The first quarter financials of the global oilfield services market painted a grim picture of the damage done to the service companies at the hands of the Covid-19 pandemic. Overall, global service revenues declined by 6% year-on-year and enormous losses were reported as impairment charges skyrocketed. In our March Supply Chain Newsletter we highlighted that oilfield service purchases are expected to face a double-digit decline in the year 2020 with all segments in this industry affected by the downturn. Despite the gloomy outlook in the market, we see a few bright spots.
Cost advantages from a strong dollar
A strong dollar can offer service companies cost advantages. Over the past months we have seen the inverse relationship between the US dollar (USD) and the oil price move into the deeper negative territory again as the spot WTI price and the US dollar index diverge.
On one hand, the negative impact of the collapse in oil prices has been slightly less for foreign operators who carry the majority of their maintenance, modification, and operation (MMO) costs in their domestic currencies. On the other hand, operators bearing most of their costs in USD will not have received much relief from the depreciation of the USD as compared to their foreign peers.
Contracts in foreign currencies paying for accrued work have already seen large gains over the past months as a result of the appreciation of the USD, and this can have a major impact on the competitiveness of foreign manufactures going forward. A strong USD going forward will create opportunities for operators collecting their revenue in USD, as manufacturing opportunities in foreign countries with a currency that is not pegged to the USD will then offer cost savings already in the near term.
Organic cost reductions through natural material and labor cost decreases
A downturn in the oil and gas industry means that the operators will have a strong appetite for reduced service pricing. The good news is that service price reductions will happen organically.
In a typical oil and gas downturn, service price declines outpace their raw material or labor counterparts. As an example, electrical and instrumentation (E&I) service companies may have to use labor reductions, efficiency gains and margin reductions to compensate for the decline in activity and thus meet operator pricing expectations.
This time however, Covid-19 has impacted demand for services across most industries and not just for oil and gas. Thus, we expect service pricing for E&I service companies to see some organic price relief through natural material and labor price decreases from early 2020 through mid-2021. E&I purchases are not alone in being passed on organic cost reductions. We would expect a similar effect to be seen across segments that have both bulk material and equipment purchases associated with them. For example, the SURF industry will greatly benefit from this price relief.
Intervention activities on the rise
The volatile oil prices and logistical challenges related to the Covid-19 pandemic have opened up several opportunities for intervention work in the years ahead.
In the 2014-2016 downturn post-completion activity on subsea wells in the US Gulf of Mexico (GoM) gained momentum, and levels for activities related to both abandonment and production enhancement rose. Fast forward to 2020, abandonment activity is likely to pick up momentum again, as operators become less patient with production decline and unproductive wells in the current low-price environment. Production enhancement activity will also increase if operators decide to re-enter temporarily abandoned wells to save costs on drilling new wells or improve recovery rates from the existing well base.
Subsea wells have become increasingly important in US GoM during the last two decades. With a growing base of aging subsea trees in the region, the stage is set for intervention activities to grow in the US GoM. Technological advancements in the last decade have increased the frequency of intervention activities in the deepest waters, which may benefit the technologically apt service companies providing these services towards 2025.
Similarly, during the previous downturns, operators on the Norwegian continental shelf (NCS) stepped up efforts to plug and abandon (P&A) unproductive wells and at the same time re-entered temporarily abandoned wells to save costs. While it is too early to see clear signs of an increase in P&A operations on the NCS, the current market conditions clearly indicate that this will be on the agenda for operators.
We have already seen temporary abandonments and shut-ins gaining a lot of attention globally.