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Crude recovery

Jeffrey Tan
Jeffrey Tan • 13 min read
Crude recovery
Oil prices have climbed 50% higher since 2014. But the offshore and marine sector would need far more to recover.
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Oil prices have climbed 50% higher since 2014. But the offshore and marine sector would need far more to recover.

SINGAPORE (July 9): On May 22, a fixed platform topside left the dock at Sembcorp Marine’s yard at Admiralty, on the northern coast of Singapore. There was quite a bit of fanfare to mark the occasion as the structure sailed away, destined for drilling in the Culzean gas field of the harsh UK North Sea.

This delivery comes after that of two other topsides in early May. All three topsides were originally fabricated for Maersk Oil. The structures were taken over by Total after it completed the full acquisition of Maersk Oil for US$5.74 billion ($7.81 billion) on March 8. This delivery also comes after a two-year hiatus. In June 2016, SembMarine delivered a topside to Norwegian company Aker BP, for the Ivar Aasen oilfield in the North Sea off Norway.

During the peak of the oil cycle in 2008, SembMarine, the world’s second-largest rigbuilder after Keppel Corp, posted an order book worth $9 billion — the highest in the last five years to that year. After oil prices crashed from over US$100 a barrel to under US$50 a barrel in 2015, oil majors such as Royal Dutch Shell and ExxonMobil cut back on capital expenditure (capex), and orders to rigbuilders and offshore service providers such as SembMarine fizzled out. The oil and gas (O&G) services companies here were hit especially hard. Some had leveraged to the hilt to capitalise on the boom. But when orders dried up and existing customers could not pay, a number of companies ran into trouble (see accompanying story) and investors shunned the sector.

Now that prices are up from their lows, will investment in the sector pick up? Is the delivery of the Culzean topsides an early signal that things might be looking up for the industry? What will it take to revive the local offshore and marine (O&M) sector?

Since the beginning of the year, crude oil prices have climbed 10% on average, owing to robust demand and lower output. The West Texas Intermediate and Brent crudes are trading at more than double the four-year lows touched in 2016. In theory, higher energy prices should incentivise oil exploration and production (E&P) companies to invest more capital to find and develop new fields. This, in turn, should increase orders for O&G equipment and machinery, as well as demand for maintenance and other support services.

There are already signs of a nascent recovery in demand for oil equipment and services, according to some industry observers. Based on Credit Suisse’s proprietary O&G Project Tracker, there has been a “gradual” recovery in order pipeline since 2H2016, which became more apparent in 2017 as crude oil prices recovered from their lows.

OCBC Investment Research analyst Low Pei Han notes that rig orders that were previously deferred when customers were unable to pay up are now being sold to secondary buyers. This “would bring in cash flows for the fabricators, though there could be a net loss recorded for some of the assets”, Low tells The Edge Singapore. Indeed, on May 16, Keppel announced that its indirect subsidiary Keppel FELS had sold five existing rigs to Borr Drilling for about US$745 million. Three of those rigs had been built for other owners — Grupo R and Falcon Energy Group, but the contracts were terminated by Keppel. Two other rigs had been built in anticipation of potential demand.

Low also notes that rates for offshore rigs and offshore support vehicles are “bottoming out”, while day rates for some segments are improving. This means that charter demand for OSVs and offshore rigs is rising.

Upstream capex

“I think oil majors are gradually feeling more confident about the state of the industry,” says Mriganka Jaipuriyar, Platts’ O&G news editor for Asia-Pacific. “They see the sense in raising capex in upstream production.”

Liaw Thong Jung, regional head of O&G services at Maybank Kim Eng Equities Markets Research, says oil companies are no longer cutting the capex budget but are maintaining or raising capex from 2018. “All these are due to the higher oil price level. Costs have also been re-based, making projects more economical now.”

OCBC’s Low says if crude oil prices continue to stabilise at these higher levels, it would spur confidence in E&P companies to increase capex. The spending would go towards resuming production of previously capped wells first, before being utilised for the development of offshore oil fields that were previously put on hold. “After these, more money could be channelled to new exploration projects,” she says.

But sentiment from the oil companies themselves is mixed.

Speaking to The Edge Singapore after the sail-away ceremony, Total E&P UK managing director Jean-Luc Guiziou says the oil supermajor as a group does not intend to deviate from its annual organic capex of between US$13 billion and US$15 billion this year. The same budget range is allocated for 2019 and 2020 too. Its budget for 2017 was between US$14 billion and US$15 billion. Total realised a capex of US$14.4 billion last year.

Total is allocating the largest portion of its capex of US$16 billion towards E&P development projects this year. These include its O&G fields in Argentina, Brazil and Angola. The rest of the budget is allocated towards production of assets, exploration and resource renewal, gas renewables and power, and downstream activities. Total did not give an exact breakdown in figures.

“We are growing our upstream activity in a steady way,” says Guiziou, noting that oil production recorded a 5% y-o-y increase last year. “As a company worldwide, we try to have a stable allocation for capex for the new projects in the coming years. For Total UK, we have a number of ongoing projects beyond [the] Culzean [field].”

Other oil majors in Asia seem more optimistic about their projects. Malaysia’s national oil company Petroliam Nasional has allocated RM26 billion ($8.8 billion) for upstream capex this year, up “slightly” from last year, according to media reports. In February, Petronas announced it will have a total capex of about RM55 billion this year compared with RM44.5 billion last year.

In Thailand and Indonesia, government-backed E&P companies are taking over or taking stakes in large gas blocks. This is to offset declining domestic production or to increase their capacity and production levels, says Jimmy Koh, managing director and head of business insights and analytics, group wholesale banking, at United Overseas Bank (UOB). Meanwhile, in China, the government’s coal-to-gas push in efforts to improve air quality is driving companies to develop domestic shale O&G reserves. PetroChina says it will increase its capex on O&G production, “in light of the strong demand for natural gas and the gradual recovery of international oil prices”. Its E&P capex is estimated to be RMB167.6 billion ($35.2 billion) this year, up 3.7% from RMB161.9 billion last year. This is 74.2% of the company’s total capex, which is set to increase 4.4% from last year to RMB225.8 billion.

Crude oil volatility

Evidently, the oil companies’ expenditures depend on whether crude oil prices trade at a level that supports their costs. According to industry consultants Wood Mackenzie, new O&G projects this year would break even, with oil ­trading at US$44 a barrel. Indeed, since the crash in crude prices in 2014, oil companies such as Total and its European peers have adapted to oil prices at less than US$60 a barrel through cost discipline, among other measures.

Recently, a decline in global crude ­inventory has helped support crude prices. The Organisation for Economic Co-operation and Development’s commercial stocks fell by 26.8 million barrels to 2.82 billion barrels in March, according to a May report by the International Energy Agency. This is the lowest level since March 2015 and one million barrels below the five-year average, the IEA says. This has been attributed to robust energy demand, resulting from broad-based and improving economic conditions globally.

But, crude oil prices have come under pressure recently in the lead-up to the June 22 meeting of the Organization of Petroleum Exporting Countries. The meeting concluded with Opec members agreeing to increase their production and reaching an agreement with non-Opec members to increase theirs too. But specific output targets were not revealed. While estimates suggest that Opec and non-Opec could jointly pump 1.45 million barrels into the market, the actual increase could be much lower, according to DBS Group Research.

As such, the research house thinks that the impact on crude oil prices is minimal. “The agreements reached in Vienna are not much of a surprise. They seek to offset production losses from Venezuela and, to a smaller extent, Libya and Angola,” it says in a June 25 report. “There was no hint of an undue flooding of the market for the coming months.” This is on top of a seasonally high demand in 2H2018 and inventory moderation, it adds. The Brent and WTI crudes have since inched higher to trade at US$78.07 and US$73.77 a barrel, respectively, on July 4.

Ehsan Khoman, head of research and strategist for MENA at MUFG Bank, says: “Irrespective of this new policy of reviving output, the alliance between Russia and Saudi [Arabia] is still one of the crucial factors driving oil supplies and prices, and markets should continue to expect coordinated market management to remain a fixture for the foreseeable future.”

Crucially, however, US shale oil producers could tilt the balance of supply and demand — like they did before — and thus put pressure on crude oil prices. While cost structures vary, they have generally been able to produce shale oil more cheaply than traditional O&G producers. Industry analysts note this also makes US shale oil producers more attractive to lenders, lowering their funding costs and further bringing down the cost of production. And, the engineers will continue to find ­pioneering ways to extract shale at lower break-even oil prices over time.

“[US shale oil] producers have adapted to a lower price environment with surprising flexibility, becoming leaner, smarter and more efficient,” Ehsan says. “We view that shale remains the firm global swing oil producer.”

DBS Group Research analyst Suvro Sarkar, however, sees a smaller impact. He notes that US shale oil producers have already ramped up production, and so far this year supplied 1.1 million barrels a day more than they did in the same period last year. There are also constraints on pipelines and other export infrastructure. As such, they are likely to be more restrained on capex, and focus on profitability and future cash flows rather than volumes, Sarkar says.

Too early to call recovery

Still, oil E&P companies have become more prudent, and activity is still muted, says UOB’s Koh. He notes these companies are using lower price assumptions as they increase their capex this year — despite higher crude oil prices now. These tighter budgets are resulting in offshore capex that remains weaker compared with onshore capex, analysts note. DBS’s Sarkar says: “Hence, we are not seeing [an] overnight spurt in E&P activity despite a rise in oil prices.”

Overall, it may yet be too early to call a recovery, at least in upstream O&G activity. “After years of frail returns, companies are questioning the value proposition of exploration with budgets remaining tight, notwithstanding an improving price outlook. Exploration’s share of upstream investment has slipped and this could be the new normal,” says Khoman of MUFG Bank.

“Given that the pace of order-award remains relatively subdued, this suggests there is still a sense of a cautious restraint in the sector,” says Johnson Loh, an analyst with Credit Suisse’s private banking research in Southeast Asia.

Compounding the situation, a glut in the rig and offshore support vessel space is still evident, says Sarkar. “Unless demand improves and scrapping accelerates to an extent that utilisation trends reach 80% or above, new ­ordering activity in commoditised segments is likely to stay subdued in the near term.”

Finally, oil prices are not the only factor governing E&P decisions. In recent years, the oil majors have acknowledged the move towards renewable energy and have made significant investments in the area.

Showing promise

Drilling and subsea engineering services provider Mermaid Maritime has said it is remaining cautious, even as it recognises that the outlook for the offshore industry is ­“dramatically ­improved” for the remainder of this year. It says crude oil prices are recovering, the industry has significantly restructured and the “obsession” with shale growth is finally diminishing. “At long last, an offshore upcycle is poised to begin,” the company said in its 1QFY2018 financial results’ filing with the stock exchange. “We continue to have a conservative view on the offshore markets but see that the rig supply/demand dynamics are better than they appear, especially for floaters and harsh-environment capable assets.”

Integrated offshore services provider Kim Heng Offshore Marine Holdings says it has reactivated eight rigs that were previously cold stacked. The company’s offshore crane utilisation for O&M activity is currently at 85%, though the rental rate is “pretty low”, according to CEO Thomas Tan. But it is enough to “make ends meet”, he says. “We are more confident as tendering activity has increased in the region. We are finding more work now compared with two years ago. It is a good sign,” says Tan.

OCBC’s Low says if a recovery in O&G activity gathers momentum, the biggest and most experienced players in this market such as Keppel and SembMarine should have no problem ramping up accordingly. “What we are waiting for currently is the return of new orders in a sustainable manner, not in fits and starts. They should also come with decent margins for them to contribute meaningfully to the bottom line of the companies.”

Loh of Credit Suisse is cautious, however. He says the sector’s 1Q results and management guidance indicate a diverging outlook in new order momentum as competition remains intense. “We give preference to balance sheet strength in an uneven recovery and are selectively positive on the sector.”

Low adds that Keppel is her preferred stock pick in the sector because of its diversified earnings base and undemanding valuations. If the recovery in new orders takes longer than expected, its property and infrastructure segments will support earnings, she says.

Keppel has said it had noticed an uptick in offshore rig transactions, for instance. The company sees pockets of opportunities, such as in the harsh environment mid-water rig segment. It had earlier in the year secured a contract from Awilco Drilling to build a customised mid-water semi-submersible.

“Over the last few years, we have been rightsizing Keppel O&M to be more efficient and compact while ensuring that we retained our talent and core capabilities. We believe we are now in a stronger position, ready to capture opportunities and scale up as necessary when the O&M industry recovers,” says Chris Ong, CEO of Keppel Offshore & Marine.

SembMarine, too, sees more business ahead. It is “receiving an encouraging pipeline of enquiries and tenders for innovative engineering solutions”, says a company spokesman. “While margins are compressed by intensifying competition, the offshore production segment is moving forward with the recent final investment decisions of several projects. Still, a recovery in rig orders will take some time as most of the drilling segments remain oversupplied, with day rates and utilisation under pressure.”

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