OilVoice

The seismic business

David Bamford
bamford_windward@hotmail.com

“There are no such things as applied sciences, only applications of science”
Louis Pasteur
French biologist & bacteriologist (1822 - 1895)

Summary

A strong, healthy, seismic technology market is vital to the health of the oil & gas industry. In 2006, whether measured in terms of Revenues, EBITDA, M&A activity, supply/demand balances, pricing etc, the sector appeared in rude health, with perhaps two truly global players – WesternGeco and the soon-to-be-merged CGG-Veritas, an emerging global player – the Chinese company BGP, two others with more modest ‘reach’ – PGS and Fugro, and a host of ‘niche’ and local players.

However, seismic has been a profoundly cyclical business over the last 15/16 years, strongly linked to commodity prices, with the main contractors experiencing truly awful times in the late ‘90’s and the first couple of years of this decade.

In this review, we consider the key role of seismic in exploration, development and production, the events that had brought the sector to its knees by 2002, its shape and health today, and ask the key question:
“when the next down-turn comes, perhaps as early as 2007, will these companies show that they have learned from their bitter experiences of the second half of the ‘90’s, when the leading exploration companies benefited through continuous low cost supply of high quality data and constant advances in processing, leading to unprecedented global exploration success rates, and yet some contractors were left with profound balance sheet problems?”

The key seems to be the capability to form relationships of “mutual advantage” with NOCs such as Aramco, the NOC, Pemex etc. There seems every reason to expect that Schlumberger (and hence WesternGeco) and BGP understand this already.

For more information contact the author.

Introduction

2006 saw three or four interesting, even remarkable, events in the seismic contracting business:

First of all, in April, Baker Hughes Incorporated announced that it had signed an agreement to sell its 30% minority interest in WesternGeco, a seismic venture jointly owned with Schlumberger Limited, to Schlumberger for $2.4 billion in cash.

Secondly, in August , PGS de-merged from its parent company – previously an unusual mixture of geophysics and production FPSOs - and is now a standalone seismic entity.

Thirdly, in September, CGG announced that it would buy U.S. rival Veritas DGC for $3.1 billion in cash and stock. The offer, just over half of which was in CGG stock, valued Veritas DGC shares at $75 -- a 21 percent premium to their closing price of $62.18 the Friday before the announcement.

Fourthly, the Chinese company BGP seemed to be on the point of emerging as a world player, with revenues comparable to WesternGeco and the combined CGG-Veritas. In case anybody wonders whether BGP intends to become a world-scale contractor, it’s worth checking out the company’s web-site at www.bgp.com.cn/About%20Us/Introduction.htm
Of course its motives for doing so seem rather different from those of a WesternGeco, a CGG-Veritas or a PGS, being related to the national strategic role of its owner CNPC to procure oil reserves.

These events signal an industry that seems to be in rude health today. However, the key question is whether the fundamentals are now right, given the painful history of the sector since the mid ‘90’s, or whether the current robustness is simply a product of recently elevated commodity prices?

We need to begin by reviewing how seismic technology fits into the broader oil & gas business.

Why Seismic?

Clearly it is vital that successful explorers know “Where to Explore”, leading to a focus on the Prolific provinces of Deep Water Gulf of Mexico, Nigeria and Angola, the Caspian etc. As new global provinces fail to materialise, explorers are confronting deeper and/or more complex geology in existing provinces.

“How to Explore?” is of course also important and Geophysical Technologies are critical. These are not in general a matter of new science – the fundamentals of potential fields, and electro-magnetic and seismic wave propagation, and their respective capabilities in terms of penetration and resolution, were written down by Poisson, Maxwell, Zoeppritz and others back when Queen Victoria was a lass – but is to do with the application of science.

Now I’ve no idea whether the aforementioned scientists ever met or even exchanged letters but if they had, they might have concluded that “Seismic is King!” on the grounds of the vastly superior resolution offered by seismic waves. As a result, a significant seismic industry has grown up, not only within the Majors and Independents but in the services sector; in a peak year, this services sector earns about $4.5bn.

It is worth reviewing “who does what” along the “seismic value chain” (Exhibits 1 and 2):
The “value chain” is somewhat fragmented:
• Essentially two companies, Input/Output and Sercel (a subsidiary of CGG), dominate the manufacture of equipment, for example, recording equipment, marine streamers and so on, and
• four companies dominate acquisition and processing, WesternGeco (a subsidiary of Schlumberger), Veritas DGC and CGG (who recently announced plans to merge, as mentioned earlier), and PGS, with the Chinese company BGP beginning to be an aggressive world-wide player. There are a host of smaller “niche” and national players. By and large, acquisition and conventional processing can be thought of as a “commodity” with several players in any market, generally competing on price.
Importantly the Majors still undertake significant in-house research on seismic imaging, for example for sub-salt targets (as discussed later).
• Interpretation software also has a host of smaller “niche” players but Landmark (a division of Halliburton) and Schlumberger dominate, the latter increasingly so with their new ‘Petrel’ product.
• The Majors and most of the bigger Independents retain actual seismic interpretation and analysis in-house and strive to gain competitive advantage in this area (again, see a later discussion).
Also, nowadays the integration of several sub-surface methodologies is key, and reservoir management for example requires the inter-disciplinary team-work of numerous sedimentologists, geophysicists, petrophysicists and reservoir engineers.
Smaller companies, without the ‘big battalions’ of geoscientists and engineers that are employed by the bigger companies, tend to ‘out-source’ rather more, to some of the contractors and/or to independent consultants.
By and large, this does not give access to the quality of integrated work found elsewhere.

Sub-salt seismic imaging for new reserves now offers a glimmer of hope of defeating one important geological complexity. It has only been in recent years that geophysicists have found the technology, both in the acquisition and the processing of seismic data, needed to peek beneath the giant sub-surface canopy of salt that spreads out across the deep waters of the Gulf of Mexico. BP and almost certainly ExxonMobil are at the forefront of applying this technology, which is allowing them to find and develop some of the largest fields in the Gulf of Mexico. The key for them is then how to leverage this technology, for example to transfer it to the salt province of Angola (see Exhibit 3), where the exploration and development of the ultra-deepwater will lead to new production from the region well into the next decade. Exhibit 3 illustrates the problem caused by salt – conventional processing will yield a poor or distorted image of the sediments lying below the “pink blobs” which are bodies of salt that have moved away from the ‘mother layer’ deeper in the section.

Beyond this, over the last 10-15 years the global industry has learned that there is much more that can be done with seismic, especially 3D seismic, above and beyond plain old structural mapping. Successful prediction of stratigraphy, facies and lithology has become the norm, and the “direct detection” of trapped hydrocarbons from seismic data, long a holy grail of explorers, has come close to perfection in for example deep water Angola – in Blocks 15, 17, 18, 31 and 32 - where ExxonMobil, Total and BP have enjoyed a better than 90% exploration success rate. These Majors have tried very hard, and managed, to keep their “in-house” techniques (illustrated in Exhibit 4) confidential with regard to many smaller oil & gas companies and most geophysical contractors.
Interestingly, one can see that some companies have been able to apply what they have learned in deep water Angola to other basins – Total for example have clearly applied their knowledge to their successful exploration campaign in deep water Nigeria.
Perhaps even more interestingly, some companies have not. Shell for example managed to have a singularly bad exploration track record in Angola Block 16, surrounded by the success of others, scoring no commercial discoveries in at least half-a-dozen spuds and then managed to transfer their approach to Morocco where they also drilled a dry hole or two!
Also, the lead operator in Mauritania, Woodside Petroleum, has drilled a string of dry holes in 2004-2006 and clearly has not learned that “all that glitters is not gold!” – well not “black gold” at least!

One result is that it is unusual nowadays for a 3D survey not to be a pre-requisite for exploration.

Another significant development of the last 10 years has been the growth of repeat or “time-lapse” 3D surveys – usually referred to as 4D - as a component of effective field management (which requires the active monitoring of reservoir properties such as pressure, saturation etc.). Increasingly reservoirs are monitored using repeated surface seismic data (4D) together with the acquisition of surface and subsurface well data, and the integrated analysis and interpretation of both to reach a good understanding of how fluids in the reservoir are behaving.

The use of 4D seismic data in reservoir management has increased rapidly in recent years (Exhibit 5 shows activity in the North Sea up to 2001). Multiple data sets covering many fields are being used in many different ways, varying between simplistic qualitative comparisons to sophisticated models. Such surveys may be used to:

• Identify compartments
• Locate possible infill targets.
• Design effective well interventions.
• Improve reservoir understanding.
• Reduce uncertainty in production forecasting.
• Improve estimates of field reserves

The use of 4D is now capable of identifying the pressure changes due to production and injection as well as changes in saturation and solution gas breakout. Some examples from published papers of 4D changes as a result of production are shown in Exhibits 6 & 7.

On the basis of the numerous published case studies, the use of 4D has been established as a very powerful way of identifying additional reserves, helping to locate infill wells and reducing costs by avoiding drilling unsuccessful wells. This achievement is not uncommon in the industry now and has been demonstrated by a wide range of operators across the world.

The Seismic Contracting Industry: 1990 – 2002

Why this period? Well, mainly because the feeling in 2002 was very different from that today. It is a fact that the Majors were having both regular internal, and occasional external, conversations about the potential for the complete collapse of the seismic acquisition and processing market.
How had things come to this point?

The roots lay in events that started nearly 15 years before:
• Largely led by Shell, a few players chasing emerging deepwater opportunities started to consider the use of 3D seismic as an exploration tool. By the early ‘90’s, the opening of deepwater opportunities around the world convinced the Majors that 3D was destined to become the standard exploration tool but that this was only possible if the seismic services sector could be encouraged to come up with much faster and much cheaper cost per unit area product. This set in train a boom in exploration 3D and with it an explosion in new boats and streamers to continue this drive for efficiency. PGS for example introduced the so-called RamForm seismic vessels which transformed the rate at which 3D could be acquired and therefore dramatically reduced cost/sq km.
• Then came the late ‘90’s collapse in oil price and with it the consolidation of the oil and gas industry and the creation of today’s Majors. Exploration became one of the primary sources of synergy savings: companies such as BP typically reduced exploration spends by 40% or more whilst maintaining or improving discovery volumes. Some of that saving came from seismic budgets and resulted in far too many boats chasing too little business.
• The problem was solved temporarily by the rise of multi-client work. But that merely transferred the capital on the contractors’ books from the boats to the multi-client libraries and also further drove down the price to the customers of high quality 3D data. Thus the leading exploration companies benefited through continuous low cost supply of high quality data and constant advances in processing, leading to unprecedented global exploration success rates. And some contractors were left with profound balance sheet problems.

Looking at various specific aspects:
• Marine acquisition was priced as a commodity product because of oversupply in a market where there was little to distinguish the major players. Attempts by some major contractors to differentiate themselves via technology had not (yet) been successful in the seismic market e.g. WesternGeco’s System Q. And despite the progress made in the industry to solve balance sheet issues, the fundamental problem of oversupply had yet to be tackled. Disposal of boats by the big players only allowed new entrants to make relatively low cost entries into the business!
• Land acquisition seemed even more of a commodity market. This is perhaps unsurprising since the key capability that was being sold was not technology but the ability to manage large-scale logistics. Moving people and equipment around the countryside efficiently is a skill but it is one that can be learned.
As a result - BGP now had more than twice the number of international land seismic crews of their nearest competitors. In fact they had about the same number as WesternGeco,Veritas, CGG and PGS added together. BGP were also moving into the conventional marine seismic market.
[We should not be surprised by this trend - the British and American universities have been awarding geophysics/geology degrees to large numbers of the Chinese for 10 years or more! And the professional societies have made huge efforts to embrace these new global communities.]
There had also been a rise of local players in several markets. Companies like Enageo in Algeria had moved into the private sector and advanced rapidly to become quality players conforming to all international standards including HSE.
• Seismic processing continued to advance rapidly and staying at the leading edge demanded significant R&D spend. This was becoming tough when cash flows were non-existent and future returns on this investment uncertain. It appeared that, as in most technology industries, product cycle times were shortening.
• Interpretation software had been more healthy both for large and small players. Entry barriers had been low and a number of entrepreneurial players made it big by developing great products and selling out to the major players who have used their scale and marketing ability to create value.
• In 2002, perhaps the one real bright spot was the rise of Production Seismic. 4D had “taken off” in mature basins and seemed (correctly) set to build its market much more widely. Well over 50% of all new North Sea seismic work was being conducted for 4D purposes, and this figure was around 95% for the Majors. The technology – though still in its infancy - was growing in West Africa, Caspian, and GoM.

The upshot of all this was that any financial analysis of the main seismic contractors made at this time would be very downbeat – see for example Exhibit 8, constructed in 2002. The comment about “Asbestos Contingent Liabilities” was a fairly transparent attempt to find something good to say about the sector!

At about this time:
• PGS – which in many ways had taken a bold technology lead in the acquisition of marine 3D – sought Chapter 11 protection in the USA.
• Customers were receiving bids where the contractor was only charging the cost of actually running the 3D seismic vessel, contractors were exiting certain regions, much processing seemed to be on offer as a “loss leader” etc etc.
• Recriminatory commentary seemed to be on offer in many quarters!

The Seismic Contracting Industry: Today

There is no doubt that as 2006 closes the current business environment seems strong for the services sector in general and the seismic sector in particular. Thus for example in describing the soon-to-be-merged CGG-Veritas entity at an October 2006 Goldman Sachs conference, the CEOs could say of the combination:

? No 1 Seismic “Pure Play”
? Last-Twelve-Month (LTM) revenues and EBITDA of ~$2.2bn and ~$0.8bm respectively
? Sound and optimised balance sheet/ capital structure
? World’s leading 3D fleet (market estimated at ~$3.8bn in 2006 of which ~$2.0bn is exclusive)
? Multi-client libraries – strong fit, enhanced potential (combined LTM revenues of $0.55bn+).

Likewise, at a September 2006 Lehman Brothers conference, the CEO of Schlumberger, soon to be the 100% owner of WesternGeco, could report of this company that:

“Results have been strong across all business lines as exploration activity grows and Q-technology uptake increases. There have been further strong signals in multi-client sales, in land crew activity and in repeat business and long-term contracts for surveys that use clearly differentiated Q technology. Backlog at $1.2 billion, is at a new record level.
In 2005 we more than doubled Q revenue from $162 million to $399 million—a performance that puts this technology firmly in line with our target for any new technology. First half of 2006 Q revenues confirm continuing strength with these results being generated at significantly differentiated pricing premiums over conventional 3D surveys. In order to meet demand we converted a fifth vessel to Q technology last year, and a sixth in May of this year.”

So perhaps the fundamentals of the seismic industry have changed?

Consider a couple of interesting notions:

1. The world’s 3D fleet consists of some 40+ vessels (owned by CGG-Veritas, WesternGeco, PGS and Fugro, with a few minor players). Roughly the same numbers are currently under construction.
When they appear, what will this do the supply/demand balance and hence prices?
2. BGP is the dominant force in land seismic, routinely tendering at prices significantly less than its western competitors. This is relatively easy to understand as they have a lower cost base (‘people costs’) than their competitors, and a different strategic imperative.
They intend to become a force in marine seismic; some of the ‘new builds’ referred to in 1. above are theirs.
Will the cost advantages they enjoy, and the tactics they use, in land seismic be transferred to the marine sector?
3. There is some evidence that uncertainties about forward commodity prices, together with the twin pressures of equipment shortages and high prices for services, are persuading oil & gas companies to rein in their 2007 spending plans.
Lack of appropriately educated, trained and experienced human resources is emerging as key constraint on both the plans of oil & gas companies and the continued growth of contractors’ services and therefore revenues.
4. Some would argue that some service sectors have already begun to see a down-turn, for example North American onshore and shallow water drillers.

Taken together, these ideas would tend to suggest that an industry whose historical cyclicity has been simply a delayed version of commodity, especially oil, price cyclicity is perhaps about to experience another down-turn. Once commodities are priced more on fundamentals, there will likely be significant downward pressure on rates due to the combination of slackening demand and capacity additions. To emphasise this latter point, if a ‘hole’ is about to appear, over-capacity will once again make it deeper and wider.

What happens next?

Before attempting to peer into a crystal ball, it’s worth emphasising that the contractors are actually running with somewhat different business models:

• Although it’s abundantly clear that Schlumberger expects WesternGeco to perform as a standalone, global, business, there is now considerable emphasis on the possibilities and opportunities that arise from it being part of the Schlumberger brand and integrating with other product lines.
• CGG-Veritas is a global business, with the executive placing great emphasis on it being a “pure seismic play”.
• PGS has recently become a “pure seismic play”, reasonably strong in marine, weak in land, and now smaller than both WesternGeco and CGG-Veritas. For example, in 2007 WesternGeco will have 12 3D vessels, CGG-Veritas 14, PGS 10; PGS’s LTM revenues are circa 50% of both WesternGeco’s and CGG-Veritas’s.
• BGP aims to be global, and has a completely different strategic motivation to the others, but its current ‘reach’ is almost entirely on land; again it is a “pure seismic play”.

The question is, when the next down-turn comes, perhaps as early as 2007, will these companies show that they have learned from their bitter experiences of the second half of the ‘90’s, when the leading exploration companies benefited through continuous low cost supply of high quality data and constant advances in processing, leading to unprecedented global exploration success rates, and yet some contractors were left with profound balance sheet problems?

The answer is not yet clear but would appear to be connected to the following:

1. At least 80% of the world’s reserves are in the hands of government-owned NOCs such as Saudi Aramco, the Iranian NIOC, the Libyan NOC, Venezuela’s PdVSA etc and less than 20% in the hands of public companies such as ExxonMobil, BP, Total etc.
2. By and large, the seismic industry got into “dire straits” last time around by pandering to the wishes of the ‘owners’ of the “20%”, especially explorers.
3. Surviving and even prospering during the next down-turn may depend on building relationships of “mutual advantage” with NOCs, and also focusing on reservoir management.
4. Schlumberger (and hence WesternGeco) appears to understand this latter point perfectly well.
From their public presentations, it’s not yet obvious that CGG-Veritas fully understand these points although at least they have a strong presence in the Middle East.
There’s no evidence, for example in their presentation at the 2006 Lehman Brothers conference, that PGS have considered these issues.
5. In respect of BGP, it seems that their whole raison d’etre is to help in accessing oil for their owner/country, and that NOCs will therefore be their prime target.

Author: David Bamford

Thursday, April 17, 2008 14:16