A desert storm: Oil Service Sector hammered by Saudi Aramco’s decision
• Saudi Arabia’s Ministry of Energy sent a directive to the country’s national oil company Saudi Aramco – the sole producer in the Kingdom – to freeze the plans to increase the maximum sustainable capacity (MSC) to 13mb/d and maintain it at the current level of 12 mb/d.
• The announcement triggered a sell-off across all oil service companies with exposure to Saudi Arabia on both sides of the Atlantic.
• Italian EPC and offshore drilling company Saipem took the hardest hit, dropping c.13% during the day on 30 January 2024.
• The French service company CGG also dropped c.6% as the news triggered concerns about its equipment business which accounts for the group’s largest exposure to Saudi Arabia.
• Vallourec, the French firm that provides tubular solutions for oil and gas producers and has benefited from increasing investments in Saudi Arabia with multiple contracts, plunged more than 6%.
Source: AlphaValue
Analysis
Current backlog is safe, future sales uncertain
CGG’s equipment business might be impacted
CGG has two lines of business comprising Digital, Data and Energy Transition (Geoscience and Earth Data) and Sensing and Monitoring through which the company sells equipment for seismic surveying (onshore and offshore) for oil and gas companies.
In Geoscience and Earth Data, CGG has limited exposure to Saudi Aramco with revenues below $10m compared to $669m in 2023. The SMO business has benefited from the increased investment activity in Saudi Arabia with mega crew agreements with BGP. Higher activity in Saudi Arabia and, more broadly, in the Middle East and Africa, drove up the top-line figures by 68%, but the margins were less impressive due to low-margin equipment sold to mega crews in Saudi Arabia.
CGG’s contract with BGP is not limited to Saudi Arabia and equipment is also deployed in other regions including China, Kuwait, Abu Dhabi, and Libya. In a recent quarterly trading update, the company had already taken into account the capex reduction by Saudi Aramco, hence expecting a reduced activity in the SMO business in 2024. The group’s top line will be similar to that in FY23, i.e. above $1bn.
Saipem’s backlog will not be impacted
The Italian contractor posted the highest drop among the service companies following the news – which was also partly triggered by an accident in Australia during a pipelaying operation.
By the end of Q3, 14% of the current backlog was made up of contracts in Saudi Arabia with the following composition: €1.1bn in drilling offshore, €1.4bn E&C offshore and €2bn in E&C onshore. These contracts on the ongoing projects will be executed with no impact.
Vallourec’s hedge with long-term agreement
Vallourec’s contracts awarded by Saudi Aramco over the past year have caught the market’s attention. Certainly, Aramco is an important client for the French tubular provider, accounting for most of the revenues from the Middle East – the region makes up only 10% of the group’s revenues. Given Aramco’s share to group-level sales, the market reaction with more than a 6% sell-off was an overestimation of the potential impact. Long-term (10-year) agreements for casing and services as well as OCTG supply agreements provide some medium-term buffer; however, the prospects for future contracts have certainly dimmed.
Implications for Saudi Aramco oil policy
Saudi Aramco currently produces around 9mb/d, giving the company a spare capacity of 3mb/d. It means that the country is not utilising its maximum sustainable capacity and has much room to accommodate any surprises. Decades ago, the government planned to increase capacity to 14mb/d, but those projects had also been scrapped during the 1980s.
Source: Jodi, OPEC, AlphaValue
As part of its 1mb/d capacity expansion and ongoing gas projects, the company announced an annual capex of $45-55bn for 2023, which would increase through the mid-decade. Around $30-35bn was planned for upstream projects, including $5-7bn potentially allocated to the development of liquids. The planned capex was twice the amount announced by the oil majors. We believe that the government had compelling reasons for the termination of the expansion plans for the following reasons.
i) We previously noted that Saudi Arabia has probably more conservative/cautious demand growth forecasts through the end of the decade than OPEC. With global supply growth to continue until 2030, the Saudis have decided not to invest in a capacity they may never use or spend money in an investment on which they will not be able to secure attractive returns.
Even if the Saudi government expects moderate demand growth through to the end of this decade and sees long-dated Brent contracts not currently providing much incentive for a big expansion, Saudi Aramco’s capital allocation will be more balanced towards stable dividend payments to shareholders – the biggest of which is the Saudi government with a direct stake of 90%.
Source: Bloomberg, AlphaValue
After the announcement, we are expecting a cumulative capex savings of more than $20bn (at least) through 2027.
ii) In our view, Saudi Aramco has signalled to the market that the disciplined crude production at 9mb/d will continue through 2025 and the country may not reach its record oil output of above 11mb/d – which was recorded in 2018.
iii) Saudi Arabia is planning to switch 1mb/d of oil demand for power generation to gas by 2030 – meaning that another 1mb/d of oil output can be channelled to exports, therefore voiding the necessity to continue with the planned expansion.
iv) If the decision is not reversed, this gives Saudi Arabia further leverage through the end of the decade (and probably next decade) to retain market management power as (crude) shale oil output will stop growing and will probably decline after the 2030s.
v) Global liquids supply growth (and also demand growth) is largely driven by natural gas liquids (NGL) and biofuel production, which forces big producers like Saudi Aramco to reconfigure their production portfolio.
This is not the full research. The full research is available on request.
