Rystad Energy Believes That Offshore Projects Are Becoming Competitive Again – Seeking Alpha

Courtesy: Maersk Drilling.

Investment thesis:

A fierce debate is raging over which oil production sector should be chosen for investment first. The investing community is deeply divided about what to consider when it comes to evaluate the US shale versus Offshore drilling production in terms of real numbers and efficiency. Particularly when it comes to "oil service" and less relevant to the oil majors whose are often invested in both segments.

Some extreme views, frequently driven by inexperience and lack of understanding, are totally discounting offshore drilling as something obsolete and expensive, which is due to disappear into oblivion, as soon as tomorrow.

On the other hand, others think that the US Shale will become a white elephant after a few years of intensive drilling, atypical depletion and hidden costs.

In fact, both are merely wrong by touting one oil production sector against another. We need both and probably more if we look at the next 25 years. Therefore, if we need both oil sources of supply, we should invest in both as well. Simple logic, right?

It is interesting to see that US Shale (tight oil) production in the USA represents less than 50% of the US total oil production now or approximately 9 MBOEPD, and will be approximately 60% of the 10+ MBOEPD expected in 2040 according to EIA.

The recurring fundamental question is to adapt a trading strategy that can fit perfectly to each segment without using anachronism or caricature in the process of selection.

To use a very simple image to illustrate this futile misconception. How can one walk without the use of his two legs functioning adequately?

The concept of walking is based on the use of two legs, period. It is a basic principle -- one leg equal falling -- Same as the concept of smooth oil consumption which is based on a balanced worldwide production, wherever oil can be found and be delivered at a profit. Profit not limited to "operating profit" by the way, but "net profit" when all expenses have been subtracted.

What is the breakeven price really?

The charts below from Rystad Energy/WoodMcKenzie are a good indicator of the US Shale recent success and its limitation as well.

Another well-known research firm called WoodMcKenzie in the US is indicating the "point break" for both the onshore and offshore in the USA which shows how important a $60 per barrel can be for the all oil industry.

However, it can also be used to express how difficult it will be for oil prices to trade well above this significant level and at least for a long period of time.

We see that we have now a pretty similar value if we compare onshore and offshore in the USA. Furthermore, the offshore industry achieved significant reduction as the chart below is showing:

Commentary:

Today, I would like to share with you my thoughts about an article from Offshore Magazine published on February 17, 2017.

The article referred to Rystad Energy, which is a well-known independent oil and gas consulting services and business intelligence data firm offering global databases, strategy advisory and research.

Rystad Energy believes that after two years of cost cutting programs in the offshore service, 2016 and 2017 are showing "full competitiveness within these two sources of supply".

For every dollar that is invested into the North American shale market in 2017, the analyst firm says, a dollar is also earmarked for the development of new offshore resources. Both sources of future production, shale and offshore, will receive around $70 billion each of planned capex.

Audun Martinsen, VP Oilfield Research at Rystad Energy, said:

E&P and oilfield service companies have worked intensively on methods to reduce costs. However, these improvements are also a result of a portfolio effect. By focusing on the areas with the highest potential within their portfolios, E&P companies naturally gained the most from these newfound efficiencies by high-grading their undeveloped fields. Non-sanctioned offshore developments can expect an improvement of 15-30% in their breakeven prices.

As we can see, the CapEx repartition between the US Shale and offshore is nearly equal in value. Another chart from Rystad is also very telling:

Rystad Energy is arguing that the US Shale and the offshore drilling segment are difficult to differentiate in terms of breakeven price and in terms of capital expenditure.

One of the reasons for offshore projects starting to become competitive again is the strong deflation of unit prices which is actually higher for offshore than onshore. In 2016, unit prices for offshore developments have been reduced 27% from the peak in 2014 for awarded contracts.

One of the key segments, which have helped the offshore cost to come down, is related to the immense pressure on day rates for drilling rigs. Here, prices have come down more than 50%. For other segments, the cost is down more in the range of 20-30%, where subsea is on the upper end.

However, due to oil prices increase and a surge in activity overall, inflation will have a negative effect going forward. The process has already started with the US Shale (see breakeven price chart).

Rystad Energy says the time window of low service prices has started to shrink, whereas it will stay open longer for offshore activity due the longer contract durations and lead times. This will impact even more the 2018 volumes of activity and also benefit service companies on their top and bottom line.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.