International drilling and exploration
Owing to the success of the North Sea since the 1970s, the UK is home to a network of businesses providing support services to the oil and gas industry. The sector is internationally recognised and many of these businesses have considerable overseas sales. As such, international exploration and production activity is an important factor in the financial performance of the support services firms based in the UK.
Whilst a reasonable proportion of North Sea production is unprofitable at $50 a barrel, energy analysts, Wood Mackenzie, estimate that across the global market, just 0.2% of supply is cash negative at this price. Even so, many operators may continue to produce oil at a loss rather than stopping production due to the complexities of resuming production or interdependencies– as seen in the North Sea. Instead, the supply response to lower oil prices is heavily centred on investment and future production.
Since the beginning of the year, investment cuts in the oil industry have accelerated and there has been a sharp fall in the number of active drilling rigs around the world. The Baker Hughes international rig count showed there was 750 fewer rigs operating in February 2015 compared to the same month a year earlier, with the total falling below 3,000 for the first time since June 2010.
Shale exploration and production companies across the US have been particularly impacted by the falling oil prices. The production curve of a typical shale field noticeably differs from that of conventional fields. The average flow from a shale gas well drops by about 50 percent to 75 percent in the first year, a much steeper decline compared with conventional wells. This creates a strong incentive to postpone projects until prices have recovered. Additionally, individual wells and the investments associated with them are relatively small so spending is more easily scaled compared with other forms of production. Given that many producers are highly leveraged and capital has become increasingly difficult to raise, follow-on investments have been cut sharply to reduce cash burn. As a result the decline in active drilling rigs is particularly acute in North America, falling by over 27% between November 2014 and February 2015.
With the cuts to capital expenditure and general climate of cost cutting, service providers are coming under increasing pressure from two fronts. Firstly, the cancelling of drilling rigs and associated field projects means sales have shrunk and productive assets and staff sit idle, generating costs but not revenue. Secondly, oil companies have increasingly placed pressure on equipment and service providers to reduce their prices. These factors have already led to two of the largest international oil and gas service providers, Schlumberger and Weatherford, to axe 17,000 jobs between them and will likely put many smaller providers, both in the UK and internationally, under significant financial pressure.