23 July 2014, News Wires – Investment by foreign companies in U.S. shale plays will continue. Foreign companies have invested in shale to gain an understanding of the technology and business approach needed for shale, which was different from traditional oil and gas in their home countries.
After that initial investment, some companies decided they would leverage the lessons learned to create organic businesses at home. Other companies have forged alliances and partnerships, while others have made opportunistic cash investments to get early positions in plays.
The industry is at the beginning of the middle phase in terms of foreign investment, Dennis Cassidy, co-lead of AlixPartners Energy Practices, told Rigzone in an interview.
“There’s still a lot we don’t know about shale, and the industry hasn’t optimized supply chains,” Cassidy commented. “As long as there is still upside to be realized, you’re still going to see investment.”
Cassidy noted – with sarcasm – that tons of private equity capital is available and wants to make its way into oil and gas, but doesn’t know how to get itself positioned quickly.
“There are guys who literally call every two weeks with millions of dollars looking for opportunities,” Cassidy commented. However, this interest tends to run up valuations and could create problems down the road.
“It may solve a short term problem with the balance sheet, but if people overpay for assets, it could make the problem more significantly down the road.”
Cassidy does not expect upstream merger and acquisition (M&A) activity to hit the record level of $700 million seen in 2012, but M&A activity this year is moving at an accelerated pace via the average of $300 million to $325 million, with activity in this year’s first quarter reaching $100 million. M&A activity has been mainly focused in the upstream sector, where operators have been swapping out assets where they feel they can’t make the most money.
To adjust to credit threshold limits, companies are selling off assets on the margin that don’t fit into their medium or long-term plans, and are placing more stringent limits on capital spending. Cassidy is seeing an all-around belt tightening in oil and gas. The “grow baby grow” mantra seen before is not out of vogue, Cassidy noted. While companies still want growth, capital efficiency also is now a focus.
Oil and gas companies also are separating their businesses into units for conventional and unconventional assets. The same executive leadership still oversees operations, but given the very difference competencies for conventional and unconventional, the business are separated out to enhance performance.
By splitting their businesses into conventional and unconventional, or spinning off businesses, companies appear to be trying to create a culture and mentality that can help them compete against their natural competitors. In the case of the majors, the competition is not other major oil companies, but small independent operators.
“The decision-making cycle time and response time, the supply chain and technical capabilities required are very different versus a deepwater project,” Cassidy explained.
The issue of onshore versus offshore is the complexity of the design and operations of offshore wells, which are primarily specialty wells, and onshore, which are standard wells. Each requires a tailored business model to be successful.
“If you mismatch the operating model to the type of well, then you can get suboptimal financial performance,” said Cassidy. “They are trying to physically separate the companies to ensure the right operating model gets applied to the correct situation for optimal operating and financial performance.”
Technological innovations in horizontal drilling and hydraulic fracturing allowed the U.S. oil and gas industry to successfully produce shale resources, and technological innovation will continue to play a key role in unlocking resources. PwC reported earlier this year that technology is being utilized to address resource scarcity and climate change concerns, and innovation is opening up new fuel sources and increasing efficiency while reducing energy production and distribution’s climate impact.
Oil and gas companies are gravitating towards oilfield service companies with the most innovative technologies and most nimble in deploying services. The demand for innovation or specific technologies means that companies are not always calling on the largest oilfield service companies, but on smaller and medium-sized companies. For these reasons, great opportunities in oil and gas for non-traditional service companies exist, particularly for technology for deploying the hydraulic fracturing process in a cost-efficient manner, Ernst & Young officials said at a presentation last month.
But for the most sophisticated and complex situations, oil companies are wanting to take as little risk as possible, and will typically stay with proven brands and companies that can stand behind their designs, Cassidy noted.
“In these cases, there are typically only a handful – or sometimes only one – qualified or battle-tested vendor. Thus, the contracting process is very different and is about lead time, technical guarantees, and joint research and development.”
Operators are willing to take a chance on a new technology or provider for mature, standard wells or low pressure, less technical risk wells.
“There are often dozens of potential proven companies that can provide this service or equipment,” said Cassidy. “Thus, they will often widen the lens of potential equipment/service companies that they will invite proposals from and have a very different type of procurement process that is very focused on reliability and quality, safety, service and cost.”
Start-up companies have typically come out of a bigger company, and can offer a similar product that offers better response at a lower cost and provide a custom solution for a particular niche. When the business cycle is extremely healthy, smaller technology start-ups are favored as a means of pursuing growth. But when the cycle goes down, these companies tend to go out of business or are folded back into larger companies due to their inability to sustain themselves in the ups and downs of the oilfield service business.
“If the industry really is in a contractionary period, the mom and pop shops will be the most impacted, particularly if they are levered up,” Cassidy commented.
If the recent pullback is a blip, they’ll continue to grow.
PUBLIC PERCEPTION, REGULATORY ISSUES REMAIN CONCERN FOR INDUSTRY
Public perception and regulatory concerns remain a significant threat in terms of factors that could halt exploration and production. Cassidy cited the perception shift of the nuclear power incident following 2011’s earthquake and tsunami that destroyed nuclear power capacity in Fukushima, Japan. The industry is very sensitive to how quickly perceptions can change and is doing everything they can to be as compliant and safe as possible.
Cassidy believes that full maturity of the unconventional market is still a few years away in terms of technology that is more productive, less costly and more environmentally friendly. Instead of designing every well from the bottom up, a portion of wells could be designed and the other half modularized or standardized for greater productivity.
Shale plays continue to face the stereotypical challenges in human capital, but public infrastructure in areas such as the Bakken are the real limiting factors for the oil and gas industry.
“When you start seeing fast-food workers being paid $20 bucks an hour, you know something is out of whack,” Cassidy noted.
Moves against oil and gas companies by activist shareholders will speed up in terms of level of activity and intensity for the remainder of 2014.
“If you look at overall average return on capital and growth that upstream oil and gas companies have provided, the return is a surprising 6 percent,” said Cassidy. “If you look in detail, there’s a high variation in performance, with an average return of 25 percent to 30 percent, and some as low as 2 to 3 percent.”
Activist shareholders are getting aggressive with companies that have an average rate of return on capital of 6 percent or less, asking questions about why one oil and gas company operating in the Eagle Ford has a greater average rate of return versus another Eagle Ford operator. Seeing more risk in owning an oil company, shareholder activists are questioning why they should buy stock in a company and just buy the S&P 500 instead.
Infrastructure, technology and management effective are all factors that can create differences in rates of return for operators in the same play.
“We’re starting to see winners and losers in different plays as some companies are more effective in some plays versus others,” said Cassidy.
The industry still continues to grapple with a scarcity of technical and craft workers, from engineers and scientists to welders and pipefitters, said Cassidy. The aging and retirement of many oil and gas workers also means that industry is losing their skill sets and competencies. These two headwinds facing the industry are offset somewhat by the tailwind of technology that can be used to help disseminate information.
The next few quarters should be interesting in terms of how the market unfolds. Some companies will get it right, while others will stumble a bit.
“Lots of planning departments and CEOs are scratching their heads about what’s next as they look at commodity prices, what it will do to margins and cost positions and how they factor into a portfolio.”