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Interview

with John Avaldsnes, Partner EMEIA Oil & Gas Leader, Ernst & Young AS

21.03.2013 / Energyboardroom

European debt crisis and cost inflation are the dark clouds on the horizon. Norway seems well positioned to weather the first storm, but is out in the open for the second. How would you compare the risk profile for Norway’s oil and gas industry relative to the rest of the EMEA?

Thankfully, the financial crisis has not affected the Norwegian market, the way it has in other parts of Europe. However there has been an increase in service requests across the oil and gas industry, which puts a strain on capacity. The pipeline is being squeezed which has implications for working capital. Some suppliers have realized that the banks are not fully willing to lend money; meaning that equity is becoming much more important and good and systematic working capital management the same. The operational arrangement with suppliers and clients is becoming more important as well because of these capital constraints.

EBITDA margins for the service industry are being squeezed and as companies still try to increase throughput and grow their operational capacity, more pressure is being placed on margins. At some point these suppliers will have to make some arrangements with the oil and gas companies or their own suppliers in order to produce sustainable margins.

You might ask, is the Norwegian oilfield service industry different from those in other countries. I would reply that in Norway, service companies like owning fixed assets: rigs, ships, heavy machinery etc. Norwegian service companies have traditionally taken more risk or have been more opportunistic than other countries. At the moment this can be an advantage for us because we do have the assets to supply to Brazil, West Africa, etc. already on the balance sheet and there is no need to request financing for new assets. However, we will see whether fixed assets or asset-light models have the potential to produce bigger margins in an upcoming Ernst & Young report for March 2013.

Norway is often seen as a political and financial safe haven for oil and gas companies. At the same time, this is a market with labour shortages, new 2013 CO2 tax, cost inflation from an overheated supply industry and fierce competition for acreage in Norway – are oil companies entering this market stepping into a trap?

I do not believe so; there is still a lot of surveying to be done in more mature parts of the North Sea and a high resource potential. Companies can very easily take on late production as a partner, learn the tricks of the trade and then develop their own capabilities. There are also immense opportunities for companies to work up North in the Barents Sea.

One of the key strengths of the Norwegian model has been the relative stability of the tax regime over time. This is in stark contrast to the UK over the last 30 years. The regulatory regime is very transparent, you know the government structure, the models and the players. There are many skilled people in place and industry development has been strong all across the industry from the yards to the technology companies.
We have run a comparative analysis of Norway and the UK over the first 30 years of their E&P development to ask why these two sectors developed so differently. The British were involved with ships for centuries so why did they not really take on the marine and offshore market. Our analysis showed that Norway built industry: yards supply bases and invested along the West coast. This means for an operator that the supporting industry is well in place.

At the same time, there is no doubt that Norway is a high cost environment. Norway added roughly 4,000 people to the oilfield service industry from 2010 – 2011. Salary as a proportion of cost is increasing significantly. There is nothing, which will take that salary down, and you cannot simply throw more people at the situation. You need to work differently in order to keep down costs. The external costs (cost of goods as a portion of total cost) are coming down, but your indirect costs are increasing and the salaries are increasing.

Industry analyst consensus of the NCS cost prices (exploration, development, lifting and OPEX included) seems to be around USD 75/bbls.. The only way of sustaining a cost level like this is to hope for continued high oil prices or to be clever and use technology, which can increase efficiency. Our thinking needs to revolve around strategies such as integrated operations, efficiency-driven technologies, partnerships between oilfield service companies etc. This is because the cost level is not sustainable in the long-term.

With Iraqi production coming back on stream, and the shale gas revolution, there do seem to be background downward pressures on the oil price. How does Ernst & Young assess the price dynamics over the coming year and the potential risk for the Norwegian industry?

Looking forward, we do not expect the price dropping below 100 per barrel over time in the long run – this seems to remain the floor. We trust the International Energy Agency (IEA) a lot in making our risk assessment. There will always be fluctuations, but you have to use an economic prediction.

As already mentioned, the cost price per barrel here in Norway is around USD75,so we are still below the floor of the oil price at least in the near future.

According to recent surveys the market is more skeptical about M&A than a few months ago, because of the European debt crisis. How is the transaction market shaping up in Norway?

We have seen two recent deals in Norway, with Centrica and Wintershall both picking up assets from Statoil and we believe that this trend will continue. Both of these companies bought a position as an operator in the production phase and we foresee more companies buying into production. This is fueled by the fact that there is a lot of room for portfolio optimization on the NCS. There have been a lot of transactions in the development phase.

Looking at the majority of players on the NCS, some do not have the capacity to fund development or do not want to transform the operating model across the value chain. They will therefore sell their discoveries, making many more assets available.

In the oilfield service space, there continues to be M&A with Kongsberg taking a subsea division, HitecVision, closing four deals in a day in December, three of which were oilfield service companies. Other Norwegian companies are being looked at right now, because Norway is interesting. You only need to look at the overall offshore investment level to see that international companies will want to buy into the NCS.

European downstream companies continue to vertically integrate into Norway’s upstream. However, the financial markets today are less in favor of integrated companies. How do you see this challenge?

Some companies are demerging as you see with Conoco Phillips, marathon, Statoil, Shell and so on. However there are still many integrated companies who have a good future. Although downstream companies may be paying a premium to have access to the upstream segment this does not mean that the deals are overpriced. Centrica incorporated gas sales to the UK as part of the deal with Statoil.

Looking at the relationship with Europe, to what extent does shale gas have the potential to overturn the traditional supply model, as it has with the US?

There will be no gas revolution in Europe, like that which has been experienced in the USA. The development of unconventional resources in Europe will be slow because the regulatory regime is not in place, the HSE standards will be very different in the case of Europe. Whereas in the US, shale gas deposits can be found in huge uninhabited basins, they can potentially occur just next to or even inside cities in densely populated Europe. In addition, Europe does not have the oilfield service capacity that USA can rely on. Over 40% of the total worldwide oilfield service capacity is North America based, and by reference of the various rig-counts per geographys this is further supported. Europe will also need to make significant investment in infrastructure. We therefore see only limited potential for the shale gas revolution to impact on Europe.

What about the ability of shale gas to feed into the global LNG industry and upset traditional dry gas supply links?

We know that there are a lot of projects in the pipeline for LNG from unconventional gas; it can be a sensitive subject, politically speaking. There are a lot of hypothetical variables to consider. At the moment we are just speculating on how much gas the USA could produce and export and what impact this could have on global prices.

At the same time, cheap gas may be the only factor America has left to remain competitive as an economy. There is a lot of lobbying from the oil and gas groups calling for cheap gas to be used domestically. This means that US gas will not be allowed just to simply flood the market without looking at this in a larger industrial perspective.

Qatar has a lot of spare capacity; Australia could have an important effect on Japan’s gas prices; significant East Africa gas discoveries in gas to liquids developments could come late to the market. You can also speculate about shale gas in China and whether this will transform their import requirements or not. There are many ifs and buts, so it is just speculation at the moment.

Jarand Rystad of Rystad Energy expressed the importance of access to data in Norway in allowing his company to build up global understanding of market trends and that Norway was a unique place in having the dual strength of the oil and gas players and service companies. What does it say that the EMEIA head for Ernst & Young is based in Stavanger – what does Norway bring to your global offering?

The rate at which the industry in Norway has developed has been quite remarkable. We have created it from scratch over the space of forty years. That said, Norway has been able to make use of some domestic strengths such as having a strong maritime industry, which could be converted to offshore work. Norway has been clever in bringing in the majors to this market. Norway has also been highly innovative in developing technological companies around the oil and gas industry; we are not just using this sector as a cash cow. Incidentally, the 78% tax regime with the ability to offset R&D from tax losses has been instrumental in developing a strong innovative climate in Norway. Not only Statoil but ConocoPhillips and BP have been very good at promoting technology, and perhaps even more importantly, adapted the new technology on the NCS. The NCS has therefore served as a test-bed for technology development and this has allowed the service sector to become very strong international players. The Norwegian government has also established an open, transparent and collaborative environment. Information is therefore shared extremely well between companies. The story of Norway is a good one, and all the elements of this dynamic environment as well as the open access to data and information from all parts of the oil and gas sector have been an instrumental asset for Ernst & Young’s global oil and gas understanding. Our base in the Norwegian market therefore offers us a lot of credibility with regards to understanding the elements of building a strong oil & gas industry.

Across EMEA, E&Y controls 4,300 highly qualified professionals – is it fair of E&Y to take these people out of the industry, and lease them back to the market, at a time when there are huge skills shortages in the industry itself?

We struggle as hard as any other company in this industry to meet our human resource needs. Many graduates however see Ernst & Young as offering a very attractive package in terms of what they may be looking for in a career coming out of university. Ernst & Young provides a very good training ground for graduates to gain experience in the industry.

However, although we pay our graduates well, oil and gas companies often pay even better, looking at the total package. As a company Ernst & Young therefore loses many talented people to the industry. However, instead of commiserating that we are losing people to the industry, we instead see ourselves recruiting and training our future clients. We therefore must take a more holistic view and see ourselves as part of the industry rather than one of many fighting over the best grauate talents out there, a competitor stealing people away.

Ernst & Young serves 44 of the top 50 global O&G firms. You can only lose market share to companies like Deloitte, KPMG and PWC who are offering very similar products on the same scale. How do you plan to maintain your leading position and maintain market share?

At Ernst & Young we believe we are one of the most global firms. We operate as a global business with one revenue stream to share so when we say that we serve our clients globally this is really what we are doing. There are no fights with counterparts in other countries for a share of the fees etc. If I am responsible for a client, I can secure services for them in any country and that means that we can serve our clients better.
Ernst & Young is also sector organized. There are some silos between our service-lines; Assurace, Tax, Transactions etc. but when it comes to clients we have a specific oil & gas business, which encompasses all of these elements. We put a lot of quality in what we do which at times may challenge our clients project schedules, but we offer a methodical approach to other people’s businesses combined with our sector insight gained from working with all our Oil & Gas clients. We get comfort and assurance from our client’s feedback that we serve them well on a global basis, and hence we feel we are on the right direction towards where we want to be.

As one of the top figures within Ernst & Young’s global oil and gas business, what do you do on a personal level, in order to stay ahead of the curve?

I have been fortunate enough to spend 10 years with Statoil in the international arena, working on financial, commercial and technical operations. Having gained this industry experience and now having worked as a consultant for close to 15 years for the same industry, I can draw on this experience when advising oil and gas companies. It gives me a sense of satisfaction to look at a company’s business and find innovative ways to create value through solutions that they would not have come up with themselves. We train our people well in this industry and give everyone in our company a thorough understanding of the business so that for a tax advisor, for instance, they are not thinking about the drilling business in abstract – they should know what they are talking about.

Do you have any final message to our readers?

Norway will be a very attractive region to work in for many, many years and should be part of any major players upstream portfolio. If your readers are looking for good advice on how to approach working here, we have 40 years’ worth of knowledge about the local realities, regulations and the tax regime, they should team up with us.

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