Cost Insights
by PowerAdvocate

Intelligence for energy companies seeking a data-driven approach to cost management

Soft Oilfield Service Prices: Implications for Supply Chains

December 24, 2019 at 5:42 PM / by Elcin Aktasosburg and Jordan Monahan

Summary

  • A nosedive in drilling activity has left OFS companies reeling as they try to remain profitable.
  • Investor sentiment has shifted in the oil patch, with operators under more pressure to produce assets and generate returns; services firms must stay lean with less work available.
  • Trimming the fat would be an understatement: services firms are doing anything they can to generate a profit while performing much fewer jobs.
  • In June of this year, the US produced 45% more barrels of oil per day than June of 2014 using roughly half the number of rigs.
  • O&G supply chain teams should seek opportunities to revisit OFS contracts in the wake of these market shifts, starting with data-driven insights on the cost drivers of key business verticals.

 

Oilfield Sector Activity Takes a Blow, and OFS Firms React

Oil and gas activity is in the midst of a sharp decline following several months of “boom times” last year. While all oil and gas firms surveyed by the Dallas Fed have seen activity decline in recent months, OFS companies have taken the hardest hit – as the chart below shows, the Dallas Fed’s OFS business activity index fell to -21.8 in 3Q 2019, with negative values indicating contraction in business activity.

Figure 1: Energy Industry Activity Index

Figure 1 Energy Industry Activity Index
Source: Dallas Fed

As a result, OFS companies are making operational adjustments to combat these trends. While oil patch activity is down and fewer jobs are being contracted by operators, OFS companies are feeling the pain, reallocating capital to stay agile and competitive. This trend is evidenced, for example, by Schlumberger’s third quarter earnings release, which said “the North American business has faced ‘significant pressure’ and ‘unsustainable margin compression down to mid-single digits’”. As explained further below, OFS companies have lost pricing power and, according to comments in the Dallas Fed survey, “are delivering services at rock bottom levels”.

What Does This Mean for O&G Supply Chains?

When market shifts in OFS occur, what questions should O&G firms be asking, and more importantly, what data is necessary to make the right business decisions in a turbulent market?

Cost models provide a starting point. PowerAdvocate’s cost model for Well Stimulation Services, shown below, charts the overall cost of well stim services (in red) alongside the individual commodities that drive those costs, such as hydraulic fracturing sand. Over the past 12 months, service costs have shown little resiliency in a bearish market. As a result, one might expect service contract costs to trend downward in the near term while the current economic environment persists.

We encourage O&G supply chain teams to seek opportunities to revisit OFS contracts in the wake of these market shifts. We recommend starting with data-driven insights and considering key business levers and asking key strategic questions such as:

  • Where are the opportunities to capture a more optimal market-based price for key services?
  • What data do we have at our disposal to evaluate and make these decisions?
  • How can we use data to consider short-term versus long-term supplier relationship management with key business partners?
  • How does our knowledge of the market impact our contracting strategy, and what data do we have to optimize our contracts?
  • Beyond OFS, based on other markets, what other services or materials offer opportunities to optimize costs and increase EBITDA for the business?
  • …and more

Figure 2: Well Stimulation Services Cost Drivers (Dec-18 = 100)

Figure 2 Well Stimulation Services Cost DriversSource: PowerAdvocate

Why is the Oilfield Services Sector in Freefall?

To add a bit more color and context for the above observations, we’ve outlined three considerations for why the oilfield services sector has declined so sharply for those looking to get a deeper microeconomic and macroeconomic dive:

  1. Macroeconomic Perspective
    Crude oil prices have fallen in recent months, with global oil supply growth outpacing demand. The International Energy Agency’s most recent Oil Market Report made downward revisions to its demand growth forecasts, for both 2019 and 2020, by 100,000 barrels per day. The reason? A weak global economy:
          • Business investment in the US – a key indicator for oil demand – has fallen steadily over the past year. New factories, office towers, and manufacturing plants require a lot of energy up and down the supply chain and are the result of positive investor sentiment. But in the current bearish economic climate, firms are more reluctant to make risky investments; this erodes oil demand.
          • More than 30 central banks around the world have cut interest rates this year, a move intended to boost investor sentiment amid mounting signs of slowing economic momentum.

Meanwhile, supply disruptions that have temporarily propped up crude prices – such as this summer’s attacks on Saudi Arabian oil processing plants and sanctions limiting oil exports from Iran – are offset by supply growth from non-OPEC nations. The US, Brazil, and Norway among others have realized a surge in oil output over the past 24 months. The bear market was recently summed up by US Energy Secretary Rick Perry’s remark that global markets are “awash in crude”.

  1. Microeconomic Perspective
    As low oil prices squeeze margins, accelerating decline rates in North American shale plays and the struggle to generate free cash flow are forcing investors to change their behavior in this capital-intensive industry. Production is becoming more expensive and low oil prices do not support ambitious production initiatives. There is a need for capital injection to boost output and increase cash flow from existing assets.
          • Capital is now harder to come by as investors shift their priorities: the prospect of long-term growth is now less attractive than immediate returns. This marks a substantial shift from years past.
          • Following the global financial crisis of 2008, the oil industry was flooded with “cheap money” from investors taking advantage of low interest rates. Without easy access to capital, operators are forced to scale back new developments.
          • Lack of easy access to capital creates a vicious cycle for OFS companies: investor pressure on financial returns from oil and gas operators is exacerbated by operators’ limited access to capital markets which consequently affects their exploration and production activity. This, in turn, affects OFS companies’ financial performance.

Stock markets reflect this bearish trend, as the chart below shows. In the past five years the S&P 500 Energy Sector Index has declined by about 28%. Meanwhile, the Philadelphia Stock Exchange Oil Services Sector Index, tracking 15 services companies in the industry, lost 70% of its value in the same timeframe.

  1. OFS Companies are Underutilizing their Assets
    The market forces described above are forcing OFS firms to operate at their bottom limit for profit margins. In many cases, therefore, their assets are underutilized. For example:
          • Excess capacity among hydraulic fracturing fleets: Halliburton has been reducing frac fleets across North America, citing an “oversupplied” pressure pumping market in a recent report, adding that the company is “not afraid to reduce [their] fleet size, as it contributes to righting the supply and demand imbalance”. This will affect their top line in the near term, but the goal for service companies is to save on labor and maintenance costs that might allow them to operate at higher margins.
          • Realigning assets to improve utilization: In addition to idling fleets and laying off workers, some companies have taken to strategic realignment initiatives to exit non-core markets and increase utilization rates in core markets. Basic Oilfield Services has relocated frac assets from the Permian to the Mid-Continent and relocated rental tools to the Permian and Eagle Ford.

 

OFS companies have lost much of their pricing power for contracted services amidst the turmoil of low activity and the battle for retaining the market share they do control. This has led to companies delivering services at record-low levels and adjusting their business units to best suit the minimal activity, low price, low profit environment. For instance, Schlumberger has divested roughly $400 million in North American assets and Weatherford International filed for Chapter 11 bankruptcy in July. Halliburton both slashed 8% of its North American workforce in 2Q 2019 and also eliminated an additional 650 jobs in the US Rocky Mountain region, with its CEO Jeff Miller citing that “feedback from [operators] leads us to believe that the rig count and completions activity [in Q4 2019] may be lower than the fourth quarter of last year”

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Continuing economic uncertainty can push the sharpest pain points further along the line on to operators. With more focus now than ever on capital discipline, understanding market trends and capturing value is a critical necessity that requires actionable analysis and incisive data insights about the market.

If you’re interested in seeing our industry best-practices savings roadmap, learning more about our proprietary industry forecasts or insights from our >$4T energy-specific database, or in hearing case studies of how >100 energy firms are already leveraging market data to manage costs, feel free to reach out to us here

 

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