For Oilfield Suppliers, It’s Adapt or Die

This post was updated on June 26, 2019. 

Oil prices have rebounded from their 2014 collapse. Yet for upstream suppliers, it’s hard to tell.

It’s going to take more than crude in the $60s to rebalance the oilfield. The problem remains structural. In short, there are too many players chasing too little demand.

Redesigned processes mean onshore operators are more productive. They spend far less on products and services to produce a barrel of oil than just a few  years ago.

Conditions are no better offshore. Drilling contractors, ignoring lessons of the past, borrowed heavily for new rigs. Many were speculative. Fleets of capable-but-costly assets now flood the market. Only the best get the work.

buyer’s market has pushed prices for products and services to the bleeding edge. Suppliers’ doors stay open, but just barely.

The bludgeoning effects of overcapacity are evident in vendors’ financial results. Beginning in 2015, operating margins fell rapidly, eventually turning negative. A string of debilitating losses followed. Last year was worse than the prior.Chart comparing financial performance of various types of oilfield suppliers and E&P companies

Sadly, there’s little reason to believe things will improve soon. In 2017, John Van Leeuwen, head of Lion & Stutz’s consultancy business, noted, “While older, less efficient equipment has been left in the back lot to rust, it’s not enough. Too many oilfield suppliers are still willing to price near breakeven to stay in business. Without a material oil price increase, the only solution may be further bankruptcies.” Two years later, little has changed.

Unfortunately, price-conscious customers hinder progress. As oil prices fell, E&Ps were slow to adjust. Heavy losses and rising debt ensued. To make ends meet, they demanded (and received) deep price cuts from suppliers. There’s been little relief for vendors since.

Cjhart comparing financial returns of shale E&Ps with integrated E&Ps
Chart comparing debt levels of oilfield suppliers and E&Ps
To some extent, vendors are paying the price for a decade of good times leading up to 2014. As oil rose from $30 to over $100 beginning in 2003, suppliers enjoyed unprecedented growth and profitability. To those drawn to it, the oilfield was the gift that kept on giving.

When prices collapsed in 2014, the industry was ill prepared to read the tea leaves. It was too slow to recognize the severity of the downturn—and too quick to predict recovery.

Runaway optimism in the face of the facts led to large overhangs of drilled-but-uncompleted (DUC) wells in North America. Most will begin producing in the next 12 months as bottlenecks fade and costs fall. The looming surge in production sits like a wet blanket on oil prices through 2020—as does production currently be withheld by OPEC.

Meanwhile, investors have soured on the sector even as the broader market hits new highs. The skepticism is understandable. Many E&Ps have shown little in the way of discipline, prioritizing production over returns. A half-hearted fixation on breakevens did little to restore confidence.

It’s not hard to see where this goes. Given the languor of commodity-prices, and the general frailty of the industry, suppliers need to resize and re-prioritize. Many still operate in a different era—too broad in scope and overly dependent on debt. They under invest, employ aging systems, and struggle to attract talent.

As currently structured, few suppliers stand a chance of covering their cost of capital any time soon. And customer satisfaction lags far behind that of other sectors.

Chart comparing oilfield suppliers segments customer satisfaction scores with those of other segments of the broader economy.
In the face of overcapacity some vendors will roll the dice, expanding their organizations in new directions. Flying leaps into the unknown will be sold as bold moves. In most cases, the hoped-for results won’t pan out.

For example, Schlumberger’s acquisition of Cameron Int’l was a costly effort to link disparate well-site processes via a single neural network. While alluring, the strategy has met with skepticism from customers loath to embrace expensive platforms that limit their options. It’s not clear these hurdles can be overcome.

Schlumberger also blurred lines with customers by pursuing greater numbers of production-sharing arrangements, while also ramping up direct E&P investments. The result is additional conflicts-of-interest and commodity-price exposure—a combination that could damage its reputation.

The smarter path  is to tighten the focus and lower costs. This means selling, spinning off, combining, or shutting down underperforming operations. For some suppliers, it may also mean choosing between the dynamic-but-volatile North American market and slower-moving, but larger, international space.

The ideal outcome would be an increase in specialized venders. Such organizations generally excel in quality, service, and financial performance. They also tend to need less debt, aiding in their ability to weather industry cycles. Companies like Core Laboratories, Oceaneering, Dril-Quip, Newpark Resources, Frank’s International and Pason Systems fit this bill.

The financial performance of specialized suppliers is compelling. Since 2013, the group’s margins, profitability, and investor returns have exceeded peers. Accordingly, their stock-price declines over the same period are materially less than for the Oil Service Index (OSX).

Chart comparing returns of oilfield suppliers and E&Ps since 2014.
In the end, the advantage lies with suppliers that accept that the market is oversupplied, understand thst it will likely remain so for years, and adapt accordingly. For some, this means a narrower scope. For others, it means improving quality and customer satisfaction. For others, it means reducing costs via reorganization and consolidation.

Regardless of the approach, it’s time suppliers get real about the challenges they face.

4 Replies to “For Oilfield Suppliers, It’s Adapt or Die”

  1. Doug – this is a really excellent read. Coming at it from the eye of the customer as you have puts things in a new perspective for me. I think the 2016/2017 uptrend in the Lower 48 rig count, frac count, frac spread volumes etc. has masked some very real problems that are still festering just beneath the surface. The chart of how O&G customer satisfaction compares to other industries is particularly revealing.

    It seems as though a financial reckoning is finally happening for the Independents, just as it did in the ranks of the Majors before the downturn. Are the suppliers next in line to face the music? This is an industry that doesn’t change unless it is forced to, and perhaps that day is drawing closer. It starts with a deeper understanding of the customer and then rethinking every process with them in mind. Some in the service industry don’t seem to be building around their customer needs as you point out in this piece. Those strategies might juice margins in the short run, but they could destroy value in the long-run…

  2. Joseph, thanks much for your comment.

    I think your observation that the same financial realities now facing Independent operators are, or will soon be, facing suppliers is a good one. A back of the envelope calculation suggests given the current structure of the sector, there’s little chance the average oilfield supplier will generate sufficient returns on invested capital should oil prices climb toward $70. The main reason is that operators don’t need to spend nearly as much on a given well as they did that last time prices were at $70/bbl.

  3. A great read! I echo your perspective and have cautioned my colleagues in the service sector for a while now to reconsider their current business model.

    I see so many lamenting about commodity prices and wondering when things will recover again. That old school mentality will endure a long, painful death. There is a new world out there and the Energy sector is just a part of it. Those that are most willing to adapt and change, will be successful.

    1. Thanks for the comment, Kevin.

      At some point, for oilfield suppliers, it becomes matter of respect–for themselves, their profession and their companies. The’ve essentially been vassals to the E&Ps. The market is not going to be kind to those who keep running their businesses hoping commodity prices will eventually bail them out. Part of the problem is investors, including private equity, who put money in the sector because of the sector’s reputation for producing large payouts on those occasioins when commodity prices pop. But OPEC is currently holding 1.7 milliom bpd off the market. So, OPEC cheaters will beat U.S. operators to the punch in the case of a price pop. Unless the sector wants to continue on the path it’s one, suppliers need to figure out what works at $50 and settle in accordingly.

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