The freefall of oil prices has taken its toll, with no end in sight. A recent update, of Wood Mackenzie’s July 2015 market analysis, hints at what is to come. Key takeaways from the report include:
- $380 billion in total project capex deferred (in real terms) from 68 projects worldwide, with just under half of that deferred capex ($170 billion) occurring from 2016 to 2020.
- Deep water will be hit hardest, with 29 deferrals representing 62% of total deferred reserves, and 56% of total capex.
- 2.9 MMbpd of liquid production will be deferred to early next decade, up from 2 MMbpd.
- Oil is the most impacted commodity, with deferred liquid volumes up 44% versus 24% for gas.
- The average break-even oil price for delayed greenfield projects is $62/bbl.
Cost deflation. Angus Rodger, principal analyst of upstream research for Wood Mackenzie, noted in the report that “one reason we are seeing a growing list of delayed projects is cost deflation, or the need for costs to fall more to stimulate investment. That accounts for the highest number of development delays in deep water, where the combination of insufficient cost deflation and significant up-front capital spending has discouraged companies from greenfield investment in the sector.” The bottom line is that costs have got to fall even more than they have, to give the industry a chance to get back to work, especially in the deepwater sector. The good news is that cost reduction in deep water is picking up, according to a Jan. 11 report by IHS Energy.
The associate director of the IHS Energy Global Deepwater and Growth Plays service, Harshal Parikh, notes in the report that several areas of key reductions will help ensure a healthy recovery for companies that weather the current crisis. Among these are steel costs, drilling rig expenses and subsea equipment costs.
- Steel prices have been trending downward since 2011, with price declines accelerating in third-quarter 2015 (declining 7% versus the previous quarter). The-larger-than anticipated quarterly fall in steel prices was due to lower global demand and overproduction by China. IHS’s steel pricing and purchasing team does not expect the steel supply/demand imbalance to be solved in the near future.
- The report notes that, since 2012, new dayrates for ultra-deepwater rigs (5,000 ft+) have fallen approximately 35%, while dayrates for deepwater rigs (1,000 ft+) are 28% lower than fourth-quarter 2014.
- Subsea equipment prices have fallen approximately 18%, compared with fourth-quarter 2015.
Similar declines have been seen across the board, from bulk materials to fabrication yards. Particularly hard-hit has been the offshore supply boat industry. Dayrates for smaller vessels (less than 2,000 dwt) have fallen about 50% in the last year, with larger vessels dropping 23% to 45%, depending on size and capability, in the same period. The cost declines are tragic. They have been managed, primarily, by massive layoffs of personnel, facilities and equipment. But, reading the IHS report offers some hope that they will be beneficial, as the situation begins to turn around.
The forecast reductions in the IHS report are “largely dependent on a project’s forecast onstream date, and where the project is in its construction cycle.” With the steep fall in capital cost over the last year, projects that started in this period, or were contracted in this period, stand to benefit the most from the low-price environment. For new-source capital projects in deep water, the largest capital cost reductions will occur between 2017 and 2021. For projects coming online after 2021 (most not yet sanctioned) the construction cycle begins in 2018 or after, leading to smaller capital cost reductions. Large deepwater projects in Brazil and the Gulf of Mexico, starting production in the 2017-2021 period, are predicted to be the largest beneficiaries of the cost downturn. But for all deepwater projects, the low-cost environment will support activity at lower price levels, somewhat hastening the return to normalcy.
Low prices everywhere. If the low oil prices depress you, don’t take it personally. This industry is one of many suffering from low commodity prices. You could be in the sugar industry. Indeed, U.S. raw and wholesale sugar prices fell more than 50% from 2010 to 2013, due to record imports of subsidized Mexican sugar. Like sugar in your coffee? Coffee should be cheaper also. The U.S. price of a kilogram of coffee fell from $4.967 in October 2014 to $3.262 in November 2015, a 35% drop in a little over a year. But, let’s move closer to home. We are, essentially, a mining industry. Like us, other mining industries have taken it on the chin. Take silver, which fell from $40/oz in March 2011 to $14/oz in January 2016, a decline of 65%. Silver’s all-time high was $107.25/oz in January 1980.
How about copper? It traded at $2.93/lb in May 2015, but had fallen to $1.99 in January, a 33% loss in just six months. Platinum faired a bit better, but not by much. The price in November 2015 stood at $1,016/oz. By January, it had fallen to $819/oz, a decline of approximately 20% in just over two months.
I don’t mean to make light of our current situation with this analysis, but three things come to mind: First, we obviously are not alone, although our price fall has been more dramatic than most. Second, while we have obviously overproduced, creating a glut of oil, we are not the only culprits. A slowing economy, particularly in China, has stifled demand growth. And, finally, lowering the cost structure will significantly aid, and speed, recovery—when it happens. 
