The oil market downturn shifted the focus of oil companies from investing for the future to seeking an immediate payoff. They cut spending on long-term capital projects, diverting nearly all their investments to short-cycle ones, such as drilling shale wells that can produce in a matter of months, as opposed to the years it takes to bring a deepwater production facility on line.
However, with oil prices having rebounded in the past year, oil companies are starting to sanction new large-scale projects. That's a welcome sight for oil-field service companies like Core Labs (NYSE:CLB) and Schlumberger (NYSE:SLB), as it means these projects should not only fill the industry's future production needs but also boost the companies' bottom lines in the coming year.
A steady string of green lights
The spending reduction on large-scale projects is starting to have an impact on global oil supplies. Schlumberger CEO Paal Kibsgaard noted on the company's third-quarter conference call that "reduced production tailwinds from new projects that were sanctioned and largely funded prior to 2014 are now uncovering the underlying weakness in the international production base." Core Labs CEO David Demshur noted the same thing on that company's conference call, pointing out that "steeply falling production in Mexico, Venezuela, Colombia, Angola, Libya, Iran, and China has tightened the global market."
Because of that, both companies believe that oil producers will need to boost spending on larger international projects. This shift is already starting to happen, and there has been a noticeable increase in final investment decisions (FIDs) on large-scale capital projects over the past year. Core's CEO noted that after making 20 FIDs last year, the industry is on pace to make 25 to 30 FIDs in 2018.
One notable trend among this year's FIDs is that they're for long-delayed projects. In April, for example, Royal Dutch Shell (NYSE:RDS.A)(NYSE:RDS.B) finally gave the green light to its Vito project in the deepwater Gulf of Mexico. Shell started redesigning that project in 2015 to cut cost due to lower oil prices. The project now has a break-even price of less than $35 per barrel. The company expects it to produce 100,000 barrels of oil equivalent per day when it starts up in 2021.
Shell also recently made an FID on the long-delayed LNG Canada. The company initially was on track to approve the project in 2016 but delayed it due to weaker market conditions. However, with market conditions on the upswing and a projected shortfall in global LNG supplies looming, Shell is finally moving forward with this project. If everything goes according to plan, the first phase, which will cost $13 billion, should start producing by the mid-2020s.
In addition, several companies are working toward making final investment decisions on newer projects by year-end. Tortue, a natural gas field discovered by Kosmos Energy (NYSE:KOS) in 2012, which straddles the border of Mauritania and Senegal, is working its way toward an FID by year-end. Kosmos brought BP (NYSE:BP) on as a partner in late 2016 to help fund additional exploration and appraisal drilling, as well as assist in the development of the Tortue project, which includes not only an offshore production facility but a floating LNG export terminal. The project could start producing as early as 2021 if BP and Kosmos Energy green-light it this year.
All signs point to a brighter 2019 for service companies
While these large-scale projects won't move the needle for oil companies for a few more years, they will provide a near-term boost to the financial results of oil-field service companies. Core Labs' CEO, for example, noted that the company's "revenue opportunity usually occurs three to four quarters after the FID has sanctioned as rigs need to be mobilized, wells drilled, and core and fluid samples taken and then returned to our laboratories." Because of that, he believes that "revenue from longer-cycle projects," which he points out has "been mainly absent from Core's Reservoir Description revenue streams dating back to 2015," should "start to bolster Reservoir Description revenue in 2019." As that is the company's largest segment, this rebound in its revenue should move the needle for Core's financial results next year.
Schlumberger, likewise, remains bullish on 2019 due to the increasing number of large-scale project FIDs. The company's CEO stated that the positive momentum it has seen in international markets over the past couple of quarters should continue into 2019. Because of that, he is "still very confident about the north of 10% revenue growth for our business internationally in 2019."
A return to normalcy in the oil market
After tightening their fiscal belts in recent years, oil companies are starting to increase their investments on longer-term offshore and international projects. It's a much-needed shift since the international production base -- which supplies 80% of the world's crude -- has experienced a notable drop-off in production from key regions over the past couple of years. In light of that, oil companies need to continue sanctioning large projects to meet future supply needs.
Those investments will help boost the fortunes of oil-field service companies, which haven't yet experienced the full impact of the oil market recovery. They believe that the recent string of project announcements will provide them with more work in the next year, which should fuel a noticeable boost to their financial results in 2019.