Oil Price Roundtable: Adapt to Survive

Everybody’s talking about the fall in oil global prices, but what does it really mean for producers, operators and the service companies that support them? Here, CEO Neil Poxon and CFO Mahesh Konduru of ProSep, Investment Director Kristian Lier of Energy Ventures and Group Commercial Director Graeme Lewis of Air Energi give their views on some of the more pressing issues.

What’s your assessment of the current oil price and its impact on the energy industry?

Kristian Lier: I think we could be in for a bit of a bumpy ride for a while. The industry has to adapt to a new situation and become more efficient – not just in terms of production or squeezing suppliers, but in the way they run their organization. One of my biggest concerns is access to capital. Oil majors should have a strong balance sheet after a lengthy good run and as listed companies they will always find ways of attracting capital. Smaller companies don’t have the same resources. It’s a perfect climate for M&A so I expect to see consolidations in the next few years.

Neil Poxon: Interestingly, the share price for some oil majors is not far off their all-time high. And activity in key areas shows no sign of slowing down – so it’s definitely not all doom and gloom. In recent months, both the Tubular Bells and Jack/St. Malo projects in the Mexican Gulf have started production – even while the oil price was falling. The oil majors have invested over decades and, of course, many have huge downstream operations that benefit from a lower oil price which helps balance things out. It’s the smaller independents, particularly onshore, who may struggle.

Mahesh Konduru: A lot of the oil and gas players are using this as an opportunity to become more efficient. One way they’re doing that is reducing their cost base in the expectation that the oil price will remain low for some time. Any investment will focus far more on operations than long-term capital projects.

Graeme Lewis: It is a constantly moving situation. We’re starting to see rates for contractors and permanent hires being cut. But when the cycle begins again, then the same problems will be there – notably an aging workforce. If this hiatus in activity goes on for much longer than six months, then people will leave the industry for good. There will be a greater skills shortage and the price of labor will go up.

How do you think the Middle East will be affected?

NP: Given their vast resources, Middle Eastern countries are best placed to emerge from this relatively unscathed. It is primarily Russia and some of the mature basin producers that are going to suffer.

MK: Producers with a higher break-even price are going to be much more affected. That means not just Russia, but places like Venezuela and Nigeria whose economies depend on a high oil price.

KL: I think it depends in part on how long this will last. We’re seeing the impact in the United States and the North Sea already, while the Middle East is less affected, but if prices remain at their current level then all markets will follow suit.

How important is the Middle East to your operations?

NP: On a personal level, I was very keen to invest in the Middle East. I lived there for 12 years and I know the environment well. It’s a huge market irrespective of the oil price. With its commitment to continued production, it presents a significant opportunity for our technology, so it’s key to our strategy.

MK: We expect the Middle East will account for a substantial portion of our revenue. It’s a growth business, which is exciting. Although we predict modest returns this year – around 10 percent of our revenue – we plan to get that two or three times higher in the next few years. The projects we are chasing have not been affected and our pipeline for this year is still in play. But we have to remain agile and able to adjust to whatever market conditions bring.

KL: There’s no doubt that the Middle East is a very important piece of what we’re trying to accomplish. The willingness to blow through this and keep activity high means exposure to the Middle East is no bad thing.

GL: It is a vital part of our business mix. We’ve got a sizeable operation based in Doha with offices in the UAE, Iraq and in Bahrain. It counts for about 20 to 23 per cent of our revenues. The oil price hasn’t affected our business in the region to the same extent as other parts of the world.

MK: Interestingly, the Middle East is proving to be better at buying innovative products than the rest of the world. Our solutions are being very well received by operators on the ground. They see that working with us will make their lives easier and deliver substantial opex savings.

GL: We have a similar view. There is an opportunity for us to bring innovation to staffing and people management, where the Middle East has tended to lag behind other countries. There’s clearly a desire to be more efficient. There’s greater transparency about how costs are calculated and the levels of service that are delivered. It’s very positive.

Where else do you see the oil price having an impact?

MK: This is not really a regional issue. We’re back to the idea that long-term thinkers with a low cost base are least affected – and that cost base is dependent on the source of oil, whether it’s onshore, shallow or deep water and the technology used.

NP: Exactly. Areas of deep water are likely to face minimal impact because they are huge investments costed over decades. That means operators in West Africa and the Gulf of Mexico are better placed than those in mature fields in the North Sea and onshore in the United States – although it’s worth noting that a North Sea operating license comes with obligations to maintain production. I think the pain will be greater for onshore operators, but there are so many different variables to consider. For example, production rates for new rigs in the [America’s] Permian basin have surged by more than 50 per cent in the past year. In Canada, operators are still planning to increase shale and tar sand production and capex through 2015 because they’ve factored in a lower price for heavy oil for years. So it’s by no means clear cut.

In terms of the project life cycle, where do you think the biggest impact will be?

KL: Pretty much everywhere within production enhancement. Seismic will be affected, especially in the United States. Exploration will be affected and probably decommissioning.

MK: I think E&P will be the first domino to fall – we’re already seeing the signs. Then we’ll see cut-backs cascading down through the midstream to oil services. Organizations will start to shelve projects early and then bring them back online when they become cost effective again.

NP: My experience in the North Sea tells me that decommissioning always suffers in environments like this – it’s an expense that can be put off. Generally, it’s capital projects with budgets that are yet to be allocated that are the ones at risk. But major operators tell us that they are postponing not cancelling.

What solutions do you think are going to come to the fore as a result of the current market situation?

KL: The industry is not known for jumping on new products and solutions. It’s also tempting to say that innovation is linked to access to capital – if the capital dries up there’s going to be less money spent on innovation and research. But the flipside is that companies have to enhance production and bring cheaper, more streamlined products to market. That’s probably going to happen quite a bit.

NP: Low oil-price environments always see a surge in innovation and technology, usually to solve here-and-now issues that have lower priority when prices are higher. Companies recognize that this is what can get them out of the slump. I think we’ll see interesting solutions particularly in the drilling and production areas to increase efficiencies in top-side production.

KL: Solutions that swing capex to opex will be winners. Or those that can perform a key task better and cheaper – but only if they do not require a big capital commitment. They have to be solutions that can be phased seamlessly into current operations and give the customers cost savings from day one.

GL: In terms of people, it’s going to be about finding cost-reduction solutions that aren’t necessarily about rate reductions but improved efficiencies. I see technology being deployed that will dramatically improve the way people are managed – and actually bring the oil and gas industry in line with other comparable sectors.

Are there any specific areas where you expect more innovation?

MK: Really smart companies are born out of a crisis – that’s true of oil and gas in particular. Taking care of produced water problems or clean-up for natural gas, for example, can make older wells viable again. So I think we’ll see solutions that enable operators to really maximize revenue from existing infrastructure coming to the fore.

KL: I think we’re going to see innovation in business models too. More functions will be outsourced. There could be a way of extending that idea to equipment, with operators being able to rent equipment or deploy it as a service with an associated fee. That could be a win-win for everyone.

What positives do you think can be garnered from the current situation?

NP: I think many in the industry should view the situation in a positive light. There are opportunities to create streamlined businesses, develop leaner and more efficient operations, reduce waste and develop a more responsive service industry. That’s got to be good for the industry as a whole.

KL: What we’re seeing now is a natural consequence of a good run for the industry. There’s been a rapid escalation in oil price over the past 10 to 15 years which has been tracked by an equally rapid cost escalation. That led to inefficiencies and it is almost inevitable that many of those inefficiencies will be eliminated. Arguably we’ll see more better-run businesses in the longer term.

GL: The industry’s cost structure had gotten out of control. Now we’re seeing more measured costs which will help deliver more long-term, financially viable projects. That should create better career opportunities with more choice, more training and more development. There’s actually been a more measured approach to retaining staff and skills this time around, which is encouraging.

What can companies do to mitigate their risk?

MK: Betting on a high oil price is never prudent. Organizations that have run their financial models based on more moderate numbers and have structured their capital accordingly will survive. Being efficient and conserving cash is the best way to mitigate risk.

KL: Suppliers probably have to spend more time with their customers to get a more in-depth understanding of what their needs are – it will take harder work and more patience to get a final purchase decision. More agile business models are also going to be important – for example hosted services, flexible contracts or some degree of outsourcing. That’s probably how to protect revenues in the future.

GL: One: hold on to good staff. There are many ways of ensuring that key personnel have a long-term interest in a project or the organization and businesses should focus on retaining skills and experience within their operations. Two: use technology to drive greater efficiencies in staffing and look at other industries who have led the way. Three:  when outsourcing, avoid box-ticking exercises and a ‘lower price wins’ mentality, which only stores up problems for the future.

How can the industry protect itself from price shocks in the future?

KL: As a private equity guy, I would say diversify. Have high gross margins on products, try to be lean on the cost side and make sure you’re well capitalized. That comes with innovative products, innovative services, exemplary execution and close relationships with the customer.

MK: It’s always good to be planning your annual and two-, three- or five-year budgets around a modest oil price and a modest cost base.

NP: I agree. There are plenty of indications that the oil majors have taken that on board and budget long-term investments around the 40 to 60 dollar barrel range.

MK: It’s easy to say from where I sit, but I would say modest aggressiveness is always better than being super aggressive.

This article was produced by ProSep, Energy Ventures and Air Energi.