Offshore in depth

These days, everyone in the petroleum industry is closely tracking oil prices. The Houston Chronicle prominently features the price per barrel on its front page every morning. The drop in crude prices—from over $100/bbl a year ago to around $60 at this writing—has sent shock waves through the industry. A major theme discussed at this year’s IHS CeraWeek and the Offshore Technology Conference was the need to control cost, to remain profitable in a sustained period of lower commodity prices. 

Budgets slashed, rig count crashes. While immediate cost reductions fell primarily on unconventional activity in North America (including a 53% drop in the land rig count and more than 50,000 service sector layoffs), the offshore industry also has been deeply affected. The Gulf of Mexico rig count has dropped 40%, while the international offshore count is down only 9% year-over-year. Wood MacKenzie reported that only 23 North Sea exploratory wells were drilled during 2014, compared to an average 81 annually for the previous decade. Driving this discontent are cuts in operator budgets, more careful evaluation and prioritization of offshore projects, and an oversupply of offshore rigs.

Since November 2014, more than 50 operators have announced capital spending reductions, with cuts ranging from 13% (Chevron) to 60% (Apache) of 2014 levels. In addition to many independents, the list includes every large IOC, and NOCs like Petrobras, Pemex, CNOOC and Petronas. In aggregate, E&P investment should be down more than $150 billion, or more than 25% below 2014 levels. Offshore projects will compete for a share of a much smaller investment pie.

Onshore vs. offshore investment? Industry observers have suggested at least two possible strategies to prioritize cost reductions and ongoing E&P investment. A Goldman Sachs analysis showed that 61 already-approved major projects are uneconomic at $60/bbl oil. Goldman Sachs predicts that any oil demand growth will be met with U.S. shale production and increased OPEC output, so offshore projects will be harder to justify. A Douglas-Westwood analyst also predicted that ultra-deepwater projects would be delayed until oil prices get up to “the right level.” 

Several major operators are pursuing an alternative strategy, according to recent investor presentations. With oil prices expected to be around $70/bbl through 2017, operators like Hess, ConocoPhillips, Chevron and Exxon Mobil are taking advantage of factory drilling, and a 30% cost deflation in unconventional fields, to improve returns onshore. Meanwhile, they are investing most of their budgets in offshore fields in the Gulf of Mexico, West Africa, North Sea and Asia-Pacific. They expect deepwater fields to make bigger contributions to their total production than shale plays. 

Larger fields in ultra-deepwater fields may be better investments, according to Rystad Energy. Most (65%) of the ultra-deepwater reservoirs planned for production in the next five years will come from fields with over 1 Bbbl of reserves, and 70% of ultra-deepwater fields will primarily produce oil. Given these fields’ large volumes, they can be economic at $60/bbl despite their costs.

Recent deepwater decisions are mixed. Statoil plans to invest $29 billion in Johan Sverup field, reported to hold 3 Bbbl of recoverable oil. Shell is pushing ahead with plans to drill in the Chukchi Sea, pending local government permits, but has pulled out of a $6.5-billion project in Qatar. And Nigeria’s NNPC announced the delay of three deepwater projects in that country.

Floating rig oversupply. Lower oil prices have compounded a floating rig oversupply, as a wave of 5th- and 6th-generation newbuild rigs continues to enter the market. In addition to the approximately 170 ultra deepwater rigs already in operation, 11 newbuild rigs scheduled for 2015 delivery do not have contracts. Another 50 rigs are under construction for market entry by the end of 2017. A number of rig owners have retired or stacked older units, but this will probably not improve conditions for drilling contractors. RigLogix reports that around 30 competitive floating rigs were available in early 2015, and another 75 will reach the end of their contracts by year’s end. Early cancellation of contracts remains a possibility, especially when the operator is a national oil company with favorable contract terms. Rig owners seeking to renew contracts or obtain new work will have to negotiate with operators that expect substantial day rate reductions. Utilization could drop below 80%, with many high-end rigs remaining idle.

Drilling contractors are also re-negotiating contracts with shipyards in Korea and China that are building rigs to fill their orders. According to Norwegian law firm Wikborg Rein, “Most participants in offshore construction are buying time…and see the benefit of working together to find solutions to weather this particular downturn… At least for the time being, we are not seeing the large number of cancellations and buyer defaults similar to those which took place in marine construction in the financial crisis of 2008.”

Service companies tighten belts. Offshore service companies also feel the squeeze, as operators expect discounts of 10% to 30% to compensate for lower oil prices. Large companies, like Schlumberger, Halliburton and Baker Hughes, also serve the onshore unconventional market and have reduced their workforces. Lower rig day rates, and reduced spread costs, make it difficult for suppliers to charge a premium for their advanced technologies.

The industry finds itself at an especially uncertain time. Speculation about oil prices and activity levels makes it difficult to commit to new projects. With the planned E&P budget reductions, it will be difficult for operators to gear up before early 2017. Yet, global population and energy demand continue to grow relentlessly, so it is encouraging that many IOCs are taking a longer-term perspective to invest in, and develop, offshore reserves.   

About the Authors

Ron Bitto

Contributing Editor

Ron Bitto has more than 30 years of experience as a technology marketer and writer in the upstream oil and gas industry. RON.BITTO@GMAIL.COM