“On Pause”: Offshore Oil Industry Faces Its Biggest Setback In Years
On any given day over the last four years, there have been around 20 oil drilling rigs somewhere in the Gulf of Mexico, tearing through submarine rock in search of oil.
Last week, there were just 12, according to data from oil services firm Baker Hughes BHI. With just one exception, that was the lowest weekly tally of rigs in the Gulf since 2000.
The world’s offshore oil industry, responsible for 30% of all the world’s oil production, faces a reckoning. With oil prices still well below levels from just months ago and key questions about future levels of oil demand unanswered as the COVID-19 pandemic reshapes the global economy, companies are reigning in capital spending and reassessing long-term goals. That could mean that a growing share of the world’s oil production is pumped from cheaper onshore alternatives, rather than pricey offshore ones, at least in coming years.
In the Gulf of Mexico, home to the vast majority of US offshore oil production, pullbacks, pauses and cancellations have been the word of the day. Royal Dutch Shell has delayed plans to finalize development of a huge new oil field called Whale until 2021. Shallow water producer Cantium LLC halted all production in late April, unable to recoup operating costs. Kosmos Energy KOS, a company that is also active in Africa, said recently it would shut in some of its production during the second quarter. On top of it all is the steep decline in number of oil rigs.
“Things are not looking good for offshore drillers,” said Jon Marsh Duesund, a partner at energy research firm Rystad Energy.
Many oil firms that operate offshore had not yet recovered from the last price downturn when this one hit. In 2014-15, oil prices collapsed from over $100 to below $40, sending seismic shocks through the industry. “A lot of these companies weren’t out of the woods from the previous downturn yet,” said Duesund.
Coming into 2020, drillers and producers alike were pinning their hopes on a cache of new projects that were given the green light in 2018 and 2019. And indeed giant new fields such as those in development by ExxonMobil XOM in South America’s Guyana are set to yield a gusher of new offshore output over the next couple years.
The real impact of the current downturn will show up not in the number of projects completed this year and next, but in the number of new projects that are greenlighted over that same period.
“We’re probably not going to see a lot of project sanctioning in 2020,” with only modest levels of comeback in 2021, he said. “What we saw in the previous downturn in 2015 was that not many projects were sanctioned [that year], and there was more sanctioning only in 2017-18.”
“Generally, companies do just put things on pause for a little while.”
Rystad said it expects even fewer projects to be greenlighted this year than at the nadir of the last price collapse in 2016. “We are seeing alarming numbers from April as the market faces postponed drilling programs, suspended rigs and cancelled contracts,” it warned last month.
Peter Maniloff, a professor of energy and environmental policy at the Colorado School of Mines, said offshore oil’s high costs and long project timelines pose a barrier.
“That means that not only does the price need to be high to make them pay off, it needs to be high for years,” he wrote in an email. “I don’t expect much new offshore drilling in the near term.”
Debt problems return
As if offshore oil companies didn’t have enough problems, they are also staring down a tidal wave of debt repayments.
After the price collapse of 2014-15, many oil firms refinanced existing debt in hopes of paying it back once prices recovered. But prices never completed their expected recoveries. The approaching wall of debt repayments will be most painful for America’s prolific but fragile shale oil sector, nourished by an ever-growing pile of loans and bonds. But many independent companies that operate in the shallow waters off Louisiana and Texas will also be hit hard. Analysts predict that companies specializing in contracting out oil drilling rigs will be hit hardest, with firms like Noble Corporation NE and London-based Valaris at risk of bankruptcy.
“Offshore drillers and offshore vessel providers will generally be unable to pay their total outstanding debt of 2020 based on their cash flow from operating activities, unless they are able to make sufficient capital expenditure cuts,” Rystad said in April. “Otherwise, they will have to turn to capital markets for refinancing.”
Surprising many industry observers, crude prices have rebounded strongly since briefly plunging below $0 per barrel for the first time ever in late April. Barrels of US benchmark crude WTI are now valued above $30 for the first time since early March.
But as offshore companies seek to revive drilling and sanctioning of new projects, they will face stiff competition: their onshore rivals in the shale basins of Texas, New Mexico and other US states are gunning for investor dollars, too. And in a post-pandemic world, these shale fracking firms may just have an edge. Shale plays are cheaper, faster, and face fewer unknowns than multi-billion dollar offshore ventures. That could make them a safer bet for firms and investors unsure of what demand for oil will look like one, two and ten years from now.
“In addition to the price collapse, deepwater Gulf of Mexico prospects are further disadvantaged by much greater risks,” said James Griffin, a professor of economics at Texas A&M University. “Much more is known about the geology of onshore prospects such as in the Permian and Delaware Basins.”
These trends could end up accelerating a transition towards onshore oil that has been long in the making. According to a November 2019 report by Sanford C. Bernstein & Co, the bounty of new offshore projects set to come online this year will briefly lift global offshore crude production. After that, though, new offshore production growth will be minimal, the report concluded. Even before COVID-19, prices were simply too low.
In Louisiana, home to all 12 remaining American oil drilling rigs, the industry’s pause on offshore activity is personal. Drilling crews wait at home and deckhands have less work.
“It’s devastating,” said Gifford Briggs, president of the Louisiana Oil and Gas Association, which said early this month that 51% of member firms who responded to a survey — or more than 100 businesses — considered bankruptcy likely. “Major companies will get through, because their revenue doesn’t solely depend on production…[But] independent producers will be hit hard.”
Still, many insist that, while they have heard about the financial and unemployment problems, they have yet to see it for themselves. That could be because most of the turbulence inside America’s offshore sector has occurred in the shallow water sections less than 200 meters deep. It is the deepwater portions of the Gulf of Mexico that actually produce most of the region’s crude. Deepwater drilling and production is dominated by supermajors like Shell, BP and Chevron — and they are not facing the kind of existential crisis that threatens to drag smaller companies under.
“Our clients are watching the market closely in mid- to long-term, but in the interim we’ve seen very little change” said Matthew Rigdon, executive vice president of Jackson Offshore Operators, which transports fuel, chemicals and other supplies to offshore rigs operated mainly by the majors.
White House reviewing a plan for industry relief
In March, smaller and independent companies most vulnerable to bankruptcy began campaigning for financial relief. But the Trump administration was opposed to the idea of offering relief to the sector, and the industry instead focused on a narrower form of relief which would be aimed primarily at the offshore oil sector. Companies have floated a range of ideas, from a temporary suspension of royalty payments — typically 18.75% of the value of all offshore production from federal waters — to a three-year extension of primary lease terms on oil wells.
Whether industry relief is on the way remains uncertain. But commodities specialist publication Argus Media, citing industry officials, reported late last week that the White House is reviewing a plan to allow oil and gas firms to defer royalty payments for three months. The policy was sent to the White House from the US Office of Natural Resources Revenue (ONRR), Argus reported, although it wasn’t clear whether the rule would target the offshore specifically or provide blanket relief.
A deferral of payments, rather than a suspension, might shield smaller businesses without extensive reserves from a cash crunch.
It isn’t clear when the White House will finish reviewing the rule, which was submitted to the Office of Information and Regulatory Affairs on May 20, federal records show.