The North Sea: life after cost cutting. By Alan McCrae
The North Sea Oil & Gas industry has experienced a turbulent time in recent years – the well documented price crash of 2014 led to widespread redundancies, cost reduction and project deferral. But are those changes sustainable in the longer term? It’s certainly a concern for shareholders in oil & gas companies as equity prices took a battering, impacting the portfolios of individuals and pension funds alike.
So, if the worst is now behind us, what can companies do to ensure that there isn’t a swift return to the bad old days of escalating costs and inefficiency?
During the downturn, many commentators predicted a wave of M&A activity as the saviour of the sector – little fish would be swallowed up and we’d see a new breed of integrated Oil Field Services (OFS) players and larger independents. That was more of a ripple than a wave.
In the OFS world, a few mergers have materialised such as Amec Foster Wheeler with the Wood Group, Technip and FMC, and GE’s merger with Baker Hughes. But with many of these deals still to complete, we’ve yet to see what this could mean in terms of cost synergies and shareholder return.
In upstream, activity has focused on the asset side, for example, Siccar Point buying OMV’s North Sea assets in a deal worth $1bn, EnQuest’s acquiring an interest in BP’s Magnus field and Sullom Voe Terminal for $85m and, perhaps most strikingly, Chrysaor announcing a deal for a portfolio of Shell’s North Sea assets for $3.8bn. And hot off the press, Neptune Oil & Gas has acquired a majority stake in Engie’s E&P business for €4.7bn.
The Neptune, Siccar Point and Chrysaor deals not only represent a game changer for those companies, but represent a real step change in attitude of Private Equity towards the North Sea.
In addition, we’ve started to see foreign investment in the UKCS pick up such as the Delek acquisition of Ithaca, not long after it acquired a 20 per cent stake in Faroe Petroleum. Interestingly, the firm was also scouting for a share in Kraken from EnQuest at the time these deals were struck. A real demonstration of foreign interest in the North Sea.
Beyond the traditional sources of capital, newer ideas are now coming to the fore – alongside the return of some older ones. Cairn Energy recently announced a $200m streaming deal with Flowstream for offtake from the Kraken and Catcher fields and Premier Oil signed a similar deal for Solan back in 2015. Interestingly, older models, such as project finance are once again being discussed as a way of breathing new capital life into the basin.
But the reality is that the majority of the significant players in the UKCS are much the same as they were pre-2014.
Major players are increasingly investing their efforts in West of Shetland and frontier plays further afield – we’ve already mentioned non-core assets being divested by Shell and BP – and this is true of many others with a large number of portfolios available at the right price.
The view is that, smaller independent players without the Corporate baggage and cost of capital, can get a bigger bang for their buck on these later-life assets. A great example of this was Serica’s acquisition of Erskine from BP – Serica has managed to significantly reduce operating costs and increase production on an asset that was basically noise level for BP – a win-win.
Companies also need to work on the assumption that oil prices will be lower – for a very long time, advancing projects on much lower breakeven points rather than assuming high oil prices will come to the rescue. Being able to cope with a period of sustained lower oil prices in the future is critical.
The clarion call for cost reduction and efficiency prevails. Huge progress has been made by the industry but this ethos must also be embedded into corporate culture in perpetuity.
Moreover, the philosophy of ‘marginal gains’ is getting traction across some operators in the North Sea. Beyond cutting costs and selling stuff, companies need to reassess their business models and strategic responses in order to be able to deal with any future volatility.
Other key focus areas include:
Innovation is key to success. The application of technology and automation are fundamental to operating more cost effectively. Companies need to explore new ways of working to be successful and examine the role that digital technologies can play in improving their performance. New applications will certainly be developed to support backoffice and shared functions, where rewards are modest, but technology adoption shouldn’t be limited to this. Digitisation should be a lever for innovation that improves productivity and efficiency in the field. In some cases, technology will be acquired through partnerships.
Differentiated capability sets. In recent years, the oil and gas sector has been characterised by a diverse range of operating environments, including onshore unconventional reservoir production and frontier exploration in increasingly challenging and remote environments. While super majors have traditionally operated across the board, even they concede that they don’t have the skills – or corporate culture – to compete like this anymore. Specialisation is becoming commonplace and it is imperative that companies of all sizes identify those capabilities critical to profitable growth, and even survival, and allocate capital accordingly.
Recent M&A activity in the OFS sector reflects the emergence of operating models built around specific capabilities: GE’s recent acquisition of Baker Hughes to form a business focused on efficient well operations through automation, enhanced imaging, and data analysis while the combination of Technip and FMC Technologies creates a company whose core capabilities will be subsea engineering and equipment.The model of a single integrated company discovering and developing an oil or gas field, and operating it until it is depleted, is being replaced.
Collaboration, strategically and operationally, amongst exploration and production (E&P) companies – especially with the supply chain – is essential to keeping costs down. The OGA recently issued guidance on collaborative working within joint ventures, and we can expect an increase in combinations where each party can rely on the others’ unique areas of specialism to extract maximum economic value from their investment. Back in the autumn, we mooted the idea of the Super Joint Venture – a vehicle which collates and operates late life or decommissioning assets for maximum benefit for the shareholders – and this theme is likely to develop both horizontally between operators and vertically along the supply chain.
Underpinning this urgency is the ongoing risk of commodity price and macroeconomic volatility. Geopolitical changes, international relations, isolationism, nationalism, shifting oil trade patterns and technology, to name but a few, could exacerbate this.
And, of course, in the longer term the offshore sector will be affected by how companies and consumers respond to the low carbon transition to electric vehicles and renewable heat and power.
So the roller coaster ride is set to continue and the industry needs to make sure it is in prime position to see it out or else it may become de-railed.
Alan McCrae is UK energy leader, PwC. PwC is a network of firms in 157 countries with more than 208,000 people who are committed to delivering quality in assurance, advisory and tax services. PwC refers to the PwC network and/or one or more of its member firms, each of which is a separate legal entity.