Julian Callanan, Dr. Roger Knight - Infield Systems
Following soon after hurricanes Gustav and Ike, just when Houston thought it had escaped relatively unscathed with the loss of 60 small and aging platforms, the biting winds of the credit crunch have started to hit, sending some highly leveraged companies into free fall, and posing questions of short- and medium-term profitability for others. Julian Callanan and Dr. Roger Knight of Infield Systems, London, look at what was a trying year for all those active in the Gulf of Mexico, and discuss the potential impact of these events, wonderingCui bono? – Who benefits?
The nature of a global financial crisis means all countries, and resultantly all industries, are exposed to the unsettling effects of the decay of economic confidence. This process has been particularly destabilizing for the offshore industry, as, intrinsically linked and, some would argue, in many ways precipitating the credit crunch, was the volatility of oil price over the last year. The fluctuations in this fundamental project sanction assumption have caused operators and contractors severe headaches. Yet, while OPEC now has taken further steps to reduce production in an attempt to arrest price decrease – a move which has historically always been successful if given enough time – the real problem for those active in the offshore industry has come from decreasing credit liquidity and its relationship to low oil price.
In many ways, the slowdown of inter-bank lending came at just the wrong time for the offshore industry. Global activity levels were at record highs, key industry health indicators, such as day rates for drilling rigs and charges for engineering services, also were up, and the general upwards hydrocarbon price movements before Christmas 2007, and certainly before the price spike of 2008, felt like it reflected these operating conditions. However, this general positive trend over many years, in tandem with the escalation towards $147/bbl, encouraged a raft of speculation by industry and finance alike in an increasingly optimistic and opportunistic series of moves. We started to see a growing speculator class of offshore actors, organizations which were securing large debt for projects without defined end users. Speculatively built FPSOs are one example.
While speculation always is present to some extent in any industry – we note for example recent plans to fill Suez Max tankers with oil and wait until prices rise before selling it – is the speculator type actors currently at the sharp end of the credit crunch, struggling to raise finance for the next project, and being hard pressed by creditors unwilling to write down further losses.
In an industry which is often perceived as “conservative,” there will be many not too disappointed to see speculative practitioners removed from the competition, hoping more broadly for a reset of prices in an industry which has witnessed general price inflation.
Some, however, will sympathize with the other group cruelly exposed to the global financial crisis, the small operator. Prolific in the Gulf of Mexico where shallow water plays are exploited by operators sometimes controlling a single wellhead platform, low oil and gas prices, after the spectre of lucrative high prices, are proving again to be troublesome.
In the opening two quarters of 2008, with many of the leading experts and many top-tier banks raising their expectations of oil price to the $200 – $250/bbl range by the end of 2009, the escalation of oil price to $147 perhaps felt like the beginning of a “golden commodities cycle,” where prices for hydrocarbon products would be driven upwards by scarcity, regardless of demand. All that was required from small independent operators was to squeeze out production for a long as possible, and watch the money roll in.
The accompanying map shows field depletion calculated solely for currently producing or future fields, taking into account total reserves and typical production rates. Shallower GoM waters have a greater collection of more highly depleted fields. This is no surprise given the age of offshore exploration in this region. However, the maturity of this region as a hydrocarbon extraction zone makes it more prone to the two-fold attack of the credit crunch: low oil prices mean that reserves are worth less and poor credit terms – in comparison to previously generous, less comprehensively secured loans – mean small operators with diminishing reserves are hard pressed. If field economics remain positive, many still lack access to a cash flow to extend field life by investment in enhanced recovery technology.
This process, as potentially uncomfortable as it is for the small independent operators, does mark a significant opportunity for the Majors. Here, we are talking about the integrated Super Majors, companies such as Chevron, ExxonMobil, BP, etc., who came to fruition through a string of high profile mergers and acquisitions at the last oil price slump at the end of the 1990s. With the price of oil since substantially lower, the integrated business model means some lost margin can be reclaimed at refining or at the pump. This leaves the Super Majors in a strong position while smaller independents are starting to struggle.
One potential conclusion of these two differing fortunes may be another spate of mergers and acquisitions as the Super Majors consolidate their positions relative to national oil companies, in the wider ongoing conflict to control global resources.
The extent of this process relies in many ways on the extent of the financial crisis. Whether it is just optimism surrounding the festive and New Year period or whether we have finally turned the corner, media coverage of the credit crunch has started to move away from the initial doom and gloom, with a spattering of analyst quotes now implying that perhaps “the worst is over.” Should oil prices stabilize, the Super Majors may stay clear of the smaller independents. Should the decline continue, the picture could be rather different.
With hurricanes causing physical destruction, and with an oil price spike followed by global economic collapse, 2008 has been a difficult year for many active in the GoM. With contextual developments such as the move towards the nationalization of resources, the continued press for reductions in carbon emissions, and a new president in the White House promising to open up coastal America to drillers, and secure “energy independence,” 2009 promises to be as challenging as any year yet known. Those who want to survive successfully will have to dig deep, in more ways than one.
Primarily for operators, but applicable for contractors also, three key attributes will help make the GoM successful in 2009. They are:
- Deep pockets. In the short to medium term it is pivotal to conduct business as free of cash flow limitations as possible. Being unable to pay off debts may make you an acquisition target, while under investing will leave you badly positioned to take advantage of any future upside. Here the Super Majors are at an advantage. The integrated business model insulates them from all the effects of a low per-barrel price. The profits gained during the oil price spike also should help.
- Deepwater. Ideally, as an operator you already have secured funding and will be working towards delivering major deepwater finds. In terms of largest reserves, and highest production rates, this is where the action is in the GoM. Failing this, without the cash flow to go it alone in deepwater, partnering in deepwater projects, such as at Independence Hub, exposes companies to the deepwater industry, while minimizing initial capex and risk.
- Deep drilling. Although rig rates are dropping from record levels, the most successful operators would have taken long-term contracts over the last two years, protecting them from price hikes, and increasing prices for rival companies. The new reserves are deeper than ever, in the Lower Tertiary or beyond, so conducting deepwater operations economically is pivotal to future success.
Some operators are more successful than others in adapting to changing global events, and this has resulted, strangely, in either business as usual, or total cancellation. Shell, for example, has pressed ahead with work around the Perdido host, setting a world water depth record in drilling and completing a subsea well 2,852 m (9,357 ft) below the water’s surface. Callon Petroleum, conversely, has been forced to suspend development of the deepwater Entrada field, Garden Banks block 782, citing rising costs and decreasing returns on commodity prices, which have declined to less than half of their levels since the Entrada development operations began in mid-2008. Helix Energy Solutions has been affected even more seriously, having to close down exploration and production operations, and sell all field assets to pay debt, repositioning the company focus instead on deepwater contracting. Meanwhile, Hess has galloped on with development of the Pony field, recently awarding an Intec/Worley Parsons joint venture a contract for the subsea system, TLP hull, and mooring pre-FEED, FEED, and execution support. Finally, in the deepwater Mississippi Canyon block 948, BP has made yet another discovery, dubbed Freedom, its third 2008 deepwater GoM discovery.
Ratio of platform, pipeline, and subsea capex in the Gulf of Mexico offshore Louisiana.
With project economics tightening, and with emerging concerns over profitability, technological savings, such as from subsea technology application, are set to become even more popular in 2009. The figure above demonstrates the ratio between pipeline capex, platform capex, and subsea capex for selected fields offshore Louisiana. Overall, the message is clear: Deepwater and subsea technologies are linked very closely. Those wishing to be successful in 2009 GoM operations would be well advised to gain exposure to at least one of these market segments.
Overall, we see both deepwater and subsea technology establishing themselves as key market growth segments for the GoM for the future. With many actors currently active in the Gulf, and with the high capex investment required to instigate deepwater operations and associated subsea expenditure, a period of low prices may force another round of merger and acquisition activity, which creates companies robust enough to cope with the increased pressures of deepwater exploration and production.
So,Cui Bono? We eagerly wait to see.
