Resetting the oil and gas industry’s structural cost base – the same old song?
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How much of the costs being taken out are structural? The progress being made on costs is significant, though much of the focus has been short term and tactical. The industry needs to keep its foot on the pedal and effect a structural reset before the opportunity is lost, with signs that the down cycle may be bottoming out.
Every time the oil price falls, it's the same old song – ''this time it's different, cost cuts will be structural''. Call me a cynic, but I've seen it before more than once and I see no reason why it should actually happen this cycle either.
This paraphrases an experienced industry executive in a discussion on costs at our Upstream Forum in September 2015.
A year on and our 2016 Global Upstream Cost Survey gives an insight to what's been achieved since oil prices fell and what's expected over the next twelve months. The survey captures responses from Majors, NOCs, Independents and Service companies. In summary, there is progress but it's varied, with big differences across company types, regions and categories of spend.
The industry has cut costs by an average of around 19% for capital expenditure categories and 16% for operating costs. The biggest wins in capex have been drilling (-23%), with subsea equipment close behind. In contrast EPIC (Engineering, Procurement, Installation and Construction) lags (-16%). Among operating cost categories logistics leads (-19%) whilst O&M (-13%) lags.
The supply chain has borne the brunt of savings achieved so far, crushing the sector's margins. Not surprisingly, service companies perception of how far operating costs have fallen (24%) exceed those of operators (16%). Point forward gains will slow - service companies expect 3% more over the next year, operators 7%. Amalgamating the two views would give two year gains of around 25%.
Drilling into the detail, operators' focus has been more on quick wins than structural change – understandable if the immediate challenge from HQ is to stabilise haemorrhaging cash flow. Retendering new contracts, renegotiating existing contracts and deferring projects ranked as the three top approaches to reduce supply chain costs.
Structural cost categories rank not far behind, but success is proving harder to achieve. Standardisation of equipment is often heralded as the Holy Grail both to reset costs for conventional projects and the industry's modus operandi. Survey responses were disappointingly downbeat, suggesting the concept has yet to translate into business practice.
One supplier observes '...we continue to get requirements for custom equipment from every customer in every environment.'
Service companies, under the cosh for two years, are sniffing better times ahead. After seven successive quarters of decline, Schlumberger's revenue and margins stabilised in Q3 2016. There are still weak markets, notably deepwater in most regions; but good ones too into 2017 including the US L48, Middle East and Russia. Schlumberger, like its service company peers, is leaner and fitter than before the crash. Recovery lies ahead, slow perhaps, but with it perhaps higher prices and margins.
The anticipated upcycle threatens to take back much of what good the industry is doing. Our survey responses suggest that only 7% to 14% of the two year cost cutting gains are expected to be sustained. In other words likely more than half of the 25% cost deflation predicted by service companies and operators could be lost to re-inflation.
Our analysis of future oil supply illustrates how critical success in structural change is for conventional projects. Tight oil plays with average break evens of US$47/bbl dominate new sources of supply, contributing 7 million b/d of the 13 million b/d needed to meet global oil demand by 2025. Productivity and efficiency gains of 30-40% in the last two years have positioned tight oil at the low end of the cost curve, though it's not clear how much of this will be retained when the cycle turns.
Conventional pre-FID projects contribute another 4 million b/d but are much higher on the cost curve with break evens averaging US$60-65/bbl. Investment in these projects simply will not happen without a significant breakthrough on costs - or higher oil prices.
But painful as it might be for the industry, the opposite might be better in the long run - an extended period of lower prices that forces through structural change and establishes a more sustainable cost base. Certainly much more work needs to be done to prove that this time it really is different.