Oilfield spending conundrum

February 12, 2014

The past few weeks have seen a string of profit warnings and capital spending cutbacks from global oil and gas exploration majors.

Should oilfield service companies be worried that the good times are coming to an end? 

According to bank and investment company Investec, the current “capex-adjustment period” has been a long time coming. “Three years of stable oil prices but ever rising costs have squeezed upstream returns and pressurized the majors’ cash flow cycles,” it says.

Industry analysts Douglas Westwood said this week: “For several years we have been voicing our concerns over a tide of issues facing the oil majors; firstly it seems that their oil production has peaked, then one year ago we noted that the spiraling capital expenditure was unsustainable.”

The past five years has seen heavy upstream investment, says Investec, and the Brent oil price benchmark has remained stable, despite the Arab Spring, security issues in Nigeria, UN sanctions against Iran and a surge in US shale oil production. But, it says, costs, both capital and spending, have risen inexorably.

“This has led to the situation where, at current oil prices, most of the international oil companies (IOCs) are not generating sufficient operational cash flow to cover both capex and dividend commitments,” says Investec. “Oil producers (and the majors in particular) are waging an interminable battle to overcome the underlying decline in their production.”

The result has been cuts. “Hess’s 2014 spend is to be 30% lower than that of two years earlier, Shell is reducing by 20% compared to 2013, BG’s is also set to fall and BP’s Bob Dudley has stressed the importance of “capital discipline”,” says Douglas Westwood’s Steve Robertson. “The brunt is likely to be felt in the high Capex segment, notably in arctic, deepwater, and LNG projects.”

How the offshore oilfield services sector deals with this is not clear, says Investec. Both lump-sum E&C players and firms working on reimbursable contracts have already been hit. Focusing on those working for national oil companies (NOCs) has not necessarily proved resilient either.

Saipem gave profit warnings last year, highlighting the risks of lump-sum contracts. Meanwhile, Wood Group, whose revenues comprise reimbursable work, with a mix of capex and opex-related activities, has also issued profit warnings, Investec says.

Douglas Westwood says the listed majors account for about one-third of industry upstream spend. “If we project the trajectory of Shell to the other IOCs then we might expect their Capex to fall by 20% over the next two or three years,” Robertson says.

“This would equate to about 7% of the total industry’s annual upstream Capex. However, there is the other 93% of Capex to go for, possibly in excess of $650bn in 2014.”

Those wielding the cash include innovative smaller independent oil companies and, at the other end of the scale, NOCs such as Saudi Aramco.

“The NOCs are typically characterized by long-term spending programs, and commit to long contracts for equipment and services,” says Robertson. Mostly, they are continuing their spend. The latest Barclay’s Capital industry survey said NOC’s expected their spend to grow at some 11%.

But, for the services sector this can be a long term game. “The process of becoming an accepted vendor to NOCs such as Saudi Aramco can take several years,” says Robertson.

Project delays in the Middle East and North Africa have also undermined earnings targets at oilfield services firms, says Investec. 

“The good news is that this situation should improve,” Investec says. “The majors’ cash flow should increase as their recent heavy investment phase starts to bear fruit.

The oilfield services sector should also benefit from the major’s efforts to grow production, Investec says.

Robertson concurs: “It must be remembered that E&P is not just Capex – the oil and gas must be kept flowing and the associated maintenance, modifications and operations (MMO) spend keeps slowly ramping upwards.”

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