also be at a time when there have been some significant new discoveries and there has been unprecedented interest in developing oil and gas fields in the latest UK licensing rounds.
Norway will not award deepwater licences in its 21st licensing round until there is more clarity around the Macondo events.
Brazil, where some of the world’s current largest deepwater opportunities exist, has no plans for any moratorium on deepwater drilling.
West African states have not made any official announcements and, given other political issues in many of the territories and the various governments’ need for oil revenues, there is unlikely to be a significant change.
Looking at the impact on deepwater rigs, many will be relocated from GoM for the remainder of 2010 in order to reduce lost days. However, this is likely to come at a cost to drilling companies, with competition for work and reduced day rates.
This potential relocation of deepwater rigs and related service providers to international opportunities is also likely to further delay the start-up of new projects once the moratorium is lifted.
Increased liability limits (there is talk of $75million to $10billion per well) will remove many independent exploration and production (E&P) companies from the US Gulf, and have pricing implications for those companies which remain.
However, the good news for drilling companies and their related supply chain is that increased regulation (which is inevitable), particularly in relation to age-related equipment, will lead to increased refurbishment and possibly earlier replacement.
Initial recommendations already being discussed include independent re-certification of blowout preventers (BOPs) for mobile offshore drilling units; more rigorous inspection requirements; additional safety training, and additional spill-containment equipment.
This would result in a permanently changed environment and increased cost base. While this may lead to short-term gains for a number of OFS players, it may have longer-term repercussions through some major projects being delayed.
Delays to subsea-related activities in GoM and Norway will also have an impact on floating production, storage and offloading vessels (FPSOs), umbilicals, remotely operated vehicles (ROVs), and installation, for example.
Organisations involved in training, operations, maintenance and inspection with proven health-and-safety and successful delivery records are likely to flourish as customer demands – international oil companies (IOCs), national oil companies (NOCs) and independents – are increased in these areas.
More advanced health-and-safety regulation, more third-party certification work and more process will all be good news for the service sector, although increased regulation will lead to higher costs.
The scale of investment being made in boosting oil production capacity globally offers tremendous opportunities for service companies. NOCs control most of these opportunities. Indeed, their needs in relation to the development of these opportunities are driving some key changes in the OFS sector.
Compared with IOCs, the relationship between the supply chain and NOCs is based on a mutual need – NOCs are the resource owners and need service companies to develop those resources.
The largest opportunity for service companies to work alongside NOCs is in countries where IOCs have been frozen out or where there has been a prolonged period of under-investment in oil&gas.
Until the global recession, many service companies had increased their backlogs over the preceding three years as a result of previously sanctioned projects and the high level of oil&gas activity across maintenance, upgrades and enhanced oil recovery.
As a result of lower crude prices and lack of finance available to many E&P companies, contracts are typically being awarded at lower prices, thus adversely impacting supply-chain gross margins.
There is also a risk to service companies that existing contracts within the backlog are re-tendered or postponed in order to take advantage of reducing costs.
However, there are opportunities here for service companies to demonstrate to their E&P customers that by actually increasing their spend, E&P companies can achieve greater efficiencies.
Although hard to achieve, cost reduction in a safe and environmentally-friendly manner should be the starting point for E&P companies, with improved effectiveness being the goal.
It will be the more innovative and flexible members of the supply chain that will flourish in these cost-cutting times.
Instead of diversifying, some service companies have chosen to expand the scope of the services they provide. The remit for many firms has moved beyond that of being purely a supplier of equipment or services; companies are being asked by some of their clients to assume more risk to benefit from greater rewards.
It is likely that only the top tier of players will have the appetite and capability to take on greater risk. These companies have the capacity and financial strength to manage the more complex projects being tendered.
However, even the major players need to ensure that there is an appropriate balance of risk-based and fixed contracts in their work programme. The rewards need to be more than sufficient to compensate for the increased risk.
Looking ahead, there is likely to be more corporate mergers and acquisitions activity – the respective deals with Baker Hughes/BJ Services and Acergy/Subsea 7 this year alone were worth $8billion – so leading to further supply-chain consolidation.
We can also expect to see non-core disposals following corporate mergers, as well as forced disposals arising from distressed and over-leveraged groups.
There is also likely to be continued private-equity activity with a healthy appetite for service companies that have strong management teams and display the right blend of geographical spread, sub-sector specialisation, customer base and order book that make them likely winners in the sector.
Deal valuations will, however, continue to be constrained by a lack of liquidity in debt markets and continued volatility on the public markets.
Ally Rule is director, transaction advisory services, at Ernst & Young
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