Opportunities For Offshore Oil And Gas Contracting

October 2012, Vol. 239 No. 10

John Westwood, Chairman, Douglas-Westwood Limited

It is estimated by Barclay’s Capital in a recent industry survey that nearly $600 billion will be spent by oil and gas exploration and production companies in 2012 (an increase of 10% over 2011). One reason is that the oil industry is mature which is reflected by the rising costs. From 1995-2004, $2.4 trillion of capital expenditure resulted in an increase of global oil production of 12.3 MMbpd; in the following six years, 2005-2010, despite the same spend oil production fell by 0.2 MMbpd.

Natural gas is a different subject; it is available in abundance but often very distant from the major end-user markets of Europe and Southeast Asia. Transcontinental transportation either by pipeline or LNG is very expensive, resulting in European gas being four times U.S. prices and Japanese six times.

A very large proportion of oil and gas E&P spend flows down the supply chain into the offshore contractors and service companies. As orders grow, industry prices will surge to new highs and could ultimately threaten the economics of some field development projects.

The Hunt Is On
A key factor in the overall spend increase is the oil price which is at its highest level since records began at the outbreak of the U.S. Civil War in 1861. In 2011 Brent crude averaged $111 – up 13% over 2010. Although the OECD economies’ oil demand is fairly flat or declining, growth is seen in the emerging economies such as China; however, OECD inventories are at their lowest since 2008.

Douglas-Westwood’s research indicates eight of the world’s top 11 oil producers may have passed peak output and the hunt for new production is on. International activity has seen continuing growth over a number of years – the Barclay’s survey shows that 73% of E&P expenditure will be outside the U.S. One major reason for this long-term trend is the increasing focus of E&P dollars offshore.

Worldwide, not only onshore oil reserves, but offshore shallow-water reserves are also depleting dramatically; the fall in production of the U.S. Gulf of Mexico and further south offshore Mexico is well-recognized. In the North Sea, oil production peaked around 2000; UK production was down a further 18% in 2011 and Norwegian 5%. This affects operating costs as each marginal barrel becomes more expensive and will require more equipment and services to extract. The impact of production decline offshore UK is a case in point; a recent survey by the industry trade body UK Oil & Gas found that field operating costs per barrel rose by 25% in 2011 and are expected to rise another 4% in 2012.

So, the drive is into deepwater, which is one of the few remaining places where oil majors can still hope to find a significant field. And after the spending slow-down following the economic crash of 2008-09 the offshore E&P players also have a lot of catching up to do.

Existing and planned offshore activity is rapidly gobbling up contractor capacity worldwide and in some sectors orders are hitting new records, backlogs are growing and prices will follow.

Deepwater Surge
The last edition of Douglas-Westwood’s ‘The World Deepwater Report’ forecasts that global spend in the deepwater sector will exceed $200 billion over the next five years with Brazil taking 34% as exploitation of Petrobras’s huge pre-salt play begins firing up an international scramble to contract the top performing deepwater assets ranging from pipelay vessels and floating production systems to drilling rigs. In the Gulf of Mexico activity is resuming following the Deepwater Horizon tragedy and in the Norwegian arctic Barents Sea Statoil is making new discoveries.

In the period to 2016, more than $72 billion will be spent on drilling development wells in deepwater fields. All of this is affecting rig demand. In 2011 worldwide orders for new-build offshore mobile drilling rigs totaled 81, the highest number recorded since 1980 (when oil prices averaged $97/bbl).

Brazil’s pre-salt play has been estimated to hold 10-20 billion barrels and, as every geology student knows, South America and Africa was once the same continent, so it came as no great surprise when both Maersk and Cobalt Energy announced West African pre-salt discoveries in 2012.

The offshore contracting world continues to evolve to meet the needs of these frontier areas. Each opportunity brings with it unique challenges, whether it is working in ultra-deep water depths, dealing with strict local content requirements or handling the environmental and logistical challenges of working in the Arctic. We have seen contractors move rapidly to establish local presence and order new equipment and vessels to tackle the changing physical and business environments they encounter.

Floating Production
The annual construction market for new-build floating production systems (FPSOs, FPSSs, Spars and TLPs) bottomed out in 2010 at about $6 billion but is now set to grow strongly with 2012-16 capex on 134 installations to total $68 billion – and there is more to come. Our databases already show a further 200 installation prospects beyond 2016, illustrating the huge opportunity for both re-deployments and new-build units.
Over the past few years the major development has been the increasing share of the market being taken by leased FPSOs. A company such as Petrobras could typically contract a new-build FPSO for an initial seven-year period with a series of optional one-year extensions.

There are several players among the leasing contractors and in our view there is a good opportunity for consolidation. This situation has occurred to the expansion in the number of contractors created in the last industry up-cycle when financial sponsors were lending freely to new ventures, often with no firm contracts and with speculative hull build programs or part-finished ‘generic FPSO’ designs.

In the downturn in 2009 these new entrants inevitably suffered, some disappeared altogether and others have been acquired and absorbed into larger firms. Vessel utilization remains an important issue and we are tracking some 19 vessels that are presently without contract. However, overall FPS utilization is at 93% which remains little changed over the past 10 months.

Subsea Opportunities
Some 4,000 subsea wells have been completed to date and the drive into deeper waters will greatly increase numbers. Together with the associated flowlines, control lines, templates and manifolds these create a business opportunity for hardware suppliers probably exceeding $150 billion over the next five years. Considerable numbers of additional vessels will be required to install, inspect and maintain all this subsea hardware and $20 billion will need to be spent in subsea inspection repair and maintenance. Furthermore, new technologies such as subsea processing are emerging into commercial reality – E&P companies likely to spend $2.6 billion on subsea processing hardware.

Equipment contractors have seen backlogs building again throughout 2011 and toward the end of the year it was interesting to note that one of the major subsea vendors was reporting in an update that engineering resource/capacity was an operational issue. Capacity constraints in this industry are fundamentally related to people – the industry has addressed many of the ‘hardware’-related issues in the last up-cycle but the availability of skilled and experienced engineers and project managers is not a problem that can be solved overnight.

All offshore installations have a finite lifespan and ultimately create business opportunities for the contracting community. Although many platforms are removed from the Gulf of Mexico, the huge structures of the North Sea represent a challenge on a completely different scale as some are the largest objects ever moved by man and were designed with little thought to their ultimate removal.

Factors such as oil and gas prices, fiscal regimes and the potential for using an existing platform as a hub for tying back surrounding small fields, impact strongly on the point at which the economic end of life is declared. However, removal is ultimately required.
Our recent ‘North Sea Offshore Decommissioning Market Report’ shows that across the region more than 478 offshore platforms and 7,888 wells will require decommissioning in the period to 2041. This involves the removal of some four million tons of steel and other materials. It is anticipated that several hundred subsea wells will need to be plugged and abandoned; and manifolds, flowlines, pipelines and umbilicals emptied of hydrocarbons before being disposed of onshore.

This is without a doubt a major opportunity for vessel operators, well service companies and dedicated yards. The next 30 years will see enormous demand for the services of such supply chain players which will generate a large number of much-needed of jobs in Denmark, Netherlands, Norway, Ireland and the UK.

Our lowest cost estimate for this decommissioning of $65 billion assumes a step change in offshore lifting technology and the development of Super Heavy Lift Vessels (SLVs) that are capable of lifting upwards of 15,000 tons. Using existing methodology of offshore deconstruction and smaller lift vessels would result in a higher cost, some $76 billion.

An Arctic Future
The Arctic is commercially heating up. A vast hydrocarbon resource is believed to exist with the USGS expecting the region to hold 13% world’s undiscovered oil and 30% of the gas and some 80% of these are likely to be offshore. In Alaska a prospective expenditure of more than $30 billion is partly driven by the growing need to refill the Trans-Alaska pipeline. LNG plants in Alaska and Canada continue to be discussed.
Off arctic Canada Statoil has made finds. Drilling off western Greenland has produced nothing yet, but new eastern blocks are being offered in 2012. Iceland is also expected to offer acreage.

Most significantly, Russia and Norway have settled their dispute over their Barents Sea border and promising finds are being made. In the words of the Norwegian Foreign Minister Jonas Gahr Stoere, “It is the project of a generation” which offers a continuity of spend for the offshore contractor community. The challenges of operating in this environment and in deepwater are considerable and with it the cost implications.

Without doubt the greatest challenge facing E&P companies and their contractors alike is people. Despite the impact of the 2009 financial downturn the major oilfield service companies grew their headcount by 67% between 2006-10. The offshore industry is again seeing strong growth and with it an increasing need for staff – some believe a further 12% in 2012; it was reported Halliburton is expected to hire 5,000 engineers and geologists worldwide and FMC to hire 240 in the UK alone.

The other element of the people problem is the so-called ‘Great Crew Change’. An older workforce is now of retirement age and will have to be replaced. The problem of doing this is increased by many developed countries’ drift away from engineering and manufacturing and the failure of the education system to produce individuals with the requisite skills to enter the workforce.

So in addition to higher prices for hardware, E&P activities are likely to face major personnel cost increases in some sectors as highly experienced people become increasingly scarce. In some cases there will undoubtedly be a continued push to use outsourced engineering man-hours based in lower-cost locations with well-educated workforces.

We are now well into the next E&P up-cycle and shortages of major exploration and construction assets, specialized hardware manufacturing capacity and skilled human resources are continuing to push prices higher, almost a repeat of the effects of the last oil price boom. Offshore contracting, manufacturing and services companies are seeing a surge of new business and could again financially out-perform their E&P company client base.

As with any other cyclical sector careful due diligence is required in selection of contractor and sector investment targets. The last cycle showed that well-financed companies were able to make handsome profits on the upslope and then cherry-pick acquisitions from among the corporate debris of over-leveraged companies that failed on the down cycle. Such financially well-managed firms have entered this latest cycle from positions of even greater strength.

So what could go wrong? It is external factors that affect oil and gas consumption and consequently the whole E&P sector and its supply chain. However, unless we have complete financial meltdown in Europe, 2012 should be another great year for the offshore contracting industry.

• Global 2012 E&P Spending Outlook. Barclays Capital (Dec 2011)
• Oil & Gas UK 2012 Activity Survey. Oil & Gas UK (2012)
• The World Deepwater Market Forecast 2012-2016. Douglas-Westwood (2012)
• The World Floating Production Market Forecast 2012-2016. Douglas-Westwood (2012)
• The North Sea Offshore Decommissioning Market Report. Deloitte & Douglas-Westwood (2012)

The Author
John Westwood
has more than 40 years’ experience of the offshore industries worldwide. From origins in North Sea subsea contracting he has founded four companies in sectors ranging from underwater technology to business research. In 1990 he formed energy business advisers Douglas-Westwood where he is now chairman.

Originally published in Exploration & Production, volume 10 issue 1.