7 minute read 29 Aug 2018
Unloading oilfield supply vessel

How oilfield services consolidation transforms the value chain

By

Andy Brogan

EY Global Oil & Gas Transaction Advisory Services Leader

Transactions and strategy leader in Oil & Gas. Speaker and industry advocate. Optimist. Music addict. Avid traveller.

7 minute read 29 Aug 2018
Related topics Oil and gas

What are the drivers of this consolidation, and how do they differ from previous consolidation waves? How is the oilfield services industry responding, and what are the future expectations?

Digital technologies and their impact on operations create new opportunities for all players.

The oil and gas industry continues to experience one of the sharpest and longest downturns in its history. Unprecedented change is occurring, and a radical transformation of the industry has started.

What are the drivers of this consolidation, and how do they differ from previous consolidation waves? How is the oilfield services industry responding, and what are the future expectations?

Previous downturns, mega mergers and economies of scale

The mega mergers among the majors in the late 1990s and early 2000s took place during the “mid cycle” when oil oversupply triggered the oil price to fall from US$30/bbl in 1985 to US$10/bbl in 1986 and then average US$18/bbl during the 1990s.

These mergers were mostly driven by the belief that bigger is better, with economies of scale leading to greater efficiencies and stronger balance sheets supporting complex mega projects. They were also the product of globalization, which led to greater concentration in the hands of a few mega caps, not only in the oil and gas industry but also in other industries, such as the pharmaceutical and automotive industries.

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Three reasons this downturn is different

Response to the downturn depends on the type of operator.

The significant growth in upstream capex spend during the period from 2000 to 2013 did not generate a commensurate increase in production and reserves, and the oil price fall of 2014 acted to intensify the challenges already faced by the industry in a high oil price environment. In this challenging environment, the response to the current downturn is different, for three reasons:

1. Operators’ behavior and competitive landscape are changing

 The response to the downturn as varied according to various types of operators.

  • International oil companies (IOCs)

The large cap IOCs continue to focus on increasing their cash flows to reduce their leverage and sustain their ability to meet their dividend payment commitments. A combination of divestments, downstream strength and working capital releases has helped support balance sheets, while significant efforts have been made to reduce an unsustainable cost base. IOCs have managed this by focusing on standardization and simplification measures and reducing project inefficiencies, while maintaining their focus on safe operations.

  • Independents

The independents have undergone significant ownership changes during the past few years, with many transitioning from publicly listed to private companies owned by private equity. These new market participants are heavily focused on returns and more willing to share the risks and rewards with the oilfield services companies.

It is likely that risk-sharing agreements will increase as private equity owners further increase pressure on contractors to deliver better outcomes at lower costs.  Such arrangements could provide contractors with an alternative approach for achieving market success and premium prices when other more traditional routes prove unsuccessful, or with the ability to move into new markets ahead of competitors or to build partnerships with key customers.

Critical to the success of these arrangements will be to deeply understand how the products and   services provided by contractors deliver value to the customer.

  • National oil companies (NOCs)

In general, NOCs have also responded to lower oil prices by driving down costs and improving efficiencies in their oil and gas production activities. Over the past few years, NOCs have also continued a long-term trend of looking to take greater control of their resources and seeking to displace the IOCs by using service providers in a more integrated manner.

Many NOCs are also focused on creating more value within the hydrocarbon value chain and are increasing their vertical integration by creating a cohesive business that efficiently operates across the value chain.

2. Onshore unconventionals have become a new core resource

The dramatic decline in oil price caused a heavy blow to many shale operators, forcing them to focus on survival, putting growth or acquisition strategies on the backburner. Although not heavily   invested in by Europeans, US unconventionals offer an interesting and strategically useful asset, driven by shorter cycles and flexible portfolio options, especially within the Permian basin, which now holds nearly as many active oil rigs as the rest of the US combined. The North American shale revolution has led to structural changes in global oil supply dynamics and dramatically lowered the fundamental economic equilibrium price point. Most participants in oil and gas markets now realize shale in particular changes the game.

Because of its abundance, the number of economically rational operators involved, its short development cycle, low risk profile and ability to deliver returns quickly, US shale will likely represent the marginal barrel of production, at least in the medium term and potentially for much longer. As a result, the oil market clearing price is expected to be set with reference to North American shale. Shale producers are able to quickly respond to price signals.

3. Digital is transforming the route to reserves and their monetization

The oil and gas industry is one of the world’s most advanced user of technology. However, to date, these technologies have been primarily focused on improving time to first oil and improving the effectiveness of hydrocarbon extraction, rather than above ground operational performance and   end-to-end integration.

Digital has the potential to disrupt the oil and gas industry on a scale equivalent to the US shale phenomenon by:

  • Connecting critical assets and reducing system failure which can easily result in costly and often life-threatening emergency situations
  • Monetizing and collecting data in real time without previously necessary human intervention
  • Managing, storing and analyzing massive amounts of business data to drive better and faster decisions
  • Further increasing reservoir management and drainage efficiencies
  • Deploying digitally enabled technologies like artificial intelligence and robotics, reducing the need for human responses and changing the skill sets needed
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How the oilfield services industry is responding

Boundaries between subsectors are becoming more vertical, as new opportunities emerge for all players.

The segmentation of the oilfield services industry — the Big Four, the drillers and well services providers, the seismic companies, the engineering and construction companies, the equipment manufacturers, and the logistics providers — has started to change.

This transformation is only in its infancy. The industry could converge into the following groups:

  • The integrated service providers are leading the current consolidation wave and using the downturn to grow market share, acquire new technologies and capture project efficiencies through vertical integration and opportunistic acquisitions (these include the large OFS companies such as TechnipFMC and GE). The integrated service providers are breaking with the past, understanding that the cost-efficient development of increasingly complex hydrocarbon resources will not occur without fundamental changes in their operating models, innovative technologies and greater collaboration with the upstream industry.
  • The specialists are focusing on a niche part of the market or a single or small set of technologies, offering specialist products and services, with or without any differentiation. The specialists either operate across the value chain and provide niche products and/or services or operate in niche markets. Although it is difficult to generalize this market, it is likely that most of them will have some differentiation through technologies or through bespoke assets (for example in drilling), allowing them to effectively compete with the integrated service providers. To thrive as specialists, they need to be best in class in their specialty and market as their position may erode rapidly.
  • The logistics providers are providing assets (vessels, rigs, helicopters, etc.) and a range of support services to the industry and are responsible for oilfield logistics, supply and training of personnel, warehousing, etc. With high leverage and many assets on their balance sheets, the logistics providers face significant challenges in the current market and   a business model that is likely to be challenged in the future. They need to join forces to survive the downturn and to think about business models that increase their differentiation and value to operators. They tend to work directly for the operators, although this might change as a consequence of the ongoing restructuring of both the supply chain as well as the business models associated with equipment, tools, consumables and personnel logistics.

The large transformational transactions already witnessed in the oilfield services sector are likely to be the prelude for a large wave of consolidation activity across the entire value chain.

Summary

The oil and gas industry is undergoing a fundamental change, which is unlikely to reverse if and when oil prices increase. Companies need to embrace these changes and decide which approach to follow and which market to play in.

About this article

By

Andy Brogan

EY Global Oil & Gas Transaction Advisory Services Leader

Transactions and strategy leader in Oil & Gas. Speaker and industry advocate. Optimist. Music addict. Avid traveller.

Related topics Oil and gas