Oil crash opens way for services deals

Schlumberger’s proposed takeover of Cameron is an attempt to better serve deepwater oil explorers

Transocean’s Deepwater Champion drilling ship in the Gulf of Mexico

This week has demonstrated that the plunge in crude prices holds opportunities as well as threats for the companies that provide the products and services needed by the offshore oil industry.

Transocean, one of the world’s largest offshore drilling contractors, announced it could no longer to afford even the greatly reduced dividend for this year that shareholders had approved in May, and warned that it expected to report a $2.1bn loss after writing down the value of its affiliated businesses.

Seadrill, one of Transocean’s leading competitors, on Thursday reported underlying operating profits down only 11 per cent in the second quarter, helping to send its shares up 13.7 per cent, but still warned of its prices coming under pressure because of “a high degree of excess capacity” in the industry.

But at the same time Schlumberger, the world’s largest oil services group by market capitalisation, was able to agree a significant deal for its long-term future at a much lower price than would have been possible a year ago.

Its planned acquisition of Cameron International, an equipment manufacturer and service provider that made 62 per cent of its revenues offshore last year, looks well-timed “at a (hopefully) low point in oil prices”, in the words of Kurt Hallead, an analyst at RBC. The cash and stock transaction gives Cameron an enterprise value of $14.9bn based on Schlumberger’s current share price.

There are long-term forces pushing oil services companies towards consolidation, especially for those serving the offshore industry. The crisis in the industry caused by low oil prices is accelerating that trend.

Weak crude prices mean that production in many offshore areas, especially in deep water, has become increasingly unattractive.

Oil projects in deep water have average production costs of $53 a barrel, according to Rystad Energy, above the current price of about $48 for internationally traded Brent crude. There is a wide range around that average, says Rystad, and new developments that need a lot of investment could easily cost more than $70 a barrel.

As oil and gas producers struggle to conserve cash and pay their dividends, they are seeking to save money wherever they can. Listed oil and gas production companies are expected to cut their capital spending 21 per cent in 2015, from $481bn last year to $379bn this year, according to Bloomberg calculations based on analysts’ forecasts, and the total is predicted to drop again in 2016.

Exploration spending, including much offshore drilling, is particularly vulnerable because it does nothing to help near-term cash flows. There is no guarantee that exploration will be successful, and even when new oil reserves are found, they can easily take a decade to come into production.

That fall in spending is hitting service companies twice: activity is slowing, so they do less, and customers are also able to negotiate lower rates.

One motive for Schlumberger’s acquisition of Cameron is therefore to respond to these immediate market pressures.

“The mindset in the industry is shifting,” says James West, an analyst at Evercore ISI. “No one expects to see $100 oil again any time soon. To make deep water viable, the business model needs to change.”

On a call with analysts to explain the Cameron deal, Paal Kibsgaard, Schlumberger’s chief executive, suggested that the offshore industry had a future only if it could cut the production cost per barrel for deepwater projects. Buying Cameron, he said, was “our contribution” to that: the deal is expected to generate $300m of benefits in its first year and $600m in its second, mostly from cost savings.

Beyond those immediate savings, though, Schlumberger also sees great potential to raise efficiency by integrating the products and services it provides “down-hole” in wells with the equipment Cameron supplies for use on the seabed and the surface in a single system. Doing that would make it possible to take production “to the next level”, said Mr Kibsgaard.

Other companies have been making similar consolidation moves in recent years, including Halliburton‘s $38bn bid in November for Baker Hughes, still grinding arduously through the regulatory process, and before that General Electric‘s series of deals to build a new division in oil and gas equipment and services.

There have also been new alliances forming. FMC Technologies of the US and Technip of France in March launched a joint venture called Forsys Subsea, intended to find new ways of bringing offshore oilfields into production. Schlumberger and Cameron knew each other through a different joint venture, called One Subsea, before the bid came.

“There has been a trend towards consolidation in the service industry over the past 30 years or more,” says Osmar Abib, global head of oil and gas at Credit Suisse.

“As oil production becomes more complex, it becomes more and more important for service companies to have the right skills and capabilities, and that means they need to be large enough.”

Mr West suggests that other companies providing services and products for the offshore industry, including Oceaneering and Dril-Quip, could be taken over by larger groups.

For as long as weak oil prices last, conditions are going to be difficult for oil services companies, but some are likely to be able to put themselves into much better positions for when the upturn comes.

ConocoPhillips drops drillship — at a price
The depth of the crisis in offshore drilling is evident from the story of the Ensco DS-9. The state of the art 755-foot drillship, built at Samsung’s yard in South Korea, is a magnificent piece of engineering, capable of sinking an oil well 40,000 feet below sea level. It was scheduled to be delivered towards the end of the year to work for ConocoPhillips, the large US exploration and production company, on a three-year contract.

But Conoco’s executives decided they did not want the DS-9. In fact, they were so determined not to take it they dropped the contract even at the potential cost of a cancellation fee of up to $400m — two years of work at $550,000 a day — depending on whether Ensco, the drilling contractor that operates the rig, can find another customer for it.

Even if Conoco has to pay that amount in full, it will still save on the staff costs, supplies and support that the drillship would have needed while the rig was working.

Conoco’s decision was part of a broader cut in the group’s spending on deep water exploration, especially in the Gulf of Mexico.

It is a sign of where the board’s priorities lie at a time when revenues are being choked by low oil prices. Conoco’s executives have made clear that paying the dividend is their top priority, and they even raised it by 1 cent to 74 cents for the third quarter. When revenues fall short, it is other uses of cash that will have to take the hit, not the dividend.

Source:: ft.com

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