Potential pitfalls await those unprepared for the push towards diversification from conventional energy writes Gregory Brown, Maritime Strategies International.
Over the first half of the year, oil companies were united in recording significant write downs on non-producing exploration assets in the wake of March’s oil price collapse. A considerable number took the opportunity to announce pathways to a lower carbon intensity future.
Those write-downs are substantial in size and significant in their implications. Instead of doubling down on crude production, these oil companies, and a horde of others are shifting towards a portfolio weighted towards lower carbon production, alternative sources of power and a general shift towards greener production.
The implicit implication is that for conventional offshore work, the client base will change. IOCs, which have traditionally accounted for the largest and most profitable (for the supply chain) projects, will hold off on exploration in new markets, while new production hubs will have to be developed in the context of lower emissions targets.
In time, we think that this will translate into divestments of existing acreage in the offshore space. Potential acquirors are set to be weighted towards a greater mix of privately financed organisations and national oil companies – most of whom would be under less pressure to develop ESG friendly portfolios. Having accounted for around 60% of awards between 2014 and 2020, those clients now account for 85% of upcoming prospects, as the IOC community retreats from the space.
As the client base transitions, offshore project activity is likely to decline in volume and scale. Independents in particular lack the balance sheet strength to develop the large-scale greenfield developments often pursued by IOCs and chased by the offshore supply chain. The average contract value awarded by Independents is less than half of those made by IOCs, and some 35% lower than the average value of $265m tracked between 2014 and 2020.
As its traditional client base transitions, the offshore supply chain will have to attempt its own transition in order to support it.
We think that players should look to be more sector agnostic and be able to support a variety of nascent markets across carbon capture and storage, hydrogen (green and blue), geothermal and offshore tidal work. By addressing these end markets, the lost revenue from the absence of long-term oil and gas projects could, at least in part, be replaced.
Much of the European upstream supply chain is already in the process of establishing or maturing its exposure to markets outside of oil and gas. Wood, Petrofac, Aker Solutions, Subsea 7 and Saipem are amongst those to derive significant revenues (if not profit) from such work.
It is hardly revolutionary to suggest that the offshore wind market offers great potential for the wider offshore supply chain. The growing installed base of infrastructure means that the operations and maintenance market, similar to the oil and gas MMO sector will provide a considerable number of opportunities. Similar opportunities exist in clean energy markets such as hydrogen, geothermal, carbon capture and storage.
The virtues of those opportunities are well known, but something that tends to go unnoticed are the associated pitfalls . The move into adjacent markets is far from risk-free. The supply chain has struggled in the past when addressing new end markets and different contracting frameworks – what has worked for decades in the offshore space may not necessarily work in the new normal and there are many instances from the not so distant past that should not be forgotten.
One such cautionary tale is Lamprell’s initial entrance into the renewables market at the East Anglia One project. In November 2016, the traditional jack-up drilling rig fabricator secured its first contract in offshore wind. Its $225m scope would see it fabricate 60 foundation jackets at its Jebel Ali and Sharjah yards in the UAE, aiming to deliver the project by the end of 2019.
Having underestimated the costs required to complete the project, and bid low to win the work, the net result for Lamprell was that it took a net $80m loss on the contract, in addition to being liable for around $34m of liquidated damages.
Encouragingly, Lamprell does appear to have applied those hard-learnt lessons in subsequent contract wins at the likes of Moray East and Seagreen, but the East Anglia project caused significant financial distress and contributed to a steep fall in earnings.
Likewise Petrofac’s issues at the £800m Laggan gas processing plant in Shetland saw it took several losses, amounting to around £500m of charges as the company faced liquidated damages in the wake of delivering the project around 18 months behind schedule – partly due to the Middle Eastern-centric EPC business having underestimated lump-sum contracting risk in Northern Europe. As a result of those charges, Petrofac pledged to no longer take construction risk on large lump-sum contracts in UK. Subsea 7 is another example of a contractor to have also encountered considerable execution issues related to its windfarm exposure.
The purpose here is to highlight that such diversification is not without risk, and as with any other decision, it requires businesses to develop fully realised strategies to mitigate the risks of entering the unknown.
While the long-term opportunities to replace lost revenues in conventional markets are clear, the offshore supply chain will need to be prudent when deciding which projects to chase and which sleeping dogs they should let lie, lest they succumb to the pitfalls that have consumed the ambitions of others.