Increased offshore expenditure not sufficient to change inevitable consolidation and shake-out

Rystad Energy have a good article on offshore CAPEX versus North American Shale. I am not sure it offers a huge degree of comfort for offshore contractors and vessel owners:

  1. 70% of expenditure comes from 10 projects (most of which were in planning long before the current downturn). Should this pattern continue the industry would become dominated by a few large contractors that worked on mega-projects only. The entire ecosystem of smaller contractors would be reduced to servicing these large EPIC contractors at hugely reduced margins and competing fiercely for IRM work to keep utilisation high. The sheer scale of these types developments favours large well-entrecnhed competitors with links across the value chain to subsea processing companies. Again the space for smaller firms is likely to be limited to subcontractors only
  2. As noted above these were all sanctioned and had final investment decisions some time ago. Large, high volume and low OPEX, deepwater fields are likely to be the core of offshore demand going forward. GIven the lead bid times the projects being bid now are likey to be extremely margin compressed for years to come, so an increase in the oil price will drop straight to the E&P company bottom line without helping the offshore fraternity at all. Time is not the friend of those long on ships and drill rigs at the moment
  3. Given current industry supply levels these larger contracting entities will likely be more “asset-light”, apart from core delivery assets, than we are used to. This is likely to result in continued, and long-lived, margin erosion for anyone apart from a tier 1 offshore contractor. If you want an unbiased example of this look to the civil contracting industry where anyone other than the prime contractor makes operating profit at close to marginal cost
  4. Jusr as importantly the pick-up in demand, if indeed it is that, has occured only by a decrease in offshore and subsea rates below what it is economically possible to supply in the long-term
  5. 3-4 large contractors, and Technip, Subsea 7, Saipem, and McDermott (with limited asset and competitive differentiation) will all be there, with some strong regional players, is enough to drive industry margins down to normal economic profit for the foreseeable future

Rystad mention the drop in drilling and offshore subsea rates, but everyone is operating at below cash break even on projects at the moment to win work. Currently in order to fund this cost deflation all drilling operators of note are refinancing and the loss in equity has been huge, and a somewhat more delayed pattern is also occurring in the OSV market. It would not appear that demand and supply are therefore balanced, or even close to it. All it indicates is the brutality of the E&P supply chain and the willingness of offshore contractors, long on fixed assets with high running costs, to bid at whatever it takes to win some work and try and last longer than anyone else.

The market would appear to be some way off equilibrium. The graph at the top is the Subsea 7 (orange line) share price versus Solstad (blue line) over the past 12 months, essentially a proxy for my thesis above (in the most general sense and picked because the weight of their relative debt should strengthen my argument and magnify equity returns), and it would appear the market consensus is similar to mine.

One thought on “Increased offshore expenditure not sufficient to change inevitable consolidation and shake-out

  1. Your articles are very interesting and I really find your breadth of industry experience shines through in them, however I have to be honest and say when I form opinions and look for trends, would it be fair to say you are not very hopeful for any sort of recovery and future for the UKCS and further afield basins ?

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