Shale versus offshore: SLB version

In 1984, a cellphone weighed two pounds, was nothing but a telephone, and cost $10,277 in today’s $. Today, a smartphone is also a camera, radio, television set, alarm clock, newspaper, photo album, voice recorder, map, and compass, and cost as little as $99…

Human Progress

A lot of press being made about the Schlumberger comments regarding shale reaching its production limits. Coincidentally(?) The Economist has a leader and an article on the same this week. I don’t have the technical knowledge to get into the Parent/Child well productivity debate  but I note this is not the first time the death of shale productivity has been forecast (particularly eagerly by the offshore community for obvious reasons).

What was less reported was this nugget from the same SLB results:

Offshore Angola, Sand Management Services deployed a combination of technologies for Total E&P Angola to save more than $100 million and gain an estimated 1 million BOE of incremental production in the Kaombo deepwater development. Combining the OptiPac* openhole Alternate Path‡ gravel-pack service with OSMP* OptiPac service mechanical packers enabled the customer to achieve target production with six wells instead of the planned eight. This combination of technologies enabled effective zonal isolation of complex stacked reservoirs in one field, while in another field the water shutoff capability of the technology enabled accelerated production. [Emphasis added]

SLB appears to have developed a technology that has reduced the number of wells by 25%? That will signficantly lower the cost of the development but at the cost of rig and vessel days as well as lower subsea well orders if applicable in other developments.

This is the future of offshore. More work onshore and less offshore proportionately where the costs and risks are significantly higher. Productivity increases like this, not based on selling high capital equipment below cost, will be important for the industry.

I am also not convinced shale productivity is decreasing. The declining demand (and margins) faced by SLB and HAL could well be the result of larger E&P companies internalizing costs and driving them down as they seek to “mass produce” shale oil. We shall see… The BHGE rig count was at levels not seen since 2015 last week.

There is actually a much bigger change going on in the supply chain. In the old offshore geographically dispersed fields and rigs made using contractors like Schlumberger the logical option from both a cost and skills point-of-view. But when you are committed to a region like the Permian (or Bakken etc) you have critical mass and it makes sense to internalise those skills and capabilities.

Shale has dropped significantly in cost terms and a plateau of some sort should be expected. But shale is a mass production technology and the slow relentless grind of an annual 1 or 2% productivity input is still a real issue for offshore where each development is to a certain extent custom designed and therefore subject to limited economies of scale. That is true for the rigs and vessels throughout the supply chain as much as it is for the field lay-out and wells. Offshore needs companies like SLB to produce innovations as described above but the future of offshore is having less assets do more for similar outcomes.

A supply contraction and rising oil prices…

The comments above are from Schlumberger’s results last week. Note the comments about the only possible sources of short-term supply increase. I think SLB are ignoring increased maintenance spending to bring shut-in wells back but this is probably not a major number.

It is worth noting that this era of rising oil prices, if they remain, is driven by OPEC trying to limit supply to drive the price up for macroeconomic reasons, and is therefore different to the 2008 -2014 increase where the dominant narrative was to increase supply for a booming economy. The narrative counts.

Here is another reason any “recovery”, or boom 5.0, or whatever, in oil prices will be:

Crude Shipments

So any recovery will be just like before only different. Some change will be cyclical and just like the past but some has clearly been secular. Business plans that assume a general “recovery” as being disingenuous.

I ran a very hot half marathon today (Southampton). Anyone who enjoys this blog and feels it has some economic value please make a contribution to the Hospice North Shore (NZ) (an amazing place that took amazing care of my Mum at the end and to whom I am forever in their debt) or the Motor Neurone Disease Association UK.

Thanks in advance.

The age of abundance… Schlumberger exits seismic…

“Geophysical measurement, survey design and seismic operations have been an essential part of Schlumberger and our R&E [research and engineering] efforts for more than 30 years,” Kibsgaard said, pointing out the company’s unique position in terms of intellectual property and its engineering and manufacturing capabilities. But as the downturn enters a sixth year for the seismic data acquisition business, “the present outlook provides no line of sight for the market recovery.”

E&P

Spencer Dale and Bassam Fattouh published an excellent article at Oxford Economics on Peak Oil Demand and Long-Term prices this week (where the headline graph comes from and is a summary of various forecasters). The core of the article is that we have entered an ‘age of abundance’ in oil and it discusses some of the consequences of this:

the real significance of peak oil demand is that it signals a shift in paradigm from an age of (perceived) scarcity to an age of abundance. The conventional wisdom that dominated oil market behaviour over the past few decades, based around the notion of peak oil ‘supply’ and the belief that oil would become increasingly scarce and valuable over time, has been debunked.

Over the past 35 years or so, for every barrel of oil consumed, two have been added to estimates of Proved Oil Reserves.  In its recent Outlook, BP estimated that based on known oil resources and using only today’s technology, enough oil could be produced to meet the world’s entire demand for oil out to 2050, more than twice over! And future oil discoveries and improvements in technology are likely to only increase that abundance. The world isn’t going to run out of oil. Rather, it seems increasingly likely that significant amounts of recoverable oil will never be extracted.

Co-incidentally, or perhaps thinking abstractly causatively, Schlumberger also announced this week that it was divesting it’s interests in seismic.

Historically one of the key drivers of offshore (and onshore) demand at the front-end has been the need to keep reserve replacement ratio (“RRR”) above 100% for supermajors. If you want an idea of how key this is read the first few chapters of Steve Coll’s outstanding book ‘Private Empire: ExxonMobil and American Power‘ (and while you’re at it do yourself a favour and grab a copy of ‘Ghost Wars’). In an age of scarcity knowing that you had a stock of a scarce resource was an important differentiating factor and gave shareholders comfort that they were paying for a company with a future.

Now the RRR of the E&P majors is declining:

Reserve Replacement Ratio Majors Since 2014

Eventually it will tautologically lead to increased exploration activity in the future. For offshore a key question is how much and in what time scale? Clearly Schlumberger think it is someway off happening. In an age of abundance reserves assume considerably less importance.

And indeed investors don’t seem to value it as much either:

Rohan Murphy, energy analyst at Allianz Global Investors, which holds shares in Shell, BP, Total and Statoil, sees a reserve life of eight to 10 years as “quite a healthy level”.

“I don’t think these companies should have a reserve life much above eight to 10 years, especially when we are trying to get to grips with what oil demand will be in 10 years from now.”

From an E&P company these reserves will not be worth as much in the future, and potentially with technology changes will be cheaper in real terms to extract. So what investors are saying (already) is don’t pull forward this expenditure now, wait… And that is a completely different dynamic to the one prior to 2014 where first oil drove all decisions.

Not only are reserves going nowhere but neither is demand as Dale and Fattouh point out. The demand side of the market is likely to be relatively stable for decades, it’s on the supply side where the action is occurring. But it is hard to overplay the significance of this, an 8 year RRR would be a ~30% drop from historical levels and see a massive reduction in rig work and associated activity. Schlumerger is changing its business model accordingly. Slowly working through these reserves down to an 8 year period would fundamentally change models used to forecast rig demand used in exploratory wells for example.

This is playing out exactly as Spencer Dale predicted in 2015 where shale can act as a “kink” in the supply curve. Marginal production gives E&P companies more flexibility and lowers CapEx and offshore commitment. It makes uncomfortable reading for offshore as the logical assumption, from a senior figure who obviously has a large influence in how an E&P major acts, is that short-term price movements will be met with an increase in investment in tight oil. It might not be as profitable per barrel, but it can adjust quickly to short term movements, and isn’t as risky given the cycle times and upfront commitment offshore requires.

The call on offshore requires a vast number of assumptions in models, which as the graph at the top of this post shows can lead to a multiplicity of reasonabe assumed outcomes contains vast room for deviation. A few percentage points in extending current fields, a few percentage points increase in productivity from existing wells, and a small drop in forecast demand (either from efficiency, substitution, or a global recession) and the amount required from offshore drops signficantly. E&P companies are underpinning a huge amount of base demand on offshore but those few percentage points in each assumption that could change they appear to be backing themselves to supply with tight oil. The future for offshore will not be a mirror of the past.

Schlumberger exiting seismic is a small example of how the offshore industry will delverage from a position of being overcapitalised as an industry relative to the amount of work, and it is a clear industrial sign that “the age of abundance” isn’t some ethereal academic concept. Schlumberger also took a huge writedown on the asset value associated with its seismic business which again places a numerical value on an economic theory. If you go long on seismic companies at this point you might want to ask yourself what you know that Schlumberger management, actively reweighting their corporate investment profile to tight oil, know that you don’t?

The scrapping of older tonnage, which has begun in earnest in the rig industry, has been delayed for longer in the offshore industry as banks resist the economic reality of depreciating tonnage by delaying principal payments. Such a situation cannot continue forever. The Seacor/COSCO deal this week, which sees vessels taking delayed delivery in the future is a sign of industry weakness not recovery. Declining values highlight that these assets no longer offer access to a scarce resource but something now viewed as an abundant commodity.

I’d have to say the more I look at presentations where the core of the logic is a return to 2013/14, after a suitable gap for the market to return to “normality”, the less convinced I am.