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Baker Hughes CEO: 'Tens of Thousands' of North American Drilling Sites

Exploration in North America's onshore remains in its earliest stages because producers are eyeing "tens of thousands" of locations for future drilling, Baker Hughes Inc. CEO Martin Craighead said Tuesday.

Craighead talked about the region's unconventional drilling outlook during a conference call to discuss 4Q2011 results. To compete, Baker is preparing to "significantly" increase North American onshore infrastructure investments in several basins to prepare for the long term, he said.

"What I say at this stage is the increase in oil basins are offsetting compression in gas basins," the former COO told analysts. Craighead took over for Chad Deaton, who retired at the end of 2011. "Obviously... people are repositioning fleets given the apparent oncoming softness in some of the gas basins...[but] this market...is in the very early stages of unconventional plays.

"That might be very hard for a lot of people to understand...but in talking to customers, tens of thousands of locations are coming up in the discussions" about future drilling "in the Marcellus, Eagle Ford and even the Utica" shales. "When you see that kind of outlook, you can't help but conclude that adding additional capacity in pressure pumping, but also in roof line, in tools, is absolutely the right way to go forward. There may be a little bit of weakness until things settle down, but overall, we don't expect any softness...and we wouldn't expect there to be anything dramatic, even if prices soften in a couple of places."

Baker underperformed in the final period of 2011 in part due to adjusting to the shale shift as onshore producers transition to oil and liquids-rich basins after years of focusing on natural gas. Competitors Schlumberger Ltd. and Halliburton Co. recently reported issues with the transition (see related story and Shale Daily, Jan. 23).

For Baker, the "issues are not with sand and mining per se, but the primary issue is getting consumables from the storage centers, that is, the first drop-off point to the respective customer locations," said Craighead. "It's a combination of rail cars and trucking fleets. The other issue around the supply chain is infrastructure, as well as processes and capabilities..."

Baker's operating margin in the final period year/year fell to 9.8% from 12.7% while total costs and expenses rose 26%. Revenue from North America, its largest segment, rose 28% while profits declined 12%.

"Let me put it this way," said the CEO. "Margin compression can be put in two buckets. One is the supply chain and one is processes, and [processes] are a a longer term issue to resolve. The other element is inflationary cost pressures on materials, proppant and fuel. I expect relief on that sooner, in the first half of the year."

The company's operating margins are predicted to gain strength as the year progresses.

"I think it's reasonable to expect a return to 3Q2011 levels based on resolving issues, and I am fully confident that we will," said Craighead. "Obviously, market conditions have to remain constant...and I feel like the market will stay where it is." All of Baker's fleets dedicated for U.S. land "are spoken for..for all of 2012."

The shift from gas to oil basins in North America was foreseen, he noted. Management last July said demand for oilfield services "was exceeding the ability to provide them" (see Shale Daily, July 26, 2011).

"The other element that's bigger than just cost is on demobilizing and repositioning fleets," said the CEO. "For us, in particular, we had what I consider to be unusual challenges relative to the market in handling demand and inefficiencies associated with that."

Craighead acknowledged that North American operating results in the final quarter of 2011 "were disappointing...We had a strong performance that was offset by problems in pressure pumping where we experienced a variety of cost and efficiency challenges in ramping up demand...We expect it to take time, but we are taking steps to fix these problems."

Logistics and workforce problems are related to the company's hydraulic fracturing services, which was built with the acquisition of BJ Services Co. in 2009. BJ gave Baker a major entry into pressure pumping; at the time 75% of its business was in pressure pumping. However, Baker wasn't able to put some of BJ's advantages to work because of problems that had been detected early last year, Craighead admitted.

Among other things Baker "experienced inefficiencies associated with freight, fuel and other logistical operations, where we experienced significant shortages of specific sizes of proppant, gel...[there were] shifted demand curves, and product costs escalated. The shortages impacted operational efficiency and we incurred incremental costs on new crews in anticipation of growth in 2012...

"We clearly understand these issues and expect it to take some time, but we are taking steps to fix these problems. We are investing in our fleet to make it more efficient and in facilities to support our fleets to store sand, consumables and rail..."

To overcome the problems, Baker is investing in "seven new major facilities within our North American land operations, each in unconventional basins," said the CEO. "In addition, we plan to accelerate our investments in the pressure pumping supply chain to lower the high costs associated with freight, etc."

Baker, which compiles a leading indicator for oil and natural gas rigs in North America, expects the 2012 rig count to grow by 5% to 2,409 total rigs this year, but the exit rate is expected to be flat compared with 4Q2011. By the end of the year Baker is forecasting the gas rig count to decline by around 218, while oil rigs are expected to increase by 220.

The "fundamentals of the business" in North America "continue to be robust driven by activity growth in the unconventional basins," Craighead said. "The geology and economics in the liquids-rich shale plays will support substantial additional drilling, and we have every reason to be confident about the long-term prospects of this market. Our drilling and evaluation, and completion and production groups showed steady improvement, except for pressure pumping."

Baker's "underlying business in North America is very strong. We intend to grow pressure pumping this year. We are increasing demand for high quality and predictable operations, which align very well with the capability of Baker Hughes. We are bullish on the long-term prospects in the market."

Net income totaled $314 million (72 cents/share) in 4Q2011, which was down from $335 million (77 cents) earned in 4Q2010. Revenue jumped 22% to $5.39 billion from $4.42 billion in 4Q2011 and it was up 4% sequentially from 3Q2011's $5.18 billion. Operating margins dropped nearly 10% in the final period of 2011 while total costs and expenses rose 26%. Revenue in North America, the largest segment, jumped 28% while profits in the region fell 12%.

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