Structural and cyclical cost reduction and demand

A good article in the FT (behind the paywall sorry) but the core point is that the supply chain had better get used to a low cost procurement environment for a long time:

[C]uts have been made across the industry, pushing investment down to historic lows. The average number of new oil and gas developments given the go-ahead globally has fallen from 35 a year between 2010 and 2014 to just 12 since 2015, according to Patrick Pouyanné, Total chief executive. This number will have to increase, he said, if a supply crunch is to be avoided in the 2020s. He and other executives stress that reduced spending also reflects efficiency gains in the industry, allowing companies to do more for less…
Many of the savings stem from cuts forced on suppliers, such as rig operators, which were in no position to resist as business dried up after the oil price crash. But Bernard Looney, head of exploration and production for BP, insisted that two-thirds of reductions are structural, rather than cyclical, and would be sustainable. “It’s as much a story of how bad the past was as how good we have become,” he said. “We got the cost of Mad Dog 2 [a development in the Gulf of Mexico] down from $20bn to $8bn but frankly we should never have been at $20bn in the first place.”

The fact is for both rigs and vessels there is huge latent capacity and this will mean the supply chain is under pricing pressure for years. Offshore supply has structurally changed: it will become dominated by a few large players with massive fleets and low margins that mean scale is vital. Subsea contracting looks set to be dominated by a few large profitable contractors, in a flight to quality, while offshore support vessel owners who supply them will find it harder to make money due to long-lived over capacity. All this is a structural change in the industry and there is likely to be lower industry profitability regardless of how big a rebound is (when compared to 2010-2014).

When the number of projects starts to rebound, and it will take a long time to re-employ the engineering capacity required to do this, there will be a cyclical upswing as overall demand for these assets increases. But this is unlikely to see the entire industry benefit as a smaller number of companies at the contracting end of the market will still be able to use their market power to charter in excess capacity at a low marginal cost.

Whereas pretty much al business models used to work in offshore  that is patently not the case now.

 

 

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