Remaining competitive through the downturn is a tall order for some. Caitlin Shaw, of Quest Offshore Resources, examines how the exploration, drilling and subsea segments are expected to fare through 2017.
The global deepwater market is facing much the same challenges as the rest of the oil and gas industry during this severe downturn. Oil companies and supply chain members alike are working diligently to realize material solutions to current problems that will provide long-term results positively affecting the overall competitiveness of deepwater.
Offshore operators are enacting strategies aimed at adjusting cost structures in a “lower for longer” scenario, slashing near-term capital expenditure budgets and placing an elevated level of scrutiny on projects that have matured through early stage engineering activities that would naturally be approaching final investment decision and tendering activities in the near term.
While some projects have been deferred outright, some operators are returning to the drawing board. One such example is Noble Energy’s Leviathan project, where a transition from the long-held floating, production, storage and offloading vessel/subsea concept to a subsea tie-in to a host fixed platform on the Israeli continental shelf is expected to offer both a quicker path to first production as well as reduced capital outlays.
Quest Offshore has also noted that some operators are assessing phased developments at new Greenfield projects as a means to more effectively spread capital outlays over a greater period of time. For instance, Premier’s Falkland Island development of the Sea Lion field (OE: March 2016) and associated discoveries is projected to be phased over a longer time horizon, well into the next decade, compared to their initially larger concept focused on a tension leg platform.
The deepwater supply chain, the majority of which have experienced declining backlogs over the last year amid declining field development prospects, have looked toward collaborative approaches as a means to expand capabilities and employ new models aimed at arresting the increase to deepwater development costs noted in the years prior to the oil price downturn. Key focuses have often included earlier involvement in the project development process, such as conceptual and front-end engineering and design (FEED) studies, as well as an expanded and more total approach to offshore development activities from the manufacture of equipment through to offshore installation and even beyond into areas such as subsea well intervention.
Deepwater drilling outlook
Global deepwater drilling demand has experienced year-on-year decline since 2013 and has created an oversupply of floating drilling assets, which has led to idle and stacking trends not seen before.
New contracts for floating rigs are expected to remain very limited in 2016, resulting in an ever increasing number of idle units. Twenty six floating rigs have been stacked in Q1 2016, bringing the total stacked count to 123, of which 80% have been sidelined in just the past 12 months. Over 60% of the idle fleet remains in warm stack mode incurring costs that range from US$40,000-$100,000 per day. Nearly 50% of the stacked units are over 18 years old and will likely never work again. Nearly 20% are part of a dying 4th and 5th generation fleet that are being squeezed out of the market by an abundant supply of newer 6th generation units. Almost 40% of the stacked rigs are among the newest 6th and 7th generation fleet, which commanded day rates as high as $700,000 just two years ago.
Heavy emphasis is placed on strategic stacking of newer rigs in effort to keep the units in a semi-warm state at a reduced cost capable of rapid reactivation once the recovery begins. With another 42 rigs rolling off contract through 2016, drilling contractors will continue to be challenged with plummeting utilization forcing day rates down to near or below break-even (See Figure 2).
There are currently 260 floating rigs in marketed supply, of which 180 are under contract putting marketed utilization at 70%. Contractors could immediately increase marketed utilization to over 80% by retiring/cold stacking 41 older rigs that are currently warm stacked. Using supply levers to increase utilization will only alleviate some of the pressure, and with more rigs rolling off contract every quarter of this year, the effects could be temporary, but it is a measure that contractors have control over and could act on immediately.
Quest Offshore forecast estimates indicate that rig demand for 2016 is around 165 rigs, which means that operators are likely to let go of 15-20 more units this year. If contractors cold stack/retire at least half of those units (~10), utilization could be stabilized just under 80% heading into 2017.
Closing the oversupply gap will be a long and arduous process as demand recovery is expected to be gradual and the timing is still unclear. As a result, leading edge day rates are expected to remain at or below break-even on higher specification rigs, and the average day rate of 6th and 7th generation units will continue to erode as more of these rigs roll off their initial contracts at the high rates that were committed years prior. Over 70% of rigs working today at $500,000+ rates are rolling off contract in the next 18 months and rig demand is expected to remain soft through this period. The objective for 2017 should be to get leading edge rates back to $400,000 per day for the 6th and 7th generation fleet through aggressive attrition focused on keeping marketed utilization at or near 80% by reducing marketed supply below 200 units total. This would mean that over 80% of all marketed rigs would be 6th or 7th generation while only about 40 older rigs essential for mid-water or harsh environments where mooring capability is necessary would remain in service globally (See figure 2).
Deepwater discoveries and long-term development opportunities
Deepwater exploration drilling demand has seen the most drastic decline over the past four years or so. Since the high-water mark in 2010, global exploration drilling has gone down in all major deepwater basins. At the same time, the success rates of those exploration spuds was also decreasing as indicated by the lower discovery level for the same years (See Figure 3). This trend could either be due to oil companies going after high-risk prospects while oil prices where high, the easiest of reserves having already been found or a combination of the two and other key factors.
Over 65% of drilling came from exploration activity during the peak years of 2010-2012. High cost campaigns in Brazil, Australia, West Africa, and Norway were enabled by high oil price, increasing rig supply, and a fierce appetite among key major operators to open new frontiers for future development.
Exploration drilling began trending downward in 2013, due to a nearly 60% drop in Brazil exploration activity while partially off-set by increases in US Gulf of Mexico and expansion into East Africa. With the exception of Africa, exploration drilling in most regions in 2014 remained flat or slightly down and by 2015 all regions had dropped leading to a nearly 50% year-on-year decline. Africa and Asia were hit particularly hard in 2015 with 60% and 50% declines, respectively. Both considered to be high cost regions for deep water, it is unlikely that Africa will return to peak levels at oil prices below $70/bbl. Australian LNG projects are slowing down, which deters the need to drill for more gas. In Brazil, Petrobras will likely use what limited funds they have to develop pre-salt. Less than 10 exploration wells are expected to be drilled in Brazil in 2016. The US Gulf of Mexico, which has been the most resilient throughout 2015, is already showing signs of weakened demand as key major operators push plans into the future in effort to preserve cash.
Global deepwater discoveries feed directly into the inventory for future development opportunities. Given the average cycle time for a major deepwater development is somewhere between 7-10 years from discovery to first oil, any potential impact from this lower discovery trend could be seen in the second half of the next decade. The severe stall of projects during the current downturn should mitigate the majority of this potential effect through the middle of the next decade as the industry works through the backlog of viable and undeveloped resources.
Looking at Quest’s long-term, greenfield development opportunities, 2016 is in the middle of the trough created by the current downturn, as is no surprise (Figure 4).
Most projects are going through a re-assessment period to ensure the best development scenario while only a handful have been completely scrapped and labeled as uneconomic under any possible revisions. As such, these projects have been pushed to the right towards the end of the decade.
We expect that the work the operators and supply chain are currently doing around reducing the cost and increasing the returns of deepwater development will result in higher sanction numbers post-2017. Reducing project scope and cycle time are important in deepwater and can potentially result in more projects being awarded each year.
Quest Offshore tracks subsea tree awards as a leading indicator of the health of the overall subsea market. As such, the vastly depressed demand levels seen in 2014 and 2015 have been mirrored through other market segment trends. The forecast has gone through two material adjustments since the start of this downturn; the first in last 2014/early 2015 when the oil price first fell and then most recently in Q1 2016 when the weakening oil price further exacerbated oil companies concerns over execution timing.
Over the five-year forecast period, the mean (mostly likely) case has been reduced by 20% and the base case by 30% (See Figure 5). The ongoing weakness and lower oil price over the past few months has all but ruled out any kind of recovery this year in terms of subsea demand. That said, recovery is on the horizon for this space and the backlog of opportunities that has been re-assessed and re-worked to find better project economics is real and waiting.
Regionally speaking, the US Gulf of Mexico is expected to be one of the most resilient areas during this downturn. The diversity of projects in queue helps potential activity as they have different reactions to market conditions. Africa has significant opportunity for subsea demand whether from the north or east, but timing is always a risk in the area and is even more in this downturn. The opening up of the pre-salt off Brazil is a real possibility for future demand and has the potential to offset, at some point, some of the demand loss by virtue of Petrobras’ challenges. Petrobras’ plans continue to trim expectations and push projects to the right materially affecting the local supply chain and their ability to survive to the next up cycle. Other operators have stake outside of the pre-salt plays and are expected to drill towards the end of the decade providing development potential in the 2020’s.
One bright spot in the subsea tree market is the install base in place and the life-of-field services they do and will require. Despite the current reduction in spending towards these types of activities, there is no getting around the need for intervention, workover, maintenance and eventual decommissioning and removal of this hardware at some point in time. As this install base grows, albeit slowly at the moment, the larger this demand will grow for future goods and services.
The water depth of these subsea trees is growing significantly as we move through time. This shows that equipment will have to evolve as well to handle the additional challenges and requirements associated with these depths.
Serious challenges lay ahead for deepwater, and they are important to keep in mind. The increased complexity of the future projects is very real and development of innovative technology must remain a priority. Easy oil has been found and developed. Industry must work harder as we move into harsh and frontier areas for the next big opportunities. Volatility in global demand and oil and natural gas prices can cause near-term, temporary disruptions in project cycles.
Caitlin Shaw is the senior director of market research and the data division for Quest Offshore Resources. She graduated from Texas A&M University Galveston in 2003 with a BS in marine biology. During her tenure at Quest she has held various strategic positions of increased responsibility leading to senior director in 2013.