Real oil service recovery still in the future

The good news is the battered oilfield service (OFS) industry is participating in the recovery. The bad news is how it is being done. When customers trumpet how they can earn acceptable returns at crude prices half of what they were three years ago it is primarily because OFS is denied the same opportunity. Think subsidy.

This means a real recovery—where clients and suppliers operate intelligent businesses that service the capital employed—remains in the future.

This is not to say activity hasn’t improved. It has. According to the Daily Oil Bulletin, to the end of this year’s first quarter there were 2,348 wells drilled on a “rig-released basis,” up an impressive 115 per cent from only 1,091 wells drilled in the same period in 2016. OFS was scrambling for people, just like the good old days. You’d think there was something really good happening.

The problem is pricing. While oil companies recognized they had to pay more, it wasn’t enough when the value of the capital assets being worn out on the job is taken into consideration. While service rates were up in the first quarter, a lot of the increased margin was consumed by higher wages, increased fuel costs and investments in getting equipment back in good working order. Mullen Group, one of the first companies to report 2016 results, indicated fuel was up 40 per cent in the first quarter of 2017 compared to 2016. Many of the experienced personnel released during the downturn either didn’t want to come back or couldn’t take the financial risk of leaving something steady for higher paying but short-term work of unknown duration. Therefore, OFS had to spend precious cash on recruiting and training. That hurt.

Some of the more revealing analysis comes from the U.S., which for the most part, operates the same way. An article on oilprice.com from April 10 by Arthur Berman, a petroleum geologist, reports that, while operators have indeed managed to figure out how to break even on new shale oil wells at US$40/bbl, most of the credit goes to reduced service prices, not oil company genius or more prolific reservoirs.

Public regulatory filings contain data that helped Berman calculate breakeven finding and development costs. Berman credits collapsed drilling and service costs as the major contributor. The Federal Reserve Bank of St. Louis publishes a producer price index for drilling oil, gas, dry or service wells dating back 30 years. After sitting at about 150 for the first five years of this century, the index went through the roof with rising oil prices and the shale boom. It peaked at 455.6 in March 2014, more than triple what it was ten years earlier. It then sank like a rock to 288.6 in January 2017. In March of this year, it was up slightly to 299.2 but was still 35 per cent lower than three years earlier.

In an earlier article, Berman figured the success operators were having putting oil on stream at lower prices was 90 per cent created by collapsed OFS rates and only 10 per cent by advanced technology or improved completion techniques. In the ten years from 2004 to 2014, Berman calculates the cost of drilling a well—including deep water offshore—rose by 400 per cent but now sits 45 per cent below peak levels. When it comes to making money at these prices, this certainly helps the customer. And only the customer.

The reward for higher service prices by some of the more mercenary clients has been intentionally extended payment terms to 90 days or longer. Thanks, buddy. OFS has been a de facto banker for customers since the early 1980s, when heavily-indebted Dome Petroleum advised its suppliers it could not pay them for 90 days due a cash shortage. To everyone’s surprise, Dome’s vendors went along with it. This emergency measure became accepted industry practice by too many operators, a phantom saving baked into prices that makes operating at low margins even more challenging.

But the biggest challenge is servicing invested capital. Examining annual reports for five top public drillers—Precision Drilling, Ensign Energy, Trinidad Drilling, Savanna Energy and Western Drilling—for six fiscal years, 2010-15, revealed these companies invested more than $8 billion in new equipment and upgrades, mostly new-generation rigs for extended-reach horizontals. The owners are currently wearing them out at margins unlikely to reflect replacement cost because OFS cannot extract anywhere near the cost reductions from its supply chain as clients are enjoying.

The new well market is elastic. Cut the price and more wells will be drilled. If the risks and rewards are shared, everybody benefits.

But they are not.

Like this? You should be reading Oilweek.

David Yager is a long-time industry commentator and an oilfield service management consultant in Calgary.

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