Deloitte: Low Oil Prices Creating Need for More Efficient Operations

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Upstream oil and gas companies will have to learn how to operate differently in order to weather the low oil price environment, Deloitte officials said Wednesday.

Unlike the downstream sector, which has been forced to operate efficiently because it doesn’t have the ebbs and flows that upstream does, costs on the exploration and production side have spiraled upwards, said Rick Carr, principal and leader of Deloitte LLP’s oil & gas operations and supply chain, at a media briefing in Houston.   

The North America shale market is “still pretty embryonic”, with nobody really having cracked the nut of running a lean, efficient operation, said Carr. In the case of North America shale operations, prices for oilfield services have not been dictated by the actual cost of the service, but what people are willing to pay to get a well done. Companies have been willing to pay 30 to 50 percent more than what a material actually costs, said Carr. 

With costs have spiraled out of control, price signals seen today indicate that the industry needs to reset its cost structures. Not only is a deflationary correction needed, but costs in the system truly need to be taken out.

“There’s a strong school of thought that low oil prices will help the industry reset costs and bring costs down for North America shale,” said Carr. “This will open up shale plays worldwide.”

The move by some companies toward greater operational efficiency started a year and a half ago, when oil prices flattened at around $100/bbl following a period of continuous growth since 2000. During that time, operational costs rose, and kept rising dramatically since 2008, even after oil prices flattened, said Peter Robertson, independent senior advisor, oil & gas practice at Deloitte. This put pressure on margins, prompting asset sales and moves toward efficiencies.

Companies that have been pursuing efficiency are taking the two-pronged approach of cost reductions and greater efficiency through changes in cost models, structures and operations, said Carr. The focus towards greater efficiency to weather low oil prices is occurring not only onshore, but offshore. Carr said that trend in newbuild offshore rigs is towards more efficient and effective rigs.

Upstream oil and gas companies will continue with cost management programs, and will work with suppliers not just to obtain short-term price concessions, but how they can drive innovation to improve drilling and well completion performance. As a result, companies will be looking to introduce new technologies, as well as restructuring operations internally, including the sale of certain assets or focusing on a particular area.

Low oil prices not only could create interesting merger and acquisition opportunities as upstream companies with stronger balance sheets hunt for strategic quality assets and oilfield service companies consolidate to optimize margins, but provide a chance for companies to pick up innovative technologies developed by smaller companies that could enhance operational efficiency. Melinda Yee, partner and leader of Deloitte’s M&A transactions practice, sees opportunity for companies looking to acquire technology related to liquefied natural gas or carbon capture technologies.

“Typically in industry, especially in oilfield services, many of the big guys have good research and development, but a lot of innovation comes from smaller types of service providers, such as technologies around fracking,” said Carr.

These technologies are test out by smaller companies; once they are built up, they’re acquired by a bigger company with more capital. Companies with better balance sheets could have the opportunity to scoop up technologies from stressed companies.

Deloitte officials view the manipulation of the upstream oil and gas’ Big Data – which has grown due to the use of sensor technologies as well as visual and audio devices that are recording greater volumes and more types of data – as key to operators boosting efficiency in shale operations. From a people perspective and a demographic perspective, more of the industry is looking at Big Data analytics and Internet of Things tools, from apps that can run off smartphones to wearable glasses. This combination of technology and efficient operations could not only enhance efficiency in operations, but in how the industry manages its workforce.

Robertson sees oil and gas operations as “the intersection between technological innovation and brute force. The public may only see the brute force behind drilling a well, but the technology being used at the end of the drilling pipe makes the oil and gas industry as high tech as anything that exists.

HOW LONG WILL LOW OIL PRICES REMAIN?

Global oil prices have hit bottom, but the question is not how low prices will go, but how long low oil prices will remain and where prices will recover to, Robertson told reporters. Oil prices could fall below $40/bbl on a half-cycle basis, according to analysis by Deloitte. However, the very low prices seen in the past are not likely to reappear on a sustained basis.

If the low price environment continues as expected through the first half of this year, it should trigger a demand response that will likely be felt in the second half of 2015. As a result, Deloitte MarketPoint expects crude prices to rise in the second half of this year. Deloitte forecasts the average 2015 WTI price to reach $62/bbl, then rise gradually over the next few years to a steady range of $75 to $80 barrel as early as 2018. Prices may return to $50 to $60 for a while, and creep up over time to $80 a barrel, but are not likely to recover to the $100 mark anytime soon, said Carr.

Deloitte clients reported that they saw supply rise dramatically in the United States and saw supply coming back online in places such as Iran, but were still surprised at how quickly that supply rose, said John England, vice chairman and leader of Deloitte’s oil & gas practice.

“For the longest time, people believed that non-OECD demand would just keep rising. When we finally saw some weakening in growth numbers in China, it spooked people.”

In 2014, the Chinese economy grew by 7.4 percent, down from 7.7 percent, the slowest growth rate seen in 24 years. While the economy’s fourth quarter 2014 performance was a bit better than expected, up 7.3 percent from a year earlier, it was still indicative of a continuing slowdown. This raises questions about future Chinese oil demand, according to according to a recent Deloitte paper, “Oil Prices in Crisis – Considerations and Implications for the Oil and Gas Industry”. The fact that the crude trading market is less liquid than in the past as Dodd-Frank regulations made it more difficult for banks to play in added an element that impacted prices, England noted.

Low oil prices does not necessarily mean that drilling activity will decline in plays such as the Bakken, as the volume of production from sweet spots could overcome the cost disadvantages of transportation. Players who are well-positioned in shale plays and in oil sands projects will be able to better withstand lower oil prices. Hedging could also sustain some operators in the short-term, but in the long-term bankruptcies may begin to occur, officials said. North American independents entered 2015 with reasonably good hedge levels this year, and their overall discipline for hedging has improved, said England.

“There will be operators who go bankrupt and others that benefit,” said Robertson. While even national oil companies like CNOOC are cutting their CAPEX budgets, large integrated oil companies are still pushing the same portfolio, including plays in deepwater and in Alaska.

 

 

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