- The Dutch oil and gas service market has become more resilient with a growing focus on costs
- Higher price expectations will not necessarily filter into new production and drilling activities
- Reserves and profitable discoveries will continue to disappoint the supply side of the balance…
- …but the Dutch oil and gas service companies are breaking into new markets
Global picture of the oil and gas market and prices
Given the OPEC production curb, healthy demand growth and limited global investments, supply and demand for oil is rebalancing with a risk of supply shortage. As a result, oil prices are expected to gain momentum. Starting in mid-2017, we have seen the futures curve swing from contango to backwardation, as over-supply shifted to under-supply. The positive price environment is boosting trading activities that, in turn, are driving oil prices. This optimistic environment, together with the low cost structure and higher efficiency of oil and gas market participants, is setting the scene for increased confidence. Although Brent oil prices have reached $80/bbl in recent months, with an overall decrease in volatility (Figure 1), prices remain below $140/bbl and therefore caution and discipline will continue to prevail.
In addition, gas is also swinging to the positive side. Global demand increased from 2016 to 2017, particularly in China (17% increase in gas consumption) and the EU (6% increase in gas consumption), with a substantial increase in the US LNG exports (~55 mln m3/day in 2017 versus 14 mln m3/day in 2016) (EIA). The global increase in demand for gas demonstrates confidence and optimism in the gas service sector. Still, we must bear in mind that policies and the clean energy transition can be a disrupter to the position of gas in the energy mix.
Characteristics of the Dutch market
This environment of disciplined optimism is present in the Dutch oil and gas service market as well. The Netherlands has one of the biggest downstream hubs in Europe (Rotterdam harbour) and is the global leader in gas and oil services. It also has one of the biggest gas fields (the Groningen gas field) and ranks second in Europe in gas production and exports. Its wide and long experience with gas has helped hone the Dutch market’s skills, fostered its logistics supply chain services and boosted other petrochemical industries. However, it is clear that the Dutch oil and gas service industry has suffered and is still recovering from the downturn in the oil prices (Figure 1). Within this new positive but disciplined environment, changes in market participants’ strategies are set to manifest within the 2020 horizon.
Ex-Post: the Dutch Market became more resilient with growing focus on costs
According to research conducted by EY (2017), the Dutch oil service industry witnessed a 19% decrease in revenues in 2016 versus 2015, with a parallel decrease in the head count (Figure 2). Average oil prices were around $44 a barrel in 2016 and it was not until Q4 2016 that prices approached $55. The market reacted by cutting costs, especially CapEx. As part of the downward pressure on the cost structure, asset maintenance and replenishment were postponed. As a result, the number of personnel for maintenance and corrective installations decreased. Although the oilfield service industry continued to suffer in 2017 due to the lagged effect of low oil prices, the industry started to rebound in 2018. We are seeing E&P companies target the replenishment of existing assets and CapEx is picking up. Therefore, employment in the service industry will follow. However, it will be more difficult for the industry to attract the right skilled personnel given that their trust in the sector is shaken after the downturn that cost them their jobs.
Ex-ante: Higher price expectations will not necessarily filter into new production and drilling activities but a replenishment of existing assets
Given the current positive price environment (~$75/bbl- Brent), the disciplined cost structure comes in handy and leaves market participants with more cash at hand. Given the exposure of the Netherlands internationally, with major exposure in the North Sea, higher price expectations may not filter into new production and drilling. This is partly due to the low profitability of the assets in the North Sea, given the high maturity and end of lifetime of reserves. Exploration of existing fields is expected to pick up but there are no plans to invest in new fields. Indeed, since 2017 we have witnessed an increase in offshore deep-water production in the Norwegian Continental Shelf and South African waters, among others, as CapEx spending has rebounded. Many offshore deep-water projects were put on hold during the downturn, but these accumulated projects are gaining attention as the downward cost curve has put pressure on the break-even point.
In addition, the extra cash is being used by E&P companies and integrated oil majors to strengthen their balance sheets and to restore shareholder returns. In 2017, the major oil and gas companies resumed their dividend pay-out programmes and some restarted their share buy-back programmes (DNV.GL, 2018). Furthermore, we are seeing more integration along the supply chain. During downturns, existing market players pick up a range of smaller players with the hope of creating value by integrating chains. Such integrations can be beneficial by (1) more easily adjusting the upstream strategy based on downstream market demands and (2) increasing the time to react to market changes. However, the added value is not always as conclusive or successful.
The signs of recovery are also signalling more consolidation and acquisition activities. E&P companies and integrated oil majors recently began using the extra cash on hand to invest and acquire existing assets that can potentially generate operational and financial synergies. Such acquisitions will replenish existing assets and therefore increase production, which will only partly rebalance supply and demand in light of the supply shortage. Still, M&A activities could be influenced by the recent increase in geopolitical risks that is driving prices and volatility.
Reserves and profitable discoveries will continue to disappoint the supply side
Despite the signs of recovery, natural gas and petroleum reserves in the Netherlands are on the decline (Figure 3). The withdrawal (production) is not being offset by new findings. On the contrary, we see that for instance new natural gas findings (bln m3) are low in comparison to withdrawals (Figure 4). This explains the downward trend in natural gas reserves (Figure 3), which is due to (1) the lack of prospective and economical locations and (2) the decrease in exploration expenditures since the downturn in 2014. And, of course, there is the cease of production in Groningen. It is important to note that these figures refer to the Dutch Groningen field, and all other offshore and onshore accumulations in the Netherlands. But the Dutch oil and gas companies’ exposure is not limited to the Netherlands and instead spans across the North Sea, the Gulf of Mexico, the Middle East and other regions.
The far-reaching implications of ceasing production in Groningen
The pivotal policy announcement to cease production in the Groningen gas field by 2030 (Figure 5) raises several issues. While the Netherlands is one of the major gas exporters, it will become a net importer moving forward (Figure 6). Groningen accounted for 60% of domestic production in 2017. For the Dutch government, this will translate into a decrease in revenues, as Groningen ranked high in production and revenues (Figure 5). According to Wood Mackenzie, the net present value of the Groningen field is $5bln, down from $26bln last year. In addition, this is happening during a period when gas is playing an increasingly bigger role as the least polluting fossil-based source in a low carbon environment. The cut in production not only implies a tremendous decrease in indigenous gas production but is forcing a switch from low calorific gas to high calorific gas in a very short period of time. This means that the gas service industry will have to focus more on the smaller independent reserves, which are at the end of their lifetime. The production loss will be partly offset by low calorific gas coming from the Northwest European countries. The rest will be imported as high calorific gas from Russia and/or LNG from Qatar, Australia and/or the US. This creates opportunities for quality conversions and the need for nitrogen plants, which are running near maximum capacity. Meanwhile it also incentivizes the need to look for cleaner sources of energy and the exploration of new cross-border trade lines. Perhaps, “bad times signal good times ahead”.
Dutch oil and gas service companies breaking into new markets
Dutch oil and gas service companies are exploring new venues to make use of their expertise as the supply shortage continues, and particularly in light of the clean energy transition. Given the increase in offshore energy deployment and the looming subsidy-free environment, it is increasingly becoming a strategic business opportunity. This is in line with the wind energy roadmap designed by the Dutch government, which aims to have 4.5GW of offshore wind installed by 2023 and 6GW of onshore wind by 2020 (Figure 7). Its long-term road map proposes a total of 11.5GW of offshore wind by 2030. This figure illustrates the increase in business opportunities alongside the rise in wind capacity. As a result, we are seeing that oil surveying and exploration companies are being hired by the Dutch government for site evaluation, resource assessment and foundation recommendation for the offshore wind industry. Dredging companies are putting their geotechnical expertise to use in the offshore wind industry and oil contractors are engaging in the design and construction of onshore and offshore windmill foundations.
Moving forward the strategy will be innovative techniques and digitalization
Consolidation within the oil and gas service industry seems to be targeting special capabilities. Some of the acquirers in the oil service industry are explicitly looking for data analytics, superior imaging capabilities and digitalization to enhance efficiency in exploration and well extraction (PWC, 2017). This, in turn, can extend the fields’ lifetime and boost profitability. Sensors and enhanced imaging will improve data collection in fields and reserves, data analytics will allow efficient data processing, and machine learning will improve processes by recognizing patterns. In addition, computer-generated simulation will help predict maintenance. Automation and advanced equipment are also part of the digital transition. While all this might sound far-fetched, it is closer than we think. Given the fact that this sector is moving into a time when only the fittest will survive, growing a competitive edge over the rest will be key. It remains essential to build a robust digital strategy to guide the integration of such technologies, especially because this will imply new cybersecurity issues.
Decommission calls for collaboration – mutual liabilities and mutual benefits
Decommissioning has been weighing on the backs of industry players and the government for a while now. Especially in the North Sea, low prices and the high cost of dismantling are factors leading to the suspension of decommissioning activities. On top of that there are other crucial aspects like legal risks, recognizing joint liabilities under joint asset contracts and strict regulations. The need to comply not only with domestic regulations but also EU environmental legislation adds another layer of complexity. The Law of Sea, IMO guidelines, protection of marine life, and waste management laws are only a few of the many protocols. Bearing the regulatory issues in mind, market players need to understand the impact of decommissioning and must explore different methods of dismantling, or even seek other alternatives. This incentivizes stakeholders to become engaged in sharing liabilities and learning experiences. Data collection and efficiency will help create innovative alternatives for decommissioning (different plugging material or technologies) or re-uses while complying with the best practices. For example, re-purposing can include the use of platforms for storage (gas), carbon recollection, reefing purposes, flexible use of pipelines etc. (EBN, 2016). Oil service companies, drilling rig companies and well service companies can provide vessels, demolition expertise and machinery, as well as disposal yards.
Caution and discipline will continue to characterize the Dutch oil and gas industry within the current positive price environment. The disciplined cost structure and rising prices are leaving market participants with more cash in hand. As result, we are witnessing an increased focus on balance sheet strengthening and recovering shareholder returns. In addition, the signs of recovery are also signalling further consolidation and acquisition activities that can potentially generate operational and financial synergies. However, higher prices will not necessarily lead to new exploration and drilling activities, but a replenishment of existing assets and assets left on hold during the downturn.
In the Netherlands, reserves and profitable discoveries will continue to disappoint the supply side of the balance with the decrease in exploration expenditure. Moreover, the recent policy to cease gas production in the Groningen field by 2030 raises several issues but also creates new windows of opportunity. Assuming the production loss will be partly offset by high calorific gas coming from Russia and other areas, this will require nitrogen conversion plants. Meanwhile, it also incentivizes the need to increase the focus on cleaner sources of energy and explore new cross-border trade lines. Given the growth in onshore and offshore wind energy deployment, there is also an increase in business opportunities for oil and gas service companies. As the oil and gas sector is moving into a time when only the fittest can survive, the integration of innovative techniques and digitalization is becoming pivotal to extend field lifetimes, predict maintenance and boost profitability.