Covid-19’s oil demand destruction is set to surpass 20 million barrels per day over the next two months and Rystad Energy estimates that the overall oil demand growth could decline by 9.5 million bpd year-over-year in 2020. Even after the OPEC+ truce meeting, where a cut of 9.7 million bpd was agreed, which in the best-case scenario could range up to 20 million bpd if US, Canada, Norway and Brazil join forces, the cuts will still not suffice to clear out the oil supply glut. Oil prices are, therefore, expected to remain low over the next two years. The current market uncertainty stemming from the low-oil price environment, combined with the logistical challenges of the coronavirus containment measures, have already started to hurt the oilfield service industry.
In our March OFS Newsletter, we forecasted deep cuts in oilfield service purchases over the next years in a $30 oil price scenario and with Brent price currently hovering between the $20-$30 range, this bearish scenario is beginning to unfold. Exploration and production companies (E&Ps) have responded quickly to the new price environment by reducing their capital expenditure budgets and scrutinizing their portfolios. The E&Ps have announced reductions of almost 30% of their collective capital budgets for 2020, but we expect to see even further downward adjustments made to the initial announced capital spending cuts over the next months.
During the last downturn, we saw cancellations and postponement of exploration and brownfield activity. Similarly, during this slump, several contract terminations have been communicated due to budget cuts and Covid-19 related operational challenges. Covid-19 has gravely impacted the oilfield service market as even those operations that typically would have continued even in a low oil price environment such as planned maintenance work and ongoing development drilling and P&A activity, have been delayed or cancelled based on the force majeure clause.
The last oil-industry downturn in 2015 and 2016 triggered major programs to trim unit costs and improve efficiency, resulting in total cost compression of around 37%. The ongoing slump will also spur major cuts in activity, however this time the E&Ps cannot expect significant cost savings within the supply chain. The gains from canceling contracts and re-contracting at a later stage will be small compared to the last downturn and will get further weakened due to contract termination fees that the operators will have to pay at the time of early cancellation of their service contracts.
The cost compression from the previous downturn has left little room for further cuts and we therefore do not expect this crisis to unlock much additional efficiency and productivity improvements. Overall, we expect total cost compression in 2020 to reach 12%, with 9% relating to service prices and the remaining 3% to efficiency improvements. We expect cost improvements within shale of around 16%, in offshore of about 12% and in other onshore of 10%, leaving the cost competitiveness between these segments little changed. Hence, operators will not be able to rely on the supply chain to help bring down the breakeven costs of expensive projects.
Looking at activity in the coming year, lower oil prices are expected to slow down sanctioning. In a $30 oil price scenario we expect the sanctioned dollar amount by operators to fall below the 2016 level for both offshore and onshore projects. In the previous downturn, the pace of sanctioning long-cycle deepwater projects slowed down, and we expect this trend to be repeated in the current cycle. The list of new deepwater projects currently under evaluation by operators is long and several projects are likely to face delays. Some large deepwater projects that have already been pushed from approval this year, include Aker Energy’s Pecan, Woodside’s Browse and ExxonMobil’s Rovuma LNG Area 4 project.
Given longer lead times for offshore, some service companies specializing within this supply segment have managed to build a solid backlog from the increased sanction activity between 2017 and 2019. Since 2017, we have seen 28 FPSO awards and Modec has won seven, followed by SBM and Yinson with three awards each. As seen in the previous oil price collapse, the most resilient segment was within offshore facility leasing, as these companies derive most of their income from long-term contracts.
Providers of maintenance and operational support services also fared relatively well during the last downturn, as demand for these services stayed strong despite declining oil prices.
The oilfield service industry is now far more fragile than it was in 2014 and the asset heavy industries, such as the providers of offshore vessels and rigs, will be living on the edge in the coming months. Many companies within these two segments will be unable to pay their total outstanding debt in 2020, based on their cash flow from operating activities, until and unless they are able make cuts to their capex – otherwise they will have to turn to capital markets for refinancing. The Norwegian vessel owner Solstad Offshore has already communicated that it intends to scrap 37 of its older vessels as part of a restructuring plan. Also, within the offshore drilling space, a new pool of scrapping candidates is poised to emerge as rig companies set out to reduce their costs. Given the high cost of stacking and potentially reactivating rigs in such an uncertain business environment, especially for managers of floating drilling units, it may make more sense to retire the older units. Even with more retirements in the floater market, the actual uptick in drilling activity will likely materialize slowly, as experienced in 2018 and 2019. With the demand for floaters expected to fall over the next two years, it’s unlikely that that the industry will be able to scrap its way to high utilization.
Not yet fully recovered from the previous oil market downturn, the OFS industry has once again embarked on a rocky ride. While some contractors are better suited to handle a low-oil price environment, a wave of bankruptcies and consolidations in the service market is on the cards.