Oil Services Sector Ripe For Restructuring To Boost Tight Profit Margins - Forbes

Oilfield service companies have been drilling at a record pace, but margins in the sector have not kept up with workloads.

The US oilfield services sector is in a rough patch, but it won’t last forever.

The outlook for the sector is gradually improving, but the oilfield services sector did not recover from the oil price collapse of 2014 as quickly as its client producers. Much of the sector is still rebuilding capacity and is struggling with older equipment at a time when clients are demanding higher-pressure fracking. Many companies are working at or beyond their capacities.

The good news is that the industry is no longer relying on higher oil prices to save it. We are taking steps to regain pricing power from our clients, which have adhered to tight capital discipline since 2015 – and still do today despite the modest recovery in oil prices.

The less oil companies are willing to pay for drilling and other field services, the less the service sector earns in revenues. That may seem like a simple statement, but it has long-term consequences. Companies that can’t afford to invest in new equipment eventually fall behind their competitors. Companies that take on too much debt to keep up make themselves vulnerable to takeover.

But service companies - the arms and legs of the oil and gas industry - realize the game has changed and are preparing to operate in an ultra-competitive environment for the long run. Upstream operators count on us for the production growth they need to meet rising global demand for energy. The unprecedented shale boom that has made this country the world’s largest oil producer at over 12 million barrels a day could not have happened without us.

After losing pricing power in 2015 and 2016, many in the service sector have not regained all the ground they previously ceded to the oil companies. Even with the recent round of consolidations that have helped concentrate the market, the sector is still in a price-taking scenario. Further industry restructuring, rationalization, and consolidation are necessary to reduce the fragmentation and surplus capacity that dogs our sector. That, in turn, will help repair lagging margins and allow more companies to invest in new equipment and human resources.

To that end, pressure-pumpers Keane and C&J Energy Services recently announced a “merger of equals” that will create the sector’s largest independent fracking company, with a market cap of nearly $2 billion. Both companies’ stocks popped on the news, which should encourage others to follow suit.

Consolidated service firms also have a better chance of attracting interest from institutional investors, many of which have minimum market-cap thresholds for investing. Getting back in the good graces of major investors would give companies more liquidity and the flexibility to maneuver.

Size and scale are not panaceas to all of our issues, though. Just look at Weatherford International. Once among the four largest oil services companies in the world behind only Schlumberger, Halliburton, and Baker Hughes, it’s now a penny stock.

Heavy debt loads and weak balance sheets remain a problem for our sector, which loaded up on debt in the first part of the decade when oil was over $100 a barrel. Not every company will make it. Companies saddled with heavy debt loads and older equipment will find it difficult to survive in the current atmosphere. There will be more bankruptcies, but that’s not necessarily a bad thing. Survival of the fittest is the name of the game in a market economy. The strong survive, the weak go home or find stronger partners.

Bankruptcies are part of the rationalization, weeding out the most inefficient players. Meanwhile, demand for oil and gas around the world continues to grow, presenting enormous opportunities for those companies that hold on.

The emphasis can’t be on making deals solely to get bigger. Transactions must be strategic and make good business sense. The attention should be on excelling at one or two products or services, not trying to be all things to all clients. The CJ-Keane deal, for instance, creates the largest pressure pumper in the country and makes strategic sense.

It’s in our hands to seize on these opportunities. Bigger services companies – with broader and deeper technological capabilities applicable to diverse operating conditions – are more likely to excel in this market. But smaller ones can too if they focus on niche opportunities, such as LNG or offshore construction.

Despite the claims of those like former EQT CEO Steve Schlotterbeck who recently said the fracking revolution has been bad for the industry and its shareholders, in reality, it was fracking and the lifting of restrictions on oil exports that saved the industry and made US energy dominance a reality.

The smaller service companies are still rebuilding their infrastructure after the 2014 crash. Many of them may be burning through cash right now, but that’s not necessarily an indicator of failure. They’re just gearing up, which is a factor in any growing industry. Data from the EIA shows smaller companies generated more cash to support operations last year than they did in the year before the crash.

There’s also plenty of reasons to be optimistic given the fundamentals of the market. Global demand for oil and natural gas continues to expand, presenting enormous opportunities for the industry. Despite fears of an economic slowdown, the International Energy Agency (IEA) expects worldwide oil demand to grow annually on average at 1.2 million barrels a day over the next five years.

The IEA says OPEC production capacity by 2024 could be 500,000 barrels a day lower than it is now. That means continued room for non-OPEC sources, particularly US shale, to contribute to growing oil markets.

The US is expected to account for 70% of the total increase in global oil production capacity increases to 2024, adding a total of 4 million barrels a day. This follows spectacular growth of 2.2 million barrels a day in 2018 and expected growth of 1.4 million barrels a day this year.

The outlook for natural gas demand is even more bullish. Global gas demand surged 4.6% in 2018, its fastest annual pace since 2010, according to the IEA. It’s forecast to rise by 1.6% annually through 2024. The US is expected to overtake Qatar as the world’s top LNG exporter in five years, according to the IEA.

The low price of natural gas is both a blessing and a curse. Gas is cheap because there is so much of it available – which is ultimately good for consumers, including manufacturers that depend on affordable energy to remain competitive. Tight margins mean lots of gas is being flared or vented, which can’t go on forever admit growing environmental concerns.

The answer to the abundance problem, though, is not less production but more markets. The Trump administration is actively pushing natural gas exports around the world through its aggressive trade agenda. A deal with Germany to build two LNG import facilities in exchange for removing tariffs on automobiles is expected soon. Energy also remains at the center of the Trump administration’s goals for negotiations with China. The approach is a win-win for the US oil and gas industry, the economy, and job-seekers.

Finally, we should not forget that shale production is a capital-intensive process and most wells have rapid decline rates after the first year. That means a lot of new drilling and infrastructure construction will be necessary to sustain and expand current output expectations.

The other issue is that oil is undervalued by the market right now. The prompt-market is tight. The forward curve is in backwardation. The current price is based on worries about a future recession that’s not coming. Market speculators, hedge funds managers, and other Wall Street investors are fretting about the Trump economy and stubbornly expecting global demand to crash. Unless there’s a deep 2008-style recession, though, the outlook for oil demand remains good.

Forbes · by Dan Eberhart · June 29, 2019

1 Like