With USD 1.5 trillion worth of investment by the oil and gas industry worldwide at risk, a new Wood Mackenzie report shines a spotlight on the need to change more than just supply chain and contract costs.

 

Since the oil price fall hundreds of billions of dollars of upstream investment has been put on ice. New data from energy industry analysts Wood Mackenzie shows that reducing cost burdens through supply chain renegotiations is required – but can only be a starting point for the kind of savings needed.

 

“As the upstream industry responds to the low oil price, investment is down USD 220 billion in 2015 and 2016 compared with our pre-crash projections. A total of 46 projects which were looking to sanction in 2015/16 have been deferred as a result of the oil price fall,” says Obo Idornigie, Principal Upstream Research Analyst at Wood Mackenzie.

 

In all, the report estimates that as much as USD 1.5 trillion of investment destined for pre-sanctioned projects is now at risk, or deemed uneconomic at a USD 50 oil price.

 

Supply chain focus

“The weak pipeline of new projects is resulting in very competitive bidding from the service sector as E&P companies negotiate hard on pre-sanction projects. We believe that pre-sanction offshore projects could benefit from 10-15% cost reductions through supply chain optimisation alone,” adds Idornigie. Maersk Oil’s response to the current market has been decisive. It was announced at the Capital Markets Day in September that through a combination of supply chain savings and some fortuitous foreign exchange impacts, opex and capex reductions of USD 1.7 billion have been realised to date.

 

Transformational responses

Just how important the success of Cost Transformation is to Maersk Oil’s right to invest and grow is underscored by the report’s findings.

 

“With supply chain reductions and contract renegotiations we have laid the foundation for the savings needed,” says Graham Talbot, Maersk Oil CFO. “Our razor-sharp focus on cost efficiency has a visible impact, but to achieve our target of a 20% opex reduction by the end of 2016 and make it sustainable we have a lot more transformational work ahead.”

 

It means changes to the way Maersk Oil works through standardisation and simplification which will create value for it in the longer term. From July 2014 to July 2015 Maersk Oil lowered its opex cost per barrel from operating units from USD 23 per barrel to USD 15 per barrel. Important contributors to this came from improved operational performance from Business Units around the world. It should be noted that a 33% opex per barrel fall, a great achievement in itself, means additional efficiencies are going to be extremely hard fought, Talbot notes.

 

“For Maersk Oil, Cost Transformation is not optional – and a pre-condition for our continued right to invest in and grow the business. It requires a cost-conscious mindset and that every single employee in every part of the business treats the company’s money like it is their own.”

Wood Mackenzie crunches global capex reductions

The index to the right represents the difference in project spend forecast for 2015/16 versus the predicted capex spend pre-oil price crash. Investment is down USD 220 billion relative to pre-oil price crash projections. Onshore North America accounts for over half of the 45% capex reduction in the Americas. This is partly explained by that market having the flexibility to rapidly dial back investment in unconventionals at low prices. Majors and international players tend to lack exposure to this flexible investment. Outside of the Lower 48 and Western Canada, Wood Mackenzie estimates 46 major projects looking to be sanctioned in 2015/16 globally have been deferred as a result of the oil price fall. Deepwater and Canadian oil sands dominate the deferred project pile.

Portfolio optimisation

Decisions to adjust the activity scope in Kazakhstan, the retiring of the Janice FSO in the UK and the recent workforce reductions connected to delaying sanctioning of Chissonga in Angola are tough calls to make, but prudent steps reflecting Maersk Oil’s sharp focus on active portfolio management and safe, low-cost operations.

 

“Whilst it is great news that we are progressing material world-class projects such as Culzean and Johan Sverdrup through these turbulent times, it is a fact that the Chissonga project is challenged by the economics of the market. It is only right that we take time to consider all the options and make a decision to move forward only if the project can demonstrate favourable economics in line with our targets for double digit returns on our invested capital,” says Talbot.

Creative thinking

In order to achieve the magnitude of cost savings the industry has said is necessary, around 20% - 30%, the Wood Mackenzie analysis outlines additional measures which are needed to manage costs. “These will include re-working field development plans, optimising project design and more innovative approaches to project management will all play important parts,” says Idornigie.

 

While a prolonged period of low oil prices over a number of years would hasten profound, structural changes to industry costs, the report suggests this was unlikely, indicating oil prices would begin to recover ‘from 2017’.  Indicating the sanction decisions of both Culzean and Johan Sverdrup may have hit something of a sweet spot, the report concluded:

 

“The winners therefore are likely to be operators with a strong pipeline of near-term projects close to sanction which are able to take advantage of the trough in costs through 2015/16.”

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