Riding the Wave of Uncertainty in the Marine Seismic Value Chain (27 November 2015)

Content Revised 13 November 2013 by Request of Company to Remove their Named Reference

What Will Customers of Marine Seismic Value Most in 2017?

Today the whole business is too much about procurement. It is very, very difficult today in the current circumstances to be in a position where we can value the technology, where we can value the innovation. At the end of the day [the] best value for money in the current circumstances means best prices, full stop.

Jean-Georges Malcor, CGG CEO

Opportunity arises for the prepared mind

Louis Pasteur (chemist and microbiologist)

In the recent article, CGG CEO: It’s All About Price , Jean-Georges Malcor assesses the current upstream O&G market environment for geoscience services.  When service company executives talk of price thresholds as the main determinant of customer choice, it points to a commoditized market environment for products or services.  In my blog post, Upstream Exploration and the Paradox of Choice (12-May-2015), I discussed the dilemma of O&G operator procurement practices which seek standardized solutions from multiple service providers.  When comparing apples to apples, choice can be reduced to just lowest price.  Reducing the complexities of project requirements through standardization of products and services is simpler, for one thing.  However, it also is a way of providing a level playing field for service providers to compete and reducing opportunities of favoritism.  Technological solutions become commoditized while operational health and safety, quality, and turn-around time become the differentiators.  The value differentiator from innovative technical solutions is lost within this procurement standardization processes.

In the past two years since the collapse in oil prices, service providers have been coming to terms with a prolonged period of time with oil prices below $70 USD/bbl.  The $70 USD/bbl price was the industries tacit price limit required to support profitable deep water project exploration and development.  Recent hedge fund predictions forecast oil rising to $70 USD/bbl by the end of 2017, as mid-November 2016 crude oil market prices were around $43 USD/bbl.  Norway’s Petroleum and Energy Ministry has recognized and become concerned over this new market reality as international companies are considering leaving Norway and selling assets to smaller, less financially resilient, oil explorers and private equity firms.  This has brought a warning to international companies that they may remain liable for the close down costs of assets in the event that new owners are not be able to handle operation expenses.  Oil and gas exploration and development market is well known for its ups and downs.  For the past two years, the industry has been trying to assess what kind of downturn this is.  Notwithstanding the geopolitics and technology differences that define each peak and slump in the O&G market, companies are coming to the realization of a prolonged period of low oil prices seems in the horizon perhaps more similar to the downturn and oil glut which occurred in the 1980s.

There was robust exploration and development following the OPEC instigated crisis in the 1970s, where there was over-supply and then a subsequent collapse in oil prices.   Between 1973-74 the real price of crude oil more than tripled. After declining slightly in 1975-78, it doubled again between 1979-80.  However, between 1981-85 the price of oil declined nearly 40% and then collapsed by nearly 50% during the first half of 1986.  This compares to the more recent crisis where international crude oil benchmark Brent fell 76% from June 19, 2014, when it traded at $115.06, to January 20, 2016, when it closed at $27.88.  The inflation adjusted average cost for the of oil from Q1 1974 through Q2 2015 has been calculated to be $53.12 USD/bbl.  However, if one studies a graph of oil prices over this period, because of oil price volatility, actual prices rarely match this average.  Nevertheless, the $53 USD/bbl historical average price is still ~25% lower than the $70 USD/bbl threshold thought to be needed for much of the commercially viable deep water field development.  Expensive areas to develop in both Asia and Africa will likely especially be affected in the near term.  This market environment therefore indicates that the industry must operate much differently going forward.  A paradigm change from the current business model is needed and this starts with how O&G companies assess their needs and value exploration and development in such a way to leverage innovation instead of standardizing it.

There are four principles to understand about differentiation and the buying factors that go beyond price: They always exist; they have economic value; they vary by customer; and they change with time, because yesterday’s differentiator’s can be tomorrow’s commodity.

Dick Kallage, Differentiating in a commoditized market

Standardization leads to rigidity, and rigidity causes things to break.

Bill James

Rig counts are sensitive to price changes and generally excellent indicators of future oil production and general market health.  Operating rigs often represents how confident oil and gas operators feel about the exploration environment.  Rig count is also used to gauge activity levels for oil field service companies.  Global deep water drilling demand has experienced year-on-year decline since 2013, creating an oversupply of floating drilling assets and unparalleled idling and stacking.  This coincides in some ways with marine geophysical exploration, mainly seismic, which most often proceeds to mitigate risks for more expensive drilling campaigns.  During the Q1 2016, twenty-six (26) were stacked.  Almost one-hundred (100) have been stacked in the past 12-months.  About half of the stacked rigs are older and would have most likely been taken out of operation indefinitely.  However, about 40% of the stacked rigs are amongst the newest and commanded the highest rates.  For the past 18-months, my blog has been evaluating the 3D marine seismic streamer fleet as a measure of the health within the marine geophysical exploration sector.  Similar to rig count, many streamer vessels have been stacked since the downturn in oil prices mid-2014.  While the differences are many between rigs and vessels, the marine seismic 3D sector has also been stacking older vessels.  However, as a global fleet, the newer vessels capable of wide tow have been retained.  In my most recent blog, Marine Seismic Streamer Time and Money 2016 , I propose that the preference of customers hiring wide-tow capable vessels, which can complete surveys more quickly, is now more dependent on the day-rate whereby time constraints are less rigid in a sluggish and vessel over-capacity market.  Widest tow may not be lowest cost per square kilometer acquisition for newer and more expensive to operate vessels because time savings is not commanding the same premium it did in a robust exploration environment.

Malcor suggests that the last period of time the market was favorable was in 2012.  I disagree somewhat.  Fugro’s acquisition by CGG in early 2013 points to this fact.  Fugro had actually established a niche market in high-risk frontier exploration markets, such as east Africa.  Exploration opportunities had been on the decline to the extent that other players understood that they needed to compete in these high-risk arenas to keep vessels busy.  In 2010, new player, Dolphin Geophysical, entered the 3D marine seismic streamer market with the belief that this was a growing market.  Unfortunately, Dolphin Geophysical became insolvent December 2015.  Dolphin Geophysical entered into the low-cost end of the market.  They chartered their vessels from GC Reiber and just prior to their demise had agreed to charter two high-capacity vessels from Sanco Shipping ASA (Sanco).  In hindsight, Dolphin Geophysical was perhaps too ambitious in their growth predictions.  Like the industry, they did not foresee the collapse in oil prices mid-2014.  Dolphin Geophysical’s two Sanco charters were taken over by a competitor.  GC Reiber continued to operate their vessels through a Dolphin Geophysical affiliate.  Recently, GC Reiber joined with Rasmussengruppen AS to create Shearwater GeoServices.  This is an interesting marriage.  Rasmussengruppen AS operates tankers and marine transportation services.  In a current marine geophysical exploration market with razor thin margins, approaching cost savings from the vessel operations and support side makes sense.  Fuel and supplies are always issues for operating a seismic fleet. In fact, it is these costs which are the most expensive part of services offered to customers, as is related in day-rates.  Shearwater GeoServices will be focused on cost of data acquisition operations.  They will likely work to expand their data processing and imaging capabilities.  Clearly, there are geoscientists available to support this initiative in the current environment.  If Shearwater GeoServices can be a low-cost provider of data acquisition services, this may make them especially appealing in such a price-sensitive market.

One seismic streamer vessel operator has continued to grow their operational streamer capacity from pre-collapse levels.  While they have stacked older vessels, this has been done while taking on high-capacity charters and the construction of new builds.  Schlumberger’s marine seismic component, WesternGeco, commissioned two new build Amazon Class vessels that also entered the market in the depressed conditions.  No market player was without some form of optimism.  Both CGG and WesternGeco stacked multiple vessels.  Polarcus once commanded one of the smaller 3D seismic streamer fleets and has stacked only one of their 3D streamer vessels.  This is how the marine seismic streamer market players have panned out the past two years.  New builds have entered the market, but mostly vessels have been stacked reducing operational streamer vessels, and to a lesser extent, operational streamer numbers.  This is because by in large newer vessels were built to tow more streamers.  However, the time efficiency advantage decreases as the number of nominal tow capacity increases.  In other words, the benefit of towing 10-streamers over 8-streamers is essentially 25% reduction in time.  Towing 12-streamers over 10-streamers provides a 20% reduction in project time.  In a price-sensitive market environment, seismic company vessel cost base needs to be within the project time benefit range in cost savings.  It’s all about the cost to survey an area.  Broadband? Which kind?  Value enhancing differentiators are especially difficult to market for proprietary contract surveys which are often put out to tender with standardized guidelines used for awarding work.

Business is other people’s money.

Delphine de Girardin

Their new label became “private equity,” a name that turns the facts upside-down: A purchase of a business by these firms almost invariably results in dramatic reductions in the equity portion of the acquiree’s capital structure compared to that previously existing.

Warren Buffet on the evils of private equity.

Successful marine geophysical exploration, and subsequent drilling operations, showcase unparalleled scientific, engineering, technical, and operational prowess, to be sure.  However, as a business enterprise, geophysical exploration’s effective use of complex science and technology is constrained by the same principles as any company providing goods and/or services to customers.  This means it does not really matter whether the enterprise is involved in providing paperclips or satellite components.  Enterprises need to generate profit.  The question is how can the same equipment and business model paradigms generate profit after a substantial decline in the price of the target commodity?  In this respect, the success of marine geophysical exploration pursuits rests more so on the value that banks, private equity, and investors place into such pursuits.  The elegance and intricate use of science and technology is often lost in the complexity assembled within hedge funds and international tax schemes.  Dolphin Geophysical’s insolvency provided an equipment bargain opportunity for Polarcus.  It also resulted in TGS-Nopec and other players are expanding their multiclient data offerings.  CGG SA also told investors earlier this month that they are considering plans to restructure debt.  However, none of these financial maneuvers fundamentally change the marine geophysical exploration market itself, so much as help geophysical exploration companies continue another day or financial quarter.  The uncertainty for all new-builds is will they be able to generate the margins needed to accommodate their debt in only two years?  This would require a significantly more favorable market for marine seismic streamer services.

Since financiers may be dictating exploration terms as much as geoscientists, the market seems to favor the lowest cost base to deliver the stated requirements to fulfill base license terms and conditions.  There is no incentive to explore for $70 USD/bbl oil when Brent Crude is trading at less than $50 USD/bbl.  The cost of oil is the main driver for exploration budgets of operators.  In spite of the amazing data acquisition and processing / imaging technologies which have been developed in the past few years, the near-term future would seem to favor service providers with the lowest cost base and final price to accommodate the minimum contractual license commitments which operators have agreed to.  Even renegotiating contract terms and postponing exploration until a significant increase in return is foreseen may be the answer.  As a geophysicist who is enthralled by new technologies and used to prepare tenders for marine seismic/EM data acquisition and processing, I see a market that will not provide reasonable returns on the research, development (R&D), and deployment of such technologies lasting for some time.  The market does not seem to favor service providers getting their due return on R&D technologies, such as multi-sensor streamers such as WesternGeco’s IsoMetrix™ and even improved dual-sensor broadband streamer technology.  On the other hand, Polarcus XArray™ technology which effectively reduces operational exposure of equipment (extra source and reduced deployed streamers) while reducing acquisition time would be desirable in a cost sensitive environment.  This is how I see the market.  Geophysical service providers will be most effective if they can reduce the base cost of operations at the front-end of the value chain.  However, this places most pressure on enterprises which have invested heavily on new vessels and technologies that mostly accentuate their data acquisition focused products and services.  At the core is what solutions operators allow service providers to propose, especially within the proprietary contract side of the business.  Operators need to improve their procurement processes to better leverage service companies innovative solutions.  Simple and easy solutions may not be the best answer.

Even if oil does go to over $70 USD/bbl, this will not immediately impact vessel day rates significantly.   There is a lot of unused – stacked – capacity which would be able to enter the market when conditions change.  Essentially, an entire extra global fleet of marine seismic vessels are currently stacked.  They are stacked for a reason. If the vessels are sold or leased, then they could potentially enter the market as low-cost competition.  Obviously, the charter rates were not negligible to Dolphin Geophysical and are part of the reason why Sanco terminated the charters due to non-payment prior to Dolphin Geophysical’s insolvency filing.  Shearwater GeoServices, as a vessel owner, can enter the low-cost end of the market.  This is how Dolphin Geophysical started too.  Since most geophysical companies have significantly reduced fleets, the advantage of global fleet placement of vessels to reduce transit costs from job-to-job is more equalized amongst the different companies.  The problem with technology too is that it changes rapidly.  But, more relevant is that in a cost sensitive environment where vessel utilization is of principal importance, it is difficult to find customers to pay for much beyond the vessel cost base.  Acquisition or operation based data improvement is more expensive than post-acquisition data processing that may also enhance the quality and grade of acquired data.  With so much streamer vessel capacity currently idle, there will be no immediate or significant change in day rates for a period of time, perhaps even beyond 2020.  Any dramatic change in oil prices would initially absorb stacked vessels, especially the newer ones, back into the market.  Cost will continue to be the driver until there are prolonged oil prices above the $70 USD / bbl threshold.  My belief is that the cost constraint supersedes the time constraint in this market.  The main cost saving to O&G operators will come from lower cost-base vessels utilized in more operationally innovative and efficient ways.  Operational efficiency in acquiring data for less cost is how banker-led data acquisition will manage the plunge in oil prices.

The first rule of any technology used in a business is that automation applied to an efficient operation will magnify the efficiency. The second is that automation applied to an inefficient operation will magnify the inefficiency.

Bill Gates

I think, particularly in our tech industry, this is an industry that has violent innovation and then commoditization, and it’s a cycle of innovation/commoditization.

Ginni Rometty