Outlook for oilfield services

Cautious optimism

Outlook for oilfield services

March 2014

Outlook for oilfield services Cautious optimism 2

Where are we now?

1. Positive factor: Short and long-term crude oil prices consistently above $80/barrel

• Long-term expectations of hydrocarbon prices drive the level of

oil and gas (O&G) operator capital spending.

• This, in turn, determines their need for oilfield services.

• Based on cost curve analysis, most industry specialists argue

that the market balance currently is somewhere between $80

and $100 per barrel.

• If crude oil prices were to drop below $80 per barrel, or where

the marginal cost of producing a barrel of oil becomes too

high for a sustained period, operators would look to reduce

production and delay or abandon planned projects.

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Source: DataStream

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Figure 1. Philadelphia Stock Exchange oil services index (OSX) relative to West Texas Intermediate (WTI) and the New York Stock Exchange All Shares index (NYSE ALL)

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Where are we now?

2. Positive factor: Robust future demand for oil and gas continues to drive spending on oilfield services

• As Figure 2 shows, demand for hydrocarbons is expected to

increase.

• In the UK, Department of Energy and Climate Change

projections show that O&G will continue to make up over 70

per cent of the UK’s primary energy mix to 2030.

• An increasing portion of projects will be located in greater

depths and in new geological, geographical and technical

frontiers. These will drive demand for specialist equipment

and skills.

• At the same time, the O&G industry faces the rapid decline of

mature assets.

Million tonnes of oil equivalent

Source: BP Energy Outlook to 2035

Figure 2. Global energy consumption by fuel

Renewables Hydroelectricity Nuclear Coal Natural Gas Oil

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Where are we now?

3. Positive factor: A customer with a growing appetite – the continued rise of the National Oil Company

• Customer base is slowly shifting from International Oil Companies (IOCs) to National Oil Companies (NOCs).

• NOCs are growing in size, number and influence: NOCs and their host governments today control some 80 per cent of the world’s proven and probable oil reserves.

• NOCs are the biggest spenders in terms of capital expenditure: The ‘Barclays Supermajors’ list shows that of the 15 O&G operators that spend over $15 billion globally, eight are NOCs. Their capital spending is expected to grow faster internationally

in 2014 than that of the IOCs during the same period.

• NOCs also present a challenge: IOCs and most independent

operators are European or North American and share common

cultures, and technical and engineering skills with oilfield

services (OFS) companies. Most NOCs have widely differing

technical expertise and strategic objectives. Some NOCs have

also become more active in developing assets or investing in

research and development.


Where are we now?

4. Positive factor: The impact of the unconventional revolution continues although at a slower pace

• The shale revolution is ‘dislodging’ part of the O&G supply

chain. It also has implications for the downstream and

midstream sectors, it is helping revive the US petrochemicals

industry and is paving the way for the renaissance of the US

manufacturing sector.

• Shale is changing the way many O&G and OFS companies think

about their asset portfolios. Investments in Canadian oil sands

now look less attractive.

• Many OFS companies benefited from early stage involvement in

US shale gas developments. However, a number of interviewees

now believe that the shale gas boom has passed its peak and

are not reallocating resources with the same magnitude that

they once did.

$ per thousand cubic feet Number of rigs

Source: US Energy Information Administration and Baker Hughes North America Rotary Rig Count

Archive, US Monthly averages by state

Figure 3. US natural gas industrial price and US monthly average rig count

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Where are we now?

5. Positive factor: Financing

• Most of the top global and mid-tier companies interviewed

indicated that access to funding has not been a significant issue.

Therefore, these companies are focusing on getting the best

deal from the wide range of financial products on offer.

• Smaller companies more often turned to private equity rather

than sourcing funding from banks or the financial market. This,

also, was available for most companies Deloitte interviewed.

• In general, investors seem to be interested in the OFS sector.

This is because they can access the O&G sector without being

exposed to the volatility that smaller O&G exploration and

production companies face.


Where are we now?

6. Challenge: O&G operator focus on cost control

• Figure 4 shows a steady increase in project costs.

• Cost rises are due to majors having to move to challenging and

politically riskier parts of the world, higher employment costs,

increasing project complexity and shareholders expectations of

dividend payments.

• The combination of these factors forces O&G operators to cut

capital and operating expenditure. A number of oil majors have

all recently announced that they will reduce capital spending in

2014, compared with 2013.

• The shift in O&G companies’ attitudes towards cost reduction

provides OFS companies with a new focus.

Source: Bernstein Energy, Financial Times and DataStream

Figure 4. Brent crude oil price ($ per barrel) and marginal cost of production

($ per barrel)

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Where are we now?

7. Challenge: Talent shortages to continue

• Skilled talent shortages is one of the most often cited factors

that has a negative impact on an OFS company’s performance.

• Companies are concerned that once engineers with 20-30 years’

experience retire, a gap will develop for staff with experience

in leading large and complex projects. This age group is also

important for training the next generation of engineers.

• Companies are spending more on recruitment and training,

have established training programmes and aim to set up

apprenticeship programmes. Some are recruiting from regions

with lower salary expectations, others are looking at sectors

such as manufacturing or the military.

Percentage of total membership

Source: Society of Petroleum Engineers

Figure 5. Society of Petroleum Engineers membership by age range

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Where are we now?

8. Challenge: Oil & Gas industry’s cautious attitude to innovation

• There is an increasing need for innovative technologies

to reduce the cost of developing resources and increase

production from declining fields.

• But companies are becoming more risk averse as projects are

getting more complex and capital intensive. Shareholders also

support this and are cautious of the potential short-term cost

increases associated with the introduction of new technologies.

• The O&G industry is slower than other sectors to adopt new

technologies. The UKCS is considered particularly slow in this

respect, or as one respondent aptly put it: “The UK rushes to be

second”.

• While the UK industry and research councils promote deployment

of existing technology and development of new ones, this activity

has to be more centrally coordinated, focused and accelerated.

There is a need for more collaboration between O&G operators,

OFS companies, academia and the regulator.


Where are we now?

9. Challenge: Regulatory environment

• Regulatory certainty: A must. Most OFS interviewees

commented on the importance of a stable, predictable

regulatory framework and tax regime. Some argued that

recent tax changes made the UK system more complicated

and are eroding the industry’s trust in the regulator.

• Health and safety regulations: A positive differentiator?

Companies believe that strict Health, Safety and Environmental

(HSE) regulations are both necessary and useful for the sector.

Some interviewees felt that being able to navigate complex

HSE regulatory systems should be viewed as a competitive

advantage.

• Increasing local content requirements. International OFS

companies interviewed believe that increasing pressure from

governments to employ a larger proportion of their workforce

locally can significantly reduce the attractiveness of projects

where a skilled workforce is not readily available


What is next?

9. Challenge: Regulatory environment

OFS companies have mixed views of US shale opportunities. Some have taken advantage of the shale boom, but they all highlighted that the competition is intense. More opportunities could exist in the downstream, midstream and petrochemicals sectors.

Many consider the Middle East politically risky, while Brazil’s complex regulatory system deters others.

While many OFS companies have been successful in Russia, China and India, some consider these countries as low priority due to high barriers to entry, political risks and transparency issues.

The mature markets of the UK and Norwegian Continental Shelves, including oil fields west of the Shetland Islands,still provide substantial opportunities.

OFS companies are interested in deepwater in Nigeria, Angola and Gabon in West Africa, Zambia, Mozambique and Tanzania in East Africa and the Falkland Islands.

Southeast Asia, particularly Malaysian and Indonesian deepwater are considered attractive.

Key:

Attractive market

Mixed views

“Not a priority” market

Figure 6. World map of opportunities


What is next?

Mergers and acquisitions: Further consolidation on the cards

• All interviewees expect that the strong M&A activity in the

OFS sector will continue in the near future.

• The main driver behind acquisitions continues to be vertical

integration.

• The second most popular driver interviewees mentioned was

access to new international markets.

• Interviewees noted a new trend of small companies being

acquired for their attractive pipeline of orders.

• The US unconventional shale boom has resulted in a surge in

the number of small companies offering services. Many believe

that there are too many companies now in the sector and this

could lead to consolidation in the near future.

• The recent profit warnings among both small and mid-tier

companies were mostly due to lost or postponed contracts.

These had a negative impact on share prices and could

accelerate the speed of M&A activity in 2014.


What is next?

Limiting factors in the short and long term

Short-term limiting factors

• Deteriorating market conditions

• Political risk

• Complex regulatory environment

• Brand credibility

• Competition from Southeast Asian countries

• Acceptability of technology

• Technological breakthroughs

• ‘Black swan’-like events

Long-term limiting factors

• Lack of a route to customers

• Lack of a regulatory framework to develop shale resources

• Demand side efficiencies


Looking further ahead

What will the OFS sector of the future look like?

• More of the same

• More technology and automation

• More efficiency

• More risks taken

• More new forms of collaboration and ownership



What will the successful company of the future look like?

• Global... yet local

• Diversified… yet focused on core functions

• A good global citizen and a good employer



Long-term opportunities

• Deepwater

• Decommissioning

• Frontier regions

• Arctic

• Unconventional resources worldwide


Contacts

Julian SmallUK Leader – Energy & Resources Global Leader – Oil & Gas Tax 020 7007 [email protected] David PatersonUK Sector Leader – Oil & Gas 020 7007 [email protected] Jon HughesPartner – Corporate Finance 020 7007 [email protected]

Derek HendersonManaging Partner – Aberdeen 01224 [email protected] Graeme SheilsPartner – Audit 01224 [email protected] Shaun ReynoldsDirector – Corporate Finance01224 [email protected] Author Netti FarkasManager – Insight020 7303 [email protected]

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Deloitte LLP is the United Kingdom member firm of DTTL.

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Outlook for oilfield services

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