The oil&gas industry in the north-east of Scotland has done much better over the last few years than I expected. The reasons for that have been successes in overseas markets rather than the domestic North Sea market.
The latter had been declining at an alarming rate, with oil&gas production falling at about 10% annually and capital spending even faster.
Nevertheless, many oil services companies in the area have been able to compensate for the contraction of the domestic market by diversifying into overseas provinces. Recent contract wins include Sakhalin Island, Brunei, Brazil and India, for example. A consequence has been that the north-east economy (Aberdeen city plus Aberdeenshire) has been the most buoyant part of the Scottish economy – and possibly the UK – over the last three or four years.
The economic growth rate has been the highest of all the 32 local-authority areas in Scotland; unemployment the lowest, and incomes well above the national average.
However, I am becoming increasingly pessimistic about the region’s prospects over the next few years because of the impact of low oil&gas prices on worldwide capital expenditure in the industry.
Many projects worldwide are being postponed or cancelled because they are not economically viable at current prices. In addition, Saudi Arabia and other Opec members are cutting back production and investment in the hope of forcing oil prices substantially higher.
There is no evidence so far of the Opec strategy working and at the time of writing, Brent crude was trading at below $45 per barrel. It may well be that the impact of the global economic slowdown will offset the intention of the Opec cuts, at least in the short run, which could extend into 2010. Even if there is a big rise in oil&gas prices, there will inevitably be a time lag before that works its beneficial way through to renewed investment.
Further, I believe that the caution over capital spending is a mixture of low prices and uncertainty over the fluctuations. A survey of 50 companies quoted in the latest edition of the Petroleum Economist magazine suggests a 10% fall in capex in 2009 and a drop of as much as 20% in 2010. I believe those estimates are too optimistic. The relatively small decline this year is attributed to current projects on which final investment decisions (FIDs) have already been made, but there are already examples of those being put on hold, particularly in the Middle East.
Apart from Saudi Aramco and other Opec state players, those most affected in my opinion will be the smaller upstream companies which are highly geared and involved in relatively high-cost projects. The UK sector of the North Sea has plenty of those, as illustrated by Oilexco plummeting into administration. Many will have great difficulty raising finance for exploration and capex this year – and for the foreseeable future.
I agree with the view that there are too many small independents operating out of Aberdeen. That implies more takeovers and mergers.
The majors will not cut spending as much as the rest of the upstream industry. ExxonMobil, BP, Chevron and others say they are still planning to maintain capex at close to their recent averages. However, my main concern is about the hundreds of service companies in the Scottish north-east that will be affected by any substantial fall in expenditure and activity. Their experiences in the 2009-12 period will be very mixed.
Those dependent on North Sea business will have a hard time. Any that have become increasingly involved in Saudi Arabia and other parts of the Middle East will also struggle, and possibly also companies with substantial interests in North America. Those active in other regions such as West Africa and Asia-Pacific may fare better.
I believe that the next few years are going to be a difficult period for the region. The era of high growth and low unemployment may be coming to an end. We have coped well with fluctuations over the last 30 years, but the current global financial crisis is in a different league.
I may be too pessimistic but, given the season that my football team, Inverness, are currently having, can you blame me for that?
Tony Mackay is MD of economists Mackay Consultants
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