In It for the Long Haul with Offshore

Due to the long-term nature of investments in offshore oil and gas drilling, the act of mitigating risk has to be baked in, says ArcLight Capital’s Lucius Taylor, and plays with high returns are the key to success.

Smart offshore energy players know that the cycles are longer than in onshore opportunities and that risk from any fluctuation in commodity prices is mitigated by the underwriting of projects that will produce high returns.

“You have to take a longer, thematic view of the commodity,” says Lucius Taylor, a principal at ArcLight Capital Partners. “Most operators can’t afford to cut investment halfway through project cycles.” He adds that planning cycles are also longer. “As a result, we’re seeing investment opportunities that aren’t necessarily immediate.”

Taylor says that the effects from the drop in oil prices depend on where in offshore an operator is focused. Those companies in shallow water and ultra-deep gas are exhibiting signs of distress, creating more near-term acquisition opportunities in shallow water pipeline systems, as well as in onshore and offshore processing facilities being sold by companies seeking capital to pay down debt and support liquidity.

“That’s one immediate change over the past year,” he adds.

Many of the offshore operators are equipped to respond to commodity prices and push service providers to drop costs, says Taylor. “The service costs come down dramatically, between 35 to 50 percent, which helps the producers. The service providers feel the impact of these downturns first; they’re at the end of the whip.”

There are risks in offshore that don’t necessarily crop up in onshore areas of energy production. Offshore investments require different amounts of capital, and it’s important to understand who the counterparty is, says Taylor. “You have to make sure there is enough credit to endure any cyclicality over the investment period. This is an area that can be mitigated through various deal structures. In general, there are ways to mitigate all manner of risk—exploration risk, operating risk, credit risk, the same things you would see in an onshore investment—in offshore.

“We have become very comfortable investing in offshore,” he adds. “We go through a very careful evaluation process.”

The most interesting aspect of offshore oil and gas activity is what’s happening with the decline of crude oil prices. Taylor says the price drop has put some projects on hold and has changed the producers’ desire for owning infrastructure related to the processing of hydrocarbons. There are, however, opportunities today to acquire infrastructure that’s being sold to repay debt or to shore up liquidity. “There’s more openness to third-party capital and ownership,” he says. “That’s a key aspect of this commodity rout.”