With two downturns in less than a decade, the service industry simply did not have enough time to fully rebound after the price crash in 2014, which saw prices fall by an average of 25% from peak. At the time, E&P companies dealt with the market shift by deploying all types of cost optimization programs and aggressively scaling back activity. With a limited volume of work, competition between service companies was rife and prices plummeted as a result. Without any room left for additional cuts after the recent downturn, service prices are now expected to drop an additional 10% from 2019 to 2021.
Lower backlog this time around
During the first downturn of the decade, subsea and fabrication companies had robust backlog to rely on. This stands in stark contrast to the current situation, where orders are about half of what they were in 2014. Already orders and cancellations are on the rise; Awilco Drilling has cancelled a semi-submersible rig order with rig builder Keppel, and Aker Energy has cancelled a contract with Yinson for a floating, storage and production (FPSO) unit for the Pecan field in Ghana. Woodside has also delayed a tender for the engineering, procurement, construction and installation (EPCI) of two FPSOs for the Browse LNG project in Australia. Apart from order cancellations, some operators are implementing lessons learnt from the previous downturn, acting with extreme cautiousness when placing equipment orders. Additional procedures have also been put in place at many companies, instituting more detailed review and approval processes and placing partial orders by ranking long lead items. Orders on backups and contingencies have fallen and initiatives have been put in place to utilize existing surplus and inventory.
Logistical challenges abound thanks to coronavirus lockdowns
Strict lockdown measures across the globe have also strained efforts to keep operations going, especially in the offshore rig market. Over the past four months the segment has been battered by waves of challenges, including cancelled contracts, delayed drilling programs, and a declining number of contracts being awarded; working utilization for jackups dropped more than 7% from March to April this year, the largest drop in 20 years. This reflects the huge impact of strict Covid-19 measures on drilling operations and has resulted in several rigs being suspended, examples include Emerald Driller offshore Qatar and Sapphire Driller offshore Congo.
Cost cutting in already lean organizations
This time around, cost cutting measures at service companies are becoming brutal, including layoffs and personnel furloughs, management salary cuts and business unit restructuring. The challenge is that organizations are already lean, having experienced massive workforce reductions just five years ago. At the same time, new costs are arising from the implementation of Covid-19 related procedures, adding to the cost burden. Additionally, as seen during the last downturn, oil companies have responded to the downturn by trying to squeeze suppliers; operators have already begun asking for 15-20% discounts on equipment and services, meaning that service providers will see their margins further compressed. This could impact the industry in the long term, as it is now losing highly skilled and competent personnel at an alarming rate. When the industry picks up there will be a need to fill these gaps, and inadequate resources or competency can potentially lead to a plethora of service quality issues.
Recovery: is the worst over?
With many countries around the world easing lockdown restrictions, demand has begun to recover from the plunge in April, which wiped out 28 million barrels of oil demand per day. However, in the event of second wave, stricter regulations could again be implemented and oil demand through 2020 will be at risk. In this scenario, we expect governmental policy responses will tend to favor more regional and sector-specific lockdowns that are shorter in duration then what has been previously seen. However, this still may not help the industry; historically, periods with high oil price volatility have resulted in less spending, in projects being pushed forward, and in shortened contract durations. Even under our effective containment scenario, oil demand is not likely to recover to pre-virus levels until 2022-2023.
Thus far, combined investment cuts announced by 120 E&P companies amount to a staggering $100 billion this year. China’s biggest NOCs – PetroChina, Sinopec and CNOOC – announced cuts amounting to about 25% on average, which we expect will be primarily directed at international projects in an effort to preserve domestic expenditures. Other NOCs in Southeast Asia initially attempted to maintain capital budgets, only to announce cuts at later stage. However, despite the cuts, companies such as the Malaysian NOC Petronas are still on track to spend more than half of budgeted spend on home ground.
We forecast the Brent oil price will be $40 and $49 per barrel in 2020 and 2021 respectively – prices that are likely to translate to low activity for the service industry. We expect operators will begin to slightly increase spending in 2020, although recovery will be segment specific, as seen in the last downturn. Segments related to onshore shale will recover the fastest, with pressure pumping recording average growth of 14% after six quarters from the trough. This will be followed by OCTG, land drillers and completions. Offshore, the facility leasing of FPSOs will be the fastest segment to recover. Some of the slowest segments to rebound will be segments with long lead times and those that are driven by backlog, such as subsea, construction and installation, and offshore drillers.