Demand at the margin…

“We’ve indicated we’re going to keep capital spending flat. We’re in a higher price environment, [but] we haven’t changed our capital budget, and I don’t expect that we will,” Mr Wirth said. “We will not fund every project. We will have projects that meet our economic hurdles, but we’ll choose not to fund, because we’ll have better options.”…

“Frontier-type projects, the riskier investments, are now . . . not as necessary,” he said. “And I think that has implications for everyone.”

For Chevron, that meant every project it invested in would have to be “best in class”, he said. “It can’t just be the kind of project you might have funded historically, because we’ve got better options.” [Emphasis added].

Mike Wirth, CEO, Chevron, Financial Times, July 18, 2018

Image above from Chevron.

Those statements are in essence why the next upswing in offshore will be fundamentally different to the cyclical nature of the industry between 1999 to 2014: in those periods, devoid of shale in a meaningful sense, every offshore project was approved, and the industry built an asset-delivery base accordingly.  As an example Exxon Mobil used to take it’s PSVs and AHTS up to the Arctic in March and wait for the ice to melt so they could start work immediately. That work simply doesn’t exist now. There were a large number of frontier and marginal projects deemed economic that are unlikely to ever be seen that way again (on a risk-weighted basis not just cost per recoverable barrel).

I am a big believer in offshore energy nand believe it will be a significant part of the value chain for a long while to come. The industry is clearly improving from a demand perspective, and if you are a manufacturing or engineering business (for example) then next year will be better than this year. But it isn’t the same for those long on rigs and boats because of the oversupply situation and the fact that the high fixed cost structure makes it hard to reduce costs (i.e. the asset opex is a lot higher than SG&A overhead) in a meaningful sense. The asset based industries face years of structurally lower profitability.

The reason I don’t believe there will be a comeback in offshore demand in terms of the timing and day-rate increases seen in previous cycles is because a significant number of E&P  companies are following the same strategy as Chevron. It is taken as a given in offshore that oil prices and will always come back up, and maybe they will (although the relationship between oil prices and offshore demand has changed), but the optionality of shale has a real value as well for E&P companies and they have fundamentally changed the project approval process. The industry cannot boom on maintenance and decommissioning work, the offshore fleet is so big now it requires a CapEx boom in order to have a cyclical upswing, and there are no signs of that appearing. Project approvals are up but nothing like the levels of of 2013/2014 and it is CapEx projects that will create demand at the margin to meaningfully lift day rates and utilisation levels.

E&P shareholders didn’t see that much of the last boom where high prices were given to the supply chain to expand capacity and you get the feeling they aren’t making the same mistake twice. The offshore supply chain needs to digest the implications that while ‘lower for longer‘ may not have held for oil prices it appears to be an apt description of demand for offshore services.

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