Finding Balance in the Global Energy Supply Chain

By Malcolm Forbes-Cable

As drivers benefit from seesaw prices at their gas pumps, the oilfield services and manufacturing sector has seen a very difficult last few years. This volatile situation has been even more acute coming on the back of the longest boom period the oil market has ever known. Subsequently, there was a collapse in the market, making business decisions even more difficult and critical. Judging by the number of e-mails that bounced back during a recent survey by Wood Mackenzie, a Verisk Analytics business, estimates of job losses could amount to a third of supply chain jobs across the entire energy sector.

Following the 2014 plummet in oil prices, activity levels within the offshore development, operations, and management space have also declined considerably. Wood Mackenzie estimates the down cycle has stripped 40 percent from global energy and production (E&P) budgets. This has resulted in greenfield and brownfield project final investment decision (FID) delays, cancellations, and deferred operating expenses (opex) through restricted inspection repair and maintenance (IRM) and integrity management programs.

Global upstream capex outlook

Substantial pressure has been placed on the supply chain to reduce costs and improve standardization of equipment and services while increasing operational efficiencies. The ultimate goal of the operator is typically to bring supply chain prices down to a level where project break-evens are in line or close to prevailing commodity prices. Profitability across the supply chain will continue to be negligible when the majority of margins remain in the single digits. In the worst cases, contractors take on negative-margin projects, struggling to secure work below cost, to boost utilization and maintain market presence.

Without question, having to reduce costs has been painful. The last few years have been all about managing down the cost base (resulting in diminished capacity) and laying the foundations for a recovery.

Wood Mackenzie maintains the privilege of being able to engage and listen to people from across the energy industry. This provides insight into the current health of the upstream business. In the second half of 2016, Wood Mackenzie’s annual Global Upstream Cost Survey focused on the intersection of operators and supply chain businesses. The survey gauged opinions on sector recovery and found strong sentiment that the majority of the price declines have been captured. And while there is still some downside risk in 2017, Wood Mackenzie anticipates the current condition as the market’s bottom—with a potential recovery beyond that.

And yet investment opportunities do still exist. Wood Mackenzie has uncovered short-term opportunities across early-phase engineering, differentiated technology in hardware and software, IRM and integrity management, and low-cost offshore supply vessel (OSV) and construction tonnage supported by experienced management. The major driver is the resetting and rebalancing of the cost base. This condition can be achieved by buying discounted assets and strategically positioning them for an industry recovery. Relinquishing debt, harnessing client relationships, and optimizing services and applications can provide a clear advantage over a legacy oilfield services (OFS) sector approach.

Weighted average of date of sub-sector market return

By achieving a greater balance between chasing capital expenditure (capex) development projects and opex life of field, companies can also realize fresh opportunities. Global IRM and integrity management work has been pushed to the right over the past two years, resulting in a backlog of integral work that must come back into play to sustain offshore infrastructure safety and production capacity. The application of optimized, cost-effective solutions and technologies could bring an obvious remedy to unlocking potential revenue.

Across the energy sector, the current expectation is for a recovery starting between 2017 and 2018. The Organization of Petroleum Exporting Countries’ (OPEC) production cut at the end of 2016 brought much-needed stability to the market. How this plays out and the pace of the recovery in tight oil production in the United States will likely determine the direction of the market. Given these uncertainties, any market recovery will initially appear as a slow drip feed of project sanctions resulting in a controlled uptick in activity, with hopes for keeping prices as competitive as possible. Operators will need to build on their recent control of supply chain costs while managing new capex projects and limiting cyclical price increases. Given the recent reductions in supply chain capacity and higher levels of market stress, Wood Mackenzie believes this to be a sizable challenge.

Is a door opening for further mergers and acquisitions and consolidation opportunities? The current market could be an advantageous entry point for trade players with resilient balance sheets or private equity and special situation funds. Such entities can take advantage of the rebasing of costs ahead of a recovery in the market. So the green shoots of optimism may be beginning to appear, although an appetite for risk is required to gain a first-mover advantage. Timing of deals tends to be everything: Wait too long and the market will be flooded with investment that often pushes up prices; go in too early and additional losses will materialize.

The window of investment opportunity has started to open and will likely remain so to the risk-savvy sector specialist able to identify a solid, well-priced solution or service over the next year. Beyond this time frame, opportunities may diminish if investment floods the sector and drives sell-side price expectations well above where they should be.

 

Malcolm Forbes-Cable

Malcolm Forbes-Cable is vice president of upstream consulting at Wood Mackenzie, a Verisk Analytics (Nasdaq:VRSK) business.