The oil price has made a slow, yet steady, return. The analysts who talk about $20 barrels are now few and far between and they don’t get the media attention they once did. Al-Falih, Saudi oil minister, speaking at an OPEC meeting last week, stated that the price of oil was acceptable is it could stay between $50 and $60. The panic, it would seem, is over.
But are we really out of the woods?
Probably not. Saudi Arabia’s strategy of forcing out high-cost producers has, and continues, to work. In fact, the rig count in the US (where Shale producers have been buckling under the strain of tighter profit margins) is down to 316, the lowest it has been in decades. Furthermore, Saudi has lowered the price of its oil, directly targeting Iranian oil exports. This sort of strategy allows for competition to be swallowed up and spat back out. But oil producers aren’t the only ones facing the dog-eat-dog reality of today’s oil market.
In fact, when compared to Oilfield Service (OFS) companies, upstream companies have it easy. The OFS industry has suffered the worst since the sudden fall of the oil price in late 2014. OFS companies thrive on drilling activities and those have been steadily decreasing over the last year and a half. The outlook up through 2017 doesn’t look positive either, with analysts predicting that skittish oil companies will limit their exploratory projects and cap drilling, further impacting on the OFS industry. A May report from Moody’s Investors Service showed that volatile energy prices and low spending from the E&P segment of the industry could push EBITDA for OFS down by as much as 30 to 40% in 2016. “The OFS industry is facing the worst downturn since the early 1980s after an unprecedented drop in global oil and North American natural gas prices,” Moody’s AVP-Analyst Sajjad Alam said in a statement. “Drilling activity has plummeted in most oil producing regions, curbing demand for oilfield support services.”
OFS companies survive off of drilling. They do not own production assets, so they can’t survive off of minimal margins. OFS companies need to be securing the large contracts that feed the industry. These services depend on drilling, and oil companies have significantly reduced their drilling activities. To illustrate this, its best to look at some of the major rig/contract cancellations to take place recently.
In February ExxonMobil cancelled a contract with Transocean. Murphy Oil similarly terminated a contract with Transocean for a rig it had originally wanted for use in the Gulf of Mexico.
Statoil cancelled its contract with Seadrill in May. Seadrill lost another contract with ExxonMobil for a drillship that was planned to be used in the Gulf of Guinea.
Hercules Offshore has been hit by Saudi Aramco when the oil company forced Hercules to accept lower rates for a second time. Saudi Aramco refused to pay $67,000 day rate, pushing Hercules down to $63,650 instead. This came after Aramco communicated its desire to cancel the contract altogether in 2015. The cut backs in activity have hit Hercules particularly hard – the company has announced its intention to again file for bankruptcy.
Oil companies lower “breakeven” costs
Oil companies have done everything to increase their profit margins. This has meant that the industry has had to cut a lot of fat, reduce staff, and scrutinise every area where operational efficiency can be improved. Oil companies have also been quite successful at squeezing the most out of OFS companies, forcing service providers to lower the cost of rig contracts, as well as for key engineering services for casing, completions, inspection, maintenance and numerous other services.
The CEO of Schlumberger commented on this, stating that the “savings” do not really add up to real reductions in the cost of producing a barrel of oil: “The apparent cost reductions seen by the operators over the past 18 months are not linked to a general improvement in efficiency in the service industry. They are simply a result of service-pricing concessions as activity levels have dropped by 40-50 percent, and most service companies are now fighting for survival with both negative earnings and cash flow,” Schlumberger CEO Paul Kibsgaard said.
In light of this, many – including Schlumberger – are calling for a new model, one that allows for projects to be delivered on time, on budget and able to meet production targets. Any new model should draw on closer collaboration between OFS companies and oil companies. Ideally OFS companies should participate in the planning stage, instead of being brought in at a later point and asked to fulfil a predefined purpose. This is inefficient.
Research shows that if OFS companies and oil companies could work closer together at the planning phase, they would be able to strategize their operations and look at local service providers to help meet project timelines and targets. Effective use of local suppliers can reduce time and costs, but this does require the ongoing support of oil companies and OFS companies working closely together to find and utilise local supply chains.