Shale-gas drilling boom props up oilfield services sector
North America's shale-gas plays supported the oilfield services industry during the economic downturn, but the boom times won't last forever
OILFIELD services companies have done spectacular business in the US and Canadian onshore markets in recent months, thanks to the shale-gas boom. But with deep-water Gulf of Mexico (GOM) still off limits and global opportunities looking distinctly patchy, the longer-term outlook for the services sector remains uncertain.
The main players showed big gains in both revenues and profits in North America during the first nine months of 2010, driven by increased business volumes resulting from soaring demand from shale-gas producers. While there has been some easing of activity in the North American gas sector, with US natural gas prices depressed, a switch to shale plays with a greater content of more valuable liquid hydrocarbons has, for now, taken up the slack.
Halliburton chief executive David Lesar said recently he expected the shift to oil and liquids-rich shale basins to offset the reduction in natural gas activity and that this would "remain a catalyst for increasing services-sector intensity in 2011, sustaining the growth opportunity in North America".
While dry gas still accounts for more than half of onshore drilling activity in the US and Canada, activity in oil- and liquids-rich areas could soon match it, analysts say. But for exactly how long oilfield services companies will benefit from such strong demand is a matter for conjecture, with few observers willing to speculate about the market beyond 2011.
Andrew Gould, Schlumberger's chief executive, has suggested that the market could ease towards the end of next year. "At some point, sufficient capacity will come on stream to bring down pricing across the hydrocarbon spectrum. It doesn't matter whether it's dry gas or liquids," he told analysts in October. "I don't think that's going to happen until the second or third quarter of next year, but there is a risk it will eventually happen."
Buoyant North American onshore activity has more than compensated for lost business in the deep-water GOM, where the fallout from April's Deepwater Horizon disaster and the associated oil leak from BP's Macondo well resulted in the imposition of an offshore drilling moratorium. While the likes of WesternGeco, Schlumberger's seismic arm, continue to benefit from demand for surveys on the outer continental shelf, growth opportunities for other services remain limited for now.
But sector observers say lost business in the Gulf has not proved a significant blow for the services sector. "The GOM is important in deep water, but it's not so significant that it offsets the strength of onshore North America," says Mark Urness, head of energy research at Credit Agricole Securities in New York.
The ramifications of the Macondo blow-out for the sector extend beyond a halt on drilling, however. By late November, the extent of Halliburton's potential liability for its work on the well was unclear. A US national commission on the oil leak concluded in late October that both Halliburton and BP knew of flaws in the cement type used by Halliburton in the well before the accident, but did not address the problem. The finding ignited fears that Halliburton could end up with a greater financial liability than previously expected. Halliburton, which argues that BP was responsible for checking the cementing, has questioned the commission's findings.
Indemnity held by both Halliburton and Transocean, the owner of the Deepwater Horizon rig, should protect them from accruing substantial losses, whatever the outcome of investigations into the incident. But one or both firms could choose to accept some liability for the accident in an attempt to move on from what could otherwise be years of legal wrangling.
"BP will probably be unable to put it [Deepwater Horizon] behind it for a decade, but Halliburton and Transocean would like to put it behind them in 2011," says Urness of the tragedy.
One wider effect is that the post-Macondo world is likely to be one of higher deep-water drilling costs, because of the need for comprehensive safety inspections and more complex equipment requirements for blowout preventers. But these increased costs are unlikely to be borne by the services sector, which will pass them on to their clients.
When the North American shale boom eventually runs out of steam, services companies will be hoping a counterweight will be provided by a post-recession pick-up in economic fortunes and drilling activity elsewhere in the world. However, a glut of capacity in many markets beyond North America is preventing some firms from raising prices. "As long as there is capacity available, it's hard to convince customers to pay more," Peter Ragauss, Baker Hughes' chief financial officer, told an investor conference in November.
Brazil's deep waters are already presenting firms with some of their highest growth rates outside North America. And Brazil looks set to remain a strong market, especially if the country's hydrocarbons law is changed to permit a new production-sharing model, boosting investment from international oil companies. Planned oil-sector expansion in Colombia and Ecuador is also providing reason for cheer in Latin America.
Mexico, however, is not. A hiatus for reappraisal of the development of the challenging onshore Chicontepec field, where production targets have been missed in recent years, has led to a collapse in activity. The number of rigs operating in Mexico fell by around a third in the year after September 2009. That has caused a big retrenchment in the country for most oilfield services companies. In October 2010, Weatherford International said it was working on only three drilling operations in Mexico compared with 50 in fourth-quarter 2009.
Iraq risks remain
Iraq should also become more profitable for services companies after a year incurring start-up costs during the initial stages of a long-term expansion of drilling activity, partially through aggressive pricing to secure business in this potentially lucrative market. But caution over a heavy commitment to big long-term projects in the country is likely to remain, given the high risk of continuing instability.
Says Schlumberger's Gould: "Everyone has equipment there. Everyone is doing callout work. It's not necessarily in big contracts. I think the real question is how much of an appetite you have for the project activity." Assuming the risks of incurring large penalties for late delivery – so-called liquidated damages – in a country where a company would not have much control over logistics or security is not an attractive proposition, he says, adding: "On big projects, we will be cautious, for everything else, we will be aggressive."
Russia, the UK North Sea, China and southeast Asia in general were other markets showing signs of life. The main companies are also hoping for a pick-up in deep-water activity beyond the Americas. Angola could start to bring in rewards, now that rigs are being put in place for the latest phase in offshore development. The picture for Nigeria, west Africa's other big offshore oil province, remains unclear, with the timetable for several big projects yet to be firmly established, and the security situation is deteriorating. The high cost of operating in both Angola and Nigeria is a disadvantage for services firms.
"You need to have a certain amount of scope and work to be able to cover that cost base. And over the past several quarters, we really haven't had the volume of business to absorb that high-cost structure, but we see that perhaps that is starting to change," says Halliburton's Lesar.
"Looking at the international outlook for next year and into 2012, there are pluses and minuses, but the pluses tend to outweigh the minuses," says Credit Agricole's Urness.
The existing bright spots around the world, together with the strength of the North American market, helped the sector's two largest firms to produce respectable-looking headline figures in their third-quarter results.
At Halliburton, an overall rise in third-quarter net income to $0.54bn from $262m masked declines in all regions outside North America. Third-quarter operating income in North America rose to $0.57bn from $37m a year earlier, with growth in onshore projects more than making up for a decline in activity in the Gulf. The company expects capital expenditure to rise to $2.5bn-3bn in 2011 from an expected $2.1bn in 2010.
The company's strong position in the provision of pressure-pumping equipment and hydraulic fracturing (fracking) techniques, much in demand for North American shale drilling, ensured a spectacular performance. Halliburton hopes to expand its strong position in fracking to potential international markets, such as India.
But controversy has cropped up for Halliburton around fracking as well as in the GOM. In November, the company was issued with a subpoena by the US Environmental Protection Agency (EPA) demanding that it provide the recipe for its fracing fluids – which are pumped into shale wells, creating tiny cracks that release gas trapped in the highly impermeable rock.
The EPA is investigating whether the fracking fluids used by various firms could be harmful to drinking water in some areas. Halliburton had claimed the level of detail requested by the EPA was "unreasonable". Seven other firms, including Schlumberger, BJ Services and Weatherford, had already supplied the requested information at the time. Halliburton has since disclosed detailed information about its fracing-fluids components through its website.
Schlumberger's net income more than doubled in the third quarter, to $1.7bn from $0.79bn a year earlier, while overall revenues rose to $6.85bn from $5.43bn, on the back of North American growth. The results reflected one month's activity from Smith International, whose merger with Schlumberger was completed at the end of August. Smith contributed revenue of $0.81bn and pre-tax operating income of $84m.
But Schlumberger, which has the sector's strongest global presence, concedes that outside North America, activity has been mixed. While demand in Asia, Russia, the North Sea, and west and South Africa have remained relatively buoyant, North Africa and the Gulf of Guinea have been weak. Latin America, outside the problematic Mexican market, performed strongly, the company said.
Gould is "very pleased" with the rapid progress made on integrating Smith and the M-I Swaco joint venture the firms had run together before the merger. "The integration teams and the area co-ordinators are rapidly identifying both revenue and cost synergy opportunities that augur well for 2011," he says.
Schlumberger says Smith's role as a large supplier of drill bits has strengthened the firm's product range. But some analysts continue to question whether the hefty price paid by Schlumberger – around $11bn in an all-share deal – plus the costs of integration were warranted, given the M-I Swaco joint venture had already given Schlumberger access to one of Smith's most attractive assets, its drilling-fluids business.
"There will be advantages from owning Smith, but it's going to be 2012 and beyond before they start to reap the benefits of the deal," says Credit Agricole's Urness.
Schlumberger has embarked on a share buy-back programme designed to realign its capital structure following the Smith merger, which was an all-share deal that closed in August 2010. Schlumberger issued 176m shares during the process, worth $11bn, but has since repurchased 6.8m shares for a total purchase price of $396m. "We expect to be aggressive and opportunistic with our buy-back programme," says Schlumberger chief financial officer Simon Ayat.
While there is unlikely to be another merger on the horizon rivalling the size of the Schlumberger-Smith deal or Baker Hughes' $6.8bn acquisition of BJ Services, mergers and acquisition activity is likely to pick up, as business recovers from the economic downturn.
Bernard Duroc-Danner, Weatherford International's chief executive, claims the sort of projects likely to emerge in Iraq and the shale-gas sector would be best served by larger players. "We need to get larger," he says, hinting at more deals to come.