Saudi Arabian national oil company (NOC) Saudi Aramco recently paused its plan to expand its maximum sustainable oil-production capacity in the country, raising questions about the spending outlook for oil and gas producers in the broader GCC region. While we understand that GCC NOCs' capital expenditure (capex) could remain elevated owing to capacity expansion plans in Qatar and the United Arab Emirates (UAE), their spending, and the pace of it, will affect the oilfield service companies along the value chain, especially drillers. Drillers' business models and revenue generation depend on producers' capex.

S&P Global Ratings believes that growth in NOCs' aggregate spending in the GCC region will slow from 2024 compared to 2022, and to a lesser extent 2023. Spending will still be sizable, at around $110 billion-$115 billion on average between 2024 and 2026, while capacity expansion plans outside our base case, particularly those for the recently announced North Field West in Qatar, could elevate it further. Nevertheless, the slowdown in growth is likely to reduce rig demand, utilization ratios, average day rates, and the profitability of the region's drillers, both in Saudi Arabia and neighboring countries.

When we stress-tested rated and publicly listed drillers' credit metrics to hypothetical losses in rig demand across GCC countries, we found that their debt to EBITDA would increase by about 1x on average for a 15%-20% loss of total rig demand in the region. We think that the rated drillers' rating headroom could shrink as a result, but we do not expect any short-term rating pressure.

GCC NOCs' Capex Remains Sizable In 2024-2026, Despite Modest Growth

We expect the region's NOCs to take a broadly cautious approach to spending, with aggregate capex increasing only modestly by about 5% on average in 2024, compared with 2023 levels. Capex is mainly driven by production plans in Saudi Arabia, the UAE, and Qatar. We estimate that the NOCs' aggregate capex will amount to $110 billion-$115 billion over the next few years. As an absolute amount, this is still elevated compared with previous years, but it is the start of a plateau after years of uninterrupted growth (see chart 1).

Chart 1

Saudi Arabia pauses capacity addition targets, while the UAE and Qatar push forward

Investments in Saudi Arabia, the UAE, and Qatar largely make up the aggregate capex for the GCC NOCs. Plans continue to increase crude oil production capacity in Qatar, and in the UAE, to five million barrels per day. Abu Dhabi's ADNOC plans to increase production capacity to five million barrels per day (mbpd) by 2027, compared with four mbpd as of February 2024, according to the Energy Information Administration. Qatar plans to increase its liquefied natural gas production capacity to 142 million metric tons per year by 2030, from 77 currently, and has announced expansions of gas projects in North Field East, South, and West. In contrast, Saudi Aramco has paused its plans to increase its capacity by an additional one mbpd, thereby maintaining its maximum sustainable capacity at 12 mbpd (see chart 2).

Chart 2

Hydrocarbon prices in 2024 and 2025 should support the intrinsic credit quality of the region's oil and gas sector

We assume that the price of Brent oil will average $85 per barrel (/bbl) for the remainder of 2024, followed by $80/bbl from 2025. Geopolitical tensions, coupled with production constraints by the Organization of the Petroleum Exporting Countries and its allies (OPEC+), should support oil prices. In turn, these prices should boost cash flows for the NOCs in the region (see "S&P Global Ratings Revises Its WTI And Brent Price Assumptions For 2025 And Beyond On Anticipated Oversupply," published March 11, 2024) and other hydrocarbon producers around the globe. However, global oil demand will grow more slowly this year, while production, mostly from North America, will help boost supply despite OPEC+ countries' reductions in output.

GCC-Based Oilfield Services: The Story In Charts

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The Pause In Saudi Capacity Additions Could Reduce Demand For Domestic Offshore Services

In January 2024, Saudi Aramco announced that it had received a directive from the Ministry of Energy to maintain its maximum sustainable capacity at 12 mbpd, rather than moving toward the planned target of 13 mbpd by 2027. This leaves the amount of spare capacity unchanged at about 3 mbpd.

As a result, during its 2023 earnings call, Saudi Aramco's management mentioned that it could defer certain projects, including the Safaniya oilfield, one of the largest offshore oilfields in the world. Management also announced that the maximum sustainable capacity directive should reduce capex by about $40 billion between 2024 and 2028, although it will continue spending on other projects.

According to media sources, Saudi Aramco has cancelled the bidding processes for multiple engineering, procurement, construction, and installation contracts worth an estimated $10 billion to expand the Safaniya field. Since the expansion project was only in the construction phase, with an expected start date in 2027, we believe that demand for offshore rigs could start declining from 2026, all else being equal.

We think that it is too early to assess the impact of the pause on GCC-based drillers' cash flow

We anticipate that the pause will likely affect drillers with more exposure to the offshore segment. Notably, a slowdown in NOCs' upstream investments is likely to reduce utilization rates and subsequently average day rates and profitability. Although drillers in the GCC have strong ties to NOCs in highly rated countries, they also tend to have meaningful concentration on a single NOC, making them vulnerable to cash flow volatility. Geographical footprint and customer concentration are two of the considerations that underpin our business risk assessment of oilfield service companies.

Over the past few years, domestic oilfield service players have benefited more from contract awards than their international peers in the region. In Saudi Arabia, domestic drillers have about 67% of the offshore market as of end-December 2023, and roughly a 78% share including GCC-based players. This aligns with the Shareek program's objective to accelerate large domestic companies' growth in Saudi Arabia. We expect this program to motivate local investment and benefit Saudi Arabia-based players the most.

Our stress test indicates that Saudi Arabia-based drillers' leverage could increase by up to 1.0x

We stress-tested the impact of rig losses on Saudi Arabia-based drillers' credit metrics, particularly debt to EBITDA. In our stress test, we assumed an impact on offshore rig demand, and put stacking costs for offshore rigs at between $15,000 and $25,000 per day.

For the Saudi offshore market as a whole, we assume that the pause in capacity additions will translate into about 15%-20% of annual rig losses, or about 15 rigs annually. As of April 2, 2024, Shelf Drilling Holdings Ltd. (Shelf Drilling; B-/Stable/--) received a suspension notice from Saudi Aramco for four out of its nine rigs in Saudi Arabia. On April 4, 2024, ADES announced that it had agreed with its client in Saudi Arabia to temporarily suspend operations of five of its 33 offshore jack-up rigs operating in the country for up to 12 months. At the same time, Arabian Drilling announced that it is in discussions with Saudi Aramco regarding contract suspensions relating to three of its offshore rigs.

Saudi Arabia-based drillers have been increasing their contribution to offshore drilling in line with Saudi Aramco's expansion plans (see chart 9). As a result, and based on their domestic market shares, we calculate that some rated and publicly listed companies operating in Saudi Arabia could lose up to 20% of their EBITDA per year, translating into additional debt to EBITDA of up to 1.0x (see chart 10). For the stress test, we took a slightly more conservative approach to lost rigs based on the market shares of ADES and Arabian Drilling, so in reality, the metric headroom of and effect on these companies should be better than we assume.

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The effect of the pause on Shelf Drilling is limited for now

Dubai-based Shelf Drilling is the only driller in our regional portfolio that has some exposure to Saudi Arabia. With 36 jack-up rigs as of December 2023, the company primarily focuses on shallow-water offshore drilling. About 25% of the company's rigs are in Saudi Arabia, with the remaining 75% outside the GCC region, particularly in South-East Asia and West Africa.

Our stress-test scenario assumes that the reduction in rig contracts will be proportional to drillers' current shares of the Saudi Arabian offshore market. For Shelf Drilling, we assume a four-rig reduction impact, in line with the driller's announcement on April 1, 2024. While the number of rigs affected is larger than Shelf Drilling's proportional market share in Saudi Arabia, its contract terms are generally aligned with those of other domestic players in terms of tenure and day rates.

It is hard to assess which of Shelf Drilling's rigs could be cancelled, as this will depend on many factors, including the type of work the rigs perform (workover/drilling), the historical performance of the drilling company, and the rigs' characteristics. That said, we calculate that Saudi Aramco's pause in capacity additions would reduce EBITDA by up to 20% for Shelf Drilling per year in 2024-2025--assuming the rigs are not contracted and are warm-stacked for the whole period--and subsequently increase reported gross debt to EBITDA by up to 1.0x-1.2x in 2024.

Despite higher reported leverage of 5.3x as of end-December 2023, we see Shelf Drilling as less vulnerable than other GCC drillers to volatility in its credit metrics in our stress scenario, with an estimated increase in debt to EBITDA of up to 1.0x. This is because Shelf Drilling benefits from greater diversification outside the GCC than other domestic drillers.

Shelf Drilling's leverage increase remains within our thresholds for the current rating. A greater risk comes from the cash outflow necessary for stacking costs or mobilization expenses if the company moves the rigs to other regions, which it has a track record of doing. However, the recent increase in Shelf Drilling's revolving credit facility to $150 million should support its liquidity needs this year.

We understand that some contracts with Saudi Aramco feature a compensation clause, whereby the driller receives up to half of the contract's value if the contract is cancelled. However, we assume limited use of this clause, as domestic drillers prioritize long-term relationships with Saudi Aramco over immediate compensation, with some drilling contracts lasting up to 10 years.

GCC Drillers Should Be Resilient To Hypothetical Knock-On Effects Of Saudi Rig Cuts

This is thanks to the drillers' comfortable leverage and limited rig supply. Moreover, NOCs' high spending requirements will continue to drive rig demand in the GCC countries apart from Saudi Arabia. As a result, while we expect NOCs to maintain their cautious spending approach, we do not expect a decline in capex, but rather a modest growth over the next three-to-five years. We highlight that our base case for spending does not include recent expansion announcements, such as in Qatar. As a result, capex could be even higher.

A 20% loss of offshore and onshore rig demand could translate into 1.0x-1.5x higher leverage for some GCC-based drillers

Even though rig cuts are contained to Saudi Arabia, we assessed the effect of a potential spillover to other GCC-based drillers' credit metrics--particularly debt to EBITDA--for illustrative purposes. In our stressed case, we assumed a loss in demand for both offshore and onshore rigs, based on current market shares. We also assumed that the stacking costs for offshore rigs would range between $15,000 and $25,000 per day, more than double those for an onshore rig.

We assumed that the pause in capacity additions would translate into a loss of about 15%-20% of annual rig demand in the region. GCC-based drillers have been increasing their contribution to offshore production (see chart 11). As a result, we calculate that some rated and publicly listed GCC drillers could lose up to 20% of their EBITDA, translating into additional debt to EBITDA of up to 1.0x-1.5x based on their domestic market share (see chart 12).

At the same time, we note that most GCC drillers have comfortable gross leverage--a weighted average of 2.5x-3.0x as of end-2023. This gives them enough headroom in our stress test to absorb the rig cuts and stacking costs until demand recovers, without needing to dispose of assets.

Moreover, spare supply in the market is limited, with a high utilization rate of 94% and 17 rigs under construction as of end-February 2024, compared to 95% and 141 rigs in April 2014. This could allow the fleet to move to other regions without putting material pressure on day rates.

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The Saudi Production Pause Is Not A Showstopper

The long-term impact on GCC drillers' credit metrics of the pause in capacity additions in Saudi Arabia is uncertain. However, we don't expect a material change in demand for GCC rigs, notably those in Saudi Arabia, at least in the coming two-to-three years.

On one hand, we think that this could prompt regional drillers to diversify their customer base and geographical footprint, although it could bring about other challenges, including execution risk. On the other hand, we think that regional drillers' ownership by NOCs or sovereign wealth funds, along with government-led efforts to increase local involvement in domestic industries, could improve these drillers' visibility when it comes to contract awards. Finally, regional drillers' generally limited leverage provides an additional buffer against any volatility due to contract cuts.

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