Oilfield service pricing on the move

OILFIELD SERVICE companies, like exploration and production companies, have been battered by the industry downturn, offering deep concessions to customers to stay afloat. Some didn't manage. One hundred and ten North American oilfield services providers filed for bankruptcy from the beginning of 2015 to December 2, 2017, according to Haynes & Boone. For the rest, 2017 may offer a glimmer of hope as oil prices steady and E&Ps cautiously, but optimistically, advance drilling and production plans.

For our January issue, EY's Deborah Byers told me there'd likely be "a lot of pressure" on service companies to "deliver some of the efficiencies and price reductions that they've given up as concessions" when the market revives in 2017. Efficiencies, sure, but what about price concessions? Service companies will have to ratchet up prices. When and how much? Much of what I've heard is rooted in supply and demand, and it is starting to take shape.

"Oil service pricing is rapidly moving higher in North America due to a lack of available equipment and labor," Evercore ISI analyst James West told me via email in late January. "The bottom was established in 3Q with pricing rapidly moving up to start this year as E&P companies struggle to secure equipment necessary to provide the production gains they promised their shareholders."

In keeping with that sentiment, Wood Mackenzie reported in late January that service costs will increase in 2017, but not to 2014 levels. Offering a few specifics, WoodMac said its "base case well cost inflation is 10% with pressure pumping and proppant poised for the strongest recovery. A risk to the upside comes down to region and price. Firms with assets in West Texas could realize greater margins, and have already felt a labor/equipment pinch in Q4 2016 driven by demand. Expect inflation to rise as South Texas and Williston Basin assets compete for resources in a $55-$60/bbl price environment."

Further, WoodMac points to 20% cost inflation on pressure pumping, "underpinned by increasing frac intensity and job size on the demand side, as well as cannibalization and lack of repair/maintenance on the supply side. Downside to our view is 1) more IPOs like Keane Group flooding the market and 2) more stacked equipment re-instated rather than retired (we assume roughly 30% of peak horsepower exits permanently in our base case)."

The proppant market saw "pricing power" already in 2016, WoodMac said, noting inflation expectations of approximately 15% in 2017, as proppant demand is likely to "increase heavily in 2017 on account of 1) continued gains in rig count and subsequent fracking, 2) continued DUC drawdown (30% lower breakevens compared to new wells), and 3) flat to rising proppant loading. As demand, and inevitably prices, for low-cost proppant rises, we expect more operators to draw from a supply of competitively priced medium to high-cost proppant."

Drillers may see "a modest cost inflation of up to ~10%," backloaded to H2 2017. WoodMac views pricing power for this group "limited" as "1) more long-term contracts from 2014 are rolled off into spot market pricing and 2) excess high-spec rig capacity is not fully absorbed until late-2017. With rig efficiencies improving during the downturn, operators appear to be less concerned about rising day rates."

E&Ps are discussing the issue and various scenarios. From a late January stint in Dallas and Midland during which Evercore ISI analysts met with Permian E&Ps and FTSI, a private pressure pumper, a glimpse of thoughts on the matter: "From an operator perspective, we heard a range of expectations regarding service cost inflation with one operator acknowledging the inevitable, another highlighting how increased efficiencies (piping water, pad drilling, bigger wells) can offset inflation, and another claiming that better well performance (through diverters, longer laterals, higher proppant) can offset the brute impact of cost inflation." RSP Permian gave "the most intellectually honest response," the analysts said, when it offered that "after oil increased by +20% it's only natural to expect service costs to rise by a similar magnitude, and that is acceptable given per well NPVs would increase on an absolute basis."

In late January, Seaport Global Securities (SGS) analysts met with various E&P companies in Denver, and the takeaway was similar. "Overall, a hyper focus and consistent message on service costs – a 10% increase YoY was expected from just about everyone," they said. As expected, the companies will keep an eye on costs. Synergy Resources told SGS that it will strive to "offset some upcoming service cost inflation with savings from incremental operational efficiencies," SGS reported, noting a "new benchmark on a recent 12K ft. lateral, TD'ed in a record 7.4 days."

Going back to the WoodMac report, price increases will mean different things to different E&Ps. "When activity increases, being vertically integrated offers insulation from spikes in service pricing. Oasis Petroleum and Pioneer Resources have their own pressure pumping fleets; EOG and Southwestern Energy have their own sand mines. Companies like these will be shielded, to some extent, from extreme re-inflation driven by service supply shortages," the firm said.

E&P companies are strategizing to offset the costs. What about investors? "For investors looking for a tangible moment when they can expect the return of service cost inflation, we would focus on the rig count. We believe there are about 800 of the latest generation drilling rigs in the marketplace today. A ramp in activity toward that level would embolden service companies to seek stronger pricing for services," offered Mizuho Securities USA Inc. in a mid-January note. As of this writing, the US rig count reported by Baker Hughes was 712.