[THE BOARDROOM] A New FPSO Paradigm: Playing The Waiting Game



Tim Haïdar
06/16/2015

Today in The Boardroom, I am speaking with Duncan Peace, Director at Crondall Energy and a veteran of more than three decades in the oil and gas industry.

Duncan’s specialisation lies in floating production and storage units, and we pick his brain about the state of the FPSO sector in view of the current oil price downturn.


SPEAKER KEY


TH
Tim Haðdar, Editor In Chief, Oil & Gas IQ

DP Duncan Peace, Director, Crondall Energy

 

TH Duncan, thank you so much for joining us today.

DP Thank you, Tim, nice to be with you.

TH Duncan, I guess this is on everybody’s minds and on the tip of everybody’s tongues at the moment: how is the current softening in oil prices affecting the FPSO sector?


DP Well, I think the effect on the FPSO sector is going to be quite marked. You use the term softening. I

think if we look at the oil price today compared with where we were a year ago, it has "softened" considerably.

We’re dealing with oil prices which are less than half of what we were enjoying back in the summer of 2014, so that has obviously changed the investment picture for a lot of oil company clients. I think there will be a significant number of projects that are going to be difficult to sanction at the current oil price. There will be some that may still be able to go forward, but a number that won’t and the reason for not going ahead is probably several fold.

Oil price and what oil companies project forward as the oil price will have an impact, but I think also the amount that the oil price has fallen and the speed with which it has fallen has undermined confidence. So, in order to get projects sanctioned we need to see confidence returning, and that’s confidence that, where the oil price is today is perhaps not going to get any worse. The second thing is that for some projects, $50 a barrel will still turn a profit, for some it will not so we’re going to see a reduction in the number of projects coming forward over the next few years.

I’m looking at some forecasts provided by EMA in their floating production outlook report in January earlier this year and what they’re forecasting is perhaps only five projects moving forward this year, growing a little bit in 2016 and 2017, but that really depends on how much the oil price stabilises, how much confidence returns to the market. I think we could see a significant reduction in the long-run average of FPSO awards over the next few years compared with what we’ve seen in the past.

Historically, we’ve seen an average of between 15 and 20 awards a year, and we would expect about five this year, and probably somewhere between five and ten next year if things start to improve. If things start to get worse, then we could see 2016 and 2017 being even worse than 2015.

TH Duncan, do you think because of the way that the oil and gas industry is suffering at the moment, that people are going to start looking at budgeting differently?


DP
Possibly. I think certainly what we’ve seen in the past is that when oil prices are depressed, people perhaps focus even more on the initial capital cost and less on the whole lifecycle of the project. I think as soon as you start to focus on lifecycle costs, generally, what that means is that you’re going to begin to look at spending a little bit more on the upfront capital cost in order to secure better value for the entire lifecycle of the project.

My sense is that when oil price is low, people will focus more of their effort on keeping capex to an absolute minimum, and when we’ve been through previous cycles like this I’ve seen is an even greater focus on keeping capex to a minimum and lifecycle value tends to get compromised.

TH So, with a view to looking towards the end of 2015 and into 2016, what do you see as the biggest strengths with regards to the FPSO market?


DP
Well, what we’ve seen so far is prices throughout the supply chain dropping. Exactly how far they will drop and how far they’ve already gone is stuff we’ll have to wait for because we won’t see any analysis of the data until industry indices are published in the next couple of months. Our sense is that prices are probably coming down between 20 to 30 per cent.

So, there may be projects that can be sanctioned at $50 a barrel or thereabout, but my sense is that the oil companies will wait until they feel they’ve reached the bottom of the market before they decide to proceed with those projects and before they decide to sanction them.

What we have now is a waiting game, so companies can make sure they’re getting the best deal, so that’s going to be one thing. There’s also a little bit of a waiting game where we could see projects getting deferred until the second half of 2016 before oil companies are ready to actually go ahead and sanction projects.

The other trend we’re going to see is that the yards and the main FPSO contractors are working their way through their existing backlogs. They obviously went into this oil price downturn with reasonable order books and most of them will be working their way through these.

When we get towards the end of 2016, a lot of that work that was in the backlog coming into this oil price downturn will be worked through and we will begin to see a much grimmer picture. Obviously, the lease/operate contractors will have a backlog of existing operational projects, but in terms of new projects - new construction projects or conversion projects - I think the order books are going to look very different by the time we get into Q4 of 2016.

It may be the oil price will change, but I still think that as an industry we need to learn to live with lower commodity prices and we need to find ways for all parts of the industry to be able to deliver reasonable returns through what I think is going to be a fairly long period of three or more years of lower oil prices. How do we do that? I think that’s the challenge that the industry is currently facing. We’ve heard a lot from various parties about cooperation and trying to work together in different contract arrangements.

There have been quite a lot of joint ventures announced within the service industries and the supply chain in general. I think we’ve seen, particularly within the subsea sector, equipment suppliers and contractors getting together to try and deliver better value to the clients. This has to happen throughout the supply chain.


TH Cooperation is something we hear a lot about, but does it ever actually happen to a meaningful degree?


DP My only observation about cooperation is that if you’re going to try and build new ways of working, these ways of working need to be that you hold to in the good times as well as the bad. It’s no good trying to cooperate and just do it when things get tough. It has to be a habit that we get into and that persists. If it’s just a response to oil prices reducing, then I’m not sure we’re going to get good enough at it to deliver real value from it.

The other thing that there’s a lot of talk about is standardisation and, again, standardisation has been discussed in the industry for as long as I’ve been working in oil and gas (since the 1970s), and there are signs that standardisation is happening.

Sometimes we forget where we have standardisation within the projects that we work on. Certainly, a lot of the big rotating equipment obviously comes in standard sizes. You get what the vendors provide. You don’t go in and try and engineer a bespoke solution for power generation or compression and so forth, so a lot of rotating machinery we pick and choose from one of those standard sizes.

When we convert a tanker into an FPSO, we pick from one of a number of standard sizes. We convert an Aframax tanker, or a Suezmax tanker, or a VLCC, but there is an opportunity to go a lot further. I would argue that that’s an initiative that could yield an awful lot of value. The problem is that standardisation requires some people to give things up in order to reach a standard which we all agree to adopt. Some people will agree to it because it seems to fit with their view of doing things; other people will say, that it is a lower standard than we would require and therefore we want the standard to be higher.

Standardisation requires people to give up what they perceive to be an existing quality standard or possibly perceive that standardisation will increase prices beyond what’s necessary. This is make the whole standardisation debate difficult, but because it’s difficult is no reason for not trying.

I’m reminded of a quote by Seneca which says it’s not "because things are difficult that we do not dare, it is because we do not dare that things are difficult." So, I think it’s something that the industry needs to confront, but it needs to see some of the bigger stakeholders within the sector coming together and promoting it, reaching that elusive compromised standard which everybody can buy into.

Personally, I’m a bit sceptical about standardisation, not that I don’t think it’s a good idea, which I absolutely do, but because I think it’s going to be difficult to get the industry to put in the necessary effort to achieve something. If it happens, I think it’s going to be a slow process, so I’m not sure it’s going to be the panacea that perhaps everybody is hoping it might be.

TH So, do you think that when the good times come again we will just revert back to type?

DP Well, I rather hope not, but I think it’s quite likely. I think it depends on how long this period of low oil price persists for. I think if it persist for long enough and these new arrangements become habits, then there’s a good chance that we could see them become engrained and people begin to see the value and it becomes a habit and people decide that that’s the way they want to carry on.

I think the more pressure there will be and the more time there will be for innovative solutions to take root and become habits, the old ways will no longer be desirable or even worthwhile.

TH How much do you think that what has happened in Brazil, with the Petrobras corruption scandal, will affect the FPSO industry going forward?


DP
Well, if we look back to the period after the global financial crisis, the order intake during that period dropped quite dramatically. Looking at the orders that did go forward during that period, a lot of them came from Petrobras One of the reasons why we’re so gloomy about the order intake in 2015-2016 in particular, is that the opportunities with Petrobras will be potentially a lot more muted now and we could see fewer FPSOs coming out of Brazil in the short-term whilst some of these issues are resolved.

In the last economic downturn, we had Petrobras keeping the order book, well, not buoyant – but at least reasonable - so the pull back by Petrobras is one of the reasons that we believe the immediate future could be so bleak. I can envisage a scenario where Petrobras might realise or decide that they can’t take some of these developments forward themselves and therefore look to work more with international partners to develop them with. That could be a good thing, but it may take several years before it starts to happen.
TH
Duncan, you said that you’ve been working in the industry since the 1970s, so you will have seen three or four significant oil price downturns in your time. How does this compare to the ones that we’ve survived before?

DP My sense is that this is worse than the previous ones that I’ve been through. I think the one that’s closest to it was the 1986 crisis, but this feels far worse. I think there’s probably a sense that we came into this downturn with a cost problem, even before oil price started to fall.

We were seeing clients putting projects on hold or going through recycle because they felt the costs in the supply chain, the costs of the developments in general were too high, even before the oil price fell. Then the oil price fell and it compounded a cost problem with a revenue problem, so that for me is why the challenges this time are probably greater.

Listening to conversations with project teams, I have a sense all the time that people are looking for a panacea, a magic bullet. They’re looking for something that’s going to dramatically cut costs. To me, this is a game of many small cost reductions which eventually, together, after working hard, could lead to a cost reduction of, say 30 per cent.


TH Duncan, thank you so much for your time and joining us in The Boardroom.


DP You’re welcome. Pleasure talking to you, Tim