FPSO OUTLOOK

FPSO industry must re-think supply chain

Suppliers cannot meet future demand without changes

Oil price growth has stopped

The structure and organization of the FPSO
supply chain and the entire approach to FPSO
development has frequently been questioned.
In addition to the Why do we do it this way?
question is, of course, Why is anything going
to change now?
To address the latter question, it is important to consider the health of both the industry
and the ultimate end customer of the FPSOs, the E&P companies. At frst glance, the
oil industry and oilfeld service industry may
appear to be in fne health. Oil prices, while not
at record highs, are still in the neighborhood
of $90-100/bbl, and overall upstream industry
spend is expected to hit record highs this year.
Underneath the impressive headline fgures,
however, is a different story.
The current upstream cycle (2010 onwards)
demonstrates very different characteristics to
the one that preceded it (2001-2008). During
the earlier cycle, prices increased more than
tenfold from trough to peak, signifcantly boosting the free cash fow of E&P companies in the
process and to some extent masking the effects
of dramatic cost increases and project delays.
While oil price growth has slowed or stopped,
oil industry cost infation has not. In fact, most
surveys show that the double-digit cost infation
seen in the last cycle has returned. Operators
52 Offshore February 2014 www.offshore-mag.com

Michael Haney
Matthew Loffman
Steve Robertson

Douglas-Westwood
costs are rising at a much faster rate than free
cash fow. This is not a sustainable. A Goldman
Sachs study highlighted the impact very clearly
the returns for oil majors (measured in terms
of cash return on cash invested) are at their lowest levels since 1999.
E&P companies will have to do something
about cost infation for projects to be viable.
They will not have the luxury of ever-rising
oil price increases to mask the impact of project over-runs.

Production industry is broken

Based on research and interviews by Douglas-Westwood with operators, contractors, suppliers, and fnancers, key contributing factors
include: hurried engineering at the front-end;
over-engineering during the detailed design
phase; conversion scope changes when unwanted surprises occur; lack of clarity relating
to contract responsibilities; and construction
delays usually as a result of engineering
changes and the requirements to continually
build one-off designs. The next question is,
Why is the production industry broken?
Driven by the need to boost valuations, oil
companies tend to approach drilling activity
with a keen sense of urgency. Few questions
are asked around offshore drillship day rates

exceeding $600,000 when large exploration

projects are on the line. Specialty drilling contractors usually shoulder a large portion of
the drilling workload. On the other hand, oil
companies have always had a detail-oriented
approach toward production costs as they
aim for maximum production and margin on
each barrel produced. This helps maintain
proftability on long-producing felds despite
fuctuations in commodity prices.
As the core competency of oil companies
is the production of hydrocarbons, this approach makes perfect sense. Operators involve many decision makers in production
decisions, ranging from project decisions
to overarching business decisions in the Csuites. As a result, the number of cooks in the
oil company kitchen is signifcantly higher
when production is on the menu. In our research, it is clear that company targets can
confict or oppose each other at times. These
conficts add to the complexity of project execution, resulting in negative implications for
suppliers and lower project effciency.
The way in which tenders are presented to
leasing and engineering/procurement/construction contractors adds further complication and risk to the supply chain. Oil companies typically perform extensive diligence
and analysis when deciding whether and how
to develop an offshore feld. When they decide to develop, tenders are often issued with
a hard deadline, requiring contractors to deliver within short timeframes that can appear
arbitrary. Tight deadlines place pressure on

E&P capex forecast

1,000,000

Actual

United States
Canada
Outside North America

900,000
Capital spending ($s in millions)

he FPSO supply chain is broken. The

foating production, storage, and offoading systems markets will be unable to
meet FPSO demand over the next fve
years unless signifcant change occurs
in an industry increasingly defned by schedule
delays and cost overruns.
Industry players understand and accept
this position, but until now they have been
unable to quantify the effect of these project
delays and cost overruns. Success in improving the supply chain model has been limited
at best, negatively affecting exploration and
production companies, suppliers, and leasing
contractors in particular.
The goal here is to quantify these delays
and cost overruns, and examine the reasons
behind the ailing FPSO supply chain. The role
of the oil companies, development complexity,
regulation, and conficts of interest within the
value chain are some of the challenges affecting FPSO project execution. Each will need to
be addressed if near and medium-term energy
demand will be met.

800,000

Estimates

700,000
600,000
500,000
400,000
300,000
200,000

Source: Barclays Capital

100,000
0
1985

1988

1991

1994

1997

2000

2003

2006

2009

2012

2015

FPSO OUTLOOK

E&P capex per barrel

$25

$20

GR
CA 13)
.9% -20
10 999
(1

$15

$10

0.9% CAGR
(1985-1999)

$5
Source: IEA, Barclays Research

$0

85 87 88 89 90 91 92 93 94 95 96 97 98 00 01 02 03 04 05 06 07 08 09 10 11 13
19 19 19 19 19 19 19 19 19 19 19 19 19 20 20 20 20 20 20 20 20 20 20 20 20 20

the fnal steps in the process, such as hull and

topside integration and commissioning.

About the research

Douglas-Westwood reviewed in depth nine

recent FPSO projects. While the FPSOs varied in terms of type (newbuild or conversion),
ownership (leased or operator-owned), and
geography, there are specifc themes that can

be drawn from the research. Signifcant cost

and schedule overruns are commonplace
and are now standard practice in the market.
The nine projects had a combined cost overrun of 38% and a collective delay of more than
12 years. The most signifcant cause of delay
was integration of hull and topside, followed
by yard availability and engineering scope. A
total of more than $2.5 billion was spent above

budget to bring these projects onstream, with

additional costs and delays continuing on two
of the projects at the time of writing.
The research suggests that these case studies are directionally representative of the industry as a whole. Of the 45 FPSOs installed
worldwide between 2008 and 2012, 30 were
delayed, many signifcantly.
These cost overruns indicate the additional
capital required to bring these nine projects online. However, this represents only part of the
fnancial challenges facing oil companies. With
each day of delay to frst oil, overall net present
value of the project suffers. Months of delays
can materially reduce feld development economics to the point where the feld is no longer
a viable investment. Lengthy production delays
frustrate oil company investors, who want barrels brought to market as quickly as possible to
maximize company fnancial returns.
As the critical decision makers in the industry, oil companies have a responsibility to address and optimize current internal practices,
the limitations of which have contributed to
project overruns in the past. To some extent, favorable contract terms passing risks to leasing
contractors have shielded the operators from
the weakness of the supply chain. However, the
gap between supply capacity, witnessed by the
diminishing appetite of many of the leasing con-

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FPSO OUTLOOK

Nine FPSO case studies

Reason for Delay

Project A

Project B

Operator Contracting

Project C

Project D

Project E

Project F

Project G

Project H

Project I

Total

14

Material Costs

Engineering Scope

Yard Availability

14
2

1
2

0.5

Raw Material Process

Equipment Package

Integration

1.5

20.5

22
5

0.5
3

9.5

28.5

Subsea Equipment

Equipment Installation
Commissioning

0.5
1

Source: Douglas-Westwood

Financing

11

Political/Unpreventable
Total Delay (Months)

6.5
3

18

18

13

52

17

14

18

13

146

$5,060

$35

$88

$375

$80

$90

$500

$132

$420

$6,780

Actual Cost ($M)

$6,200

$44

$132

$675

$190

$240

$1,017

$200

$669

$9,367

Extra Cost Total ($M)

$1,140

$9

$44

$300

$110

$150

$517

$68

$249

$2,587

23%

26%

50%

80%

138%

167%

103%

52%

59%

38%

Original Cost ($M)

Extra Cost %

tractors to take on these projects, and demand

for FPSOs in the coming years will leave some
operators disappointed, and will bring these
concerns into sharper focus.

Project complexity
Every offshore feld is different and therefore requires different production infrastructure. Each feld has particular characteristics;
production curve, water depth, oil and gas
mix, API gravity, well numbers and locations,
pressure ratings, responses to enhanced recovery techniques, lifetime estimates, and so
on. The different nature of each offshore development project has led to a feet of uniquely
designed FPSO solutions. Such a variance
increases the complexity of supplying FPSOs;
more so than in other areas of the oil and gas,
such as drillships and supply vessels.
Field owners need to have comfort that
their feld is being optimally exploited. This is
particularly true of national oil companies who
steward hydrocarbon resources in their waters.
As NOCs lead developments in critical producing regions, this factor has become more
prominent, ensuring that subsea infrastructure,
topsides equipment, and FPSOs are designed
for the maximum production possible. Strong
competition among the majors in offshore plays
supports governments capacities to place stringent targets and other requirements.
Accurately evaluating reservoir potential is
an industry-wide challenge. Unique geological
features, extended production lives, and lack
of information at the start of the evaluation process complicate estimates. Reliance on early
and limited data is necessary, but has a strong
impact on production infrastructure. A higher
proportion of development capital is required
up front, and the observed impacts on FPSO
design have been negative and severe. Based

on limited data at the beginning of the design

process, engineering specifcations for FPSOs
are made to decimal place detail. As production data is added throughout the process, it
frequently becomes obvious that the basis of
these specifcations miss the mark by several

orders of magnitude. The inaccuracy of the

data underpinning FPSO design is exacerbated
by technology innovations and improvements
throughout the lifecycle of the feld. Due to
their extended operational life, FPSOs suffer
more than other areas of the industry.

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FPSO OUTLOOK

Regulation issues

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Regulation of FPSOs is another challenge that will continue to cause

serious issues, particularly as deployments become increasingly international, incorporating multiple jurisdictions.
FPSOs can be ship-shaped and make self-propelled voyages, making them subject to certain shipping and marine rules and regulations.
Other FPSOs are neither ship-shaped nor self-propelled. Likewise,
once in operation the unit is tied to subsea equipment and the seabed,
albeit not permanently. In these cases regulation reference is to E&P
installations. There is considerable overlap and confusion between
these positions. Inconsistent regulatory conditions, combined with
increased complexity in feld specifc solutions, drive the regulatory
bureaucracy to the extreme with proportional cost ramifcations.

Local content
The FPSO supply chain further suffers from local content requirements. While benefts to local communities must be a priority, the execution of these plans in diverse regions threatens the advancement of
technology and supply chain effciency in critical markets. Reliance on
inexperienced shipyards to complete complex integration of hull and topsides has led to eye-watering delays and cost additions in the past fve
years, and this will continue to grow unless there are signifcant changes.
Related issues around availability of engineers, experience of procurement personnel, and the supply of minor necessary equipment all continue to contribute to complications in FPSO delivery.

Supply chain complexity

The FPSO supply chain is complex and involves a wide range of
equipment and service providers. Oil companies contract either an
FPSO leasing contractor or a major EPC company to design and procure the FPSO. Major EPC contractors may own fabrication yards and
have equipment manufacturing capacity, although much construction
work is further sub-contracted to shipyards. Lease operators and EPC
companies procure equipment from specialist providers. Suppliers
range from international conglomerates to niche and regional players.
With so many players working to bring an FPSO online, project execution suffers as conficts of interest between parties arise throughout
the process. Engineering houses bill hours worked and have professional and fnancial interests in extending the scope of front-end engineering. Construction yards favor effcient delivery with little interest in
adjusting work scope throughout the process. Yards will often have multiple major projects to execute, with scope changes potentially moving
an FPSO to the back of the line. Oil companies themselves have an interest in achieving fast frst oil, so long as the FPSO is safely integrated,
yet still place a high priority on reducing engineering hours and costs.

Organizational learning
The research highlights the lack of institutional experience among
FPSO operators. In drilling projects, repeated delivery allows operators and contractors to build experience and develop repeatable
practices. However, few companies have completed enough FPSO
projects to institutionalize lessons learned. In addition, key FPSO
personnel often change frms from one project to the next. These
lessons of past projects need to be learned as an industry, if near
future demand for FPSOs is to be met.

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56 Offshore February 2014 www.offshore-mag.com

Often, the sheer size of the projects brings additional complications. With FPSOs costing hundreds of millions of dollars, lease operators are required to raise such signifcant volumes of capital that
the fnancial health of the company is at risk on each project. This
is not sustainable, even in the short-term. This is particularly true
when, after cost overruns are distributed, many projects originally
considered quite proftable end up instead making substantial losses.

FPSO OUTLOOK

Shipping industry infuence

Many early FPSOs were developed by the
shipping industry, and these were often older
vessels converted to store oil at relatively low
cost. This gave feld operators an inexpensive,
convenient option to assist in feld developments, as well as offering vessel owners new
revenue opportunities for older, lower-value
assets. The offshore oil and gas industry has
developed signifcantly in recent years, as capacities have increased, depth and formation
capabilities have increased, and HSE regulations have gained prominence.
The economics of conversions is further
tested by current technology and cost trends.
With current complexity of projects and
technical solutions, the proportion of topside
expenditure compared with the hull is signifcantly reduced. This further reduces the
advantages to ship owners associated with
conversions of old tankers. Research indicates that the relative savings associated with
conversions will become less infuential.

Drilling industry
comparison
The high level of oil company involvement
in the organization of FPSOs contrasts with the
drilling industry, where operators outsource
operations to specialist contractors. Contracting practice allows oil companies to incentivize
drillers who offer bundled solutions, limiting
the hands-on decision-making involvement
of the operators. By shifting administrative
responsibility to drillers, the web of decision
making has become far simpler compared
with the production side. Whether elements
of this approach could be transferred remains
to be explored. Given oil company culture
and typically higher levels of involvement in
production decisions, oil companies will need
to increase their responsibility for that supply
chain, particularly when it breaks down.

Next steps
Re-addressing the Why is anything going
to change now? question requires examination of the current ethos and belief systems
within the supplier community. Offshore production is often conservative in adopting new
technologies and practices. A mentality exists
that there is no alternative to the current practice, often based on almost mythical stories of
failed past attempts at change, or on a handful
of individual experiences over the years.
There is little doubt that emotional factors
are instrumental in driving contractors decisions across the board, ranging from equipment selection to evaluation processes. The
diffculty now is that demand outstrips supply
to the extent that the supply chain simply is not
sustainable, and these challenges are increasing, not decreasing. There is a pressing need
to address supply chain concerns, and this will

involve a serious, rational examination of options with no room for hearsay or hunches.
Approximately 100 new FPSOs will need
to be built by the end of 2017, representing
a 50%+ growth in feet size. The supply chain
will not meet demand over the next fve
years or further into the future unless substantial changes are made in the industry.
The industry value chain will need to be
restructured. Leasing contractors FPSOs
are major, multi-billion dollar investments.
Observing the growth of leasing as a procurement model for FPSOs, contract risk terms
equate to operators using some contractors as
a bank, hedging their investments. With leasing contractors suffering across the board,
there may be an opportunity for them to refocus, potentially separating into technology
development and own and operate groups.
Project repeatability is another way to
improve FPSO supply. Project methods that
build on industry knowledge of delivery and
operations can improve execution quality
and effciency. The interviews with oil companies and others suggest that beginning
each major project from a blank sheet of
paper may not be necessary if safe and effective alternatives are developed.
Oil companies have an important role in
nurturing the supply chain beneath them,

otherwise they will continue to see costs rise

with no improvements on overruns. Only 10
or 15 years ago an FPSO would cost tens of
millions of dollars; now they cost hundreds
of millions. With oil companies seriously examining cost in the sector, there is an urgent
need for change in the buying process.
Changes to the regulatory framework could
signifcantly impact the ability of the supply
chain to meet demand in the years ahead.
Current regulations governing FPSOs are
cumbersome and under-developed. With each
FPSO treated as unique, relocation and other
mobilization are overly complex. This is apparent when compared with drillships, which are
typically regulated as part of a class and far
more easily mobilized. With industry consensus and effort, improved regulation could help
oil companies complete the production phase
more effciently and professionally.
These and other measures may offer hope
to the ailing supply chain as demand continues to ramp up. Signifcant changes and intentional involvement are required from all parties for the FPSO supply chain to be fxed to
the extent that upcoming demand is met. The
offshore industry has met multiple challenges
in the past. Working together, the key players can develop faster and more cost-effective
FPSO facilities to meet growing demand.

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