Crunch looms for U.S. service/supply sector

Richard Wheatley
Associate Managing Editor-News

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A leaner U.S. oil field service/supply sector is benefiting from increased industry activity levels and higher volumes of oil and gas production worldwide. But higher activity levels have put the sector in a catch-up mode. Supply companies and especially drilling and service rig contractors are having to cope with trying to meet operator demand for drilling units and related components in a business environment punctuated by shortages of equipment and experienced personnel. Those were some of the messages delivered recently at the Randall Morton International Inc. oil field forum in Houston.

Catching up

Volume, not price, is the market factor to be reckoned with today, stressed C. Russell Luigs, chairman and CEO of Global Marine Inc., Houston, adding that 1997 is a period of growing hydrocarbon consumption amid worked-off excess production and rig capacity. "We've got at least 5 good years out there, so enjoy it," said Luigs, who also cited the detrimental effects of oil and gas industry restructuring on his business sector. While hydrocarbon demand has been increasing, the industry as a whole has been cutting back, said Luigs. "Concurrently, in recent years, what we've been doing is downsizing and rightsizing and reengineering and (doing) total quality management and so on and so forth, all of which, ultimately, are euphemisms for cutting back. We've cut back on the number of rigs; we've cut back on the manufacturing capacity to provide oil field equipment. "As an industry, we did not hire a whole generation, and then we turned around and gave early retirement packages to the graybeards who should have been training the people who never got hired." Luigs said that oil service/supply companies and rig contractors are now having to sprint from a long period of excess capacity and oversupply-"and all the economic devastation that goes with that-and, overnight, we're going to shortages, and that is going to be another big challenge."

Land rig scene

From the perspective of a land rig contractor, prices and revenues "are beginning to get to the point where we can adequately replace and rebuild the fleet," said Eugene Isenberg, chairman and CEO of Nabors Industries Inc., Houston. But Isenberg was quick to caution that economics still are not at the point where land contractors can comfortably build new rigs. And, he said, older, top-quality, used rigs are hard to find. Also, years of attrition and cannibalization of parts have taken a toll on land rig supply (see tables, this page). "It's almost impossible to get good quality used equipment," Isenberg said. He said the reactivation cost of a 20,000-ft-rated SCR land rig was almost $2.5 million about 4 months ago but now is about $5 million, while the costs of refurbishing, or buying the same rig new, are about $7.75 million and $12.45 million, respectively. To buy the same rig new would require day rates of $16,600-18,800/day to generate a 15% or 20% internal rate of return. But Isenberg said day rates are currently averaging only $6,000-$8,500.

One analyst's views

"I think we're in the first or second inning of the overall oil service cycle," said Marshall Adkins, research vice-president and oil service analyst for Raymond James & Associates, Houston. Adkins addressed overall market fundamentals and the question of whether or not the service/supply segment is on the verge of a boom-and-crash period similar to 1981-82. Adkins said the current business cycle has closer comparisons with the 1963-73 business cycle than with the cycle of the mid-1970s and early 1980s. "This is a very long-term, cyclical business...a 2-3 decade time cycle," Adkins said. "It takes a long time to change supply/demand fundamentals." He noted Standard & Poor's Oil Well Equipment and Services Index (now called the Oil and Gas Drilling and Equipment Index), moves up in anticipation of newbuild cycles and moves down in anticipation of the peaks in each cycle (see chart, this page). The market-weighted index measures market value creation based on the combined values of the stocks of seven companies: Baker Hughes Inc., Dresser Industries Inc., Halliburton Co., Helmerich & Payne International Drilling Co., Rowan Cos. Inc., Schlumberger Dowell, and Western Atlas International Inc. "When we look at 1981 and compare the actual rig data that we have to this decade that we're in right now, I see very few comparisons," Adkins said. "In the decade leading up to 1981, we have steadily increasing sizes of the rig fleet. In fact, it was up threefold over the course of the decade. "Over the most recent decade, leading up to 1997, we started from a lower base, number one; and, number two, it's been steadily declining."

Stock price, newbuilds

Regarding the implications for oil service stock prices and price-to-earnings' multiples, Adkins said oil service stocks-currently undervalued-doubled going into the newbuild cycle of 1971. Then, when newbuilding was under way, oil service stocks rose another threefold, he said. In the current cycle, to 1997, oil service stock prices have doubled, he said, noting, "I think we have a lot further to go in this cycle before we reach the top, the heady levels of 1981." He said there was higher rig fleet utilization in 1996 than in 1971, but indicated activity and commodity prices are continuing to drive rig utilization rates upward, even though no land or marine rig newbuilds are occurring on a wide scale. "I think it's (utilization) going to continue to increase. If this thing continues to increase, we're going to start building new stuff; it's going to happen in the next year or two."