Market is way down, but North Sea companies are already warming up for the rebound

Posted on 03 July 2009

By Jeremy Cresswell, contributing editor

A year ago, with oil prices headed towards $150 a barrel, upstream petroleum appeared to be bucking the slide toward global recession that basically started in late 2007 and intensified through 2008.

The Seadrill West Phoenix is under contract to TOTAL to work offshore Norway into early 2012.

Inevitably, the barrel started to roll back down the hill, with prices retreating more than $100 to around $33 for WTI and $39 or so for Brent Blend this winter past; not a nice place to be, though not as bad as during the depths of the late 1990s slump, when oil slid below $10 for a short period.

There has been a rapid rebound in recent weeks with the price of WTI edging above $69 a barrel on 5 June.

Basically, the offshore industry has enjoyed a 10-year run of prosperity, albeit the first three or four years were tinged with extreme caution, underpinned by the need to make up for time lost in the downturn and apparently tightening global petroleum resources.

This latest slide has served as a warning against complacency. Cumulatively, thousands of jobs have been shed, especially by the supply chain as operators revisit contracts, and a fair number of smaller projects have been delayed, put on hold or, in some cases, canceled.

Worst hit have been high-cost provinces, notably the North Sea, where the picture is made all the more complex by the myriad of small and largely debt-financed exploration and production companies that have entered that arena, especially in the UK sector and, to some extent, the Norwegian patch.

The drying up of credit lines has had a dramatic impact on such firms. This has in turn had a strong knock-on impact on drilling activity, especially exploration and appraisal work on the UKCS. NCS activity remains relatively unaffected as it is fundamentally different, driven as it is by StatoilHydro’s long-term, sustained approach.

There are just eight mobile rigs on UKCS E&A work at the time of writing. Up to the end of May, just five wells, broadly balanced between E&A, had been drilled. In addition, 14 sidetracks were initiated this year, 11 being appraisal and one a well re-entry. And half of that activity was in the Central North Sea.

Jim Hannon of drilling analysts Hannon Westwood told Drilling Contractor that 2009 had got off to a poor start on the UKCS and that there were various reasons for this, with British government policy and the credit crunch particularly blamed. Hannon Westwood has been closely involved with advising government on how it could/should stimulate activity that might ultimately benefit the British balance of payments.

He says those discussions showed that, in a $40-60 climate in particular, it would be useful to incentivise activity, particularly small fields where significant money has already been spent in surveys and the drilling of E&A wells.

“We have such a large tail of small fields … 426 wells on the UKCS with oil or gas discoveries in them,” said Mr Hannon.

“If you put $60 oil and a small fields allowance together, you’ve got yourself one heck of a lot of commercial properties there. There are a lot of companies that are underfunded and can’t afford to progress them without help.

“We’ve had a very good four to five years of exploration and some appraisal drilling. That typically costs the industry $1-2 billion a year in wells.

“Where we’ve got to in the UK North Sea is that we’ve backed up quite a lot of success, and I think that the stock tank is currently sitting at around 8 billion barrels of unrisked discoveries that could perhaps be risked down to 4 billion barrels.

“But if you think about each barrel requiring anything from $12 to $20 per barrel, that’s a lot of billions of dollars required in the industry to move that 4-8 billion barrels into production.

Ocean Rig’s Leiv Eiriksson is working on contract to Shell in
Northwest European waters, where activity levels are
expected to pick up if oil prices stay in the high $60s.

“There’s been this great four/five years building the stock up again … great amount of energy and money expended, including by new companies coming through.

“But just at the point when the industry needs huge amounts of money to push on towards development, suddenly the banks aren’t there.

“However, what that has done is create a vacuum into which oil majors and independents such as Premier can move in.”

The reference to Premier is because of the just-over-$500 billion deal struck early this year to buy up bankrupt Oilexco, a company that was a bold and prolific driller during its few years in the North Sea limelight. The company had crashed, largely as a result of its credit line being curtailed by the Royal Bank of Scotland, which was itself in trouble and has been nationalized.

Despite such problems, Mr Hannon still rates the UKCS as a good bet when compared with rival Norway.

“The UK still remains the most attractive overall for me in that the NPV (net present value) per UK barrel can be anything from four or five or six times stronger than a Norwegian NPV, simply because the tax take is so different.

“As for the Netherlands, we’re currently examining the position there. My take is that they’re looking with interest at what has happened in the UK with the latest fiscal changes there, because they too have a long tail of small gas discoveries and are trying to figure out how appraisal of those finds can be stimulated, and presumably for exploration too.

“I imagine we’ll see some extra activity in the Netherlands in the next 12 months, probably fiscally driven.”

One of the big problems right now is predicting the outlook for investment anywhere and not just the North Sea. The combination of recession and extreme oil price gyrations has trashed existing forecasts.

Of greater value is the line being taken by the majors, who still control much of the North Sea, especially Norway, where StatoilHydro clearly rules.
“Once you bring the oil price up to $60 and beyond … as BP said, $60 is quite a comfortable number,” said Mr Hannon. “A lot of things start to become commercial again, despite high well costs, despite high capex costs.

“Interestingly, if we do see the oil price drive up to, say, $70 and if a reduction in capex and well costs feeds through because of recent events, there could be a ‘purple patch’ for oil companies when it becomes very attractive to do almost anything. There’s a very rich irony going on here.”

Of course, if oil goes up to $70 and stays there, it will put a brake on declining rig rates and there is the risk that drilling will quickly go back to being high-cost again. There is a sound basis to that argument as far as Mr Hannon is concerned, and it has to do with planned wells.

“We keep a scouting record of all planned wells that we hear about in the UK, and what’s amazed me is that for the three years since we started this database, it has held in it anything from 175 to 250 planned wells … by planned wells, I mean talked about by operators/partners, wells that may not be finalized but could happen anywhere from next week through to two years ahead.

“I thought the stock of about 200 would reduce and things would start to decline, but even after three years of drill-out of about 60 to 70 wells a year, that stock is still 200 today.”

But Mr Hannon said that the critical difference between wells planned for the current year and 2008 is that, last year, two-thirds were fully funded versus only 50% now.

“Think about it … that’s a big stock tank of opportunity. Obviously there are people who are being very creative … maps are being made, prospects are being reviewed and people want to drill … they just don’t have the funds. But the appetite’s there,” he said.

“But if oil goes back up to $70 and rig rates soften, capex too, you can see funds returning to the market … at least oil company money. But what I can’t see is where the banks come into it anymore, so I guess there will be underfunding.”
This begs the question as to whether this represents a blessing in disguise for the North Sea because of limited rig capacity? In a way, yes, according to Mr Hannon.

“We’ve typically had 12 units working on the UKCS this last three or four years, and now it’s down to about eight. Drilling companies have the ability to pull them in order to try and keep the active units near capacity. If there’s an upturn, the same thing’s going to happen again.”

Even though Norway is relatively steady, there are issues and, like the UKCS, again it is among smaller companies.

“I hear that some Norwegian companies could go bust. Like the UK, if you’re not funded, then you can’t survive. Norway has been heated, and the company count has gone up from about 20 companies to around 55 … a bit like the UK but on a smaller scale; all of course on the promise … fatal promise, I think … of tax relief on exploration wells.

“Norwegian exploration attracts 80% relief of the well costs; to me, that creates a distorted market and holds false promise to new entrants. Once a discovery has been made, then the trouble starts as you have to find the funds to take things further.

North Sea workhorse Sedco 704 is currently listed as working for ADTI into early 2010

“But costs are extremely high because of the heat generated by this 80% cheque and, of course, timing is a risk because, in Norway as I understand, nothing has changed in that development can only take place when government approves, and approval is planned to pass continuous work through the yards.

“The market doesn’t prevail. You are at the mercy of a bigger system. As people often say to me: ‘If we find something in Norway, what do we do next?’

“Some say it’s a pity we can’t just explore the Norway boundary and develop from the UK!

“I don’t really understand the Norway model. I don’t know why it should work for small companies. If I were a new-start, I would be happiest starting in the UK than Norway. The Netherlands may be even better, partly because it has a lower cost base; whereas Denmark is sown up while Ireland has been a bit slow.”

On Ireland, Mr Hannon said there’s a lot of mapped resource there but that progress has been slow, with too many disappointments perhaps. He suggested, however, that the Irish Atlantic Frontier, where the semisubmersible Ocean Guardian was drilling the Bandon gas prospect mid-May into June, may yet yield considerable hydrocarbon resources and become a game-changer.

If oil locks in around the high $60s, does Mr Hannon see the market for Northwest Europe drilling gradually ticking up as opposed to a mighty rush?
“Yes, I do because it should pick up,” is the reply. “But instead of having the banks and others rush in, the only funding is going to come from within well-funded oil companies, and they can do only so much.

“Where the big companies have succeeded quietly over the last three or four years is that they’ve concentrated on frontier acreage (Atlantic Frontier) and the Central North Sea condensate play. Both plays have been successful, with very material finds made.

“The other side of the coin is that smaller companies haven’t been able to afford, or get involved or have the acreage to participate in either of those two theatres, but they have been able to explore in the Tertiary, Jurassic, Carboniferous and Rotliegendes plays.

“So, whereas the majors have been finding 50-100 million barrels boe, the smaller guys have been finding 15-20 million. There’s nothing wrong with either. In fact, they sit comfortably alongside one another because they are geographically and financially separate.”

The combination of a bank of untapped discoveries coupled with scarce money is setting the scene for mergers and acquisitions; indeed, there have been several, such as Revus of Norway being taken out by Wintershall of Germany and Bow Valley by Dana.

Mr Hannon confirmed that an active market is brewing and that his firm is being asked to get involved in matchmaking.

“One of the things we’re getting inquiries on is shall we try and buy into a discovery … can we find one that will suit us.

“I can see a steady move in the market towards more aggressive pursuit of other people’s portfolios. Equally, on the other side, I don’t see people with portfolios saying ‘I’m for sale.’ They appear to prefer to consolidate, cut costs and hope for the best. Where they get their funds from, I do not know. To me, the only source I can see is other larger companies with a surplus of funds, as we have just seen with Premier and Oilexco.”

And so it seems that things in the North Sea could go full circle, with the emphasis once again on larger companies.

“Consolidation should lend itself to creating more Talisman-like companies … medium-sized with the ability to absorb a number of smaller companies. To me, that looks like the model that we should be moving towards.”

This in turn has implications for future drilling in the North Sea, that is, the re-emergence of robust series drilling programmes. And Mr Hannon said this is necessary in order to access the reserves already in the tank.

“It would need a return to the more aggressive drilling patterns that we used to see in the 1980s and early 1990s when companies thought nothing of drilling 10 wells a year, or getting involved in that number every year. Seeing the stock of acreage out there, that’s the sort of demand that should be placed on a portfolio.
“The thing I find disappointing is that, with so many companies out there this last five years … 174 companies just now … some of those are getting involved in maybe one well a year or every two years, and that’s far too low to make any sense.

“That’s why it’s important that they either disappear or consolidate and become part of a bigger machine that can drill five-plus wells a year.”

QUICK OPERATOR RESPONSE

Glenn White, currently joint vice chairman of the IADC North Sea Chapter, describes the present situation as “challenging,” not least because of the speed at which oil prices spiked, then headed for the basement and fairly rapidly started the recovery process.

It has not escaped him that, at $60-plus, late May/early June oil prices pretty much matched the average for 2007 and that $50 was the average for 2005. Equally, the speed with which operators moved to push down drilling rates and other supply chain costs has not escaped Mr White’s attention.

“We’ve seen a quick response from the operators,” he said. “Obviously, right away they’re looking to the drilling contractors for decreased dayrates; everybody is having to do what the leaders (operators) want to do.

Several rigs will likely become market-ready over the next few months, including the Ocean Guardian, said Ian Burdis, VP well management at AGR Petroleum Services. The rig is currently drilling west of Ireland for Serica and which AGR is managing.

“We’re seeing fewer opportunities, even seeing a few rigs leave the area, and we’ve seen a few rigs stacking. But, in general, I think that the industry is going through this far better than the dips of the past.

“We’re already seeing the price of oil, having dropped to a low of $33 (Gulf of Mexico), reaching the mid-$60s and heading towards $70 a barrel, so I think things are coming along better.”

However, he is concerned, especially about the UK government’s apparent failure to grasp the immense strategic value of the North Sea, even in deep maturity.

“I just don’t know whether the UK government realizes the urgency of the situation … even to get operators to try to continue to do the work, whether it’s through tax reductions or whatever, but I guess there are other problems for them to fix, and they probably see the oil industry as being able to sort out its own difficulties.

“Given where the price of oil is today, it’s hard to look up at Invergordon and see three or four rigs stacked, and now there’s at least one in Dundee without a job (Galaxy 2).”

However, Mr White, whose day job is with Rowan Drilling in Aberdeen, points to growing interest among operators in recovering drilling momentum, as evidenced by the various tenders issued during Q2 this year. While this might not deliver work to IADC member companies until 2010 or even 2011, such activity is welcome indeed.

“We think the light is there … at the end of the tunnel … and everybody should get through this.

“Operators in general may have stopped their spending and maybe even pulled their budgets back, but we see activity, and we’re only six to nine months into this; and I think that another six to nine months more and we’re going to be on our way out of this downturn, if not completely out of it.”

Mr White agreed that, while the going has been tough of late, panic has not been in the vocabulary, unlike the 1985 crash and late 1990s slump. “You see layoffs, but that’s kind of normal. But you have to remember that we were at $50 just four years ago … then up to $140 … then fell back to $30, and we’re only talking of a few months and it’s back to $50 and now above $60.

“Of course, we’re all aware of the drilling rigs that are being built, and there seemed to be a bit of worry about that but, surprisingly, and I have first-hand knowledge of this. There’s just been a jackup kit ordered from LeTourneau (a unit of Rowan).

“So those people hoping for the chance to go out and buy a rig being built but which someone can’t pay for are out of luck. Here we have another rig being added to the market.

“As for IADC members, most of the contractors are strong and are going to live through this. There may be one or two of the smaller companies that might struggle for six months or a year, but they’re going to make it through too, albeit we could end up seeing mergers.

“It happened with GSF (GlobalSantaFe) and Transocean, so that doesn’t rule out the rest of us. We may see some of that.”

So is Mr White optimistic about the North Sea?

“Big time,” is the answer. “We’re seeing a lot of activity for the North Sea … not just the UK, Norway too.

Mr White added: “And one of the things I’m really pleased about through IADC is seeing everybody, no matter how big or small their company, continuing to stress safety standards and hold on to that as a priority.

“Downturn or not, struggling to get a job or whatever, everyone is staying on board with safety and, to me, that is a very positive message.”

ENSCO has eight jackups currently working in the North Sea, a market that Mark Burns, president of ENSCO’s international business unit, regards as “ ‘rather insulated’… special in that it’s very difficult to enter that market unless you have special equipment for the North Sea.”

He pointed out that barriers to entry are high; regulatory requirements are tough (UK, Norway, Germany and Denmark) but that the North Sea is also a “very balanced market” with an eclectic mix of companies across the size spectrum.

“There are currently 35 jackups in the North Sea, and demand is for about that number over the next two years, so we don’t see a big swing (in the market),” said Mr Burns, adding that about a third of ENSCO’s jackup fleet is based in Northwest Europe and mostly engaged in continuous development work.

He concurs with the view of Jim Hannon that smaller exploration and production companies are worst affected by the double whammy of lurching oil markets and recession … especially the latter.

Ian Burdis, VP well management at AGR Petroleum Services, admits that the company has taken a hit in this down market. In 2008, they did 23 wells on the UKCS. This year, they’ve done one, with one more to come.

Mr Burns said that this has of course had an impact on the drilling community but that the outlook for jackups is optimistic.

“We feel there is some softness in the second half of 2009; however, there are a lot of inquiries for 2010, which is shaping up to be a good year.

“I would say that 75% of our units, that’s six of them, are operating in the Southern North Sea with the smaller independents, which are continuing development of existing fields, putting more wells online.

“Obviously natural gas prices have had an impact, but then we have high-specification units capable of working in the Central North Sea where there is more oil infrastructure. So it’s a mix, with about 75% working on bread-and-butter drilling.”

When Drilling Contractor met up with Mr Burns, the oil price had surged past $50 but had not yet climbed to $60-plus. And even at $50, he seemed happy enough.

“A lot of people can live with that,” he said. “And important to remember is that the fundamentals are still intact. If you look at previous declines that we’ve been through, there has been a greater gap in supply and demand than during this recession.

“Yes, 2009 will be the first year in many that there has been a decline in demand for hydrocarbons worldwide; however, if you look at 2010, you’re starting to see demand pick up again and as the (global) economy recovers, that delta between demand and supply will become smaller than it has ever been.”

Mr Burns said ENSCO is committed to sustaining its North Sea presence … the market remains very important and last year accounted for about 30% of the company’s business.

“We have one of the youngest jackup fleets in the industry, if not the youngest. We’re very pleased with our position. I’ve been in this business all my life. I’m very proud to work for ENSCO; we’re a part of the North Sea industry, and we’re very proud of that.

“We’re a participant in the community in Aberdeen and we want to continue to be. We see the North Sea as a great market for us.”

A ‘BIZARRE’ YEAR

It has been a “bizarre” North Sea year thus far for Ian Burdis, VP well management at AGR Petroleum Services, which has for several years led the boutique end of the drilling market in the UK and Norwegian sectors.

He is clearly relieved that oil prices are healthier than during the winter and that they have perked up just in time for operators starting 2010 budget preparations to make provision for that year’s anticipated drilling commitments.

Mr Burdis is of the view that, while there will be a recovery in drilling activity, the immense damage done to small E&P companies by the credit crunch will destroy their chances of being able to credibly finance exploration programmes.

“They’re away, hiding in the long grass at the moment,” he said. “Some will run out of money before they get their opportunity. It’s worrying as the exploration side of the business has primarily been down to the mid-caps and new entrants, and they’re not really doing much at all.

“There are lots of people looking for alternative methods of financing, including, can the contracting community bring more to the table than expertise.”

He thinks interest will be sparse and then only at the development stage; most certainly not exploration because of the risks involved. What is really needed is for the banking community to get back on its feet and to start lending again.

He admits that AGR has taken a hit. However, the diversity and robustness of this Norwegian group has enabled it  to cope with the drilling famine that has so far characterized the UKCS this year, though not Norway, where, for Mr Burdis, activity is more or less at the same level as in 2008.

“In Northwest Europe, AGR in 2007 was the third most active E&A driller; last year we were second.” Add in what ADTI does, Senergy, Norwell and Fraser Offshore do and an awful lot of the drilling management activity is handled by such companies.

“In 2008 (on the UKCS), we did 32 reservoir penetrations, including sidetracks; there were 23 wells. This year we’ve done one, with one more to come at this point,” said Mr Burdis.

“That’s how dramatic it’s been, though Norway’s been pretty steady; we had a full year there last year with one rig and a full year this year. We’re looking to do about the same number of wells (seven) as last year.”

So what’s the critical difference between these neighboring markets?

“In Norway there’s a longer-term commitment. The rig market is tighter,” said Mr Burdis. “For the rig, we have (Bredford Dolphin), we’ve put together a consortium of seven operators, none of whom had sufficient demand in their own right to contract a rig for a term that met the requirements of the drilling contractor.

“Bredford Dolphin is on a three-year term, and the participants involved are of sufficient strength that they are not suffering from the credit crisis as much as some of the start-ups … it’s the likes of Marathon, BG, Lundin, DNO.

“We’ll be working on that contract until next summer, and we’re talking to various parties about an extension to that, and a second multiyear contract. I think there’s sufficient demand in Norway to take in another big jackup and a semisub.”

Mr Burdis likened the current North Sea rig market to housing. “Everyone says house prices are dropping; but if nobody’s buying, then they’re not dropping. That’s pretty much the situation with the semisubmersible market.

“There have been a couple of sublets in the $250,000-260,000 range, which seems acceptable to some. Transocean has said it’s not going to work any rig at less than $300,000 a day, so they will stack if they don’t get that sort of rate, though that may turn out to be a little too aggressive.

“People are getting ready; they fully expect to come out of this (low period). It will be like a light switch … when they suddenly realize that all the conditions are right to drill. Click! Off we go.”

— Ian Burdis, AGR Petroleum Services

“The market will always balance itself. Any rig that’s cold-stacked is not going to come out for one or two wells; it’s effectively off the market. Historically they’ve not come out for less than a year’s worth of work.”

Mr Burdis reckoned several rigs will be market-ready over the next few months, including the Ocean Guardian currently drilling west of Ireland for Serica and which AGR is managing.

“There are three or four units that could be available in Q3 this year, which might put some competition into the market for a short while because the drilling contractors have to decide what to do with the units. That means stack them, keep them crewed or take them out of the North Sea to place somewhere else.”

His view is that there is a lot of pent-up demand for rigs and that $60-plus oil is a good catalyst. However, other regions may free up faster than the North Sea and siphon capacity away from the region, including 1,500-ft water capability semisubmersibles.

“They’re a peculiarly North Sea animal. They’re what we need here. Of all the 170 or so new rigs that are being built, of which 76 are jackups, the vast majority of everything else is deepwater/ultra-deepwater.

“There’s nothing that’s going to replace the Aker H3 or Sedco 700 Series, which are the workhorses of the North Sea. They’re 30-odd years old (hulls) and will probably be around for quite a while yet. For us, that’s the dilemma.

“The jackup market seems reasonably robust. Some are a bit on and off, but the deeper-water jackups seem fairly secure on development work; though one could go to Norway or the Baltic as there is demand from Petro-Baltic and Svenska, who have about nine months of work. That could be combined with activity in Norway for a 400-ft jackup.”

As for how AGR is coping, bearing in mind that it is the largest well management contractor in the North Sea, Mr Burdis has kept his team busy on well planning … getting a number of projects to drill-ready.

It means that the company is ready to set its teeth into three, four and possibly more wells during the second half of this year, given the chance.

“What operators won’t want to do is miss out, hopefully, on being able to start drilling again in Q3 rather than waiting until winter. It could be that all available units are taken up around that time. We and others have been getting clients to a drill-ready status; with the work programs all but written and permits all but done.

“People are getting ready; they fully expect to come out of this (low period). It will be like a light switch … when they suddenly realize that all the conditions are right to drill. Click! Off we go.”

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