Two seemingly unrelated events over the past week were positive for the offshore oil sector and the Gulf of Mexico.
Last week, the U.S. Bureau of Ocean Energy Management held Central Gulf of Mexico Lease Sale 247. While the results didn’t set records, the $275 million in high bids and $315 million in total bids submitted by 28 oil companies reflected the growing optimism that an offshore sector recovery is coming. This comes after last year’s sale for this area was marked by historically low returns.
The other significant development came from a meeting of OPEC and non-OPEC technical officials assessing the performance of their November 2016 agreement to cut roughly 1.8 million barrels a day of oil production, equal to about 1% of global supply.
According to OPEC officials, compliance with the deal reached 94% in February. OPEC Secretary General Mohammad Barkindo noted that low seasonal demand for oil and large oil exporting countries pumping flat out at the end of the last year (prior to the start of the production cut agreement) have contributed to global oil inventories that are higher than desired. He acknowledged that lower supply volumes are working their way through the system and inventories will decline — it will just take a little longer. Barkindo’s assessment suggests that OPEC and non-OPEC producers are likely to extend the six-month production cut when it comes up for renewal in June. Falling inventories during the second half of this year should lead to higher oil prices.
In the Gulf of Mexico, the lease sale results indicate growing producer optimism after the bottom in oil prices was reached last March. Remember, last year’s Central Gulf sale took place shortly after crude oil prices fell to $26 bbl., before climbing above $50 bbl. following the OPEC agreement in December.
Oil producers are always assessing exploration prospects. Their decisions about how much money to wager in a sale reflects their long-term views on oil and gas price trends, the attractiveness of the prospect, and, importantly, cost trends related to finding and developing a prospect. The latter is particularly key, as improved drilling and development technologies can move offshore discovery production dates forward by years, dramatically improving economic returns. These improvements can also reduce the total cost to find and develop new prospects, further aiding offshore economics.
It's possible that the most significant cost improvement is coming in response to the oversupply of offshore equipment. That has led to sharply lower pricing for drilling and completions, placing significant financial strain on service companies. As these companies restructure their balance sheets and fleets in response to the downturn, evolving cost structures will lead to better offshore economics. The industry cycle is working, and last week’s events are a reflection of trends that will help the cycle along.