The good times of early to mid-2008, when most oil companies were benefiting from the seemingly relentless rise in oil prices, are now a distant memory for many.
The average price of Brent crude in the first five months of 2009 was $48/bbl, almost 70% below the peak of July 2008, and oil companies are responding by demanding price cuts and/or efficiencies from their oilfield service (OFS) suppliers.
In addition to recent oil-price movements, gas prices have also declined from the highs of 2008. The average price of Henry Hub gas in the first half of 2009 was a little over $4 per MMBTU (million British thermal units), 53% lower than the average for 2008 and some 59% lower than in the first six months of 2008.
The oilfield service sector is generally under pressure from its customers as a result of the cancellation or delay of projects and requests for lower prices. This is impacting those who live off capital and/or operating expenditure projects.
Improving the reliability and efficiency of services, equipment and operations will entail moving away from time-based preventative maintenance to predictive maintenance technologies and methods. The transition from preventative to predictive strategies will allow OFS companies and customers to plan operations more effectively and efficiently, as well as to reduce costs.
The stronger OFS companies are those which measure favourably in the following categories:
Customer base.
Order-book position.
Geographic and sector fragmentation.
Customers of OFS companies tend to be a combination of international oil companies (IOCs), national oil companies (NOCs) and independent exploration and production (E&P) companies.
Many NOCs are planning to maintain or raise their level of capital investment in the year ahead, but they will also be seeking to reduce costs on some large-scale projects.
Compared with IOCs, the relationship between OFS companies and NOCs is based on a mutual need – NOCs are the resource owners and need OFS companies to help develop those resources.
The largest opportunity for OFS companies to work in partnership with NOCs is in countries where IOCs have been frozen out or where there has been a prolonged period of under-investment in the oil&gas sector.
OFS companies have generally increased their backlogs over the past 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, current and future contracts are likely to be awarded at lower prices, thus adversely impacting OFS companies’ gross margins.
There is also a risk to OFS companies that existing contracts within backlog are re-tendered or postponed in order to take advantage of falling costs.
The order-book position, in many cases, in the OFS sector allows visibility for the subsequent year’s revenue, particularly for engineering and construction companies and rig companies. The trend of a company’s order book can be a good indicator of potential growth, while a declining order-book trend can be the first sign of problems ahead.
However, there are opportunities here for OFS 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 should be the starting point for E&P companies, with improved effectiveness being the goal. It will be the more innovative and flexible OFS companies which will flourish in these cost-cutting times.
North America is suffering from a significant reduction in onshore drilling rigs. In the first week of July 2009, the US onshore rig count was 52% lower than the same period a year earlier (1,850 and 886, respectively), while in Canada, many oil-sands projects have been cancelled or delayed as a result of not being economic at current oil prices.
OFS companies with operations in these sectors and regions will have typically suffered significant downturns in their business activity and profitability.
Such companies active in the North Sea are also under significant cost pressure and are becoming more dependent on the activity of independent E&P companies as IOCs continue to divest their assets in this mature basin.
Russia continues to have ruble devaluations and political stability issues, although it has huge long-term reserves to be developed.
Middle East opportunities are going to be fantastic for OFS companies when the market into Iraq opens up and political consensus is reached on opening up offshore hydrocarbon projects in Iran and Kuwait to foreign investment.
Deepwater African opportunities continue, although with varying degrees of political risks and security concerns in differing countries.
We consider the deepwater and subsea sub-sectors to offer best growth opportunities for OFS companies:
The shortage of deepwater rigs over the last three years means that there is a backlog of activity. Exploration activity in deepwater markets of Africa, South America and the Gulf of Mexico remains relatively strong. Perhaps the biggest short-term opportunities are deepwater Brazil, where rig building is continuing even in the current turbulent times.
Increased interest is being generated in subsea developments, in part due to the move into harsher and more technically challenging regions. However, in the short term, these high-cost recovery regions will struggle to secure investment unless the oil price stabilises at higher levels.
Subsea developments could also be an attractive option for accessing smaller deposits in mature markets which are near to existing infrastructure.
Together, these and other factors are pushing the oil&gas industry, including the OFS sector, to new geographical, geological and technical frontiers.
While many OFS companies’ profitability and cash flows will suffer as a result of continued pricing pressures from their customers, and also reduced activity in certain sectors, there are still fantastic opportunities in the OFS sector across the globe.
The unprecedented circumstances confronting the OFS industry are prompting it to re-evaluate its long-term business strategies, as well as to explore, develop and implement new capabilities and approaches to the business.
Ally Rule is director, transaction advisory services, at Ernst & Young
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