Wednesday 5 August 2020

Blame Covid-19, the oil price or both in equal measures. Either way, the offshore rig industry will need to adapt.

Just last week during Saipem’s quarterly results presentation, CEO, Stefano Cao, was asked an interesting question that appears to be at the forefront of many minds in the oil and gas industry just now. Cao was queried that in terms of Saipem’s second quarter revenue decline, how much is related to the Covid-19 pandemic and logistical issues and how much is down to the low oil price?

Cao stated that most of their revenue reduction is related to changing of contract timings. Some operators are requesting to move timings due to cash constraints due to the lower oil price but other delays have been caused by physical difficulties in managing the Covid situation. The CEO believes both issues are interconnected, which of course, they are.

E&P company's 2020 second quarter results have not made for pleasant reading. Shell reported a loss of over $18 billion during the quarter, Chevron reported a $8.3 billion loss, BP reported a $6.7 billion loss, Eni reported a $5 billion loss… the list goes on. These firms have since been slashing capex and awarding few rig contracts of late. The strain is spreading down through the supply chain with very few immune and the list of bankruptcy casualties in the industry is growing at an astonishing pace. Late last week Noble became the latest driller to file for Chapter 11 bankruptcy and just yesterday Valaris announced plans for its imminent restructuring.

Is Covid-19 or the oil price most to blame?

On one hand it has been argued that a low oil price cannot be the main factor behind operator hesitance at moving ahead with drilling projects because, since reaching its lowest point on April 21 , the price has since more than doubled to well above the $40 per barrel mark. Not exactly something to write home about but it is a price at which many oil companies had previously reported their break-even levels to be at or below to make their offshore projects economic. So why are companies holding off? Some are provocatively claiming that perhaps oil companies have used the pandemic as an opportunity to protect cash flow. Meanwhile, it has been counter-argued, that the oil price would need to remain at a sustained higher level for a certain period before operators would feel confident enough to move ahead with their projects. A similar point made time over during the last market collapse.

The Coronavirus situation remains a very real threat to not only E&P companies but across the whole supply chain. Four months down the line and the industry is still in survival mode and the thought of moving ahead with a project only to be hit by a new wave of lockdowns or an outbreak on board a rig is daunting. There have also recently been some new cases of Covid-19 reported on offshore rigs, highlighting the continued logistical challenges associated with the virus, even with strict testing and quarantine measures. Last weekend, a worker tested positive for the virus onboard the West Phoenix semisub, off Norway, resulting in drilling being suspended. Meanwhile, during June there was an outbreak on two ONGC jackups in Indian waters, causing one death and 54 others contracting it. Many other drillers are reported to have had Covid outbreaks onboard their rigs including two of the biggest players – Transocean and Valaris.

However, it is also important to note that despite these safety and logistical worries there are still drilling campaigns that have proceeded during the pandemic without suspension, delay, or cancellation. Therefore, this counter argues somewhat that even if there was another wave of lockdowns and the resulting challenges that they bring, it does not necessarily mean operations have to stop.

As Bassoe Analytics stated in its most recent article, national oil companies will be the ones to set the pace of the recovery in terms of jackup demand, while independents will be the ones behind deepwater rig demand.

It’s what happens next that will count

The oil price crash and pandemic have given operators a terminal shock, which they will remember each time they make a decision from now on. Spending will remain restrained until there is more clarity and control of the virus, and until there is more confidence in commodity prices. Until then we will see several things happen: many rigs will be cold stacked or scrapped and ready supply will reduce significantly, so when operators do return to market there will be less choice and prices could increase in certain segments. We will also continue to witness more bankruptcy casualties and increased M&A within the market. Meanwhile, the recent surge of redundancies will mean a lot of expertise leaving the industry and the younger generation becoming disenchanted by it.

However, this does not necessarily spell the end for offshore drilling, but the landscape will need to change, and that includes the rigs. As today’s “perfect storm” has sped up the energy transition, operators and drillers will have to focus more on financial prudence, technological innovation, and lowering carbon emissions. Maersk Drilling is one of those leading the way in terms of technological advancements and just last week announced a $1 million investment to develop a technology that will help towards carbon-neutral drilling. Additionally, Maersk along with others such as Transocean and Northern Drilling, have been upgrading their offshore units with hybrid power systems and battery technologies to increase fuel efficiency and lower CO2 emissions.

Meanwhile, rig recycling efforts have increased since March and this time round it is not just the vintage tonnage that is heading to the scrap yards. Valaris has announced plans to scrap several drillships with the youngest of these just nine years old. During Transocean’s Q2 2020 call CEO, Jeremy Thigpen, stated “when the costs associated with maintaining, reactivating and/or operating an asset outweigh our view of its cash flow potential, we will take prudent action to remove the asset from our fleet.” It is likely that most drillers will be considering similar options right now.

Saipem’s Cao concluded his answer last week regarding the analysis of the two factors contributing to the market crash by stating that “it is indeed an interesting exercise but quite frankly I have to say at the moment this is not our highest priority. Our highest priority is to set up the organisation to cope with the overall situation.” No matter what the biggest cause of the problem is, it is how it is dealt with and what will happen next that matters. Basic survival is of course the top priority for offshore rig owners at present, whether that be through restructuring or other efforts, however once the storm passes it will be those that are willing to embrace change and adapt that will remain afloat for years to come.