Offshore Activity Outlook: A bump in the road or long term changes

February 18, 2015

Author: Jarand Rystad, Managing Partner, and Espen Erlingsen, VP Analysis

The article has been published by Eurmoney Insitutional Investor. Jarand Rystad presents on the topic at the OGFAmsterdam on 19-20 March 2015.

The year 2014 marked the end of the investment cycle the offshore oil and gas industry had experienced since 2010. The 60% drop in the oil price since late 2014 has made some analysts claim that the oil price will stay low for a very long time and that E&P activity will suffer in the long run. This article will observe some of the recent trends and discuss the possible outlook for the offshore oil and gas industry.

Over the last decade E&P companies have on average discovered 15.4 billion boe per year globally. During the same time period the average yearly production has been 15.8 billion boe, indicating that the industry has been able to add the same amount as consumption. Figure 1 shows the global discovered volumes per year split by the top operators. Petrobras has been the most successful operator discovering 37 billion boe. The Lula, Libra and Buzios discoveries in the Santos Basin are the key contributors to this. Following Petrobras, Anadarko and Eni made large gas discoveries in East Africa during 2009-2013. Statoil is on the fourth place in total resources discovers, however the company is in second place when only considering oil discoveries.

The peak year in terms of offshore discoveries was 2010, with 34 billion boe of discovered resources. Since then the yearly discovered volumes has been trending downwards, reaching the lowest point in 2014. From 2005 to 2014 the yearly investment related to offshore exploration increased from 25 BUSD to 72 BUSD. The increase in investment is a combination of higher activity as well as inflation. In 2005 the average cost per exploration well was 34 MUSD, by 2010 the same costs increased to 75 MUSD and again to 95 MUSD by 2014. The rising unit costs and the lower exploration performances have resulted in lower profitability for exploration; in 2014 the average global discovery cost surpassed 10 USD/bbl.

In 2005 the global offshore liquid production was 26.9 million bbl/d, making up 32% of the global liquid supply. Since then the offshore industry has been through two investments and two downwards cycles. From 2005 to 2008 offshore investments grew with an average yearly rate of 20%, resulting in a production peak in 2010. After the collapse in oil prices in 2008, activity contracted in 2009 and 2010. The postponement of projects and the natural decline in old fields resulted in a production decline from 2011-2013. Oil prices recovered in 2010, resulting in the second investment phase lasting from 2011-2014. During this time period the investment grew with a yearly rate of 11%. The increased activity started to impact the production in 2014, where the declining trend was broken and production started to increase again. For 2015 the total offshore liquid production is estimated to be 26.7 million bbl/d, almost at the same level as 10 years ago.

From 2005-2014 offshore investments have increased from 140 to 360 BUSD, or 2.6 times. This growth is higher than the growth in oil prices, restricting the margins for the oil and gas companies. As a result, in the beginning of 2014, oil companies became more focused on spending discipline. In addition, the oil price collapse during the second part of 2014 further emphasized the already reduced offshore activity.  Based on this, Rystad Energy estimates that the offshore investments will fall with an average yearly rate of 8% in 2015 and 2016.

Even though global offshore production has been constant over the last decade, there are considerable changes among the producing countries. In 2005 Norway was the largest offshore producer. From 2005 to 2013 the Norwegian production declined from 3 million bbl/d to 1.8 million bbl/d. Going forward the Norwegian liquid production is expected to be constant until 2020, when the giant J. Sverdrup is expected to start up and contribute to production growth. Other countries with declining production over this time period are Mexico, United Kingdom and Venezuela. Countries that experienced production growth during the last decade were Brazil and Qatar, where the Brazilian production increased by 1 million bbl/d.  


Outlook: Oil prices will come back, and offshore is well positioned

As we are at the beginning of a downwards investment cycle, the key question will be how long this will last and how will offshore perform against other sources of production?

When forecasting it is important to separate the short term from the long term, and to consider how they impact each other. Currently, we observe a low oil price as a result of a supply surplus. Looking ahead 6-12 months, the short term situation will not change considerably. As revenue starts to fall, oil companies will have to balance the cash flow through reduced spending and activity in 2015 and 2016. The cuts for 2015 will be less dramatic for offshore compared to onshore as offshore contracts and investments have longer lead times.

Short term lower activity will put pressure on production. Less infill drilling and delaying of new projects will quickly balance the supply and demand for oil. By looking at each individual field globally, its breakeven price and potential 2020 production, Rystad Energy believes that the long term oil price has to stay above 100 USD/bbl, if supply and demand should balance in 2020. For offshore this means that the downwards cycle we currently experience could last a bit longer than what we expected after the global recession in 2008, but by 2017/2018 the trend is expected to turn around and investment will come back. Figure 3 compares the commerciality of the different sources of new oil and gas production, expressed as breakeven prices.  From this we observe that new offshore projects typically have a breakeven price from 65-75 USD/bbl, marginally more expensive than most of the onshore sources. This illustrate that offshore is competitive, and Rystad Energy believes that offshore will be the most important source of new production by 2020-2025. In many ways the lower activity we are currently observing could be seen as a short term correction: the long term fundamentals are still strong for offshore, and will be an important source of new production for the next decade.