People forget how fast you did a job - but they remember how well you did it…
Howard Newton
……and how much you charged!
Our image of the oil & gas industry is mainly driven by the Majors through their marketing arms – after all, we see the names Exxon, BP, Shell, Total etc every day as we drive. Subsequently, we recognize that these big companies explore for, develop and produce oil and gas, and figure in the ‘top ten’ when all types of companies are ranked by market capitalization. In contrast, most members of the public would struggle to recognize the name of a single AIM oil & gas company.
There is another sector of the oil & gas business that bypasses public recognition, but that ‘professionals’ in the industry know all about, and that is the oilfield service contracting industry that is driven by revenues from the Majors, from NOCs, and others. Bernstein Research estimate that the oilfield services industry generated revenues of almost $246bn globally in 2007 and that this figure will rise by more than 10% in 2008.
These massive revenues have not passed unnoticed by the private equity houses and a recent Sunday Times article (13th April 2008) recognizes this trend in a discussion of potential bids (allegedly from Kohlberg Kravis Roberts and Candover*) for the UK oil services firm Expro:
“A possible battle for Expro, which specialises in deep-sea oil and gas technology, underlines the huge interest in businesses that provide specialist services to the energy sector, which is booming on the back of record oil prices.
There has been a flurry of recent deals resulting in firms going for eyewatering prices.
Expro has been another beneficiary of the boom. In 2007 it made underlying profits of £72.5m on sales of £518.8m, and last week it said full-year profits would be at the top end of management expectations.
Demand for the company’s services has soared as international oil companies increase exploration work worldwide and national oil firms become more able to finance their own exploration work.”
My question is - what is going to happen next? Analysts (for example HSBC and Morgan Stanley) have been fairly bullish about continued medium term revenue growth driven especially by deep water developments, exploration and LNG. The public pronouncements of the larger service companies are nowadays routinely optimistic – see for example an April 7th presentation by the Chairman & CEO of Schlumberger at:
http://www.slb.com/content/news/presentations/2008/20080407_agould_louisiana.asp
and by Weatherford at:
http://library.corporate-ir.net/library/77/777/77782/items/286056/4-3-08_Pres.pdf
However, the sector has a reputation of being highly cyclical, with the drilling and seismic contractors particularly responsible: in an earlier article (“House of Cards”, from early 2007, but which can be accessed in my OilVoice columns with a 17th April 2008 date)), I looked at the seismic industry’s painful history since 1990 and I don’t plan to earn more brickbats from my friends in the geophysical service sector by focusing on that time again!
Drilling and seismic are but two of a dozen or so separate sectors within the broad oilfield services industry which is quite diversified technically, but US and European-centric, with typically a small number of larger companies having the dominant share of any one sector. As a general guide, ~4% of the total spend is on seismic, ~25% on drilling (onshore and offshore combined), defining these as ~$10bn and ~$62bn per annum sectors respectively.
So, there is a lot of money flowing into the oilfield services sector in general and into drilling and seismic in particular. The sector may not be visible to the general public but are knowledgeable investors (including canny oil & gas ‘professionals’) rewarding the companies involved with share price growth in these good times? The answer seems to be – it depends.
The table below shows the change in share price of nine oilfield service companies from early April 2007 to early April 2008. The first three, Schlumberger, Baker Hughes and Weatherford, can be described as integrated, offering services across a number of sectors; Petrofac is a global facilities and infrastructure provider; the next two, PGS and CGGVeritas, provide a broad range of seismic services; the next three, EMGS, OHM and GETECH provide specialist or ‘niche’ geophysical services:
Company % Change in Share price, April 2007 – April 2008
Schlumberger +43%
Baker Hughes +5%
Weatherford +62%
Petrofac +40%
CGGVeritas -1%
PGS -18%
EMGS -82%*
OHM -64%**
GETECH -47%***
* from IPO in early April 2007
** -72% from mid-2007 peak price
*** -54% from IPO in early April 2006
So what’s going on here? Let’s start at one end so to speak and look at the most recent Trading Statement from OHM (it could equally well have been EMGS’s, for example):
“24 January 2008
Offshore Hydrocarbon Mapping plc (“OHM” or “the Company”)
Trading Update
Offshore Hydrocarbon Mapping plc presents the following trading update for the six months ending 29 February 2008 and full year to 31 August 2008.
It has become apparent to the Board that two issues are affecting our business at the moment: the lumpiness of market adoption and a pronounced seasonal imprint on the CSEM market. These issues mean that it is likely that the Company’s performance will fall significantly short of the Board’s expectations for the half year to 29 February and for the full year to 31 August 2008.
Market Adoption: Controlled Source Electromagnetic Imaging (CSEM) is becoming accepted as a mainstream exploration tool, however, as we move through the adoption curve, order flow is proving to be lumpy – the same happened in early stages of adoption of 3D seismic.
To date, CSEM technology has been used by predictable early-adopters and first-movers. There are good signs that the late majority will follow soon as significant budgets for CSEM are being created.
Seasonal bias: On a regional basis, driven by government acceptance of the technology in Norway and UK, oil companies are including CSEM in their planned work programs for new licenses and adoption is proceeding well. In other geographies, adoption has not yet moved at quite this pace which results in a significant seasonal bias to the overall CSEM market.
OHM had anticipated this seasonal downturn in demand for work and had planned to occupy its vessels on data library surveys, inter-leaved with our share of a number of significant planned proprietary surveys that we had identified and which were in negotiation.
Delays in getting permits for our South East Asian data library program resulted from the novelty of CSEM technology and cost recovery issues under Production Sharing Contracts has delayed this program until these are resolved. A number of large anticipated proprietary programs in the region have also been delayed contributing further to a gap in demand.
Anticipated proprietary work programs in West Africa have also been delayed and, in one case, cancelled. OHM Express’s rapid transit-capability leaves it well placed to mobilise for these programs as they come to award and, until then, we are likely to continue creating future value in our Northern Hemisphere data library.
OHM currently has the capacity to field 2 crews with a 3rd planned to enter service in 2008.
While seasonal demand in the summer has been enough to keep OHM and its competitor’s crews occupied, winter demand is predictably much less and accordingly there is currently significant over-supply of capacity.
We believe that the OHM business model is flexible and robust enough to accommodate both the pace of adoption and seasonal fluctuations. OHM operates with a mix of long- term and short-term chartered vessels in order to accommodate such potential fluctuations in the market. In addition, our long terms charters allow us to significantly reduce charter costs during periods of temporary inactivity.”
My apologies for quoting this statement at such length but I do so because it illustrates a fundamental problem of both ‘niche’ and ‘single sector’ service providers, namely predicting what the order book, and therefore revenues, will look like over a 12 month period (corresponding to their customers’ capital expenditure/budget cycles); at an IPO for example, my guess is that brokers are drawn towards the more optimistic predictions.
More integrated companies, offering services across several sectors, are probably more able to predict what their total order book and revenues will look like and, perhaps, benefit from drawing at least in part on their customers’ operating expenditures which tends to be a little more stable than capital expenditure (as I recall!). Although specialised, deep water drillers are able to negotiate 3+year deals for new 4th and 5th generation rigs; such extremely predictable revenue is not available, say, to drillers onshore in North America.
The table above suggests that canny investors recognise these issues and are rewarding integrated companies and/or those that are somewhat specialised but with good geographic spread – direct sensitivity to high oil & gas prices seems less important.
So in predicting the future for the oilfield service sector, it may be sensible to focus rather less on oil & gas prices – although there will obviously a downward shift in spend if there’s a significant fall in oil and gas prices – and look at the future another way, namely by considering the question as to whether the current high level of spend is delivering value for money? Before seismic and drilling companies send me some (even more!) hostile e-mails, let me say that what I mean is whether there is any evidence that as a whole companies and NOCs are improving their situation by spending this amount of money?
To think about this, I want to review what’s happened recently in:
1. global exploration performance, and
2. delineation drilling, to mitigate field production decline
towards which we can assume that much seismic and drilling spend is targeted (although I’m conscious that I am neglecting the whole area of development drilling).
On global exploration performance, we can say that by the end of 2007:
1. Global exploration discovery volumes had been on a generally down-ward trend since the first half of the 1970’s, with 2006 volumes down on 2005, and, whilst the facts about 2007 are not yet fully recorded, it does seem that:
2. Overall, global exploration performance was again weak, despite significantly increased expenditures, with a shrinking number of large (>250mm boe) discoveries.
3. Deep water exploration saw a surge in activity but a further down-turn in success, with total discovered volumes and average discovery size, continuing a 21stC declining trend, despite the 2006 opening of the so-called “Lower Tertiary” trend in the western Gulf of Mexico Deep Water and of the sub-salt play in the Santos basin, offshore Brasil (in 2007).
Many industry analysts and observers call for even more exploration expenditure so as to increase global discovery volumes. However, it’s my view that this is a bad call – global exploration as a whole is hitting a buffer that’s due to the rocks and simply escalating expenditure won’t solve the problem.
Global exploration is an ‘open book’ compared with figuring out the impact of delineation drilling on lessening production decline. Matt Simmons has reported on the decline issues many times: a good recent example can be found at:
http://www.simmonsco-intl.com/files/NYC%20SCI%20Investor%20Lunch.pdf
The issues are that there is a general vacuum of decline data, especially from the major OPEC producers, and that where field decline data is available, for example, in the Deepwater Gulf of Mexico, the North Sea, Alaska, Mexico and Oman, the picture is alarming. Fields routinely decline at ~20% per year and even ‘hyper-active’ drilling campaigns merely lessen the rate, as opposed to returning the field to any sort of plateau. Again, individual fields are hitting the buffers due to the rocks. Interestingly, in the Schlumberger presentation mentioned above, their CEO makes pretty much this point using examples from China and Oman: of course, even more drilling and use of advanced technology is suggested as a means to attack this problem!
Linking these two points, the fundamental issue concerns reserves growth – the money being spent, the drilling being done, the technology being deployed is not translating into enough discoveries, additions and extensions. Data on this subject from the major OPEC producers is also more or less non-existent but if we accept that the Majors and the bigger Independents are reasonably representative of what’s going on, then the picture looks something like this: for 25 IOCs, average reserve replacement ratios have slid from around 150% in 1998 to around 80%, or slightly less, in 2007 (this is illustrated by Slide 7 in the aforementioned Schlumberger presentation).
It’s my opinion that the combination of ‘oil patch’ cost inflation and the above outlined poor reserves growth performance must lead at least some of these IOCs to a strategic re-think – indeed a recent article in World Oil that can be found at:
http://www.worldoil.com/Magazine/MAGAZINE_DETAIL.asp?ART_ID=3508&MONTH_YEAR=Apr-2008
suggests that ExxonMobil have already reached this conclusion regarding exploration, with the company’s message being reported as:
“Despite high oil prices, exploration is irrational in today’s highly competitive and restricted business environment. Rudolf described the unacceptable cost of international opportunity capture because of increased competition, tougher production-sharing terms by host governments, and the rising cost of products and services.
Remaining opportunities in the international arena are relatively small, because most available blocks are in their second or third phase of appraisal; there is just not much left that is attractive. Rudolf calls this the “winner’s curse,” because if you win a bid round in today’s environment, you lose because the reward doesn’t justify the cost.”
Arguably, BP and Shell’s focus on cost reduction is at least in part a reaction against spending more and more with 3rd parties but not improving results.
It seems that companies that are very exposed to strategic re-thinks by some or all of the leading IOCs, especially the Majors, have already found themselves unloved by investors – these would include any of the ‘pure’ seismic companies, especially those with a narrow geographic focus, and also the ‘niche’ geophysical companies.
My message to my fellow sub-surface professionals is that we need to be doing this (re-)thinking in earnest: if you work for one of the ’25 IOCs’, average reserve replacement has been on a downward slope from just over 100% in 2000 – so far this decade has not really ‘worked’!
* On 17th April 2008, it was reported that Funds managed by private equity outfit Candover, Goldman Sachs and Alpinvest have agreed to buy British oil services company Expro International for 1,435 pence per share, valuing Expro at £1.605 billion ($3.16 billion).
Author:
David Bamford
Thursday, April 17, 2008 14:28