A Less Volatile Environment
The sharp decline in oil and gas (O&G) prices since 2014 has put pressure on businesses to reduce costs and reassess investments. The latest report from DNV GL shows that O&G companies are seeking to rebalance business portfolios and reorganise for a new era of production, with a focus on standardisation, digitalisation and collaboration.
Confidence in the O&G sector has stabilised for now, but few expect any significant recovery in 2017, and the low oil price environment is still revealing company wounds. Statoil recently reported a 2016 Q4 loss of $2.8bn.
Cost Management In a Low Price World
In January 2016, oil prices fell below $30 a barrel. The downturn followed a period of high spending in the O&G industry. The response from the industry was unprecedented, with cost management becoming the top management priority through 2016, and continuing into 2017. However, there is a difference between the initial reaction, which Elisabeth Tørstad of DNV GL has characterised as “intense and painful short-term cost-cutting measures” and longer-term permanent shift we are now seeing. While there is a general feeling that the ‘easy oil’ has already been exploited, industry professionals are aware that oil production has not become any easier.
The cost-efficiency drive has been two-pronged: covering activity and spending. In terms of activity, we have seen organisational restructuring as high-cost production is taken offline or reduced. The other part of the equation is spending. To reduce operational expenditure (OPEX) and Improve efficiency from existing assets. Old production techniques are being ditched and replaced with new more efficient types of technology, often based on in-house innovation programmes. FX has also played a part in reducing costs, given the weakening of domestic currencies in most major producer countries.
Historically, when oil prices fell, companies would delay or cancel projects, reduce headcount and ask suppliers to cut their prices, hoping for a price recovery in the medium term. It is unlikely that the oil price will recover, but given the cost reductions achieved so far, many are hopeful that producers can economically meet demand at lower prices, of c$50/ barrel.
But many industry analysts looked beyond the negative number, focusing on the company’s positive outlook, which largely stems from Statoil’s cost-cutting and optimisation efforts. Bank UBS highlighted the firm’s “very impressive operational progress”.
One positive effect of cost pressures is that they have forced a new paradigm of industry collaboration. The existing partnerships between service companies and the operator communities, characterised in the past by prescriptive work orders and functional specifications are now focussed on innovation.
The Government is also engaging with the industry to look at ‘maximising economic recovery UK’ through MER UK and The Wood Report. Companies are lobbying harder than ever before to secure additional government support at UK and Scottish levels, though the Scottish Government has been accused of spending too much time on its independence agenda and neglecting industry issues.
A key part of cost-cutting is standardisation: the idea of using standardised solutions for similar projects. Grethe Moen, the CEO of Petoro, has called this “reducing costs one step at a time using familiar solutions, interfaces and work processes”. Likewise, Margareth Ovrum, Statoil’s executive VP for technology, projects and drilling, has said that “copy-paste is good for us”.
Opportunities are being created for major efficiency gains – across equipment and tool standardisation, technology sharing and knowledge sharing e.g. work on challenging basin geologies. There is also an ongoing commoditisation of components, removing the cost of bespoke manufacture.
Digitalisation will help to enhance operational efficiency, while allowing a greater focus on the end-user. The latest generation of specialist systems also reduces complexities around data and modelling. This trend is aided by industry groups and the government. Oil & Gas UK has issued new 2017 guidelines to simplify subsea developments, which it hopes will boost prospects for undeveloped “small pools” of exploitable resources.
Statoil and its partners have managed to reduce planned investment in the two phases of Johan Sverdrup offshore in Norway by 25-35% — partly by copying across 40% of the equipment specification from phase one to phase two. can be “copied” from phase 1. Oil produced in phase one is now expected to generate a profit even if oil prices fall below $20, while phase two is expected to break even at below $30.
Diversification and M&A
We expect increased industry consolidation in 2017, with M&A activity driven by diversification efforts, by companies looking beyond traditional O&G plays. Investments in renewables are popular as a shift in long-term business strategy, while gas power (including LNG) is shaping up to be increasingly important over the next ten years. CAPEX has dropped overall, but investments across the value chain to entrench existing positions and allow sustainable growth.
Tørstad commented that “despite the drawn-out recovery, investments are still being planned across the value chain. In 2017 we will see a broadening of business portfolios and consolidations for growth as a way of reorganising for the future”.
The Long Term Impact
Typically it will only take one to three years for existing contracts to expire and for renegotiated costs to filter through. The real danger of austerity is the long term impact. Large reductions in spending could lead to a gaping supply hole.
It is worth bearing in mind that the cost reduction has both structural and cyclical elements. Over the next few years, oil exploration companies will likely be dictating the terms to service companies. However, when the cycle shifts, service companies are unlikely to let upstream companies retain the profits from higher oil prices.
Thousands of highly trained O&G staff have been laid off in the last couple of years, and many of these have now left the industry. It is unlikely that they will return, resulting in a long-term skills shortages and higher operational costs as the industry recovers and the market rebalances.
Standardisation, digitalisation and collaboration can only go so far.