By Stephen Eisenhammer
LONDON (Reuters) - Under pressure from their shareholders to spend less, international oil companies are demanding cheaper and simpler services, equipment and engineering, a red flag for contract firms which rely heavily on their needs.
Contractors have cashed in on the oil boom of the last few years. The Thomson Reuters index of 164 global oil services companies (.TRXFLDGLPUE13) is up some 70 percent since 2010.
But the gravy train that increased earnings by a third across the sector in that period, thanks partly to lucrative engineering, procurement and construction (EPC) contracts, looks to be over according to Charles Whall, who manages the energy portfolio at Investec.
Those in the sector who do business with state-backed firms may prove more resilient, as will those involved in cutting-edge developments such as liquefied natural gas (LNG) and gas to liquids (GTL) - but sector-wide the cycle seems to be turning lower.
BP (LSE:BP.) recently scrapped bespoke plans to develop its Mad Dog 2 project in the Gulf of Mexico, opting instead for a repeatable model it had used before. BP said it thought the old model could recover 90 percent as much oil at a fraction of the cost.
Statoil (STL.OL), which has been a heavy investor in innovation, is rethinking a project in the Johan Castberg field in the Arctic after changes in the tax code made the original plan too expensive.
"They (oil companies) are probably going to contract a bit tougher, they're not going to allow changes of scope, you're not going to have a Kashagan which continues to change its shape as it develops," he told Reuters, referring to a project in the Caspian sea which has taken 13 years and some $50 billion to develop and has shut down again due to a gas leak.
Rising costs and a flat oil price are behind the pressures contractors now face - mirroring a development in mining, where projects have been mothballed and contractors squeezed to keep costs down.
Caterpillar (CAT), the biggest supplier of mining equipment, recently cut its full-year outlook for the third time this year and said demand would be weak into 2014.
For the EPC part of oil services companies, the pain might only come a bit later, as contracts signed in the good years continue to be executed. But the cloud is already visible on the horizon.
Doug Sheridan, managing director of EnergyPoint Research, which offers customer satisfaction surveys on oil services and equipment, said a move away from bespoke designs and equipment could be devastating.
"I think the oil companies will coerce standardization at some point," and that "would be a death knell for the suppliers," he said.
EPC firms are in the front line as companies target value over production. A company that wants output at all costs is happy to pay for design changes during construction. The more complex the project, the more likely this is to occur, and a number of EPC firms bid below cost to win work and then rely on these "changes of scope" for their profits.
Chris Brown, chief executive at Kentz (KENZ.L) which provides construction services for a number of LNG projects as well as EPC services for smaller jobs, says a firm can tell if a project will require a number of revisions.
They then decide; "let's tactically bid it so we'll underprice it in our initial bid knowing that we'll change-order our client to death," Brown said.
It is these last minute changes that are likely to be reduced as companies look to save.
For Brown the knock-on effect of the need for cheaper execution is better early-stage engineering. This could favor one section of the industry - firms like Wood Group (LSE:WG.) and Amec (AMEC.L) which specialize in so-called Front End Engineering (FEED).
Technip shares sank 7 percent last month as it cut its subsea profit guidance for 2013. Chief Executive Thierry Pilenko said on results day he did not know if the firm would achieve the same growth going forward as it had in recent years.
EPC contractors who get most of their work from national oil companies (NOCs) - state bodies less worried about shrinking profits and threatened dividends than their shareholder-controlled International Oil Company (IOC) rivals - should prove more resilient to the trend.
"National oil companies, whilst they are clearly driven by economics, tend to look through shorter run cycles more clearly than the IOCs do," said Tim Weller, chief financial officer of Petrofac (PFC.L), which gets about 70 percent of its revenue from NOCs, mainly in the Middle East.
"We certainly saw that in 2008 when NOCs kept spending but the IOCs turned the wick right down on their capital spend."
For Rod Christie, chief executive of GE (GE) Subsea Systems, a leading supplier of offshore oil and gas equipment, price cutting is not the whole story, and savings could be made if the process of ordering and qualifying kit were simplified.
"The oil and gas industry is about 20-30 years behind the power generation and aviation industry with respect to QAQC (quality assurance and quality control)," he said.
Currently duplicate teams exist at both the supplier and the oil company sides, with a myriad of different standards which can even vary between similar projects within the same company. These get in the way of placing bulk orders and developing a more efficient supply chain.
Christie said this is beginning to improve, pointing to Chevron's (CVX) Lianzi project in Angola and Congo as a good example of using a more structured approach to keep costs down.
But he adds, "we're not there yet, and the industry is not there yet and the international oil companies aren't there yet."
(Additional reporting by Benjamin Mallet and Michel Rose in Paris; Editing by Andrew Callus and Peter Graff)