The North Sea oil & gas operations at a standstill
Offshore workers at the Wood Group, a leading subcontractor of Royal Dutch Shell announced a 48-hour strike over pay and soaring lay-offs as the industry struggles under plummeting oil prices. The current strike was preceded by a shorter stoppage of work in July. Two strikes in less than one month is a dramatic event for a sector characterised by a remarkable industrial stability over the past three decades.
ECEGA’s View: So far production has not been disrupted but as the anger spreads across the industry workforce, laying down of tools on platforms and rigs might well become a commonplace in the future. The industry has been plagued by plummeting profits and stricter environmental and safety regulations. Upstream operations suffered dramatic losses in the first two quarters: the protracted slump in oil prices have plunged profits on average of 60% for Shell, Total, ConocoPhillips and BP. The takeover of BG group by Shell earlier in the year compounded the situation for the Anglo-Dutch group. In the North Sea the situation is especially tense given the dwindling output of wells which exacerbate the effect of lower energy prices. As tight commodity markets put pressure on earnings, project cancellations and delays have become recurrent for the industry, and the emphasis on cost-cutting to keep shareholder dividends is a coping mechanism, which should not come as a surprise. The result: more than 120,000 jobs will be cut only in the UK by the end of 2016 [projections by Oil & Gas UK, the offshore industry association]. Recent research into rising depression and suicidal tendencies amongst industry workers in Aberdeen reveals the far-fetching effect of an industry in decline. Same is happening across the Atlantic, as Brent crude and West Texas Intermediate has dropped again to about $40 on Monday and production continuing to soar in Iran and the Middle East, US shale producers face a threatening glut. The bear market (a 20 per cent decline) drop is still above the nadir reached at the beginning of the year but small shale producers struggle and filings for bankruptcy multiply. A balanced market is still far from sight though, in the past months, especially in the US, the glut has spread also to derivative products - gasoline and diesel stocks are soaring. Further, onshore and offshore (floating) storage tanks filled up with oil for futures markets (so called contango markets) do not facilitate the situation.
In a jaded market, where profits are squeezed and companies struggle to ensure sufficient cash flow to cover their capex investment, less the dividend return to shareholders, a structural change is primordial.
All of the above reveals a chronic bubble for the industry which, if left unchecked, might cause far more serious disturbance than the financial shock of 2008. In a jaded market, where profits are squeezed and companies struggle to ensure sufficient cash flow to cover their capex investment, less the dividend return to shareholders, a structural change is primordial. The industry needs to diversify its assets in order to buttress revenue and adaption in a more carbon-constrained and low oil price world. As we have announced earlier this year, Shell and Total have officially launched Clean Energy departments and this is clearly the path forward. Moving towards smaller-scale, more nimble and less capital-intensive projects is another strategy, already embraced by Chevron.
But the industry has to improve efficiency and avoid the habitual cost overruns underpinning the delivery of major projects, especially deepwater drilling and liquified natural gas plants (where some projects end up costing 200 per cent more than the initial budget, Chevron’s Gorgon is a most recent example of cost explosion costing $20bn more than the approved budget). In the North Sea alone, a recent insight by McKinsey shows that the cost of extracting a barrel of oil has doubled for a span of 5 years, from about $8/barrel to a staggering $19 in 2015. This cost inflation has not been backed by material or technology advances. With the end of the age of plenty for the sector, these previously tolerated inefficiencies and cost overruns have to stop. Operations optimisation has to become the new mantra for a sector used to spashing out. The transition was never going to be easy.
Sustainable cost reduction could be realised by a simple vertical integration and better coordination between operators and suppliers: currently a fragmented supplier base brings large-scale inefficiencies and high coordination costs between global offices and companies. Today, an engineering firm in Europe uses different methodology for platform design than a similar firm in Australia or India for instance. When the work is coordinated by the European company with contractors in Australia building the actual oil rig lack of common methodologies often leads to delays and cost overruns covered by the operator. Coordination between operators and contractors on the ground should be mainstreamed, and more efforts invested in harmonising the project tools and work methodologies, but also, crucially, linking contracts to performance and/or making cost overruns covered by the supplier. These are immediate steps which will stabilise cost and reduce the need to lay-off workers or reduce pay.
In the medium to long term the sector needs to up its investment in technological efficiency, digitalisation and automation - the Internet of Things has made substantial cost optimisation strides in other sectors but has not yet penetrated the oil and gas industry. The potential there is vast. But investment should also be directed towards workforce retraining to pave the way to the energy transition and build capacity for a future resource needs. Public investment would need to buttress such private initiatives, because the spreading redundancies in the industry will put unbearable pressure on public welfare budgets. Avoiding this by helping retrain and retain human capital in oil and gas will be cheaper to the debt stridden public purse.
While it is premature to spur the end of big oil just as yet, the industry, but also governments need to lay a strategic vision on future growth for the sector which seals it off from a potential burst and facilitate a gradual transition. Establishing robust private-public-scientific partnerships for adaptation and growth is essential for bulletproofing the process. ECEGA’s major report Is Green the new Black? Transition pathways for the Oil and Gas Industry in a Carbon Constrained World provides detailed insights for the choices ahead for traditional energy giants. The report is currently available for Premium purchase. Please contact us for further information and insights.