Weathering the storm

OIL AND GAS PROVIDERS TO WEATHER THE STORM

31.MAR.2015
Mining commodities prices have fallen substantially over the past few years. These falls have prompted major mining companies to adopt austerity measures and lower their costs to salvage what’s left of their margins. This Insight explores how the sharp decline in the price of oil may impact the oil and gas services sector and whether they’re likely to follow in the footsteps of their mining services counterparts.
Mining commodities falls have led to austerity

A number of mining mega-projects have been on hold for over 18 months including BHP’s $20 billion Olympic Dam expansion in South Australia and Glencore Xstrata’s $7 billion Wandoan coal project in Queensland.
More recently, a number of operations have seen mines closed. For example, Rio Tinto condensed its operations into four key groups and laid off thousands of workers across Australia. Arrium shut down its Southern Iron mining operations, and Sumitomo and Vale shut down the Isaac Plains coal mine.
These events have had immense knock-on effects for the mining services sector, forcing many service providers to re-tender for work in a new, fiercely competitive environment. For example, Fortescue Metals Group recently consolidated its Christmas Creek One and Christmas Creek Two contracts with a single provider to reduce costs.
Oil and gas prices are following suit

The oil and gas services industry now faces similar challenges. The price of oil has fallen by 50 per cent since June 2014, placing enormous pressure on major producers to preserve margins by cutting costs.
In Queensland, Origin Energy is in the process of laying off many workers in towns surrounding the Surat Basin. We are also likely to see a number of major LNG projects near Gladstone move from construction to operation, which will create thousands of redundancies in the next two years.
In Western Australia, Woodside has told its staff it will make around 300 people redundant – nearly 10% of its workforce. Chevron has also notified staff that it will make positions redundant as it gets ready to switch from a builder to an operator of the $US54 billion Gorgon LNG project and $US29 billion Wheatstone LNG project over the next two years.
Chevron’s workforce was always going to shrink as the big LNG projects in WA reached completion, but its cost-cutting will be more severe because the oil price downturn will slash oil-linked LNG revenue. It’s likely around 1,500 of Chevron’s 4,000-strong workforce stand to lose their jobs. The effect this will have on local businesses could be significant.
Why oil and gas will weather the storm

Despite drops in the price of oil, we are confident that most oil and gas service providers will survive belt-tightening by the sector’s leading players. We base this on three key differentiators between oil and gas service providers and their peers in the mining sector.
1. Higher barriers to entry

Higher risk and greater consequences of disaster mean petroleum and LNG operations demand more rigorous regulation and due diligence than mining projects. This requires service providers to invest in talent and processes that provide many extra layers of testing and safety assurance.
These requirements deter companies from entering the industry, resulting in a smaller number of core service providers and less excess service capacity in the oil and gas industry than in mining. The lack of excess capacity means the oil and gas services sector will experience the adverse effects of price drops on a much smaller scale than the mining services sector.
2. In-house expertise

The momentum of the Australian mining boom caused many local providers to outsource significant elements of their operations in order to meet skyrocketing demand. The drop in commodities prices means many of these contractors will be out of work.
By comparison, oil and gas service providers tend to employ and retain highly skilled workers with specialist expertise rather than outsource. The industry has also not seen an increase in projects and production requirements. For these reasons, the sector’s service providers will not suffer as badly as those in mining when major oil and gas companies consolidate to cut costs.
3. Highly diversified risk

Mining projects enjoy lower risk than oil and gas projects and are often managed by single companies as a result. Given the high risks of total loss or catastrophe in petroleum projects, oil and gas companies are more accustomed to sharing risk through joint ventures and creating carefully balanced global project portfolios.
This diversification means oil and gas service providers are less likely to experience the flow-on effect from a price slump in the same way as service providers in the Australian mining industry.
Despite these relative strengths, oil and gas service providers will face considerable challenges in the coming months. Advisers to oil and gas service providers need to understand where their clients fit into the exploration and production life cycle. Those that have invested in developing unique service offerings will be better positioned to minimise the downside risks of recent austerity measures and weather the impending storm.