E&P capex forecast

1,000,000

900,000

800,000

700,000

600,000

500,000

400,000

300,000

200,000

100,000

1985 1988 1991 1994

United States

Canada

Outside North America

1997

Actual Estimates

Ca

pita

l spend

ing (

$s

in m

illio

ns)

2000 2003 2006 2009 2012 2015

0

52 Offshore February 2014 www.offshore-mag.com

F P S O O U T L O O K

FPSO industry must re-think supply chain

Suppliers cannot meet future demand without changes

The FPSO supply chain is broken. The foating production, storage, and offoad-ing systems markets will be unable to meet FPSO demand over the next fve years unless signifcant change occurs

in an industry increasingly defned by schedule delays and cost overruns.

Industry players understand and accept this position, but until now they have been unable to quantify the effect of these project delays and cost overruns. Success in improv-ing the supply chain model has been limited at best, negatively affecting exploration and production companies, suppliers, and leasing contractors in particular.

The goal here is to quantify these delays and cost overruns, and examine the reasons behind the ailing FPSO supply chain. The role of the oil companies, development complexity, regulation, and conficts of interest within the value chain are some of the challenges affect-ing FPSO project execution. Each will need to be addressed if near and medium-term energy demand will be met.

Oil price growth has stoppedThe structure and organization of the FPSO

supply chain and the entire approach to FPSO development has frequently been questioned. In addition to the Why do we do it this way? question is, of course, Why is anything going to change now?

To address the latter question, it is impor-tant to consider the health of both the industry and the ultimate end customer of the FP-SOs, the E&P companies. At frst glance, the oil industry and oilfeld service industry may appear to be in fne health. Oil prices, while not at record highs, are still in the neighborhood of $90-100/bbl, and overall upstream industry spend is expected to hit record highs this year. Underneath the impressive headline fgures, however, is a different story.

The current upstream cycle (2010 onwards) demonstrates very different characteristics to the one that preceded it (2001-2008). During the earlier cycle, prices increased more than tenfold from trough to peak, signifcantly boost-ing the free cash fow of E&P companies in the process and to some extent masking the effects of dramatic cost increases and project delays.

While oil price growth has slowed or stopped, oil industry cost infation has not. In fact, most surveys show that the double-digit cost infation seen in the last cycle has returned. Operators

costs are rising at a much faster rate than free cash fow. This is not a sustainable. A Goldman Sachs study highlighted the impact very clearly the returns for oil majors (measured in terms of cash return on cash invested) are at their low-est levels since 1999.

E&P companies will have to do something about cost infation for projects to be viable. They will not have the luxury of ever-rising oil price increases to mask the impact of proj-ect over-runs.

Production industry is brokenBased on research and interviews by Doug-

las-Westwood with operators, contractors, sup-pliers, and fnancers, key contributing factors include: hurried engineering at the front-end; over-engineering during the detailed design phase; conversion scope changes when un-wanted surprises occur; lack of clarity relating to contract responsibilities; and construction delays usually as a result of engineering changes and the requirements to continually build one-off designs. The next question is, Why is the production industry broken?

Driven by the need to boost valuations, oil companies tend to approach drilling activity with a keen sense of urgency. Few questions are asked around offshore drillship day rates

exceeding $600,000 when large exploration projects are on the line. Specialty drilling con-tractors usually shoulder a large portion of the drilling workload. On the other hand, oil companies have always had a detail-oriented approach toward production costs as they aim for maximum production and margin on each barrel produced. This helps maintain proftability on long-producing felds despite fuctuations in commodity prices.

As the core competency of oil companies is the production of hydrocarbons, this ap-proach makes perfect sense. Operators in-volve many decision makers in production decisions, ranging from project decisions to overarching business decisions in the C-suites. As a result, the number of cooks in the oil company kitchen is signifcantly higher when production is on the menu. In our re-search, it is clear that company targets can confict or oppose each other at times. These conficts add to the complexity of project ex-ecution, resulting in negative implications for suppliers and lower project effciency.

The way in which tenders are presented to leasing and engineering/procurement/con-struction contractors adds further complica-tion and risk to the supply chain. Oil com-panies typically perform extensive diligence and analysis when deciding whether and how to develop an offshore feld. When they de-cide to develop, tenders are often issued with a hard deadline, requiring contractors to de-liver within short timeframes that can appear arbitrary. Tight deadlines place pressure on

Michael Haney Matthew Loffman Steve RobertsonDouglas-Westwood

Source: Barclays Capital

1402off_52 52 1/29/14 1:58 PM

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E&P capex per barrel

$25

0.9% CAGR(1985-1999)

10.9%

CAG

R

(1999

-2013

)

$20

$15

$10

$5

19851987198819891990199119921993199419951996199719982000200120022003200420052006200720082009201020112013

$0

F P S O O U T L O O K

the fnal steps in the process, such as hull and topside integration and commissioning.

About the research

Douglas-Westwood reviewed in depth nine recent FPSO projects. While the FPSOs var-ied in terms of type (newbuild or conversion), ownership (leased or operator-owned), and geography, there are specifc themes that can

be drawn from the research. Signifcant cost and schedule overruns are commonplace and are now standard practice in the market.

The nine projects had a combined cost over-run of 38% and a collective delay of more than 12 years. The most signifcant cause of delay was integration of hull and topside, followed by yard availability and engineering scope. A total of more than $2.5 billion was spent above

budget to bring these projects onstream, with additional costs and delays continuing on two of the projects at the time of writing.

The research suggests that these case stud-ies are directionally representative of the in-dustry as a whole. Of the 45 FPSOs installed worldwide between 2008 and 2012, 30 were delayed, many signifcantly.

These cost overruns indicate the additional capital required to bring these nine projects on-line. However, this represents only part of the fnancial challenges facing oil companies. With each day of delay to frst oil, overall net present value of the project suffers. Months of delays can materially reduce feld development eco-nomics to the point where the feld is no longer a viable investment. Lengthy production delays frustrate oil company investors, who want bar-rels brought to market as quickly as possible to maximize company fnancial returns.

As the critical decision makers in the indus-try, oil companies have a responsibility to ad-dress and optimize current internal practices, the limitations of which have contributed to project overruns in the past. To some extent, fa-vorable contract terms passing risks to leasing contractors have shielded the operators from the weakness of the supply chain. However, the gap between supply capacity, witnessed by the diminishing appetite of many of the leasing con-

Source: IEA, Barclays Research

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Nine FPSO case studies

Reason for Delay Project A Project B Project C Project D Project E Project F Project G Project H Project I Total

Operator Contracting 14 14

Material Costs 6 2 8

Engineering Scope 1 1 4 8 1 0.5 2 1 2 20.5

Yard Availability 2 7 3 2 2 6 22

Raw Material Process 1 4 5

Equipment Package 1 2 4 0.5 2 9.5

Integration 3 1.5 3 3 1 8 9 28.5

Subsea Equipment 0

Equipment Installation 0.5 6 6.5

Commissioning 1 1 6 3 11

Financing 3 3

Political/Unpreventable 18 18

Total Delay (Months) 13 6 52 17 9 4 14 18 13 146

Original Cost ($M) $5,060 $35 $88 $375 $80 $90 $500 $132 $420 $6,780

Actual Cost ($M) $6,200 $44 $132 $675 $190 $240 $1,017 $200 $669 $9,367

Extra Cost Total ($M) $1,140 $9 $44 $300 $110 $150 $517 $68 $249 $2,587

Extra Cost % 23% 26% 50% 80% 138% 167% 103% 52% 59% 38%

F P S O O U T L O O K

tractors to take on these projects, and demand for FPSOs in the coming years will leave some operators disappointed, and will bring these concerns into sharper focus.

Project complexityEvery offshore feld is different and there-

fore requires different production infrastruc-ture. Each feld has particular characteristics; production curve, water depth, oil and gas mix, API gravity, well numbers and locations, pressure ratings, responses to enhanced re-covery techniques, lifetime estimates, and so on. The different nature of each offshore de-velopment project has led to a feet of uniquely designed FPSO solutions. Such a variance increases the complexity of supplying FPSOs; more so than in other areas of the oil and gas, such as drillships and supply vessels.

Field owners need to have comfort that their feld is being optimally exploited. This is particularly true of national oil companies who steward hydrocarbon resources in their waters. As NOCs lead developments in critical pro-ducing regions, this factor has become more prominent, ensuring that subsea infrastructure, topsides equipment, and FPSOs are designed for the maximum production possible. Strong competition among the majors in offshore plays supports governments capacities to place strin-gent targets and other requirements.

Accurately evaluating reservoir potential is an industry-wide challenge. Unique geological features, extended production lives, and lack of information at the start of the evaluation pro-cess complicate estimates. Reliance on early and limited data is necessary, but has a strong impact on production infrastructure. A higher proportion of development capital is required up front, and the observed impacts on FPSO design have been negative and severe. Based

on limited data at the beginning of the design process, engineering specifcations for FPSOs are made to decimal place detail. As produc-tion data is added throughout the process, it frequently becomes obvious that the basis of these specifcations miss the mark by several

orders of magnitude. The inaccuracy of the data underpinning FPSO design is exacerbated by technology innovations and improvements throughout the lifecycle of the feld. Due to their extended operational life, FPSOs suffer more than other areas of the industry.

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F P S O O U T L O O K

Regulation issuesRegulation of FPSOs is another challenge that will continue to cause

serious issues, particularly as deployments become increasingly inter-national, incorporating multiple jurisdictions.FPSOs can be ship-shaped and make self-propelled voyages, mak-

ing them subject to certain shipping and marine rules and regulations. Other FPSOs are neither ship-shaped nor self-propelled. Likewise, once in operation the unit is tied to subsea equipment and the seabed, albeit not permanently. In these cases regulation reference is to E&P installations. There is considerable overlap and confusion between these positions. Inconsistent regulatory conditions, combined with increased complexity in feld specifc solutions, drive the regulatory bureaucracy to the extreme with proportional cost ramifcations.

Local contentThe FPSO supply chain further suffers from local content require-

ments. While benefts to local communities must be a priority, the ex-ecution of these plans in diverse regions threatens the advancement of technology and supply chain effciency in critical markets. Reliance on inexperienced shipyards to complete complex integration of hull and top-sides has led to eye-watering delays and cost additions in the past fve years, and this will continue to grow unless there are signifcant changes. Related issues around availability of engineers, experience of procure-ment personnel, and the supply of minor necessary equipment all con-tinue to contribute to complications in FPSO delivery.

Supply chain complexityThe FPSO supply chain is complex and involves a wide range of

equipment and service providers. Oil companies contract either an FPSO leasing contractor or a major EPC company to design and pro-cure the FPSO. Major EPC contractors may own fabrication yards and have equipment manufacturing capacity, although much construction work is further sub-contracted to shipyards. Lease operators and EPC companies procure equipment from specialist providers. Suppliers range from international conglomerates to niche and regional players.With so many players working to bring an FPSO online, project ex-

ecution suffers as conficts of interest between parties arise throughout the process. Engineering houses bill hours worked and have profes-sional and fnancial interests in extending the scope of front-end engi-neering. Construction yards favor effcient delivery with little interest in adjusting work scope throughout the process. Yards will often have mul-tiple major projects to execute, with scope changes potentially moving an FPSO to the back of the line. Oil companies themselves have an in-terest in achieving fast frst oil, so long as the FPSO is safely integrated, yet still place a high priority on reducing engineering hours and costs.

Organizational learningThe research highlights the lack of institutional experience among

FPSO operators. In drilling projects, repeated delivery allows op-erators and contractors to build experience and develop repeatable practices. However, few companies have completed enough FPSO projects to institutionalize lessons learned. In addition, key FPSO personnel often change frms from one project to the next. These lessons of past projects need to be learned as an industry, if near future demand for FPSOs is to be met.

Project size and natureOften, the sheer size of the projects brings additional complica-

tions. With FPSOs costing hundreds of millions of dollars, lease op-erators are required to raise such signifcant volumes of capital that the fnancial health of the company is at risk on each project. This is not sustainable, even in the short-term. This is particularly true when, after cost overruns are distributed, many projects originally considered quite proftable end up instead making substantial losses.

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F P S O O U T L O O K

Shipping industry infuence Many early FPSOs were developed by the

shipping industry, and these were often older vessels converted to store oil at relatively low cost. This gave feld operators an inexpensive, convenient option to assist in feld develop-ments, as well as offering vessel owners new revenue opportunities for older, lower-value assets. The offshore oil and gas industry has developed signifcantly in recent years, as ca-pacities have increased, depth and formation capabilities have increased, and HSE regula-tions have gained prominence.

The economics of conversions is further tested by current technology and cost trends. With current complexity of projects and technical solutions, the proportion of topside expenditure compared with the hull is sig-nifcantly reduced. This further reduces the advantages to ship owners associated with conversions of old tankers. Research indi-cates that the relative savings associated with conversions will become less infuential.

Drilling industry comparison

The high level of oil company involvement in the organization of FPSOs contrasts with the drilling industry, where operators outsource operations to specialist contractors. Contract-ing practice allows oil companies to incentivize drillers who offer bundled solutions, limiting the hands-on decision-making involvement of the operators. By shifting administrative responsibility to drillers, the web of decision making has become far simpler compared with the production side. Whether elements of this approach could be transferred remains to be explored. Given oil company culture and typically higher levels of involvement in production decisions, oil companies will need to increase their responsibility for that supply chain, particularly when it breaks down.

Next stepsRe-addressing the Why is anything going

to change now? question requires examina-tion of the current ethos and belief systems within the supplier community. Offshore pro-duction is often conservative in adopting new technologies and practices. A mentality exists that there is no alternative to the current prac-tice, often based on almost mythical stories of failed past attempts at change, or on a handful of individual experiences over the years.

There is little doubt that emotional factors are instrumental in driving contractors deci-sions across the board, ranging from equip-ment selection to evaluation processes. The diffculty now is that demand outstrips supply to the extent that the supply chain simply is not sustainable, and these challenges are increas-ing, not decreasing. There is a pressing need to address supply chain concerns, and this will

involve a serious, rational examination of op-tions with no room for hearsay or hunches.

Approximately 100 new FPSOs will need to be built by the end of 2017, representing a 50%+ growth in feet size. The supply chain will not meet demand over the next fve years or further into the future unless sub-stantial changes are made in the industry.

The industry value chain will need to be restructured. Leasing contractors FPSOs are major, multi-billion dollar investments. Observing the growth of leasing as a procure-ment model for FPSOs, contract risk terms equate to operators using some contractors as a bank, hedging their investments. With leas-ing contractors suffering across the board, there may be an opportunity for them to re-focus, potentially separating into technology development and own and operate groups.

Project repeatability is another way to improve FPSO supply. Project methods that build on industry knowledge of delivery and operations can improve execution quality and effciency. The interviews with oil com-panies and others suggest that beginning each major project from a blank sheet of paper may not be necessary if safe and ef-fective alternatives are developed.

Oil companies have an important role in nurturing the supply chain beneath them,

otherwise they will continue to see costs rise with no improvements on overruns. Only 10 or 15 years ago an FPSO would cost tens of millions of dollars; now they cost hundreds of millions. With oil companies seriously ex-amining cost in the sector, there is an urgent need for change in the buying process.

Changes to the regulatory framework could signifcantly impact the ability of the supply chain to meet demand in the years ahead. Current regulations governing FPSOs are cumbersome and under-developed. With each FPSO treated as unique, relocation and other mobilization are overly complex. This is appar-ent when compared with drillships, which are typically regulated as part of a class and far more easily mobilized. With industry consen-sus and effort, improved regulation could help oil companies complete the production phase more effciently and professionally.

These and other measures may offer hope to the ailing supply chain as demand contin-ues to ramp up. Signifcant changes and inten-tional involvement are required from all par-ties for the FPSO supply chain to be fxed to the extent that upcoming demand is met. The offshore industry has met multiple challenges in the past. Working together, the key play-ers can develop faster and more cost-effective FPSO facilities to meet growing demand.

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