Even if oil prices rise, Canadian oilfield services must drill deeper for margins

Yager: Even if oil prices rise, Canadian oilfield services must drill deeper for margins

By David Yager

Sept. 23, 2016, 1:46 p.m.

http://www.jwnenergy.com/article/2016/9/yager-even-if-oil-prices-rise-canadian-oilfield-services-must-drill-deeper-margins/

 

When it comes to oilfield services (OFS), it’s not unreasonable to say Dave Lesar, the chief executive officer of the world’s second-largest operator, speaks for everyone.

While there are obvious advantages to being huge, Halliburton can’t charge higher prices than its competitors regardless of where it operates.

In an August 18 Bloomberg News article, Lesar says, “Some of the efficiency gains we have made with customers are in fact sustainable and will continue, but others, including deep uneconomic pricing cuts, are unsustainable and will have to be reversed.”

Unsustainable describes the Canadian OFS industry as it enters the fourth quarter of 2016. Certainly, there’s a bit more business out there, but at 150 active rigs on August 18, it’s the worst market for this month anyone can remember. The last time it was this bad was so long ago it’s irrelevant.

There have been several responses. Some companies are gone, either voluntarily or with the help of their banker. Some are going, technically underwater because of too much debt but still answering the phone because they have persuaded lenders they are worth more alive than dead.

The rest have figured out how to sort of match revenue with cash costs and hold their own with whatever business comes in the door. Few are excited about going to work.

In the challenged, but ultimately symbiotic, relationship between OFS and its exploration and production (E&P) clients, how does the future look? Without a significant increase spike in commodity prices, how are E&P companies going to replace reserves to stay in business while paying OFS more so it can remain solvent for the next year? And the year after that?

The Bloomberg article quoted several E&P companies that, of course, claim much of the credit for reduced costs. BP, for example, brags about a deep drilling project in the Gulf of Mexico originally budgeted for US$20 billion that came it at US$9 billion. While obviously reduced input costs helped, BP took credit for simplifying the project’s scope. As they released second-quarter financials, Bloomberg reported U.S. shale drillers claim half their cost reductions are permanent improvements in efficiency. Apache’s chief financial officer, Stephen Riney, said, “A lot of the actions that we’ve taken are what we call self-help type of things, changing the way we work. These are things that are not dependent upon the pricing from third parties.”

Finally. It’s always refreshing to learn more E&P companies are understanding how much their own operating practices escalate their total costs. But financial challenges for OFS remain. It is impossible for service and supply to be profitable when its clients are not. Low prices have capped development costs. OFS claims it has cut prices to the bone and perhaps even deeper. But E&Ps that keep producing must replace reserves or the company will disappear. When E&P goes broke so does OFS. Then what?

Out of necessity, OFS has slashed every possible imaginable expense except structural corporate sales, general and administrative costs. The extended, and nearly uninterrupted, growth cycle from 2000 to 2014 allowed the formation of hundreds of new and smaller players. As larger companies continually consolidated OFS through buying competitors to make it more efficient, many of the former owners were back in the game the day their non-competes expired, adding more capacity and players.

But OFS must also remember the marketplace is elastic. Cut costs and E&Ps will drill more wells. Getting a better margin for ongoing work while expanding the market under fixed commodity prices remains a monumental challenge.

While many of the smaller OFS players may quite rightly brag about offering better service, most cannot touch the big dogs when it comes to financial management and investment discipline. They employ systems and people to count the pennies on every job while ensuring each new capital asset will yield a double-digit after-tax rate of return. But tragically, even some of the fast-growing larger outfits of the post-2009 recession era weren’t good at this either.

Nobody ever published a Harvard Business School case study highlighting the remarkable financial efficiency of the oil service industry or its E&P customers. Too fat for too long. OFS has proven it can cut costs but can it reinvent itself? However awful, OFS must manufacture a positive operating margin with whatever business is available. This will require consolidation, financial management and finally understanding their client’s objectives and become a partner, not just a vendor. There’s no other way.

About prosperitysaskatchewan

Consultant on Saskatchewan's natural resources.

Posted on September 23, 2016, in economic impact, miscellaneous, oil, political. Bookmark the permalink. Leave a comment.

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