The upturn accelerates

Jan. 22, 2020
Through innovation, cost reductions, reduced cycle times and consolidation the offshore industry is leaner, nimbler, and ready for the long and strong upcycle we believe is under way.

James West, Evercore ISI

The offshore industry is back. As we close the books on 2019 and move into 2020 the outlook for offshore drilling and development has improved dramatically versus the 2015 to 2018 time-period. The euphoria of oil shale has waned as financial results have suffered, shareholder angst has risen, and capital markets have closed. Therefore, the growth rate of shale production has slowed dramatically and may soon move into decline. However, the world still needs oil and production growth and once again the call for offshore oil is being made and companies are responding.

As the call for offshore has improved so have final investment decisions (FID) for offshore projects. At the bottom in 2016 FIDs reached a low of 44; however, more than 100 projects reached FID in 2019 closing in on the most recent high of 120 in 2013.

The industry has been completely reshaped during the downturn. Initially the subsea companies moved first with several joint ventures and then combinations. TechnipFMC led the way with their tie up quickly followed by Schlumberger’s acquisition of Cameron. These combinations have led to lower development costs through better integration. The offshore drillers also combined leading to reduced over-supply, the removal of older, less capable assets, and the emergence of stronger companies. The rig companies have also applied better technology and continuous improvements in operations to lower the time to drill offshore wells. In some cases, this has reduced drilling times by 30%. Combining faster drilling times with lower development costs has substantially reduced industry break-evens. Break-evens are estimated to have fallen by close to one-third, from ~$65/bbl to ~$45/bbl.

This new paradigm in the offshore arena is creating enormous opportunity; not only for equipment and asset supplies but also for operators. With reduced project economics, lower cost structures for oil companies and their suppliers, the economic potential of prolific offshore wells has likely never been better. A new growth cycle is emerging and while some areas will always be hot spots like West Africa, Brazil, and the US Gulf of Mexico, new regions such as East Africa, Guyana, and Mexico are opening as well.

Offshore rig utilization is quickly increasing with utilization for marketed floaters at 80% and marketed jackups at 83%. This compares to ~68% for both at the trough. With these gains in utilization pricing power has also returned to the industry with floating and jackup rig rates up 40-50% off the bottom. More day rate gains are ahead as a rig market short-squeeze is likely in the coming quarters. Recent day rates for floaters in the Gulf of Mexico jumped from $175,000 to $200,000 and are poised to reach the mid-$200,000s in the near term. In the tightest market in the world, day rates for HDHE floaters in Norway jumped from $150,000 at the bottom to $350,000 and are increasing now.

While global E&P spending is anticipated to only rise by mid-single digits in 2020, this will be led by low double-digit growth in the offshore markets. The North American land business is expected to see a ~10% decline in capital spending while international land markets are likely to grow a modest ~5-7%. Offshore is once again on top when it comes to capital allocation.

With a flurry of FIDs last year, intentions to ramp offshore spending, and a new, simplified development process backlogs for offshore-leveraged companies are poised to inflect. In fact, TechnipFMC has already experienced several recent record quarters for subsea awards, and the offshore drillers are suggesting customer interest is at the highest levels in five years. Direct negotiations outweigh open tenders and thus publicly available demand is understating the real outlook. The back half of 2020 appears especially strong with a large number of term contracts being tendered for major drilling campaigns. Many awards are expected to be announced in the next few months for this work.

Positive indications abound in many offshore basins around the world. In the US Gulf of Mexico, cycle times have been reduced which is de-risking many plays, and the infrastructure heavy market remains ripe with tieback opportunities. In Mexico, recent exploration success is likely to lead to major project awards while the success in Guyana and potentially Suriname and Trinidad should continue to draw interest and assets. In Brazil, the IOCs are getting ready to kick off presalt programs, while up and down both sides of Africa look promising for incremental drilling activity. The North Sea, especially the Norwegian parts has been and will likely continue to be a very strong area. In addition, several countries in Southeast Asia are bidding for rigs. The early signs of a tightening market have arrived.

The improvement in offshore rig activity will also have the knock-on effect of higher utilization throughout the offshore value chain. This will lead to high margin service work, better supply vessel and helicopter utilization, and potentially a squeeze on labor. After an almost five-year downturn many mariners have likely moved on to other industries.

A solid leading indicator for offshore is exploration spending which many of the largest IOCs ramped significantly in 2019. For example, Petrobras anticipated a 66% increase in exploration spending while Equinor was up about 20% and Chevron’s spending rose by about 18%. For BP, exploration doubled year over year while Eni drilled 35 exploration wells versus 20 in 2018. Exxon is perhaps still the most aggressive with a 40% CAGR in exploration wells planned from 2017 to 2021. The improvement in exploration activity should not have been a surprise as 2018 marked a 20-year low for reserve replacements. The IOCs have been replenishing reserves at a very low rate. This is expected to rebound as these companies understand that shale is slowing and new reserves need to be brought to market.

At this time last year, we felt comfortable that the bottoming process was over and a recovery was under way. Not only has our confidence increased since then but we now believe industry activity is poised to accelerate higher. We expect a squeeze on engineering capacity, on offshore assets, and on crews to become very apparent as 2020 unfolds. Through innovation, cost reductions, reduced cycle times and consolidation the offshore industry is leaner, nimbler, and ready for the long and strong upcycle we believe is under way. •