As oil prices hit what the industry will be hoping is rock bottom, market volatility remains high and demand recovery looks set to be a long, drawn-out process. The price per barrel for crude oil benchmarks Brent and Texas light sweet is still struggling to clear $60, and while optimism varies between oil executives, analysts and traders, many expect the price to stay largely where it is for many months to come.
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At industry conference IHS CERAWeek in Houston in late April, Occidental Petroleum CEO Stephen Chazen – whose company is planning for $60 oil – argued that waiting for a dramatic price rally was akin to "whistling past the graveyard".
With billions of dollars of global funding for new drilling projects threatened by the price slump, the short-term landscape for securing offshore project finance is a hostile one, particularly for small and medium-sized exploration and production (E&P) companies, which are struggling under tightened bank lending standards and don’t have the capital necessary to proceed with new projects unsupported.
Chris Lo spoke to Dr Wei Liu, manager of energy analyst Infield Systems’ transaction services business, to discuss the outlook for offshore project financing in more detail.
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Chris Lo: How dependent are new offshore drilling projects on securing credit?
Wei Liu: It’s pretty important, because the use of debt or leverage is pretty common in the offshore drilling industry, as the projects are quite capital-intensive. Drilling projects can take a long time and can require millions of dollars just for building a drilling rig. They can rent one but day rates are pretty high, ranging from $100,000 – $600,000 per day. So yes, it is pretty important.
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By GlobalDataCL: What are the major risk factors for offshore oil and gas projects that can influence the availability and cost of credit in the market?
Key insight from the Platt’s London Oil Forum 2015.
WL: The foremost risk is oil price. The oil price assumptions for the next five to ten years will determine, largely, the revenue part of the business. The next part would be the risk of their reserve portfolio of E&P companies. If their blocks are located in geopolitically unstable regions, this will increase the risk, for example in Russia or Nigeria, which are affected by different factors. The next one would be how risky technically it is to extract the oil. So they would assess the meteorological conditions, as well as geotechnical and geophysical conditions. So if you are located in ultra-deepwater with oil that is very hard to extract and there’s a possibility of accidents, for example with Macondo in 2010 – these kinds of factors will all affect the cost of capital.
CL: Presumably the current low oil price is making it much harder for new offshore projects to secure funding – is that what you’ve observed in the market?
WL: Yes, that’s true. Actually, the banks have now introduced tightened lending standards, particularly to small and medium-sized players. It’s pretty hard now to get finance. But there are alternative sources of funding, for example approaching partners by farming out your block, private equity and also export credit agencies. It’s a mix of sources where you can find funds.
CL: So it’s more likely in this environment that offshore E&P companies will be looking for investment partners?
WL: It depends, really. If it’s an NOC with a very large war chest, like Statoil in Norway or Saudi Aramco in Saudi Arabia, they don’t need much financing and they can still get quite good interest rates. If it’s for companies, even for NOCs like, say, the national oil companies in Venezuela, Anglo, Gabon or Congo, they have a credit rating of BB+ or less, so they will find it harder to go into the bond market. So in this case, if they can’t secure finance they may need to delay their investments.
For smaller players, if you are highly leveraged, you would probably need to go with a PE [private equity] partner, or you’d go for distressed financing if it’s necessary. But what we’ve observed at the moment is a general delay in the sanctioning of new projects. People are waiting to see how the oil price will evolve. We believe this is the bottom, but there is still uncertainty around in the next couple of months. We have a feeling that towards the end of the year, we will see more activity in terms of mergers and acquisitions, as well as the sanctioning of new projects. But for now it’s pretty quiet.
CL: How much do projections of future oil prices play into financing projects today?
WL: You need to value the whole project, so the cash flow is affected by the oil price. When you’re calculating the profitability of a project, if oil prices are low it is going to be hard to get finance because the prospects are not good. Not only does the price need to be high, it also needs to be stable, to have less volatility. In the current conditions, the volatility is still very high, which is why people are still waiting.
CL: In this kind of market, what can offshore operators do to make their borrowing as cost-effective as possible?
WL: That’s a difficult question. For smaller players, it’s more a question of can they get finance at all, not how to do it cost-effectively. And now is not a very good time to go for IPO [initial public offering] or first issues because oil and gas company valuations are pretty low at the moment. To take private equity investment could be a good idea because it could broaden their portfolio. People are still waiting at the moment.
CL: You mentioned the importance of revolving credit facilities; is it important for offshore companies to build and maintain relationships with banks to find a consistent source of credit?
WL: Absolutely, because this is going to support companies’ day-to-day operations and when they need funds they will have access to this facility. So it’s really important that you maintain a good relationship with not only one bank, but a syndicate of banks.
CL: In September last year, CAMAC Energy closed a $100m credit facility with Nigeria’s Zenith Bank to further develop its licenses offshore Nigeria. Can cheaper or more easily-available credit sometimes be found with national banks?
WL: In theory, yes. However, it’s not that straightforward because in these countries, like Brazil and Nigeria, their banks will be in favour of lending to their own NOCs, like NNPC [Nigerian National Petroleum Corporation] and Petrobras. The reason they are inviting E&P players to come into their offshore blocks is because they need not only technology, but also the finance. So they may not have the capacity to lend, especially in these conditions.
What can the offshore oil and gas industry expect in terms of CAPEX spending, regional hotspots, oil prices and potential challenges in 2015?
CL: What are your expectations for the offshore oil and gas project financing landscape over the next five to ten years?
WL: For this year and next year, we’re not that optimistic. The oil price is still low, but it’s bottomed out. However, it’s not good enough to support continued development of new offshore projects, as offshore projects are getting deeper and more remote, which means larger finances are required, which they don’t have. Next year, it will probably be even harder for the E&P companies because there’s a delayed effect of the oil price drop. The oil price just started to fall from November last year, and the effect will be felt continuously in the next two to three quarters.
But if you are talking about five to ten years on the horizon, we are quite optimistic because offshore oil actually comprises about 29-30% of global oil production, which is a very important source of oil supply. Oil demand is recovering; on average, every year the demand is increasing by about 1.1-1.5%. Last year it was quite low, but in the next five to ten years, we will see demand gradually recover to its average historic value. However, we need enough investment to keep production to satisfy the growing demand. So in this case, oil prices need to stay above $80 at least in the long run to support continued development of unconventional resources.
CL: How much will the current shale boom in the US and other countries affect the oil price recovery in the long term?
WL: It will apply a cap to the oil price. Over the past three or four years, since 2011, we saw oil prices consistently above $100 per barrel. However, with the shale revolution, we think the oil price will stay around $80-90, but not above. Because whenever oil prices reach above, let’s say, $90 per barrel, more shale oil will come into the market. So we need a balanced market of
around $70-90, which should allow continued shale development, but not a shale boom.
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