Analysis: A Healthier 2011 for the Energy Industry?

Despite the Gulf of Mexico moratorium, IHS reported seeing a healthier growth outlook for the energy industry in 2011 thanks to rising oil prices, unconventional North American drilling and multiple offshore opportunities worldwide.

In the IHS Herold Review on the Oil Field Services Sector, key oil company financial performance for the first nine months of this year were compared against sector performance for the same period in 2009, and included multi-service companies such as Baker Hughes, Halliburton and Schlumberger as well as offshore drilling contractors Transocean, Diamond Offshore and Oceaneering International, among others.

"Many of the service companies, and in particular the offshore drilling companies, took a financial beating following the Gulf drilling moratorium. Companies exposed to the Gulf incurred costs related to redeploying assets and personnel to other opportunities, primarily onshore North America or international markets," said John B. Parry, principle energy analyst at IHS and author of the IHS Herold Review on The Oil Field Services Sector.

"With the lifting of the moratorium, the industry has moved to a more offensive posture. While valuation of the underlying equities in the sector remain about 35 percent below their peak in 2008, we believe strong oil prices and higher exploration and production budgets will help drive growth in the oil field services sector in 2011, and current forward earnings estimates suggest a potential restoration to prior peak 2008 stock price levels by 2012," Parry said.

Companies such as Baker Hughes and Halliburton recorded increases in revenues during the first nine months of 2010 due to the shifting of resources to meet demand for U.S. onshore drilling and international projects. Halliburton noted in its third quarter 2010 earnings calls that the shift into oil- and liquids-rich plays would lead to continued growth in its U.S. land business. Multi-service providers fared better than onshore drillers, who either recorded declines in revenue or marginal revenue growth. Only Oceaneering posted positive revenue and earnings growth of companies in the drilling segment.

While overall earnings growth for the sector is a positive sign for the industry, the IHS study noted, post-moratorium challenges still persist, since a return to drilling has been slow. This has fed a general decline in rig-utilization rates while new-build rigs continue to enter a sluggish market. These challenges and the significant impact on the Gulf of the federally imposed moratorium on offshore drilling issued in the wake of the spill were further illustrated in the IHS CERA Upstream Capital Cost Index (UCCI), which indicated that upstream construction costs for new oil and gas facilities rose three percent in the past six months after bottoming out during the previous six-month tracking period an increase the report attributed to oil and gas activities worldwide.

The IHS CERA UCCI report and the IHS Herold Review on The Oil Field Services Sector both noted that idle rigs and a backlog of new rigs leaving the construction fields will lead to a softening of the rig market for the time being.

In an earlier study this year, IHS noted that more sophisticated new-build jackups and floaters (semisubmersibles and drill-ships) were expected to swell the world fleet of approximately 675 units more than 10 percent by the end of 2011, excluding possible retirements. The current status indicates a count of 760 (35 percent floaters) by year-end 2011, with approximately one-half of these additions lacking a firm long-term contract commitment.

These rig additions may seem daunting to some, but others, like Diamond Offshore, may view them as opportunities. "This attitude, along with an eye toward mergers and acquisitions (M&A) will be a feature of the sector moving forward," Parry said. "For these companies to continue to help meet the changing competitive and technological requirements, particularly for offshore drilling, we see ongoing consolidation as part of the mix. In 2009 and 2010, our energy M&A team tracked more than 80 transactions in the oil field services sector, valued at nearly $40 billion. We expect that number is likely to remain healthy in 2011."

API View on U.S. Gulf Outlook

Kyle Isakower, vice president of regulatory and economic policy at the American Petroleum Institute (API), said the long-term outlook in the U.S. Gulf of Mexico and elsewhere on the Outer Continental Shelf (OCS) look good, but production is being stymied by the Department of the Interior's inability and/or unwillingness to proceed with the issuance of permits. "Now it appears the Interior will not proceed with planned lease sales in 2011, further exacerbating the economically damaging de facto moratorium," said Isakower, citing analysis indicating that a prolonged moratorium could put 175,000 U.S. jobs at risk.

While the oil and gas industry has worked with Interior since the Deepwater Horizon incident and has had many of the safety improvements it has recommended incorporated by Interior into their rule-makings, it is still somewhat unclear as to what the final requirements will be. "We do anticipate greater oversight from Interior in the way of on-site inspectors, and support this change that should lead to improved coordination between the industry and Interior. But interior should also be resourced with additional staff for permitting, environmental review and oil and gas planning," Isakower said.

Isawkower anticipates that many of the same issues API currently is addressing will remain API's focus in 2011, including returning exploration and production activities to the Gulf of Mexico and expanding them elsewhere on the OCS. API anticipates the Obama administration including additional taxes on its proposed 2012 budget that could affect the industry. The organization also will continue to address the over-reaching authority of the U.S. Environmental Protection Agency regarding greenhouse gas regulations and other issues, as well as revenue transparency rules, Isakower said.