What does the future hold for offshore drilling? Four feasible market scenarios
May 2016 | Ryan Peacock, William Wu
Since the middle of 2014 the global oil industry has been punished by freefalling oil prices. The impact on the offshore market has been brutal; the volume of new contracts has decreased by almost two thirds for floating rigs and 49% for jackups, while oversupply has led to significant downward pressure on day rates – with new contracts demanding up to 50% discount on pre-decline figures.
Rig owners are understandably struggling. With share prices declining by up to 80%, overheads are being slashed, rigs are taking early retirement and new build contracts are being mothballed for the foreseeable future. In the worst cases, some are entering bankruptcy to restructure debt.
After almost two years the entire industry is looking for the bottom of the cycle and the first signs of recovery.
With geo-political, economic, environmental and technological dynamics impacting on prices; not to mention a near-revolutionary shift towards unconventionals, there’s little that the industry itself can do to control change.
By identifying feasible market scenarios however, and developing reference cases around them, rig owners can at least position themselves to respond appropriately when the market does start to turn.
So what are these potential scenarios – and the influences driving them?
Four potential scenarios for oil market recovery
1. Fast recovery – a potential scenario if the market switches back to demand outstripping supply. Political instability in Venezuela, Russia, Brazil and the Middle East could contribute to this switch, as could a prolonged increase in demand across Asia and OECD countries as a result of low oil prices.
2. Slow recovery – entirely feasible if OPEC producers only slow production after non-OPEC supply is delayed or removed from the market. In this scenario supply could be reduced by delays in mega-projects, a slowdown in North American shale and a decline in mature assets – and will be balanced out by a dampening in long-term demand as a result of greater energy efficiency and fuel substitution.
3. Under-investment – with rig owners currently stacking and retiring rigs, and deferring or cancelling new build projects, there’s a chance we’ll see a reaction to under-investment with a tightening of the market during 2018-2019 and a swift return to higher prices. An even likelier scenario if spare capacity from OPEC producers isn’t available to react to price volatility.
4. Supply abundance – with OPEC producers continuing to operate in a chaotic, embattled regional market, production continues apace, saturating an already over-supplied market. Technological advancements driving down costs for new projects, and a slowdown in demand as a result of energy efficiency and regulation could see this over-abundance continue, with suppliers fighting for diminishing returns.
How will these oil market recovery scenarios affect rig demand?
Oil prices affect oil demand, which in turn affects the number of rig projects that are undertaken and the level of production that follows.
In the case of a fast recovery, production looks set to remain high right through to 2030, as prices recover quickly and new rig projects are sanctioned.
In the case of a slow recovery, we would see a more gradual return to higher prices, which in turn would see an increase in offshore production, albeit more steady.
Under-investment as a result of the current depressed market, could lead to a rapid sanctioning of new projects in 2018-2019, with production coming online in the early 2020s.
If we continue to see abundant supply and oil prices remaining low, higher breakeven deepwater projects could be cancelled or suspended indefinitely.
Oil supply will be more susceptible to producers’ attitudes to risk
As prices remain depressed, speculative build remains at an all-time low, with cold-stacking and retirements looking set to reach historical levels by 2017.
Should we hit the bottom of the cycle at the end of 2016 as many anticipate, we could see a return to speculative development – and even the over-placement of new orders from drilling contractors and speculators from next year onwards.
In a more responsive scenario, rig owners will continue to cold-stack and retire rigs until 2020, but new orders will be placed in time to balance the market when demand accelerates.
However, burnt by the punishing and unforeseen drop in oil prices, it’s reasonable to assume owners will take a more conservative approach, continuing to cold-stack and retire rigs even after the market tightens as a result of lower production. In this scenario, players are likely to wait for strong market recovery signals before placing new orders, and even then, the total fleet size is likely to remain relatively low.
Hope for the best but plan for the worst
The fortunes for the market continue to be difficult to predict. In April, prices rose slightly as a draft agreement to freeze global output, with the aim of triggering a return to higher prices, was tabled for discussion at a meeting of major producers in Doha. But bitter political rivalries reared their heads and the meeting ended in discord – firmly dashing hopes of any such pact in the near future.
As time goes on and alternative fuels continue to creep into traditional oil territory, while environmental regulation further dampens demand, producers may become even less likely to cooperate, as they fight to protect diminishing market returns.
The only certainty right now is uncertainty – and it’s this that rig owners must work to their advantage. Understand the potential scenarios and plan for every eventuality; taking any positives the downturn has enforced, into the upturn.