2018's challenges for oil and gas

Oil and gas rig EW
By Robert Outram

10 May 2018

What does the year hold for the oil and gas industry? Robert Outram hears from a range of experts as they read the runes.

The CA magazine asked a panel of oil and gas-industry experts how 2018 is looking and whether the sector has learned anything from its recent difficulties.

What are the main challenges for you and your organisation in 2018?

Peter Rose: Our main challenge is to remain competitive and deliver a competitively priced, quality, reliable product which is technologically superior and on time. Our balance sheet/cash flows need to cope with extended credit taken by our customers and inflationary pressures on wage and raw-material costs. In time, if the market continues to improve we will, along with our peers, be required to rehire engineers to run production.

Stuart Bannerman: M2 Subsea is a relatively new service entity (15 months since starting up), so we are different from the established entities. Our challenges are establishing track record and obtaining enabling agreements in a market where supply exceeds demand.

Clients are delaying contract awards until the last possible moment and although market activity seems to be improving it is still difficult to judge to what extent. Pricing levels remain flat and it is reasonable to expect some degree of cost pressure as the market recovers (salaries in particular), so further margin erosion is likely in the near term.

More than one billion people still have no electricity and global energy demand is expected to double in the next 100 years.

William Ross: Diversifying services offerings from pure oil and gas exploration and development [is our challenge]. With this sector in a slump, it is important for businesses to focus on future trends and become adept at competing in emerging opportunities. Much of the oil and gas engineering talent can be applied to growing infrastructure projects such as renewable energy, electricity and telecommunications, and it is important to develop the skills to service these sectors.

Jim Robertson: One big challenge is to explain to stakeholders that, according to the International Energy Agency, it is “too early to write the obituary of oil”. More than one billion people still have no electricity and global energy demand is expected to double in the next 100 years.

Although about 1% of the world’s vehicles are now electric, by 2035 that only rises to about 20%. Even with a bigger shift to electric vehicles, the energy intensity of fossil fuels will still be needed to power planes and ships. Renewable energy sources such as wind, solar and biofuels, although increasingly important, cannot plug this widening gap between demand and supply.

What steps has your organisation taken to become more efficient or to cut costs?

William Ross: We have cut all discretionary spending while focusing payroll costs to service sectors of the economy that are growing.

Alister Cowan: Over the past three years we have increased production by 30% and reduced total operating costs by 5% by increasing reliability, increasing productivity and making selective value-accretive acquisitions. Cost-reduction efforts have focused on streamlining or eliminating processes, eliminating non-essential/non-value-added work. We are holding the line but not reducing employee compensation, working with suppliers to reduce their costs of supplying and implementing automation.

Peter Rose: We have reduced our workforce, introduced lean manufacturing and continuous-improvement initiatives, and equipped our facilities with more efficient – and in some cases robotic – manufacturing processes. A number of our facilities and distribution points have been closed to save additional costs.

More collaboration between operators and the service sector [has] seen the development of new contractual models, such as long-term rig-sharing agreements and strategic alliances, to focus on cost efficiency.

Clare Munro: We have seen pressure on margins across the whole of the supply chain because of the downturn in the market. On a positive note, this has led to more collaboration between operators and the service sector, and seen the development of new contractual models, such as long-term rig-sharing agreements and strategic alliances, to focus on cost efficiency. Given that these are long-term contractual arrangements these cost efficiencies should survive the anticipated upturn in activity without significant increase in cost, hence delivering real value to all parties.

Jim Robertson: The industry has cut costs by nearly 40%. In the short term, planned capital expenditure was delayed to the extent possible, operating costs were cut by competitive tendering, discretionary budget items were eliminated and much internal service delivery was outsourced or moved to affiliates in lower-cost countries. At the longer-term strategic level, companies sold off or closed down assets that were uneconomic.

The strategic portfolio choices and relocation of services can be thought of as fundamental but, with activity picking up again, it’s moving from a buyer’s market back to a seller’s market as regards drilling services, and this is driving operating costs up again.

Has the industry as a whole learned the lessons of 2014-18?

Alan Barr: Costs have been cut, but the test is what happens when activity levels go up again? Have real efficiency gains been made, or have operators deferred costs by simply deferring activity?

Jim Robertson: This industry is very resilient. It knows how to respond to changes in commodity prices. One lesson is that having shale oil and gas in the portfolio helps with speed of response. It is much easier to turn the taps on and off in rural Texas than it is in a deep-water development off the coast of Brazil.

It’s not the first time prices have dropped and it won’t be the last. Having been in this business for more than 35 years, I’m not sure there are very many new lessons to be learned.

If anything, the key lesson is to maintain an organisation with a flexible cost structure that can respond quickly to changing circumstances.

Stuart Bannerman: We will see. We have many new operators acquiring assets on the UK continental shelf, some lean mid-size operators and a few consolidations among major contractors. Much will depend on the level at which the price of oil stabilises.

William Ross: The risks inherent from global geopolitical events have always hampered the oil and gas sector. What was different this time was the speed with which this precipitated demand. If anything, the key lesson is to maintain an organisation with a flexible cost structure that can respond quickly to changing circumstances. We likely will see less fixed overhead and the increased use of contract work to sustain non-core operations.

Alister Cowan: It has been a traumatic experience for the industry and those who were not prepared or were slow to adjust have not survived. Those who were have prospered. Shareholders are today looking for return on capital, free cash-flow generation and increasing cash returns. The industry seems to be heeding that message – but I fear that, as the oil price climbs, both the industry and shareholders will abandon this focus and seek production growth and sacrifice return on capital and free cash-flow discipline.

Peter Rose: Significant expense has been removed from the industry cost base. However, when commodity prices increase/improve this will probably lead to inflationary pressures on pricing across the industry, and cost/spend disciplines and controls experienced in the downturn may be forgotten.

What is the outlook for the sector?

Clare Munro: While we are seeing some recovery in outlook among operators, the sense is that 2018 could be another tough year for the service sector, with recovery hopefully picking up during 2019.

Tax reform could encourage further activity, by making it more feasible to use legacy tax assets and offset the cost of decommissioning in future.

Alan Barr: It’s been a tough few years. Recently we’ve seen investment in areas such as west of Shetland, but oil at $70 is still placing a cap on activity. Tax reform could encourage further activity, by making it more feasible to use legacy tax assets and offset the cost of decommissioning in future. It’s not a silver bullet but it could unlock some large transactions.

Jim Robertson: In a downturn, service industry companies such as Schlumberger and Halliburton usually feel the pain before operator companies like Shell and BP, as discretionary drilling activity is cut. Conversely, in the recovery that we’re now seeing, demand for drilling rigs is rising, pushing up prices, which immediately improves the profits of the drillers at the expense of the operators, who will only see the benefit when additional production comes through.

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