The oilfield services industry, just like the rest of the wider economy, has gone through a tough period over the last twelve months. The price of crude oil, the industry’s key benchmark, has fallen from a high of $147/bbl to $35/bbl within a year which has resulted in some operators reconsidering their risk profiles as the comfort of a large price differential between sanction hurdle and prevailing price is eroded. Many would argue the lack of credit has had an even greater impact on activity than oil price movements. There is lack of funding available to smaller, independent operators with limited cash reserves as banks withdraw project financing lines and distressed investors seek to unbundle their investments.
This has created a degree of uncertainty in the market and has led to reduced activity and project delays. One of the principal reasons for the project delays is the deterioration in the ‘cushion’ between prevailing and sanction prices leading to cost re-evaluation which has, in turn, slowed the final investment decision on a number of projects. Thus, oilfield service companies have come under short-term pressure not only from falling volumes but also tightening pricing as operators seek to renegotiate the cost of their supply base and unwind some of the recent price rises.
The future is bright
Despite some of the short-term challenges facing the oilfield services sector August Equity believes that the outlook is positive. We are keen to continue investing capital into high quality oilfield products and services businesses for whom there remain significant opportunities for growth. Our sanguine outlook is based on a number of factors:
• The medium and long term supply/demand fundamentals remain strong. While there has been a slow down in demand driven growth as a result of the global recession, increasing depletion rates combined with growing reservoir complexity, increasing water depth and harsh environmental conditions means that the offshore industry will continue to demand higher levels of activity than before.
• A significant percentage of the record oil price was a “speculative premium” divorced from the reality of decision making in the offshore industry. The economic sanction point of the majority of offshore projects is between $40-50/bbl and, given their long lead times, there is currently a highly visible order backlog of sanctioned projects.
• There remain certain subsectors within the overall oilfield services market where future growth looks strong and there are opportunities for businesses to carve out a niche, defensible position. For example, one subsector we are interested in is subsea which is projected to grow strongly as developments move towards deep and ultra deepwater. The subsea sector is based largely upon an outsourced model and is characterised by highly complex materials and engineering and, as a result, commands high margins. Aberdeen is well renowned as a ‘centre of excellence’ for subsea engineering which ensures there are significant opportunities for UK based companies to export their skills and know-how to deep water basin developments around the globe.
Keys to Success
In the face of the short-term challenges facing the sector, we believe that there are a number of characteristics of successful service companies which we look for when investing:
• A core capability that an individual E&P company wishes to outsource and which they would struggle to replicate. This would include technology development, broad supply chain relationships or access to a specialist workforce.
• An established and strong track record in delivering to customer specifications, particularly for critical path and 24/7 services, that generates significant trust with clients.
• A geographically diverse business model with strong multi-tiered customer contacts not only with the operators and major contractors but also with the National Oil Companies.
We have already demonstrated our interest in the oil and gas market through our recent acquisition of Accura, a supply chain services business focused on short lead time procurement and engineering of specialist components, and we remain keen to invest further capital from our new fund into companies operating in the sector.