Low Energy Prices Signals Long Term Retrenchment

Industry slashes costs after price drop; longer period of low prices means sustainable cost cuts.

The slump in crude prices has jolted the oil industry into deep cost cutting which, unlike the previous downturn, could last for a few years at least.

After overspending by the industry during the boom years, the collapse in prices in the second half of last year laid bare the need to reduce costs and introduce efficiencies.

Oil producers globally have embarked on billions of dollars in savings in recent months, forcing oil service providers and contractors, in turn, to slash rates by as much as 50 percent in some cases.

A partial rebound in crude prices this year will give service companies such as Baker Hughes, Schlumberger (SLB)  and Petrofac (POFCF) little respite.

Unlike the previous collapse in 2009, when prices plunged 75 percent only to rebound within months, industry analysts forecast a very gradual recovery in prices this time, which means costs will need to fall a lot further still.

"Higher prices have led to cost inflation over the past years and now we need to reverse that trend," BP's Chief Executive Officer, Bob Dudley, told the OPEC seminar in Vienna on Wednesday.

"This will be tough and will require some very new thinking, but I believe it will lead the industry leaner and thinner into the future to use capital more efficiently."

Rig rates and service costs rose by up to 35 percent between 2010 and 2014 as oil prices held above $100 a barrel.

Since prices reversed companies are scrambling to trim costs wherever they can: from hardball negotiations with rig suppliers and contractors, to cutting rig workers' onshore leave and changing supply ship travel patterns. Some rig operators are now sharing vessels and helicopters to shuttle staff offshore.

But that may be only the tip of what's to come, and service providers could be hit hard.

In the North Sea, an area that has suffered in recent years from particularly high operating costs, well drilling costs are expected to drop by an average of 30 percent by the end of next year due to a surplus of rigs in the market, according to Malcolm Dickson, Principal North Sea Analyst at oil consultancy Wood Mackenzie.

"The industry has been through ups and downs before, but this is a different situation," Dickson said.

"We believe there will be a more sustainable deflation effect from this drop-off because companies have realized you need to focus more on costs and value over volume. The supply chain has realized that as well and is collaborating more."
           
STANDARDISATION TREND
Brent crude, at around $65 a barrel, is still 40 percent lower than a year ago and a Reuters poll sees it rising  only to $75.90 on average in 2017 as ample supply and U.S. shale production keep it in check.

Wood Mackenzie sees Brent still well below $100 in 2018, at $85 a barrel.

The current downturn has forced major oil companies to cut hundreds of jobs in the North Sea alone. It has also significantly accelerated a move towards standardisation of kit including everything from complex subsea equipment to pipes, ladders, doors and paints.

Companies see the introduction of standardised equipment across the entire production chain as a vital way to reduce costs.

For example, some North Sea platforms use eight different types of ladders and stairwells, and 20 types of paint are used for subsea equipment, according to industry sources.

Shell is working with energy, procurement and construction companies (EPCs) to integrate the engineering data, in what it calls Project Vantage, to offer savings in project designing, a company spokeswoman said.

It also standardizes and replicates equipment including subsea well designs, known in the industry as "Christmas trees", which has helped shrink the gap between order and delivery by up to 12 months.

BP is also focused on standardisation. "We've built a habit of every project as a new challenge that needs a new solution and this has led to some great new technology. But in fact there is often a real case for using more solutions off the shelf," CEO Dudley said.

"We have now dramatically reduced the number of versions of hardware that we use. We now have the same subsea control pods  on the seabeds in the Gulf of Mexico and Azerbaijan, the same well-heads in the West Nile delta of Egypt and Trinidad."

Some of the standardisation efforts are expected to take place through consolidation in the oil services and supply sector, such as this year's $35 billion merger of Baker Hughes and Halliburton.

James West, senior managing director at Evercore ISI investment bank, expects more consolidation in the services sector.

"There is a drive towards standardization but we believe that at this stage it isn't enough to generate big economies of scale," Wood Mackenzie's Dickson said.

That means not just more cost-cutting, but a change in mentality as well.

John Catlow, cost efficiency project manager, at Total UK exploration and production division, sees a need to challenge design requirements and implement "good enough" solutions, rather than the best technology solution.

"Engineers who become contract managers always go for the best engineered solution, so they are having to be taught to think about the cost," Catlow said.

By Ron Bousso and Claire Milhench