Pressure is continuing to mount on rig rates with a clear softening across most segments of the global fleet as more and more oil companies focus on ratcheting down costs.
Seeking to get back to previous profitability has increasingly become the priority of oil and gas companies where the ratio of total assets to earnings before interest, tax, depreciation and amortisation (EBITDA) has plummeted from 24% over the period 2004-08 to almost 15% last year.
However, analyst RS Platou warns in its latest monthly rig report that profitability of oil and gas companies is likely to drop further given expectations of increases in E&P (exploration and production) spending, unless there is a sustained rise in oil prices.
RS Platou says in its June report that leading surveys are pointing to 3-4% growth in E&P spending this year, while estimates of oil service companies’ revenues is expected to increase 5.7% this year and 8.1% next (2015).
The growth of oil service revenues has been revised down lately; nonetheless growth is still expected from at least some segments, though falling rig rates point to shrinking demand for the services of mobile offshore drilling units.
“One datapoint as released by the Norwegian central statistical agency (SSB) is pointing to a drop in E&P spending of 20% in 2015 on the Norwegian Continental Shelf (NCS),” warns RS Platou.
“The drop has mitigating factors, but nevertheless it points toward a slowdown in E&P spending.”
The analyst points out that, as price takers the “only tool” oil companies have to return to higher profitability is of course to cut costs and this will naturally have ramifications for the oil service industry.
As it is, selected oil service companies are reporting lower inbound orders. Indeed service companies’ “inbound orders” totalled $24billion during Q1 this year, marking a 40% drop on the same period last year.
“The drop is nearly across the board. Seismic is down 26%, equipment & services is down 35% and offshore drilling is down 86%,” warns RS Platou.
“The only oil service segment which has recorded an increase in inbound orders is subsea with 13%.
“Inbound orders of oil service companies are likely to remain weak until costs have come under control and profitability restored, but how long will this take?”
As is well known, earnings of the offshore rigs are highly sensitive to fluctuations in fleet utilisation.
“Today, we have entered a situation where rig demand has stalled, but due to prior investments rig fleets are expanding and utilisations and hence earnings are coming under increasing pressure,” says RS Platou.
“In other words, the cost cutting process is well under way.
“The importance of drilling in cutting costs should not be underestimated and especially for deepwater activity.
“Rig hire represents as much as 50% of the cost of deepwater exploration campaigns and 35- 45% of field development costs in deepwater.”
But RS Platou argues that reducing costs in the construction of production units is probably more difficult.
Prices are mainly a function of the backlog of the yards, but also the backlog of the sub-suppliers of equipment which are in many cases not only exposed to the E&P industry.
RS Platou concludes that, so long as oil companies enforce capital discipline, costs will come down; but that costs will come down at different speeds according to oil service segment.
But the analyst warns: “In that process the incentives of some OGCs to break rank and increase investments are, however, rising.”
Meanwhile, the massive global drilling rig build programmes continues apace. The current orderbook includes 250 jack-ups, 69 drillships of which 65 are classed as deepwater, plus 26 semi-submersibles.
The current grand total is 245 of which more than 100 are due for delivery from 2016.
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