Rig market hits hard times

Orderbooks reflect reined-in spending based on conservative near-term oil price estimates. ABS’ James Graf sets out the detail.

MODU new construction projects through 4Q/14.  Source: ABS.

Weak demand, excess oil supply – due in part to shale oil production – and the decision by the Organization of the Petroleum Exporting Countries (OPEC) to maintain production levels have driven the price of oil down. While there has been oil price volatility in the past, the 33% drop in a three-month period at the end of 2014 was precipitous. And the outlook is far from rosy, with the average price per barrel likely to remain below US$60/bbl through 2015 with modest increase the following year. At present, there is no expectation for oil to rise to $90/bbl until 2017 or later.

The numbers in perspective

Forecasts, by their nature, are speculative; so it is important to understand the basis for the projections. In this case, the outlook is framed by macro industry demand drivers and uses a supply vs. demand approach to project future supply needs. Oil price and oil demand are closely correlated to activity in the offshore industry on a longer-term trend basis and consequently represent a primary base demand indicator that can be used for longer-term activity projections. This outlook does not specifically address or directly consider the award, startup, or development of specific projects that collectively could create short-term volatility.

Demand outlook

Oil prices have declined significantly, and despite a few optimistic ticks upward, they have dropped steadily over the past few months. Meanwhile, production numbers remain relatively constant, and OPEC, which has in the past stepped in to alter production levels to reflect demand, has shown no interest in pursuing that route this time around. At the 166th meeting of the organization in Vienna, Austria, on 27 November 2014 under the Chairmanship of its President HE Abdourhman Ataher Al-Ahirish, Libyan Vice Prime Minister for Corporations and Head of its Delegation, OPEC members agreed to hold firm on production targets despite falling prices.

Distribution of current MODU fleet through 4Q/14. Source: ABS.

While OPEC’s intentions are never entirely transparent, the organization’s motivation is likely based on its desire to preserve long-term market share, which sends a signal to the North American unconventional oil producers. Weak demand growth in Europe and Japan and the slowing growth in China contribute to weak global demand, and that is expected to continue through 2015. Indications at present imply the low oil price environment could last as long as two years, from 2H 2014 through 1H 2016. And a low oil price (sub $80/bbl Brent) does not bode well for the offshore industry.

In the Gulf of Mexico (GOM), additional post-Macondo safety requirements – which are the primary driver behind a 13% longer time to drill – are escalating costs for projects in deepwater. It is worth pointing out that there has been a 25% increase in cost in the GOM since 2010. While some of this increase undeniably is a result of more strict regulations, there is a portion of that 25% increase that is due to the escalating cost of skilled workers. Operators in the GOM are competing for workers with operators developing shale projects onshore, where field workers have the benefit of spending more time with their families. Despite the cost increases, however, drilling in the GOM remains attractive in comparison to other parts of the world because of the potential for profit. There are many petroleum-rich nations from the Middle East to Latin America that continue to limit the amount of profit energy companies can make.

Overall, the picture that comes into focus for the next 18-24 months is one of weaker new investment. The projected low oil price environment will have the greatest impact on deepwater, ultra-deepwater and harsh environment projects, which have a higher oil price threshold for viability. The knock-on effect also will impact new investment in offshore production units and offshore support vessels.

Supply outlook

The orderbook for mobile offshore drilling and production units for the next few years will be smaller than projected six months ago. Jackups will continue to make up the lion’s share, particularly those capable of working in 300ft (91.4m) or greater water depth as the renewal of the industry’s jackup fleet continues. The mobile offshore drilling unit (MODU) orderbook will decline through 2016, followed by a period of slow buildup through 2018.

Weak demand growth for floating production units will keep the orderbook relatively flat for the next several years. Floating, production, storage and offloading units will continue to contribute 40%-60% of all new investment activity.

Meanwhile, offshore support vessels, which saw an uptick in newbuilds in 2014, will expand the existing fleet by almost 5%. Growth will be scaled back to a more modest 2%-3% per annum growth in 2015 and 2016.

The total mobile offshore fleet is projected to grow by nearly 1400 units by yearend. With offshore support vessels included in the number, the total offshore mobile fleet is projected to grow 4.8% to 8869 units by year end, with an additional 17% growth by the end of 2020.

Current MODU Fleet (4Q/04 through 4Q/14) by construction date. Source: ABS.

Looking ahead

Volatility is inherent to the oil and gas industry; so it comes as no surprise that the long climb upward in oil prices has come to an abrupt halt. The reversal in oil prices, while dramatic, is not a show stopper for exploration and development, but it represents a significant obstacle in the near term, and it will be quite some time before there is another oil price reversal that will be sustained long enough to encourage an increase in offshore exploration and production activity.

James Graf is ABS Corporate Vice President of Business Planning and Analysis, based in New York, where he has responsibility for global business planning and performance and industry outlooks. He holds a BE in Naval Architecture from the State University of New York Maritime College and is a member of the Society of Naval Architects & Marine Engineers (SNAME), Society of Marine Port Engineers (SMPE) and the Shipping Analysis Institute (SAI) in Stockholm.