Global Oil Services Monthly:Inaugural Edition,With Offshore Cost Deflation Still in its Early Days,Share Remains Up for Grabs

The J.P. Morgan Global Oilfield Services equity research team is launching anew global monthly product that aims to: (1) keep investors up to date on our latestthoughts on the oil services sector across North America, Europe and Asia, (2) providein-depth analytics on industry data sets and market-related metrics, and (3) discussbroader, longer-term secular narratives driving our sector views. Building on ourNorth American Weekly Insights & Analytics, in this report we provide a morecomprehensive screen of the oil services markets globally, with incremental datapoints on production, pressure pumping, onshore and offshore drilling, capitalequipment, marine seismic and engineering & construction projects. In light of ourrecent initiation on SDRL, SBMO and AKSO, we take the opportunity to discuss theproliferation of JVs and other tie-ups across the offshore value chain and the possibleimplications on market positioning, project economics and activity levels.

    Deepwater cost deflation cycle drags on. While the recent oil price retrenchmentis likely to result in a greater delta to NAM onshore budgets, parallel cost cutting,production optimization and supply chain consolidation trends have already beentwo years in the making offshore. IOC budget reallocation to shorter-cycleproduction has markedly reduced activity levels off 2013 peak (exploratoryspending -30%, working rig count -20%), initiating not only a deflationary pricingcycle (rig dayrates -30-40%) but also broader FEED recalibration. WoodMac counts68 project FID deferrals to date (including 22 since June), and we see scope forfurther slippage among larger projects pegged for 2H16 sanction (JPMe 2016 treeawards -23% v. Quest). As IOCs restack portfolios to prioritize cash flow anddefend dividends, we expect brownfield EOR, incremental field tie-backs and postsanctionstartup ramps to be able to mostly offset decline curves, affording time todeferred project FIDs to fully capture benefits from reengineering and supply sidecost deflation.

    Chasing a structural step change in breakevens. Deepwater capex/boe isestimated to have fallen ~10% y/y, though commentary around projectreengineering has suggested supply chain savings have been augmented byproduction optimization. Major sanctions in 2015 cited as much as 20% savings(including Shell’s Appomattox, Wintershall’s Maria), Premier’s Sea Lion recentlymoved forward with FPSO FEED after reducing its budget by 30%, and Statoil’sJohan Castberg concept redesign has already achieved 50% lower breakevens andperhaps encouraged the recent Lundin stake purchase. However, despite theseimprovements, WoodMac estimates roughly 80%/50% of deferred deepwaterprojects’ breakeven oil price lay north of $50/$60, implying that an incremental 30-40% of cost savings are necessary to make just over half of major sanctionscommercial at the current strip (~$42 average) and assuming a 15% IRR hurdle.

    Reengineering the engineering process. Project FEED studies generally begin witha blank slate, analyzing the reservoir geometry and geologic/fluid properties toinform optimal well count, placement and production profile, then weighing variousplatform options by functional requirements like processing (topside deckrequirements), export, well access (wet/dry), drilling and enhanced recovery.Bespoke concept planning will always have value, in our view, particularly offshore.However, re-phasing developments and leaving flexibility to add capacity (throughtie-backs and topside debottlenecking) and adapt recovery strategy through thedevelopment (i.e., CVX’s Jack/St. Malo) has emerged as a reliable way to improveeconomics by simplifying upfront design, smoothing capex, and accelerating time tofirst oil (i.e., BP’s West Nile Delta, LLOG’s Delta House).