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North American Land Market Trending Toward General Contractor Model, Says Schlumberger CEO

The North American land drilling market will move toward a general contractor model for oilfield services, a big reason that Schlumberger Ltd. has begun allying with other drilling services, CEO Paal Kibsgaard said Friday.

He discussed the 2Q2014 earnings and operational performance during a conference call with analysts. Many of the questions were centered on Schlumberger's build-up of services in the U.S. land market.

Just days ago, Schlumberger agreed to an alliance with Precision Drilling Corp., Canada's largest oilfield services business with a big market share in the United States (see Shale Daily,July 16). Schlumberger plans to use Precision drilling rigs in exchange for access to its bottomhole assembly and services. The agreement applies to all of North America.

"We have decided to pursue the North American well construction market more through alliances, and that's where the Precision Drilling alliance comes into play," Kibsgaard said.

It's all part of a larger plan to gain market share in North America's onshore, which likely will take 18-24 months to fully integrate.

"In terms of our investment into new rig technologies, that is something we are just starting, so that's going to obviously take a little bit of time before we have something to put into the market," he said. "And we will then just gradually add capacity as we have viable work for these type of rigs going forward...

"Part of the reason for doing this alliance with Precision Drilling is that both ourselves and Precision Drilling believe that over time, the North America land drilling market will move toward a general contractor model, toward more of a construction turnkey type of market.

"And in that setup, we have now established this alliance where Precision Drilling will be the general contractor and we will rent them our downhole technologies. In addition, we will train their people to run it. Obviously, we will own the equipment and we will maintain the equipment for Precision Drilling. We see this as an avenue to establish further penetration for our unique technologies in the North America land drilling market and hence it’s another good growth opportunity for us."

There are "a lot of moving parts for us in North America at the moment," said the CEO. "The way I see it, we have been focusing lately on revenue and expanding our revenue base in North America land. At $3.9 billion [in revenues] in the quarter, revenue was up 6% sequentially and 16% year-on-year, which is a record for North America in spite of the Canadian breakup.

"Now the growth came from both efficiency and share, including pressure pumping, artificial lift and drilling services. In pressure pumping, we added one more fleet during the quarter and that takes the total of eight additional fleets in the past year, so we have clearly gained share in pressure pumping."

The key to expand North American revenue and market share is to "further broaden our platform for technology-driven growth in the coming years. Now with that we see some temporary impact on margins as we take on a higher proportion of somewhat lower margin businesses, but we plan to drive margins up in the coming quarters in these businesses through integration, scale and new technology introduction."

In North America operations, Schlumberger reported a 53 basis points (bp) reduction sequentially in 2Q2014 and a 170 bp reduction year/year -- all impacts related to supply chain issues.

"What happened toward the end of 1Q2014 and also into 2Q2014, there were some significant changes in the way some of our customers operated in terms of sand prices, in terms of volumes, and these were basically somewhat unannounced and something we had to respond to relatively quickly," said Kibsgaard.

"We managed to continue to support our customers and support our operations, but we took some additional costs in order to do that. And over time, we are able to pass these on...but there were some short-term changes that resulted in additional cost for us that we decided to absorb...

"For instance, on sand, we took some higher costs because there were some significant changes in sand price and volume for several of our customers, and also transportation had some higher costs due to the fact that we had a very high growth rate and transportation availability become quite tight.

"In addition to that you have the Canada [spring] breakup, and you also have somewhat lower multi-client sales...That drove the 53 basis points reduction, but our focus going forward again is to drive the margins back up, but on a much broader platform for revenue growth."

For the rest of this year, Schlumberger is expecting to see a "relatively constant mix of headwinds and tailwinds in the global economy and in our industry, which leads us to maintain our already established outlook for the year," said the CEO. With Brent prices holding steady above $100.00/bbl, they should "encourage oil-directed investments in both the North American and international markets.

"The North America natural gas market appears more comfortably supplied as U.S. production continues to grow and storage levels gradually reconnect with historical averages, while the market balances in the international natural gas markets remain more or less unchanged."

In the latest quarter, new technologies helped meet customer challenges in North America "in increasing drilling efficiency, assuring wellbore integrity and improving well production," Kibsgaard noted. His comments mirrored some by Baker Hughes Inc. CEO Martin Craighead on Thursday (see Shale Daily, July 17).

Schlumberger's income from continuing operations totaled $1.80 billion ($1.37/share) in 2Q2014, up 13% sequentially and 17% more year/year. Total revenue was $12.05 billion versus $11.24 billion sequentially and $11.18 billion in 2Q2013.

North America pretax operating income was $700 million, up 3% sequentially and 18% from a year ago. North America revenue of $3.89 billion increased $205 million, or 6% sequentially.

In response to the results, Tudor, Pickering, Holt & Co.'s Jeff Tillery and Byron Pope said the "stand-out revenues" were muted a bit by the retreat in North American margins. Schlumberger's "starting point on margins (1Q2014 18.5% op margin) is higher than peers, but we expect the decline to nonetheless be viewed as a slight disappointment.

"Headed into 3Q2014, we expect the continued U.S. land strength, rebound in Canada and strengthening Gulf of Mexico (notwithstanding activity risk during hurricane season) to result in another solid quarter/quarter revenue increase...and strong incremental margins should take operating margins back over 19%..."

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