A sharp decline in North American land activity hurt Schlumberger Ltd.'s revenues and earnings in the first quarter, but the worst days may be ahead, CEO Paal Kibsgaard said Friday. North American revenues likely will fall further in the second quarter, and visibility on where the bottom is remains murky.
Management is working overtime to ensure it's able to capture new opportunities, usually available when a market craters. However, these are uncertain times.
"The pace and magnitude" of the fall-off in activity "have been almost unprecedented and we have to go back to 1980s to find anything similar," Kibsgaard said. "In spite of the detailed preparations we made in the fourth quarter, the abruptness of the fall in activity, particularly in North America, required us to take additional actions during the quarter," which included laying off even more people than it has since oil prices plummeted.
It was a "difficult decision to make a further reduction in our workforce of 11,000 employees, leading to a total reduction of about 15% compared to the peak of the third quarter of 2014,” Kibsgaard said. Schlumberger has fired close to 20,000 people worldwide in just a few months (see Shale Daily, Jan. 16).
The company also is cutting its capital expenditures (capex) even more this year. It had guided capex for this year to $3 billion, versus $4 billion in 2014. The company now expects to spend about $2.4 billion in 2015.
The first quarter was "challenging to manage" and it's led to a new way of thinking for Schlumberger, the world's No. 1 oilfield services (OFS) company. The business environment today requires more risk-taking, the CEO said. Usually in a downturn, well financed companies are able to capture more market share. Schlumberger is attempting to differentiate itself with its technologies, considered the biggest selling point. Management has chosen "to think differently" regarding project costs and their value, which has led to a closer collaboration with exploration and production (E&P) companies.
"We are seeing a steady, changing service mix for most of our customers," said Kibsgaard. In U.S. land, drilling stimulation services were down in all of the basins, with activity significantly off in Canada too as the rig count was impacted by an early spring breakup. The biggest decline in North American land was for fracturing services, mitigated by new technology.
"In spite of this, market pricing already has reached unsustainable levels," said the CEO. "We continue to work with customers on lower completion costs" by marketing the benefits new technologies can bring to find the "best solution for each reservoir, each well. Our track record now gives us confidence to offer a range of new business models" because "the current financial challenges will not disappear. We have to seek new ways of working together to reduce costs."
Market "visibility remains limited" for 2015, particularly for North America. "The biggest E&P investment cutbacks are in North America, and there's no clear line of sight on a recovery. We believe that a recovery in U.S. land drilling activity will be pushed out in time, as the inventory of uncompleted wells builds and as the refracturing market expands...We also anticipate that a recovery in activity will fall well short of reaching previous levels, hence extending the period of pricing weakness." However, the onshore refractured well market isn't likely to take up the slack in OFS overcapacity.
The macro view hasn't changed much since the beginning of the year. U.S. sequential production finally is "seeing the first signs of flattening," and oil demand "remains strong and is rising upwards," based on data by the International Energy Agency. "We expect global supply to continue to tighten in the second half of the year," but it's still not clear what that would mean for the market.
A big change was seen in the refracturing business, a sign of things to come.
"In terms of how many wells, there are thousands in North American land that are candidates for refracturing, both shale liquids and shale gas," said the CEO. Regarding market potential, "we're talking billions in terms of revenue opportunities over an extended period of time...and it's a significant market opportunity. So we are confident in our ability to identify the right candidates and execute refracturing work, and we're prepared to take significant risks. If we can foot the entire bill, we will be paid back in production."
The upheaval in the market was bound to happen, he said.
"I think if you look at what's taken place over the past three or four years with shale liquids in North America, there's been significant growth in activity, but a growing free cash flow deficit for E&Ps...That's not a sustainable way to operate." The core areas of the North American onshore basins, the Tier 1 areas, are "viable at current prices and they will continue to be developed. As industry improves on cost side and more so on production per well, a growing part of Tier 2 and Tier 3 acreage that can be developed, but today it's only Tier 1."
Schlumberger is in "much closer collaboration" with E&Ps on "more risk-based contract models" to achieve mutual objectives. For instance, the company now is willing to carry, in some cases, the full costs to drill some wells. "These contract structures are being taken by a number of customers."
That's a different business model than before, when an OFS was given a job to do and did it for a contracted price. But the North American rig counts aren’t going to return to year-ago levels.
"Given the cash flow constraints, we don't expect rig counts to come back to 2,000," Kibsgaard said. "For the service industry, pricing concessions are something we have to live with for a while because there's pretty significant overcapacity for all sorts of services."
Over time, "basins mature" and operators today want to do more than maintain production. It's all about "drilling intensity" today, drilling the best wells -- and refracturing older ones.
"This is important for industry," said Kibsgaard. "All players have something to contribute...how we design the solutions of what we're looking to, and all are invited to the table...Remaining humble, Schlumberger has a lot to contribute. We are supporting customers for major drilling and completion development...
"It's not going to be quick and we're not able to do it by ourselves...We're not saying we can do the work our customers are doing better. But given our abilities, we are underutilized today and have more to contribute to designs related to our expertise." Working with E&P engineers to achieve more efficient well designs may cut costs before a plan is implemented.
"This is something we will offer...Some customers might take us up on this and some might not...But we want to put more skin in the game."
Although earnings were down sequentially and year/year, Schlumberger still beat Wall Street's estimates and "delivered significantly better decremental margins versus previous cycles...creating a strong platform going forward," Kibsgaard said. North American decremental margins were 39%, better than anticipated.
The drop-off in activity as it translated to profits was stark. Total net income fell 30% sequentially and 15% year/year. Revenues declined 19% from the fourth quarter and 9% from a year ago. Net income was $975 million (76 cents/share), versus $302 million (23 cents) in 4Q2014, and from a year ago when profits reached $1.59 billion ($1.21).
The biggest hit was to the North American segment, where revenues plunged sequentially by 25% to $3.2 billion because of lower pressure pumping activity and increased pricing pressures. In the U.S. Gulf of Mexico, activity was flat sequentially but revenues fell because of lower multiclient seismic license sales.
Among the technologies, Production Group revenue declined 22% sequentially, Reservoir Characterization was down 21% and Drilling Group revenues dropped 15% because of a sharp decrease in exploration-related services and development drilling. Product, software and multiclient sales also declined as customers further curtailed exploration and discretionary spending.
North America pretax operating margin declined 670 basis points sequentially to 12.9% Despite the severity of the revenue decline, cost management limited the sequential decremental margin to 39%.
Tudor, Pickering, Holt & Co. (TPH) analysts said Friday they had "no illusion" that Schlumberger's North American business would be off in the first quarter. Jeff Tillery and Byron Pope said, however, that the decremental margins "were impressive. We'd modeled 42% so to some degree were expecting...superior decrementals than most of the group." Revenues down 25% were within TPH's forecast of 28% decline.
One highlight, according to TPH, was the refracturing uptick. "We don't see this is a big macro issue to worry about on the supply side but it is a definite positive on the company-specific level." However, the uptick in that segment of the business won't extend across the OFS sector because the enabling technology "resides in just a few pressure pumpers..."