Has the deepwater sector irreparably sunk?

 

A day before Halloween, major international companies announced some spooky news. After 17 months of dropping oil prices with no end in sight, they are turning away from the costly, high-risk megaprojects that were previously claimed as the future of the industry. US oil producers are switching to safer shale operations that generate the cash needed to satisfy worried investors. These companies include ExxonMobil Corp., Royal Dutch Shell, Chevron, and ConocoPhillips, all of which will be reducing their investment in Canada’s oil sands and the US Arctic, but most impacting for Mexico, they will be cutting down on deepwater activities, if not exiting the sector completely, as is the case for ConocoPhillips. It may be more sensible to drill many wells in Texas, where the likeliness of finding oil is high, than to try one’s luck at drilling a US$100million well in the deepwaters of the Gulf of Mexico. All exploration budgets will be slashed, but deepwater exploration will be hit hardest, with spending being cut from 20-25%. Oil and gas analysts explain that the environment is not propitious to megaprojects, which require a lot of wiggle room to make a return. At US$45/b, deepwater is a luxury companies cannot afford.

In an interview with the Houston Chronicle, the CFO of ConocoPhillips explained that one of the main advantages of shale production is that it allows companies to be more responsive to the price environment. The investment in capital is more flexible, as companies can move rig rates up and down. In deepwater however, projects take several years and billions of dollars before the first barrels can be produced, and reducing production to adapt to a changing environment would result in significant losses. Breaking a contract would be nearly impossible. The announcement that ConocoPhillips would retract all of its current deepwater activities came after the company reported a loss of US$1.1 billion for the third quarter. The US oil major will be selling any offshore leases it does not plan to drill, even if they are partially excavated. According to the Ocean Energy Bureau, the company has 1.8 million acres in the Gulf, but these are underdeveloped.

Although this trend may affect Mexico, it is important to point out that our side of the Gulf of Mexico remains largely unexplored, increasing the chances of an important amount of oil being found at the bottom of a well. The competitiveness of Mexican deepwater with US shale production, however, may still remain dubious. Does this mean Round One L-04 is bound to be a disappointment? Not necessarily.

While some oil Majors are exiting the deepwater race, others, such as France’s Total, are looking at ways to bring down the cost of these developments. Frivolities are first on the hit list, according to Mateen, Total’s Vice President of Engineering and Technology. “We have to do things simply, rather than making designs which can do everything. Let us go for something that is good enough for what you are trying to do; simplify things,” he said. Mateen projects that by simplifying, standardizing, and industrializing deepwater technologies, reductions of 25-30% can be achieved. He makes a good point, as the deepwater sector has not undergone this beneficial process so far simply because prices did not require it to. Be that as it may, he warns that there is a limit to how much can be saved through this process. Unlike the automotive industry and other commodity industries, the oil industry cannot create an economy of scale or scope, but Marteen explained that Total “firmly believes that technology and constant innovation is what will bring acceptable economic profitability, which will allow [the company] to continue deepwater development”. Key to this development is an industry-wide collaboration that would allow firms to enjoy reduced costs for technology. The industry wastes a lot of money qualifying technologies multiple times, and through competition during the development process.

This is good news for Mexico’s deepwater bidding round, which is planned to take place next year.

 

 

Sources: Bloomberg Business, Houston Chronicle, NY Times, Bloomberg, Offshore Engineer

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