Competing on performance, not bottom dollar

Critical D&C issues with Brian Taylor, KCA DEUTAG

By Jeremy Cresswell, contributing editor

Drilling Contractor caught up with Brian Taylor, KCA DEUTAG’s chief operating officer, to seek his views on where the drilling market appears to be going.

DC: On the basis that OPEC will manage the oil price back up the hill, how do you see 2009 shaping up for drilling in these rather extraordinary times?

Taylor: It will be interesting to see how it works out. As usual, some OPEC members will find holding to quotas easier than others. I think the overall question will remain where will the oil price go and how long will it take to lift.

I think it’s a combination of those two, not simply the level at which the price finds its floor but how long it takes to recover. I think these will be the main issues for oil companies.

DC: Of course, we do have the comfort of knowing that the Saudis see $75 as an important threshold price, not just for OPEC but for many smaller and increasingly marginal producers. Do you not think we have to assume that, in the same way that they managed the oil world out of the late 1990s mess, OPEC will do the same again, one way or another?

Taylor: You would imagine that might be the case, but I think they will have the same sort of difficulties with demand as anyone else. How are they to predict what the level of demand is really going to be? That will be the difficult issue.

So they make a cut; the question for several months ahead will be the degree of cohesion they achieve and where demand actually goes.

DC: So what’s the impact on the drilling contracting community going to be?

Taylor: Uncertainty. That’s the first thing, and anyone who would gainsay that hasn’t been awake over the last four or five months.

There are some tough times ahead, but our strategic presence in some key markets internationally with low lifting costs or committed programmes to increase production backed by national oil companies, means that we are in a robust position to weather the current economic climate.

There are still some significant contract opportunities in the Middle East, North Africa and Caspian, and we are optimistic about some organic growth in the next 12-18 months in some markets. The fundamentals are still there in terms of energy supply and demand, so we remain confident of long-term growth, and our strategy for growth remains in place, albeit deferred slightly due to the global economic climate.

DC: But what does the uncertainty mean in detail terms – contract renegotiation, softening of rates, what?

Taylor: First of all, activity levels. Bear in mind that there are areas where development is expensive, like the UK North Sea where we’re already seeing companies rethinking their plans. Whatever OPEC’s actions in the near term, it is important to get an understanding of how our clients will think long-term. Much of our work is associated with significant development projects.

DC: KCA DEUTAG is heavily involved in platform-based drilling in the North Sea. Surely that’s so bread and butter that it’s least likely to be affected by cutbacks?

Taylor: That depends on what the lifting costs are on any particular platform. The UK North Sea is a particular case. We see declining production from mature fields while, at the same time over the last four years, we’ve probably seen roughly 100% oilfield cost inflation. Imagine a platform the production of which has halved over that period while costs have doubled – you’re looking at a four-fold rise in lifting costs.

Probably four years ago we all had in our minds that lifting costs were of the order of $10 to $15 a barrel. I suspect for many fields that it’s now $40 to $60. I know of examples where lifting costs are $80 a barrel for some North Sea platforms, or at least that’s what the operator tells me. Therefore, I think there are some very severe problems for the UK sector.

DC: Presumably there are additional tensions between field partners where some can afford to press ahead with new/ongoing development plans, but others can’t raise the cash needed because of the credit crunch?

Taylor: Even in the now mature UK North Sea, you may have a major and three or four much smaller partners involved, and each and every one has to say yes or no to (2009’s) development plans. And each of the four or five involved in a field or platform may have different cash limitations.

I can go and talk to some of the larger companies, and they are very clear about what they want to do over the next 12 months. They’re very committed, have done all the calculations and have the cash. But they have smaller partners who are saying, “Yes, it makes perfect sense, but I haven’t got any cash.”

DC: If that’s the case, then surely it is time for government to do something to protect the viability of the North Sea?

Taylor: Absolutely, Malcolm Webb (CEO of Oil & Gas UK) has made very strong efforts to get the UK government to understand that. But I think there are people in government and even in our industry who probably don’t have a proper understanding of what the costs really are.

DC: In the context of your business, what percentage of group revenues are generated by bread-and-butter platform-based drilling in the North Sea?

Taylor: Roughly 15%. The bulk of our business these days is international – mainland Russia, Caspian, Sakhalin, North Africa, Middle East.

Take the Caspian – Azerbaijan and Kazakhstan – I think we’re working very successfully with two major clients. Drilling performance is good, I think costs are under control, and I would expect to see our position in Azerbaijan strengthening as our major client there looks at additional platforms. I would think that for us it will remain a very secure province.

I could pick examples in the Middle East where things may be more marginal. I may not have the most up-to-date information on break-even costs, but I imagine in places like Oman, where we have nine land rigs working, break-even costs are probably now around $30-40 a barrel.

There may be some fields that are $20, but I’m sure that in Oman, Qatar, places like these, $30-40 will be about right, and this is something I’m sure OPEC is well focused on.

Another area is of course Russia, where there has been huge demand for our services. We have rigs with TNK-BP, with Shell in Salym where operational performance is very good and is improving. But, as I’m sure everyone will understand, there are economic and other problems within Russia that also need to be handled.

I think that, for the industry generally, the word uncertainty is the first thing that comes to mind as to the likely progress of companies like ourselves into and within Russia.

Consider security of hydrocarbon sales out of Russia into Europe. There’s a big question mark at the moment. We’re not sure what the proposed increase in price of gas to the Ukraine will do. Much has been written, but the outcome is not clear.

However, the general market conditions in Russia, and particularly the area that we’ve been in, Tyumen, have been commendably stable. We hear anecdotally of other companies in the service sector having great difficulty with general trading conditions – payment, security of contract, that sort of thing.

Either we have planned well or have established ourselves reasonably well in the right areas, and that’s why we’re stable. Also, working for the right clients helps, of course.

But, in terms of investment, many people, including us, will be very cautious about further investment (in Russia) until we see how the market develops in the current environment.

DC: Russia isn’t going sour on you, is it?

Taylor: No, we have 10 rigs working in Russia. However, we are mindful of the kind of announcements that TNK-BP made in mid-December. 40% of our rigs are with TNK-BP, and they’re very clearly going to cut investment in 2009 by 25%-30% compared with 2008. That will have an effect; it may happen to us in terms of an activity reduction, or a challenge on rates and costs.

DC: Libya has been a part of KCA DEUTAG for a very long time. Do you see any oil price impact on your business there?

Taylor: Libya remains as it always has been – a challenge. We’ve worked there since the late 1950s and been there more or less continuously. But there are particular challenges and, again, there are severe pressures on costs.

For us, Libya has been an environment in which we have learned to operate. There’s integrity in the contracts. There is stability in how we interact with our national clients. Plus, we have been of some assistance to Western operators in re-entering the country because we understand the system and how to set up and operate there. A number of these Western clients are grappling with the processes, but it’s slow. Consequently, the type of work that we want to do, which is development drilling mostly, has been slower in realizing than we would all wish.

DC: What is the outlook for mobile offshore drilling units, given that KCA DEUTAG has a number of jackups?

Taylor: We’re a very small player in terms of owned rigs in the offshore market, but our three jackups account for a significant proportion of our income.

I actually think people are underestimating the difficulty that a lot of the new-build players will have in completing the rigs they’ve committed to. A significant number of the 50-odd jackups that are due to come out for various companies won’t appear. My sense is that jackup rates in the markets that we’re in, Mexico and West Africa, will remain. We have cause to be reasonably optimistic. PEMEX’s award of a new contract for our Ben Loyal jackup in the Gulf of Mexico, in September last year, is an indication of their continuing commitment to their drilling programme.

DC: You’ve put the brakes on some ambitions, but are you still going to look for fresh opportunities? It’s not as if KCA DEUTAG’s battened down the hatches?

Taylor: We’re not going to batten down all the hatches. We will look at opportunities for growth, whether organicly or through opportunistic acquisition. We’ll be prepared to do that. With the support of a private equity company, we still have access to cash for future investments. But what we must do is get the company into a position where we can hunker down for a period of 12-18 months and be in a position at the other end to take immediate advantage of opportunities.
It’s no good coming out in 12-18 months with the company unable to respond.

DC: Do you have any sense as to how far into the oil part of the current crisis the industry is now? Is it just months?

Taylor: None of us were terribly good at predicting where the oil price was headed. I didn’t do it any better than many of the great and the good. I would imagine we’re in for a difficult period. I’ve settled myself to 12-18 months. I don’t think it’s four to five months. That’s the company view too.

We’ll keep the antennae up throughout, but you have to have the determination that says you’re going to come out the other side in the right shape to take advantage of a rising market.

We don’t know what we may have to do. We’ve long been a contractor that has put great store on performance and performance improvement. It’s much more than just a strapline to us. We have to mean it. If we can save an operator the spread rate from five or 10 days per well, we’ll do far more for the operator, the industry and ourselves than we will by making short-term cuts to contract rates. If we did that, we would leave ourselves vulnerable and deliver less value to the client.

The question for the client becomes: Are you serious about sustainable performance? We would not aspire to compete on bottom dollar. We believe our success with clients like BP and Shell and ExxonMobil and in places like the Caspian is built on an eyeball-to-eyeball relationship and delivering performance. If we start to chase some sort of spiral and very short-term commercial discussions, that really benefits no one.

DC: Bentec, KCA DEUTAG’s sister company, is a significant manufacturer of land rigs. What’s the outlook for these? Matt Simmons (“Industry must guard against knee-jerk reactions,” Page 36) seems rather pessimistic that current manufacturers can keep up with demand.

Taylor: That would certainly be true if we were talking a couple of years back. But since then, and Bentec is at the forefront of this, there has been a big effort made to design, build and invest in much more modern land rig kit. They also have a strong backlog of orders from Russian and European customers.

I could take you to Western Siberia, where we have T-500 series rigs at work, and they are very much state-of-the-art cluster slider high-performance production rigs. Similarly, we have a state-of-the-art Middle East and North Africa style of rig.

I’m sure others are doing it. However, the uncertainty of client plans has made some manufacturers step back. In KCA DEUTAG’s case, 10 months ago we had it in mind to build 10-15 rigs over a three-year-or-so period – big units for deployment in areas like Western Siberia and North Africa. I think that number is now going to be much smaller. KCA DEUTAG was headed towards a build programme – part replacement, part build for new contracts against a portfolio of opportunities, but I think any prudent contractor would be cautious about building speculatively. So we’ll step back a little from our ambitions.

In any case, we’re able to upgrade our existing older units by installing more modern equipment and tools as necessary to keep the fleet operable and efficient.