The bull case for oil… but does it really matter for offshore anyway?

I’m basically an iconoclast by nature and therefore I want to believe things like this:

Burgrabben “Crude Oil: Are you ready for triple digit prices”

And it’s a smart piece of work with loads of really interesting data points. But it is also a variation of “shale can’t possibly work” which I have heard now many times, with a million different reasons, all generally based on shale/tight oil reaching a technical frontier. Subsequently over the years this has been shown to wrong as productivity constantly improves. But if you want the bull case it’s been written for you…

I think it is very hard to believe though that major investors and E&P companies have got this so wrong? A lot of large companies seem to have some fairly explicit forecasts about their production levels and would look very stupid backtracking on the scale some of the shale pessimists seem to think will happen. Surely before the supermajors make major acquisitions they talk to a shale engineer and say “you know like if we buy these wells this will work right?” And maybe more than one and get some opinions? And then some really smart engineers in-house put their names to this? The fact a small number of people seem to think, not for the first time, they have caught out everyone else with something they hadn’t thought of strikes me as a low probability event. I get this goes against everything I say about investment bubbles at times… it’s just this time…

There is also a large section on a “supply gap” with other assets and that maybe true… the market will respond to higher prices just not as quickly as some people hope. I will leave it at that. For the record I have no view on the oil price, in the short run I think it’s a random walk as I always say, and in the long run, the very long run, I believe in technology. But it’s a risky and cyclical business and in a rational world you need a high rate of return to cover for this. Clearly an industry operating at a price level below that of marginal production costs will see a rise in price for a commodity like oil which has an inelastic demand curve.

My major point here is that even if the oil price recovers demand conditions for the offshore industry are extremely unlikely to return to the 2013 type years. Shale only needed to take 5% of global production to drop utilisation rates for offshore assets and change the industry economics over a very short time span. The offshore industry used to need very high utilisation levels and day rates to make the economics work and I find it hard to see a scenario where this will return quickly. Even this report acknowledges the cycle times in offshore and is clear about the increasing role of shale in an absolute sense. The fact remains a larger portion E&P capital expenditure for the next few years is focused on shale/tight oil in an environment where CapEx budgets have been cut. Unless someone can explain to you how they expect a bounce-back in demand that deals with that fact then it isn’t a sensible explanation.

Saipem’s most recent results had a good graphic example of this:

Saipem Q1 2018 backlog.png

Backlog down another 13%… yet Saipem still went long on a USD 275m asset that will keep capacity in the rigid-reel SURF market and force them to lower prices to gain market share. And in fact that asset went to the worst possible competitor for everyone else in the market because Saipem have the resources and technical skills to maximise the value of the Constellation.

Focusing less on the daily change in the spot price of oil and more on the marginal drivers of demand for offshore utilisation would strike me as a better way of gauging industry profitability going forward.

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