Some Signs Offshore May Come Back To Life

One topic that I have received numerous questions about is when we anticipate offshore will come back to life, if at all. Some have argued that given the ability of shale wells to respond quickly to market conditions, and the fact that oil markets are now likely to have shorter boom and bust cycles, big oil is unlikely to invest in expensive, long term projects.

But as unlikely as it seems today, several authorities are warning that because of the tremendous investment cuts, prices in oil could actually dramatically increase, leaving the world with an oil shortage in a few years.

And in earnings calls, we seemed to have some differing opinions. The CEO of Oceaneering appears to believe that offshore will remain dead through 2017. Yet, FMC seemed to have a different take: noting that they were working on numerous tenders that were in active negotiations which could become real projects in 2017. FMC also told us that their customers are reporting that they do indeed intend to maintain an offshore portfolio. And various Saudi officials have started raising red flags that if large projects aren’t resumed, we could see another supply shortage. Which makes sense.

The first thing to understand when assessing long-term viability of offshore projects is well decline rates. I.e. – how fast does production curtail after initial drilling. Despite calls that offshore is dead, I personally think what will allow offshore to remain viable is decline rates and equipment standardization. Offshore obviously produces tremendous amounts oil. It has a substantially slower decline rate than shale plays but a faster decline rate that traditional plays. That means that you get a longer well life.

In addition, major players, as we have reported previously, are working to standardize equipment or build multiple rigs from a single design. These actions will result in cost efficiencies which will allow offshore to recover more quickly as the breakeven per barrel will be lower.

To meet world oil demand, I we will have to start investing in offshore again. And it will start getting cheaper. First, there is a big push to standardize offshore equipment. As we dealt with in our article on the issue - platforms are being built on a "design one, build two" basis, and GE and NOV announced a partnership to standardize some equipment. These efforts should drive costs down. Additionally, technology that has reduced Shale decline rates and allowed enhanced recovery over just the past two years will be applied and that knowledge will influence decline rates for offshore platforms - thereby again driving down the high costs associated with offshore. This technology will just continue to evolve. Certainly, less profitable fields will suffer, but I don't think offshore is dead.

And as offshore projects have gone offline, the oil extracted will need to be replaced as world oil demand will likely continue to increase. Against the warning from Saudi Arabia discussed above, we also had the CEO of Anadarko saying that Anadarko might look to bring Gulf assets back in the $60.00 per barrel range.

Two other factors give us a glimmer of hope for offshore. First, it appears that we are seeing a pick up in extraction from the North Sea. Apparently, producers will increase 10 percent month on month. (click here to read more). Second, the floating production market seems to be showing some signs of recovery. (click here to read more). It appears that in 3Q 2016, two more FSRU contracts were awarded, bringing the total up to four units for the year and that there are 10 possible awards within 2016 (although they will most likely be deferred to 2017). However, on a cautionary note: the EIA recently stated that offshore production is becoming deeper and more expensive. According to the EIA, some shallow water resources have been depleted, pushing production into deeper water (translation: more expensive). In 2015, offshore production accounted for about 30% of total world oil supply (down modestly from 32% in 2005). Most deepwater production is in the U.S. and Brazil and both countries are expected to increase offshore production in 2017. However, should the trend hold and more and more offshore production becomes ultra deepwater, that would entail a significant cost increase which could further delay offshores recovery.

Either way, I believe that offshore drilling is poised to come back. I am not sure when we will see it, and I do not believe it will likely occur in 2017 to any real degree. But there is a bit of an incentive: right now costs are at historic lows. Producers who wait too long will end up paying higher prices for their equipment. Therefore, there is a bit of an incentive to invest sooner rather than later. How will it play out? Only time will tell.

By: Ty Chapman

Five Star Metals, Inc.

Raising the Bar for Customer Service and Quality

Twitter: @FSM_TY

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