January 1, 2016
Author: Jon Fredrik Müller, Senior Project Manager, and Audun M. Martinsen, VP Analysis
Publisher: OE Digital - January 2016
With high development activity and cost inflation in the industry since 2010, the breakeven prices for subsea developments have increased significantly. With cost levels as in 2014, many of the discoveries not yet sanctioned would be unprofitable at the current oil price regime. So how are the costs reacting to this downturn and how do we believe the subsea market will develop going forward?
The oil market is currently oversupplied resulting in a sluggish oil price. Going into 2016, Rystad Energy believes the oil price will continue at the levels seen in 2015 and trade in the range of 45-60 USD/bbl (Brent). However, from 2017 the market balance is forecasted to improve as supply responds to lower prices, and demand is forecasted to continue to grow. Moving towards 2020 the oil price is expected to strengthen significantly, potentially reaching the same price level as seen in 2014 (USD 100 real).
In terms of supply capacity, the oil and gas industry differs from other industries. In most other industries one can maintain an established production capacity with a small amount of maintenance. However, the inherent production decline within oil and gas fields results in large continuous investments needed, just to keep production flat at the current level. To be able to grow production and in order to meet growing global demand, significant investments will be required towards 2020. In terms of production growth, there are mainly two sources of growth possibilities - shale/tight and offshore resources. It is Rystad Energy’s view that it is not a question of one or the other. We need production growth from both sources to be able to deliver on projected demand by 2020.
The reduction in offshore activity, in conjunction with growing capacity in many of the offshore segments like rig, PSV and AHTS, have hit the suppliers hard. Companies are reorganizing, cutting costs and reducing staff, and as a result unit prices are coming down. The cost reduction varies greatly from segment to segment, but overall the cost compression within offshore segments is in the range of 20-30%. Within offshore rigs, one of the segments that has been hit hardest, rates for large deepwater rigs have come down around 50%. Within the subsea segment, there has also been an increasing number of joint ventures aimed at bringing down costs through increased cooperation between the SPS producers and installation companies.
The intense focus on cost cutting among E&P companies resulted in several development projects put on hold in late 2014 and into 2015. In 2014, Rosebank and Mad Dog phase 2 were some of the projects that got hit as companies could not prioritize new large cost commitments. Not all projects were cancelled, as they showed potential for significant production additions to a portfolio of falling offshore production. Instead, projects were reassessed for their potential of downsizing or re-engineering in order to cut costs. While this happened, the oil price was falling towards and below the 50-dollar mark. Consequently, investments were cut to a minimum, which in the end led to decreasing pricing power among service companies and unit prices started to trend downwards. Subsequently, this has led to a large cost saving potential for the previously shelved projects and Rystad Energy now observes offshore projects to come in at an average of 10-30% lower costs than before the oil price crash.
Figure 1 shows selected offshore greenfield projects that have been recycled or obtained new greenfield cost estimates based on either re-engineering, downsizing or lower service unit prices. As shown, E&P companies have accomplished cost savings of up to 50%, both due to re-engineering and cost reductions. Mad Dog phase 2 is an example where simplification of design and project phasing has translated to cost reductions of close to 40%, however the recovered volumes will likely be reduced as well. Another example is the giant Johan Sverdrup development, which has been able to cut more than 1 USD billion on lower unit prices alone.
Cost reductions have had a dramatic effect on breakeven prices. Prior to the oil price drop, un-developed offshore projects had an average breakeven price of around 70 USD/bbl. Assuming that a “typical” offshore project’s costs can be reduced by 20% due to cost savings, yields a new breakeven price closer to 55 USD/bbl. The cost compression will significantly enhance the competitiveness of offshore resources, and projects that were not economical a year ago, might now be ”in the money” due to cost compression.
Although we believe that offshore will be an important source of supply growth towards the end of the decade, the current oversupply has impacted offshore investments, like for the remainder of the market. The short-term activity has been significantly reduced as operators have pushed the brakes and cut back on investments in order to improve cash flows in the low oil price environment. However, the cost compression in the industry is improving the profitability of subsea projects. Figure 2 shows historical and forecasted subsea expenditure (capex and opex) split by market segment. The market has contracted approximately 10% in 2015 compared to 2014 levels of USD 45 billion. The negative trend is forecasted to continue in 2016 and stabilize in 2017. However, with a tightening of the market balance foreseen in 2017, expenditure in the subsea segment is expected to grow from 2018 reaching USD 52 billion in 2020, a compounded annual growth rate of 11% from 2017-2020. This is a growth slightly less than the previous growth cycle from 2010-2014 of 12%, and far behind the 25% growth experienced leading up to the financial crisis in 2008.
Figure 2 also illustrates how the different subsea segments are affected differently by the downturn. The segment Subsea Services, which is primarily subsea inspection, repair and maintenance is a more stable segment driven by operational expenditure. The SURF (Subsea installation, Umbilical, Riser and Flowline) and Subsea Equipment segment (production systems like christmas trees and manifolds), which are primarily driven by investments in greenfield developments, fluctuate more and are affected harder by the downturn and project postponements.
The current market downturn is forecasted to be both deeper and longer than the downturn experienced during the financial crisis. The reason for this is that while the financial crisis was a demand driven downturn, the current downturn is driven by an oversupply, which takes longer time to correct. However, Rystad Energy believes that the market balance on oil will become increasingly tighter from 2017 onwards and with the addition of lowered unit costs, the subsea industry is set for a new growth cycle from 2018.
Contact: Jon Fredrik Müller, Senior Project Manager
Mobile: +47 92 49 90 56
Contact: Audun M. Martinsen, VP Analysis
Mobile: +47 48 07 76 11
Contact: Julia Weiss, VP Marketing
Phone: +47 24 00 42 90
Mobile: +47 48 29 87 61
About Rystad Energy
Rystad Energy is an independent oil and gas consulting services and business intelligence data firm offering global databases, strategy consulting and research products.
Rystad Energy’s headquarters are located in Oslo, Norway, with additional research teams in India. Further presence has been established in Norway (Stavanger), the UK (London), USA (New York & Houston), Russia (Moscow), South Amercia (Rio de Janeiro), Africa as well as South East Asia.