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U.S. Oil, Natural Gas Machinery Orders Down Sharply, Says Commerce Department

The outlook for U.S. oilfield service (OFS) operators continues to be bleak, with new orders for drilling equipment used in oil and natural gas fields down 16.6% in February from January, the Department of Commerce reported on Thursday.

The Commerce report is the third in a row to indicate orders for drilling equipment are on the decline, which is attributed to the sharp drop in oil prices. Year-to-date, orders for mining, oilfield and natural gas field machinery were down almost 30% from a year ago. The February decline was the biggest monthly drop since October, officials said.

Oil and gas machinery orders are only 0.1% of U.S. gross domestic product. However, their impact across the country is being felt acutely as job losses grow and solvency problems escalate (see related story).

It's not only North America's OFS sector that's slumping. Weak oil prices and extensive upstream capital expenditure (capex) reductions by exploration and production (E&P) companies are expected to prolong the pain, according to Moody's Investors Service analysts. Oil prices are expected to remain weak and volatile through 2015, with aggregate E&P capex down around 25% year/year (y/y).

The U.S. land rig count has fallen about 46% since November, faster than in past downcycles, said Moody's analyst Sajjad Alam. "E&P companies are releasing rigs early, unwilling to make long-term commitments and are seeking significant rate reductions, particularly in North American shale plays." However, offshore drilling markets also may continue to deteriorate as rig availability climbs and upstream demand weakens.

Across the board, the OFS sector is preparing for a lengthy downturn, Alam said.

"The upstream sector has already substantially reduced capital spending, but will cut more later in 2015 if oil prices continue to trend lower. Small, high-cost and highly leveraged oil companies have announced more dramatic spending reductions thus far, while larger E&P companies and IOCs [international oil companies] have taken less draconian measures."

Among Moody's North American-rated issuers, the speculative-grade E&Ps have reduced capex by 47% from 2014 levels, with investment-grade companies cutting spend by 36% and the integrateds slashing capex by about 10%. "But even the large companies that tend to invest through a cycle will scale back their budgets if prices remain depressed over a prolonged period," Alam said. E&Ps focused on oil production rather than natural gas "are cutting especially aggressively," with more than 50% of the rated North American E&Ps reducing capex by 40% or more.

Like in previous commodity price-driven downturns, "pricing and demand will erode less severely for production-related OFS services than for services tied to exploration and new well drilling and completion." For instance, workover rigs, helicopters that transport employees to offshore production facilities and artificial lift technology providers should fare better than the pressure pumpers, drillers and seismic service operators.

"Upstream companies will focus on their drilled wells and projects that can quickly raise cash flow, and will postpone major investment decisions until OFS costs better align with commodity prices," said Alam. "Competition for OFS work will intensify, driving down prices across the board as companies try to keep equipment working and experienced crews intact. Excess equipment supply is already straining the offshore rig and vessel markets, and overcapacity conditions will surface in most other OFS segments by mid-2015 as upstream activity plummets."

Analysts with Tudor, Pickering, Holt & Co. (TPH) expect softer OFS activity than they had forecast just a couple months ago. They initially had pegged the U.S. rig count to decline overall in 2015 by about 33% y/y. However, that was too optimistic.

The "velocity and magnitude" of the decline in the domestic rig count has been a surprise, analysts. Factors have coalesced to drive "heavier decrementals than we previously modeled, thereby pulling trough operating margins/earnings further forward in 2015. Everyone expects 2015 earnings to be down hard y/y, but harsher decrementals are sooner than we expected as pricing/margins fall close to breakeven levels, yield ripple effects and kick the earnings power recovery can down the road..."

Margin decrementals are derived by how much profits decline given a decline in revenues. Some of the bigger OFS providers have indicated they hope to improve on decremental margins during this severe downcycle. For instance, Halliburton Co. has cited that its recent profits were pegged to technological efficiency gains, not prices, so the impetus to trim prices to ensure it manages to keep its market share could be less severe. Halliburton is the leading pressure pumper in the United States, however, so what its decremental margins are can't be easily translated to competitors.

OFS providers in the United States may not return to 2014 earnings levels before 2017 -- and that's for the "best performers," according to TPH. A return to profitability is "further out for most of the sector."

TPH trued-up its domestic rig count assumptions on the "harsher reality" of what's happening in the U.S. onshore. The 2015 onshore rig count now is expected to be on average about half of 2014, with a slower reduction in dropped rigs from April to the end of the year.

"2016 feels a ways off and it's certainly nebulous," analysts said. "Prior downcycles have shown symmetrical percent bounces in U.S. activity out of the trough," but given E&P industry leverage profiles, 2016 activity now is modeled to be about 20% higher y/y.

For anyone looking for positives in the OFS forecast for the United States, TPH analysts expect completions to be about  25-30% higher in 2016 y/y, outpacing drilling, "as the drilled but uncompleted wells attract initial E&P capex dollars in the next cyclical upturn." Still, it may be 2017 before the sector returns to 2014 earnings levels, and that's for the "best performers." For most of the sector, it's "further out."

To get the gist of what the rig decline may do to the domestic OFS sector, TPH now is estimating profits could slump by 80-90% y/y "for certain names." Going into 2015, the margin improvement is forecast to be "far from uniform," with the initial trough -- and initial recovery -- in completions margins.

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