The upstream supply chain’s emerging challenges
Radical steps needed to boost returns
Chairman, Chief Analyst and author of The Edge
Chairman, Chief Analyst and author of The Edge
Simon is our Chief Analyst; he provides thought leadership on the trends and innovations shaping the energy industry.
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Oil and gas companies are back in the money. Operationally and financially, all lights are green – production is up, costs are down and margins are up. The Majors are generating more free cash flow at US$60 per barrel than they were five years ago at US$100.
The same can’t be said for the service sector, which has continued to have a miserable time of it since the 2014 bust. Returns for many service companies are still scraping along well below pre-crash levels. Why so? I asked two of our supply chain experts, Mhairidh Evans, Principal Analyst, and Malcolm Forbes Cable, VP Upstream Consulting.
Upstream investment globally is still constrained
Global upstream investment is only slowly pulling out of the downturn. The service sector thrives in an upcycle. Upstream companies have only just recovered from the ghastly hangover brought on by overspend in the last boom. The industry is determined not to lapse again, is religiously sticking to capital discipline and is shunning growth. The more discipline, the more the stock market seems to reward for returning surplus capital to shareholders. It’s symbiotic and could last for some time.
Global upstream spend is up from lows of US$450 billion in 2016 and 2017, having collapsed from the 2014 peak of US$750 billion. But not by much. We think spend will recover to over US$500 billion by 2020, driven by the US L48, a flurry of deepwater projects and a new phase of LNG investment. It’s a sluggish recovery, geographically very patchy, and a long way from being called a new boom.
Spending peaked in 2014
And fell to a low in 2016 and 2017
We expect it to reach this level by 2020
Large excess capacity in the service sector
There has been rationalisation – global capacity across the sector reduced by around 25% on average since 2014. Yet capacity utilisation is still modest, based on key indicators like jackup rigs (70%) and floating production system fabricators (50%). The spend increase we forecast won’t tighten most markets and bring back pricing power. More capacity needs to come out.
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Digital disruption poses a new threat to established players
Integrated oilfield service providers have become integral to the upstream industry, particularly on more complex projects. Digitalisation threatens this relationship. Cloud-based platforms that can manage multiple types of data and simplify data management will break down value siloes. This will negate the need for different, proprietary systems that are the domain of the service companies. Increasingly, operators will be able to measure and benchmark all facets of their operation, opening the way for a new approach.
Big tech companies with cloud computing and advanced analytics are attracted to upstream as a high-margin industry with giant data management needs. Innovators are already emerging in autonomous robots, drone sensing and surveillance, automated drilling control and other specialisms. Our research will delve deeper into the implications of digitalisation in the coming weeks.
E&P companies reacted to the downturn by revitalising their business
Operators have reset portfolios aggressively: cutting costs, making portfolios more resilient by shedding higher cost assets and investing sparingly for the future in higher return, low-cost projects. Critically, executive pay for many oil and gas is now more closely linked to returns rather than growth. The reset is already paying off with much-improved profitability and cash flow. The sense is that there’s much more to be done to protect against future uncertainties such as peak oil demand and the energy transition. Digitalisation is one of the big opportunities for ongoing cost reduction.
What can service companies do to improve performance?
The big integrated oilfield service providers chose the consolidation route in the downturn, building on the one-stop-shop model. The idea was that scale and market concentration in key business segments would help bring pricing power and drive returns up. In a market that’s still lean, it hasn’t panned out like this.
The simple option is to wait for the investment cycle to pick up. That could take some time, and risks courting antipathy from investors. If the market stays lean, the sector needs to embrace tighter capital discipline and deeper cost cuts to boost returns and show that the integrated model can work in a difficult environment. Just as the oil Majors have begun to focus on advantaged assets, the bolder service companies could take a long hard look at the merits of the business model. Should capital be tied up in fragmented, fiercely competitive segments with low margins?
The sector is on the cusp of disruption, with digitally enabled new entrants and performance-based contracts.
Service companies need to present a vision of how they can adapt to these big challenges.