Meeting the challenge of offshore project cost improvement in a strategic and sustainable manner
When the oil price slumped at the end of 2014, the initial reaction of the industry was also its traditional response: projects were put on hold and headcounts were reduced. This was done in the expectation that these would be short term measures and ‘business as usual’ would resume fairly quickly as it always had done. However, operators are now having to come to terms with the realisation that this time it is different, and a more strategic and sustainable approach is called for.
The oil price has dropped to levels that were last seen in 2004, and it would be very tempting to think that the answer is simply to return to cost levels associated with that period, but is that feasible or the right thing to do? To even begin to answer that question, we need to examine some of the differences between then and now.
In 2004 the oil price had been rising slowly and steadily, so $50 per barrel (bbl) was normal for the time. This period saw some very large and complex projects coming to fruition, with Gulf of Mexico, Australia and Indonesia being particularly active, and West Africa starting to become an area of greater attention. Projects had been estimated on the basis of lower than $50/bbl, or on the presumption that prices would not drop, and were economically viable. It was a forward looking, and generally optimistic period.
At the end of 2015, many analysts were predicting a return to $75/bbl within 12 months, but the highly anticipated recovery did not materialise. Only recently with the announcement of cuts from OPEC and non-OPEC production have we seen some optimism in prices.
As we approach the end of 2016 the oil price has returned to around $50/bbl, but this time the industry has been used to a period of relatively stable prices around $100/bbl in the 4-5 years prior to the drop. Projects sanctioned during this period and currently in execution are likely to be no longer economically viable as previously designed. Faced with potentially loss-making new developments, most operators have severely cut back on capital expenditure, with many nascent projects being deferred or cancelled. The industry is on hold, and the mood is generally pessimistic.
Competitive barrels need a commercial mindset
It is widely believed that costs for projects currently under development need to drop by around 30 percent from 2014 levels in order to become economically viable for sanction. Both operators and contractors need new projects to go ahead to generate revenue in the longer term, so waiting for a recovery in crude price is not an option
From our experience in supporting project development through the pre-FID stages we see operators moving now to a design to cost approach, where the mandate is bare-bones. Simplifying requirements and maximising standard solutions is the new normal. The days of pre-investment to increase long-term revenue have given way to investments on demand while maximising capital efficiency and profitability.
Five key factors for delivering on ambitious cost improvement targets
There are a number of factors that influence the cost of a project. We have identified five key areas that need to be addressed if cost bases are to be lowered:
- Design and specification
- Market conditions
- Efficiency of execution
- Phasing of developments
- Clarity and accuracy of information
Nobody would disagree that all of these factors are important in offshore project cost reduction, but what is more difficult to ascertain is their relative magnitudes and the best way of achieving maximum sustainable benefit.
Design and specification: innovate to simplify?
Scope reduction and design simplification/standardisation have become commonplace in cost reduction exercises. Neither of these is necessarily straightforward: indeed it is ironic that some projects may require innovative solutions to achieve the desired simplified design and lower cost. Going back to the drawing board many have both advantages and disadvantages: on the one hand confidence levels in the subsurface data may have improved since the initial scoping, but on the other hand revised designs may lead to impaired recovery over the lifetime of the asset which would have implications beyond the capex phase, all the way to decommissioning.
The impact of changing scope and design on project cost reduction will be highly variable. Beyond the more obvious measures of re-use of previous designs and reductions in numbers of wells and/or manifolds (although not necessarily well complexity), operators, perhaps understandably, are somewhat coy about exactly how project scopes are being re-designed. However, we can be sure that significant time will be spent on design reviews to ensure both cost and value are optimised.
Multi-discipline integrated design reviews will be required to choose between the minimum acceptable design or a higher cost/value option.
A common methodology followed is to produce a cost/value/risk staircase as shown in chart 2.
A decision must then be taken for each staircase step to identify clear values and trade-offs. The final result should be a competitive scope.
Market conditions: risk to weak links in the supply chain
There is no denying that market deflation has taken place during 2015 and 2016, and that contractors have been open to negotiation in order to survive. However, timing of negotiations may be critical for some project components, either because of the nature of the component itself, or because contractors cannot go much further with cost reductions and stay in business.
Steel prices are a good example of the former – they have always tended to have more of a ‘self-levelling’ mechanism than many other parts of the supply chain, whereas offshore marine vessels are perhaps more indicative of the latter. The risk of weak links in the supply chain breaking has been growing and may well have reached a critical point, even for some of the larger contractors.
Taking a look at publically available information on the scale of market deflation it becomes obvious that published values are highly dependent upon the context in which they are generated. Examples of inclusions/exclusions that can have a significant effect include drilling and completion costs, onshore projects, and allowances for contractor margins, with some commentators specifically restricting their observations to particular project types (e.g. deepwater). Of course, it also matters when the article is published and how much the commentators have the benefit of hindsight.
From our examination of a number of publications in the public domain from the end of December 2015 to November 2016, the range of averaged reductions in project costs may be anywhere from 15 percent to 40 percent. Given that they all have different ways of looking at the data, this is perhaps to be expected. Where there is more general agreement, although variable, market effects generally account for less than half of that reduction, and more probably less than one quarter, although there are always exceptions.
The Performance Forum monitors market data and publishes a series of cost escalation indices in order to adjust historical costs to current market conditions. Their indices suggest the deflationary effects on three key offshore facility types from 4Q 2014 to 4Q 2016 are as follows:
|Fixed platform||FSPO||Subsea tieback|
It is important to note that these do not include drilling and completion of wells, and drilling rig rates have been particularly hard hit by the reduction in project activity over the past year and a half.
Efficiency of execution: improve the human factor
Efficiency gains present perhaps the most complex and contentious arena for cost reduction, as they have arguably the greater reliance on the ‘human factor’ in the design, estimation and execution of projects. They require changes in procedures, interfaces/relationships, behaviours and incentives. Key words and phrases that recur in this context are collaboration, standardisation, compliance and risk/reward sharing. Operators have much to achieve in-house, in addition to re-examining their dealings with contractors, and determining the scale of cost reduction that efficiency gains might yield is therefore likely to be highly specific to the operator and project.
Phasing of developments: don’t build Rome in a day
This may be the simplest of all of the steps suggested. No longer will we see operators trying to build Rome in a day, but instead following a phased development process. Pre-investing for future barrels will be removed, and instead investments based on demand (and value) at that time. This is likely to result in leaving incremental/high cost barrels in the ground and evaluating improved oil recovery (IOR) options.
Clarity and accuracy of information: be predictable and repeatable
Cost improvements need to go much further than just making the estimates for capex projects economically viable on an individual basis: the results need to be predictable (i.e. carried through execution and beyond) and repeatable. This means balancing commercial aspects (cost/value) with technical considerations (e.g. safety/production flexibility/maintenance/decommissioning) much more rigorously than before, and reducing uncertainty as early as possible in the project lifecycle (e.g. by using P80 subsurface scenarios rather than the more usual P50).
Strengthen a culture that delivers on cost, efficiency and profitability
Both operators and contractors think that the rate of market deflation will slow, or even start to reverse, in the next year, with some contractors cautioning that they will seek relaxation of what they regard as cost ‘concessions’ within 12-18 months. Some industry commentators are already questioning how sustainable the current cost reductions will prove to be: our industry does not have a good track record in that respect. The key to success will be strengthening a culture that delivers not only on cost, but also on efficiency and profitability.