Oil service companies bear brunt of downturn
Pessimism has arrived as oil companies continue to make cuts
The quick and steep drop in the oil price over the past year is causing pain across the industry, but nowhere is it felt as deeply as in the oilfield services business.
Oil service companies’ fortunes turn on the upstream sector’s budgets and drilling activity, which in turn depends on the oil price and optimism about the future. After the oil sector’s quick recovery from the financial crisis, the oil service sector -- everyone from drillers to frackers to pipe layers to seismic surveyors and offshore rig operators -- enjoyed a golden age of surging demand and expansion. They took on tens of thousands of new employees and pumped money into research and development that helped push the industry into new deep-water and unconventional frontiers.
But in just a few months a deep pessimism has settled in, and the sector’s outlook has turned grim. As oil prices have plunged, exploration and production companies are slashing drilling budgets, pulling rigs out of action, putting off projects and demanding lower prices from contractors, setting the stage for an extended period of pain for the service sector.
Upstream spending is being slashed across the board. Mid and small-size North American drillers will cut spending by around 30% this year, according to Deutsche Bank. International mid and small-cap companies will cut by 34%. National oil companies will spend about a quarter less this year than last. The supermajors have only announced spending cuts of around 11%, equal to about $20 billion, but many expect further reductions.
In total, the industry’s capital spending will be down at least 20%, more than $100 billion, much deeper than the cuts seen after the financial crisis and the oil crash of the late 1990s. That will translate into far less demand for oilfield services.
The reduced spending is being felt in the oil patch. The rig count, a proxy for oilfield service demand, is down globally about 8% from a year ago and probably has some way still to fall. In North America, the rig count as of mid-March had fallen by a third from a year ago and was at its lowest level since the financial crisis and the early 2000s before that, according to Baker Hughes data. The US oil-directed rig count will likely be half what it was in 2014 when it hits bottom.
Where drilling is still going ahead, oil companies are demanding the service companies do more for less. Many exploration and production companies are looking to reduce their service costs by as much as 30%, compounding the pressure on service providers’ bottom lines.
That the swift turnaround came after a period of unprecedented growth for the oil service companies has only made the need for cutbacks more severe. Bernstein Research, an investment bank, tallied at total of 40,000 job cuts across the sector announced since September 2014, 6% of the workforce. Schlumberger has laid off 9,000 of its workers. Baker Hughes plans to sack 7,000 people. Weatherford has let go of 5,000 of its workforce. Offshore specialists have been particularly hard hit as business dries up. Brazil’s EAS cut 40% of its staff. Norway’s Odfjell Drilling cut 37%.
Bernstein reckons more layoffs are coming. As much as 20% of the sector’s workforce may have to be cut, Bernstein says. That could mean more than 100,000 job losses before the recovery comes. Wages will also have to fall in a sector where until recently new graduates were in such high demand they could expect to make more than $100,000 a year.
Investors are feeling the pain too, as earnings across the sector plunge and companies are forced to take on more debt. The PHLX Oil Service Sector index, which is traded on the Nasdaq and includes the major international oil service companies, is down 40% from its peak last summer, when oil prices were well over $100 a barrel. Again, offshore specialists have been hardest hit. Transocean, one of the largest offshore drillers and rig operators, has seen its shares fall by 60% from a year ago.
The slowdown offshore and beyond, Bernstein reckons, is set to lead to a harsh multi-year offshore services recession, much worse than previous downturns, as operators hit the brakes on projects around the world because of lower oil prices.
The next few years will be the slowest for new offshore projects in at least two decades. “Our forecast for the four years of 2014-17 amounts to seeing 50% fewer new projects than the industry has become used to,” Bernstein analysts said in the report. “In fact, our forecast suggests the recession in offshore demand will lead to work levels last seen in the 1990s, when the oil price was below $20/b.”
Bernstein used upstream companies’ final investment decisions (FID) for new offshore projects as a barometer for near-term services demand and found a sharp slowdown. Just 34 new projects holding 9bn barrels of oil equivalent (boe) will be sanctioned per year from to 2017 compared with 74 FIDs a year covering 22bn boe from 2000 to 2013.
This year will likely mark a low point, with just 19 new offshore projects getting sanctioned, compared with 86 as recently as 2012 and the lowest level since the early 1990s when the offshore oil business was much smaller than it is today. That means far fewer new contracts for service companies to bid on, and far more competition for those contracts that are put out for tender. For oil producers, that means they’ll be able to pit companies against each other to extract price cuts. But for service companies it means lower margins.
Moreover, many offshore fields that are under construction now will be slowed down or halted altogether as oil company management wait for an oil price recovery. While it’s true the economics for these fields will depend on the oil price over the lifetime of the projects, which will be more than 20 years, companies, especially those expecting an oil price recovery, could still look to put off projects until there are more favourable conditions.
The problem for companies with projects already underway is that the oil price now is far lower than when the decision to move forward on the project was taken. It will be an unfamiliar position for many oil companies coming after more than a decade of generally rising oil prices. Bernstein’s analysis shows that for the average offshore oil project over the past 13 years, the oil price was $15/b, or roughly 40%, higher when it started production compared to when the FID was taken. That made management look smart and helped mask the industry’s endemic problems of delay and cost overruns.
Bernstein analysts say that a lower oil price will inevitably make companies more cautious. “In a negative environment, we believe oil companies will defer decisions and slow the ‘define’ phase. This ebb and flow is crucial to oil services companies, as it drives demand in a given year,” says Bernstein.
The UK and Norwegian North Sea and US Gulf of Mexico in particular could see field start ups delayed as a large number of projects in the pipeline were sanctioned when oil prices were well over $100/b. For instance, Anadarko’s Gulf of Mexico Heidelberg oilfield, scheduled for first oil later this year, was sanctioned when the oil price was around $110/b. It could take years before projects look as good as they did when they got the green light.
To cope with low prices, successful service companies will have to shed assets, cut costs, keep winning new business even at lower margins and keep their balance sheet in order to maintain access to financing. A wave of mergers and acquisitions, which kicked off last year with Halliburton’s $34.6bn takeover of Baker Hughes, is likely to hit the industry in late 2015 as some companies see their positions weaken.
This could provide an opportunity for bigger companies with relatively strong financial position come out of the downturn stronger. Schlumberger has said that it will look to do deals to keep pace with the new, much larger Halliburton. “We see the current environment as being flush with opportunities for us,” Paal Kibsgaard, Schlumberger’s chief executive, told analysts earlier this year.
The new oil price dynamic could also lead to a change in the relationship between the service and upstream companies. As producers try to squeeze lower costs from the services sector, the relationship is likely to become more combative and less collaborative than it has been in recent years.