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Offshore Needs Structural Revamp to Compete Cost-Wise with U.S. Land, Says Raymond James

Structural changes in the highly priced offshore industry are underway, but to compete with U.S. land peers, it's going to require a revolution in how projects are developed, Raymond James & Associates Inc. analysts said Monday.

Energy analysts J. Marshall Adkins and Praveen Narra offered their take on last weeks' Offshore Technology Conference (OTC) 2016 in Houston, undoubtedly the largest annual oil and gas showcase in the world. More than 68,000 passed through the doors to see technology innovations (see related story).

The analyst team came away from the week-long event with several takeaways about how operators are attempting to stay in the game by reinventing their operations, including:

  • Structural, sustainable offshore cost reduction changes are needed to compete with U.S. land;
  • Equipment standardization will be a key method to improve field economics;
  • Service company initiatives, including joint ventures (JV) have attacked the changes but require support/coordination/money to be successful;
  • Lower cost tiebacks to single wells will take precedence over full-field development in the near-to-medium term; and
  • Onshore pressure pumping equipment manufacturers, which had a "large presence" at OTC, appear best positioned for a U.S.-driven recovery.

"We walked away from the OTC modestly depressed but with a better understanding that a significant structural transformation needs to emerge within the offshore complex to reduce project costs and improve offshore economics," Adkins and his colleagues wrote. "What is becoming increasingly evident is that most cost reductions and solutions proposed thus far only take a haircut to costs and are temporary in nature (i.e., service costs) thus not transformational."

The cost curve shift downward has been slow to date, and many offshore operators "remain holdouts on standardization, JVs and other steps. That said, the willingness of most companies to make these incremental changes has increased as the downturn has persisted and this industry has historically been very good at adapting to changing conditions."

Most operators are aware of inherent problems in working offshore, i.e. it's more expensive both labor-wise and equipment wise. However, Raymond James analysts think the pace of structural improvements could improve as prices increase and exploration and production (E&P) companies shift from a slash-and-burn strategy to optimization.

Because most of the changes proposed to date don't address the brunt of the cost burden, the Raymond James analysts don't expect the offshore to recover until economics are "structurally and sustainably improved. We are still in the early innings of trimming these offshore costs, and a revolution of structural changes will be needed to make offshore fields competitive with the U.S. onshore market."

OTC exhibitors in almost every booth said "something has to change" in the offshore arena, but how and what?

"Essentially all attendees, particularly those from manufacturing and E&P companies, were acutely aware that costs to develop offshore fields must fall, but theories on how to do it are just broad speculation," Adkins wrote. "The sinking ship within the offshore space cannot stay afloat by just throwing crew and parts over the side, the hull of the industry must be repaired to be a viable long-term option. Even then, it is likely to be a much smaller industry than only a few years ago."

To compete with U.S. land, the industry has to be able to post a sustainable 30-40% reduction in costs, analysts said. They noted that U.S. land still is below offshore pricing "and both don't really work at today's oil prices." Over time, structural costs may come down in the offshore but costs always will be higher than onshore.

"That means over the next decade we shouldn't expect offshore drilling activity to return to activity levels or prices seen just a few years ago," the analysts said.

One example is the BP plc-operated Mad Dog project, with the second phase of the project underway. Mad Dog, about 200 miles south of New Orleans, initially ramped up in early 2005 (see Daily GPIJan. 19, 2005). The final investment decision (FID) for phase two, which has been delayed several times, now is expected this year (see Daily GPIApril 26;Jan. 7).

"The original FID was targeted for 2013 and the price tag ballooned to $20 billion," the Raymond James analysts said. "BP scrapped the original spar design and re-oriented its approach to the design. As of today, the Gulf of Mexico development has been replaced with a slimmer more cost-effective design." In 2015 the FID was expected at $14 billion, but it now is targeting a capital spend of less than $10 billion.

More subsea tiebacks also are likely, as evidenced in recent earnings conference calls. Anadarko Petroleum Corp., one of the big collaborators in the Gulf of Mexico deepwater, earlier this month said it plans tiebacks at several of its installations, which would be much less expensive than drilling new wells (see Daily GPIMay 4). Anadarko has identified up to 30 development tieback opportunities in the GOM.

"By scaling back field size and focusing primarily only on the best zones with single well tiebacks, E&Ps can meaningfully reduce the cost of production," Adkins said. "Unfortunately, it is nearly impossible to replicate this strategy on a broad scale, keeping overall offshore production up with natural decline rates...That said, in today's environment where focus centers on only the most economic offshore projects, subsea tiebacks will likely dominate given the cost benefits."

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