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Subsea Production: The Next Big Trend In Offshore Drilling

The oil industry has steadily moved deeper and deeper offshore to tap oil reserves in harder to reach places. This trend is a function of depleting reserves of easy oil, but it is only possible because of radical advancements in deepwater drilling.

But as oil companies move to more remote places, they are increasingly turning to subsea production systems rather than conventional platform drilling. Subsea production involves the installation of equipment at the bottom of the ocean, on the seafloor. Several systems can be installed near each other, and are installed on top of completed wells. They monitor and control the production of oil, pumping it to a central line – or riser – which is then sent back up to a ship or platform at the surface of the sea. Due to the array of lines tying to each other, these systems are often called “trees” or “subsea trees.”

Subsea production has been around for decades, but the problem until recently has been their cost and their inability to extract oil as efficiently as conventional platform drilling. However, designs have improved in recent years that have increased productivity.

Subsea production systems have progressed to the point where they can boost the overall production of deepwater fields over conventional drilling. For example, Statoil (NYSE: STO) is deploying a subsea system at its Tordis field in the North Sea. The tree it is using will allow it to increase its recovery factor from 49% to 55%, yielding an extra 35 million barrels than it would have otherwise been unable to extract.

They are also more suitable for production in deepwater and in remote locations. Due to the increasing technical challenges of deepwater development, the subsea production sector is seeing dramatic growth. From 2012 to 2017, new orders for subsea trees are estimated to jump to 3,000, which is a 60% increase over the previous five-year period.

For now, demand for subsea production systems is highly concentrated in Brazil, West Africa, the Gulf of Mexico, and the North Sea. These four regions will account for 70% of the market in the coming years. Take Petrobras as an example. The partially state-owned oil company in Brazil, is relying heavily on subsea systems to tap the pre-salt – a vast basin of oil beneath a thick layer of salt. Petrobras will likely account for 25% of global capital expenditures on subsea systems over the next several years.

Spending on subsea production is set to rise from $45 billion in 2014 to $115 billion by 2020.

Subsea production systems are clearly becoming the method of choice for offshore developers. Hess Corporation (NYSE: HES) announced on October 28, 2014 that it would proceed with a $6 billion deep-water project in the Gulf of Mexico. The project will consist of six subsea production wells that produce oil and send it to the surface.

There are a few major players supplying subsea production systems that investors should keep an eye on. The market leader is FMC Technologies (NYSE: FTI), headquartered in Texas. FMC manufactures subsea systems, including trees, pipelines, connectors, pumps and other equipment. In April 2014 FMC was awarded a $322 million contract to supply BP with subsea systems for the second phase of its iconic Shah Deniz field in the Caspian Sea. FMC supplies roughly one-third of the subsea production market.

On October 21, FMC Technologies reported that its third quarter profit surged 46 percent from a year earlier on brisk business for its subsea systems. “Quarterly subsea margins are at the highest level we have delivered in over four years,” FMC Technologies CEO John Gremp said in a statement. The company’s share price has recently taken a hit due to falling oil prices, but this company will be a great investment over the long run.

Another major supplier of subsea systems is OneSubsea. The company is a joint venture between Cameron International (NYSE: CAM) and Schlumberger (NYSE: SLB). The combined company recently announced an agreement with BG Group (LON: BG) to supply subsea equipment and services for 10 years. That came after OneSubsea was awarded a $270 million contract from Mexico’s Pemex to supply seven well systems and services after installation. The project will mark the first subsea development project pursued by Pemex, and expands OneSubsea’s reach in the Gulf of Mexico.

One of the big challenges for subsea production is accessing the system at a later point, if something goes wrong, for example. This could disrupt production and ruin the economics of the project. But Cameron has developed a system that allows subsea systems to be accessed and addressed post-installation, without needing costly intervention. Cameron’s systems have been deployed by Royal Dutch Shell (NYSE: RDS.A), BP (NYSE: BP), and Total (NYSE: TOT).

Cameron continues to perform well, in part from its participation in OneSubsea. Cameron reported record earnings per share for the third quarter.

Then there is the alliance between Baker Hughes (NYSE: BHI) and Aker Solutions (Oslo: AKSO.OL). Dubbed the Subsea Production Alliance, the two companies say that their equipment and services complement each other – Aker’s specialization in subsea systems works perfectly with Baker Hughes’ expertise in well completion and artificial lift.

GE (NYSE: GE) is also in the game and it recently pocketed a major contract from Brazilian oil giant Petrobras. GE’s Oil and Gas unit will supply Petrobras with subsea systems for the pre-salt. GE is a leader in an endless array of industrial sectors, so it should be no surprise that it is a major player for subsea systems as well.

While demand for subsea equipment and services is expected to see strong growth in the coming years, there still are a range of challenges facing these companies. First is cost. Developing equipment that can withstand massive amounts of pressure and installing them several miles below the surface of the sea is challenging to say the least.

More recently, a slide in oil prices will likely slow the roll out of new deepwater projects. Oil majors are already under pressure from their shareholders to rein in spending. A slide in oil prices could put major deepwater projects on hold. And that could hurt subsea production suppliers.

On the other hand, there is a lot of room for cost reduction. One area is in standardization. International oil companies are beginning to agree to a set of standards for subsea oil production technologies. Up until now, many subsea projects were uniquely assembled, with equipment designed for a specific set of circumstances.

But by committing to fostering the development of subsea production systems with standard designs and practices could allow the industry to cut costs and streamline development.

And there are signs that this is beginning to happen in a big way. FMC Technologies recently said that it has signed up several oil majors to agree to standardized designs. BP (NYSE: BP) and ConocoPhillips (NYSE: COP) have signed onto FMC’s push, along with others. Such a trend dovetails with the oil majors’ desires to exercise capital spending restraint in an era of high costs and lower profitability.

It also bodes well for the future of subsea production systems. Investors should watch this space as it is emerging as a very promising way to produce oil from deepwater.

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