Texas roughnecks.
The oilfield services sector ended last year with a bang. The OSX index tracking some of the largest services firms rose over 23 percent in the fourth quarter, well ahead of the 3 percent increase notched by the S&P 500 but also much better than the XOP index-tracking exploration and production (E&P) companies, which showed a 10% gain.
The outlook for 2020 remains challenging, though, and the fourth-quarter strong performance belies many structural challenges for the beaten-down oilfield services sector, which has yet to recover from the oil price collapse of 2014 fully.
Producer spending remains disciplined and constrained, meaning there won’t be any sudden surge in demand for drilling rigs, pressure pumping crews or other equipment the services sector provides. Oversupplied markets for equipment and field services have killed sector profit margins over the past five years, and further rationalization — retiring older rigs, for instance — and consolidation is needed to turn the tide.
Recent tensions in the Middle East may not have injected a hefty risk premium into oil price calculations. Still, they do appear to have set a price floor of around $60 a barrel for the global benchmark Brent and $55 a barrel for U.S. West Texas Intermediate.
There is a feeling among many oilfield services executives that the worst days are in the past, and that increasing exploration and production (E&P) activity offshore and outside North America could lay the groundwork for a return to profitability in the coming years.
In the U.S. shale sector, there is hope that activity may pick up now that operators see the light at the end of the tunnel and that any delayed drilling caused by year-end “budget exhaustion” will soon resume.
Global exploration and production spending is expected to rise by about 2% in 2020, according to investment bank Barclays. The sector saw growth of 3percent in 2019.
The “risk floor” established by rising tensions in the Middle East should solidify producers’ capital budgets for 2020 — and perhaps even provide a windfall if supply disruptions occur and prices exceed expectations.
Yes, the slowdown in U.S. shale will continue, which poses a severe challenge for oilfield services firms. Barclays sees a 10 percent drop in North American onshore spending in 2020, compared with a 5 percent increase internationally.
U.S. pressure pumpers, who rely primarily on demand for hydraulic fracturing services for revenue, are likely in for another challenging year. There’s still too much hydraulic horsepower capacity available, with some analysts saying current demand warrants a 20 percent to 30 percent reduction in the market. The surplus gives shale-focused services firms little leverage in negotiating with their operator clients.
Millions of “cold-stacked” unused horsepower capacity have already been retired over the past couple of years, but it still hasn’t been enough to bring down prices. More capacity will need to come off the market before margins improve, particularly after the erosion in the U.S. rig count. Realistically, improved margins may be more of a 2021 event.
It also would help for the Trump administration to resolve trade disputes that have led to tariffs on imports of foreign steel and other products the oilfield services sector needs to operate. The recent phase one trade agreement with China, which includes a promise by Beijing to purchase $50 billion in additional U.S. energy, provides some hope. Operators have to be smiling at the announcement of the trade deal after watching China cut energy imports from the United States by nearly 90 percent last year.
As 2020 progresses, the oil market and investor sentiment toward the services sector should improve if the current trends of slower shale growth and a better outlook for global trade continue.
Shale has been the main culprit holding back oil prices in recent years. The more production growth in the sector slows, the more market share OPEC regains, allowing it to exert more power over prices. And the cartel’s members need to generate more cash to stop their growing budget deficits.
For offshore operators, the outlook could be even brighter. Consultant Rystad Energy this week noted the appearance of telltale signs that we are entering a new offshore investment cycle. Globally, the amount of offshore oil and gas resources approved for development last year surpassed 20 billion barrels of oil equivalent, the highest level since 2011.
Offshore drillers are already seeing day-rates for their rigs tick up and expect even sharper increases in 2021 due to the increasingly limited availability of high-specification drilling platforms. In the U.S. Gulf of Mexico, executives see more projects in the queue over the next 12 to 18 months than there are rigs available in the region.
After total offshore CAPEX grew by 5 percent last year, Rystad says investment in the offshore sector is on track to grow by 8 percent this year, with deepwater up 12 percent and shelf spending up 2 percent. That’s an excellent sign for providers of offshore and subsea services.
Regions like Latin America and the Middle East look primed for increased activity in the early 2020s, too, as national oil companies ramp up new drilling and development work to take advantage of slower U.S. supply growth.
The oilfield services sector has learned that it cannot rely on fleeting commodity-price strength to rescue it. The success of ongoing “self-help” initiatives will differentiate the survivors in the sector compared with the acquisition targets.
Even the largest, most diversified players in the services sector are moving aggressively to overhaul their cost structures and strategies. The bankruptcy of industry giant Weatherford last year showed that no company is impervious to the market pressures.
No one likes making layoffs or sidelining expensive equipment. Still, tough decisions like these are necessary to turn a profit in this market — and may be essential for the future in a “lower for longer” price environment.
