“This time it’s different…” … But it really is…

I sometimes think the brief downturn of 2008/2009 in oil prices and offshore demand has a lot to do with how the downturn that started in 2014 is interpreted. I was there, got the t-shirt, and it was brutal, but it was short and there was an asset base that was vastly smaller than the current active (or potentially) rig and vessel fleet of today.

The graph above show’s the EIA forecast for US crude oil production by grade (that includes onshore and offshore). Unless you believe this graph to be completely wrong you would have to accept there has been a significant structural change in the industry… as a comparison have a look at the US production levels leading up to the 2008/09 downturn:

US oil production 1986 -2010.jpeg

US domestic oil production was on a downward trend at 5m barrels a day, slowly rising in 2009, before its meteroric 2010 rise. In 2009 the logical dominant narrative, both in investment terms, and operational terms, was that offshore production had to be increased: there was no alternative. Shale was expensive, companies were still thinking oil sands production was a viable technology within current constraints to keep pursuing, and although the investment dip was brutal it was a single season, and the spot price recovered quickly as well.

Now the graph at the top is the dominant logic. There is a self-reinforcing cycle here that is leading investors at the margin to use shale as the swing production method of choice. From 5m barrels a day to 10m and realistic scenarios involve this being 12m. Not only this as a marginal production technology shale is shorter cycle and uses much less initial capex, the trade-off being lower overall profitability. But on a risk-weighted and time-commitment basis it is a far less intensive production technology. As I keep saying here everything Spencer Dale wrote is coming to fruition here over the shale doubters. The force of economics triumphs over engineering constraints of the current technology curve yet again!

Change at the margin it is occurring every day when investment managers at either E&P companies, or fund managers/PE investors, decide to back a shale project over an offshore project. No one is saying offshore is going away, but at the margin the total volume of decisions made one way or the other will dictate what a “recovery” for offshore looks like. There is no doubt this summer will be busier than last summer for work, particularly for IRM where the spending taps have been loosened a little, but the supply situation is such that no one is reporting increased rates it’s all about utilisation.

My point with this, as I constantly stress, isn’t that offshore is going to zero, but that any recovery in offshore is going to look very different to any prior to 1986, because there is now a viable swing producer with a very different commitment profile. Offshore will be part of the energy solution not THE solution, and that is a very different dynamic.

Up until 2010 offshore was the only viable solution so there was a reasonable belief that this was cyclical pause in investment driven by a cash flow issues oil companies were having with the spot oil price. I am just not sure that is a reasonable assumption now?

Frac spread count

The Frac Spread Count is the equivalent of the BH rig count for frac spreads. You can see the tremendous growth in onshore capital equipment utilised that has occurred in a fairly short space of time. This process of capital deepening will not go away, this equipment, which is getting more efficient, will need to be traded even if the price of oil drops. Like vessels it will price at marginal cost if required to keep utilisation high.

And shale appears to be getting ever more efficient:

Now a second revolution is on the horizon as operators prepare to re-enter those wells that launched the first revolution and implement secondary recovery projects. That can consist of operators reinjecting gas into the reservoir to restore pressure and then producing the additional crude and natural gas…

the Permian Basin has been producing for close to 100 years and “we’re not even close to getting all the oil.”

Which led the IEA to issue this graph this morning with the byline “US shale oil growth is set to see the largest sustained rise in history matching the huge expansion seen in Saudi Arabia in the 1960s and 1970s”

IMG_0445.JPG

And as a topic for another day gas is becoming so cheap that for bulk energy it will take market share off oil eventually. There is growth in offshore as Brazil and the GoM show:

Brazilian production forecast.JPG

There might well be another bull market in oil… but whether it leads to one for rig and vessel companies is altogether a different question? There will be profitable companies in offshore they will be just look, and in some cases be, different from those in 2013/2014.

There is an interesting parallel in shale infratsructure to offshore infratsructure providers in investment terms:

That fate has just arrived for the pipes and plants connected to some of the first great shale-gas plays in Barnett, Woodford and Haynesville. In September, Wells Fargo analysts estimated that four pipelines serving the original boom areas would be re-contracted for much lower volumes. Recurring operating costs and lower prices create distressing leverage on those declines.

According to Wells: “We estimate the four pipelines will see a median tariff decrease of 39 per cent and ebitda [earnings before interest, tax, depreciation and amortisation] decreases of 66 per cent, once legacy contracts expire.”…

This is not the end of the world for the midstream business. Other, better informed sources of capital can replace MLP money. However, the oil and gas infrastructure bubble is over. An American Petroleum Institute study in 2017 estimated “pipeline and gathering capex” would decline from an annual average of $31.3bn in 2013-16 to $20.8bn in 2017-35.

That is still a lot of pipeline but the ongoing returns appear to be weighted in the E&P companies favour, not the infrastructure providers. Offshore investors probably have some sympathy for pipeline owners.

Any offshore reovery scenario needs to be realistic about how the “new demand” will play out on the current and future asset base. Demand will vary by region, asset class, and type of project at the margin, but an overall contraction in the supply side of the market is a certainty as US shale production continues to grow faster than overall oil demand.

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