Changing landscape of OFS

FIRST, THERE WAS the news that Halliburton brokered a deal with Baker Hughes. Then, details about Schlumberger's agreement to acquire Cameron in hopes of creating a "pore to pipeline" company capable of handling a significant portion of E&P company needs. Shortly after the news posted I heard from one reader-a biofuels, biomass and petroleum consultant, who detailed a few ins and outs about Imperial Chemical Industries (ICI), where he managed new technology for oil and gas drilling projects in the late 80s. ICI, he said, partnered with companies like Amoco, Chevron, and BP. ICI in Canada produced natural gas and owned various service firms, and even provided geological consulting services. Together, he said, the case can be made that ICI was the first "pore to pipeline" company.

Ten years into my oil patch stint, the phrase "pore to pipeline" was one I seldom encountered. Then came the mid-September oil service industry report from Cowen and Company and the notion that the stage may be set for change.

"To succeed in the challenging environment that we foresee over the next three-to-five years companies will need to come up with revised business models that will allow their customers to make attractive returns in a $40-$60 per barrel environment," said Cowen analyst James Crandell.

In terms of the decline in E&P spending, oil service industry observers view the current downturn as "the worst ever," Crandell said. The downcycle of the 80s had "a much more severe impact on the industry," he said, but ultimately, while the decade brought significant consolidation to the space, "there was little change in the way business was done." Companies in the oil services sector waited for prices to improve and then raised prices, he said.

"We believe that the cycle we are in now will be different. We estimate that when all is said and done, the 2015-2016 downcycle will see a decline in global exploration and production spending of about 35-40%, with a drop internationally of 30% and in North America of 50%," Crandell continued, noting Cowen's skepticism of a strong oil price bringing prosperity back to the oil service industry "anytime soon."

The more obvious steps have been taken-workforce reductions, location closures-now what? While just one piece of the "back to prosperity" pie, a sizable portion of what comes next is consolidation, he continued.

How much consolidation is needed/wanted is up for debate.

Crandell offered his view, saying "we need to get down to where there are no more than two or three significant competitors to bring about a more rational pricing structure. While we are already there in some subsectors, in others there is a long way to go."

"The Halliburton-Baker Hughes proposed merger will help to the extent that most product line consolidations are allowed, but there may well be several that are not allowed, starting with bits and logging while drilling which Halliburton has agreed to sell, and others such as certain gravel packing or completion tools, offshore cementing, and offshore stimulation. However, many of the consolidations - such as wireline and drilling fluids - may well go through," he continued.

Technology introduction is another large piece of the pie.

"It is not just consolidation and cost reduction that will return the industry (or certain companies in the industry) to prosperity. The two other keys to the environment we see ahead are technology introductions, which can lower the costs of drilling and completing wells, and partnering with oil companies to jointly work on items that can lower costs such as standardization," he explained.

Cowen calls Schlumberger "the most-forward thinking company" in regard to standardization and technology. "By acquiring Smith International it can apply its technology to the drill string and by acquiring all of Saxon it gives the company an integration platform through ownership of drilling rigs." And now, should the deal to acquire Cameron come to fruition, "Schlumberger can integrate its reservoir technology with Cameron's wellhead and surface technology, forming a complete drilling and production system as Schlumberger would automate and run Cameron equipment with software." The key, he said, "is not only that integrated service lines would bring down development costs but that this can give a further push to performance based work which Schlumberger is emphasizing. This is the type of transaction we need to continue to see to make the industry go forward with drilling and development plans in a $40-$60/bbl world."

Is this integration of equipment and service/engineering the beginning of a new age in the oil service industry?

I posed that question to Wunderlich Securities analyst Jason Wangler recently. The discussion about the changing landscape of the oil services industry is one that, in his experience, "ebbs and flows in the energy patch quite often with larger players (aka SLB and the CAM deal) trying to be the complete service provider, while smaller players argue that clients like to have choices, multiple bids, etc."

For some, especially internationally, he said, "we continue to see a move toward a one-stop shop," but the US landscape contains "multiple players, lots of bids, and a fight for the lowest price. It is yet to be determined how that changes given the downturn," he said, but for now, E&Ps like the competition of many players.

As this issue hits desks, existing OFS companies are learning the fate of their bids for HAL assets being sold prior to the DOJ review of its acquisition of Baker Hughes. With that, some E&P companies learn where they may turn instead of HAL for certain products and services.

One way or another, the landscape is changing.