A handful of items of immediate interest stand out for the North East supply chain in Shell’s proposed takeover of the BG Group.
The first of these is access the £47bn deal will give Shell to BG’s plentiful deepwater reserves in Brazil and Australia, which tallies with Shell’s January market announcement that it is shifting its focus from US shale, into deepwater and Arctic developments.
This could open up opportunities for the North East world-leading subsea supply chain, with companies such as flexible pipe maker Wellstream (now GE Oil & Gas), of Newcastle already supplying to Shell, offshore Brazil.
The second is the direction of travel in the oil price, with Shell saying its projections are based on calculations assuming Brent Oil prices of $67 a barrel in 2016, rising to $75 a barrel in 2017 and $90 a barrel in 2018-2020.
Shell recently put £15bn of exploration and production development on hold, a trend being mirrored across the industry. With increasing numbers of projects being deferred or cancelled these Shell projections suggest this contraction will cut supply and push up prices.
However these forecasts should come with a health warning as few analysts predicted the recent halving of the oil price, and its duration.
The third strand of note is the suggestion the deal could achieve £2.5bn in savings with speculation this could lead to the loss of a further 250 North Sea Shell jobs on top of the 250 it has already axed.
However Shell also says it wants to see the North Sea return to ‘health’ and has traditionally delegated supply chain responsibility to regional managers.
Stalled projects and cost cutting are the new realities impacting on the performance and decisions of all North East supply chain companies.
Tony Trapp, founder and managing director of Northumberland-based Osbit Power, says the trend of consolidation highlighted by the Shell/BG deal will gather momentum with the prospects for the rest of 2015 ‘looking bleak’.
“The current downturn looks like lasting for some time with no signs of relief this year. There are lots of people being made redundant in the North East supply chain.
“The oil price fall means the amount of money coming into the industry has been halved, whether that means workforces will be halved only time will tell.
“There is a lot of contraction with projects being shifted to the right or cancelled and there are huge pressures on supply chain companies to pare back costs and this will lead to further consolidation, in the industry and supply chain.
“But, a few years down the line, those companies which have survived will be much fitter, leaner and stronger.”
Shell’s proposed £47bn takeover of the BG Group – an offshoot of the previously nationalised British Gas – will make Shell the largest producer of liquefied natural gas in the world.
It demonstrates how Shell see gas as a vital source of energy, particularly for the fast growing economies in Asia, and in supporting global efforts to reduce greenhouse gas emissions, with gas having half the CO2 of coal.
It is the largest deal in the sector in the last 10 years adds around 25% to Shell’s proven reserves and 20% to its production, and may well be a sign of things to come.
With global interest rates at record low levels the larger oil companies have been loading up on cheap debt to prop up their balance sheets and support dividend payments.
The money is also being used for acquisitions with those companies experiencing declining revenue streams and carrying high debt burdens being the targets.
The BG Group has suffered in the new price environment, recently issuing a profit warning and writing-off £6bn in value of its rigs and pipelines.
The deal comes as the signs of distress in the supply chain are increasing with the Begbies Traynor Red Flag Alert data for Q4 2014, showing the number of oil and gas businesses experiencing ‘Significant’ distress has increased by 69% to 486 compared to the same period last year.
Andrew Davison, a partner at Newcastle law firm Muckle and head of its energy team, said he expected to see greater consolidation and that businesses should ‘plan for the worst, but hope for the best’. He said it would be ‘dangerous’ to base a business plan on Shell’s projection of the oil price (see panel).
“Over the coming months those businesses with strong cash positions will be in a good position to acquire some really good businesses that have not managed their costs as well,” he said.
Many North East companies already supply Shell and BG through sub-contracting arrangements with the major Tier 1 contractors such as Wood Group and Schlumberger.
Some companies who supply one or both may be worried about how the deal will impact on these relationships, however Mr Davison believes these concerns should not be overriding.
“Shell has said it wants to make the North Sea a ‘healthy province again’ which can be viewed as a statement of intent to make its assets viable.
“Shell has also traditionally had a hands-off relationship allowing local management the freedom to manage their local supply chain,” he said.
He said the North East supply chain is in a strong position to support operators and major contractors cut costs, as the region has and established record in developing innovative technology solutions, a point echoed by George Rafferty, chief executive of Durham-based NOF Energy.
Mr Rafferty believes the deal is an ‘encouraging development’ for the energy industry, and one which will have a ‘positive effect on opportunities’ for the supply chain.
He said: “Influenced by the drop in oil and gas prices, but also to deliver a more sustainable and productive industry, companies are looking sharply at their cost base and how they can maximise the expertise within their organisations and from the supply chain.
“This deal will open up new markets for supply chain companies as Shell looks to apply its capabilities to the BG assets around the world creating fresh impetus across the industry for upstream exploration and drilling operations and downstream refining.
“The confidence Shell is demonstrating in the industry and its long-term future, based on the calculated rises in the oil price over the next five years, could encourage others to implement development and investment plans that will help deliver a strong and balanced energy mix served by a secure and stable energy sector.”
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Plan for the worst, hope for the best
With the oil price crash leading to redundancies at leading North East businesses such as Bel Valves, and Deep Ocean it is vital to develop strategies to cope, says a leading industry figure.
Andrew Davison, a partner at Newcastle law firm Muckle and head of its energy team, said: “We are seeing some huge changes in the market. If it has not hit your business yet there is every chance it will, and it’s best to be prepared.
“Businesses should be talking to their customers to see what they can do to help reduce costs and taking positive action to help their customers, and themselves, work through the current difficulties.
“On the defensive side it’s a good time to reassess banking covenants, cost bases and asses the health of contracts.
“Is there a chance to form alliances or joint ventures? Will there have to be redundancies? They should be talking to their advisors about a whole manner of issues.”
With some operators imposing cost reductions of 25% and seeking to extend supplier terms, this could create a liquidity squeeze that will ripple down the supply chain.
Mr Davison said: “The negative impact will hit cash first, significantly before it impacts on reported profits.
”To navigate through these challenges, companies experiencing difficulty will need to be prepared by having clear visibility over short and medium term cash flows and working capital.
“It is vital to have accurate and up to date financial information as part of your supply chain management process.”