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No Gain, More Pain Forecast For OFS Sector

As first quarter results are unveiled, expect to hear more hardship from the oilfield services (OFS) sector, energy analysts said.

Basic Energy Services Inc. kicked of the earnings season for the OFS sector on Thursday (see related story). On Friday, No. 1 operator Schlumberger Ltd. will issue its results, followed next week by No. 2 Halliburton Co. and No. 3 Baker Hughes Inc.

Drilling efficiencies and an abundance of rigs, both for the offshore and onshore, will push the pricing power for the oilfield services (OFS) sector at least another year out as attrition continues across the sector, based on analyst forecasts.

Assuming the onshore rig count averages 650 in 2017 and slightly more than 900 in 2018, the utilization rate should reach 80-85% sometime in late 2017/early 2018, said Tudor, Pickering, Holt & Co. (TPH) analysts George O’Leary, Taylor Zurcher and Byron Pope. They recently put pencil to paper to figure out when pressure pumpers would regain pricing power, combining attrition expectations, average fleet size, and rigs/fractionation spread assumptions.

"We believe utilization reaches the 80-85% level sometime late 2017/early 2018 at the 700-800 overall rig count level," with fewer horizontals needed to achieve utilization above 80%.

Given the big percentage of the marketed hydraulic fracturing fleet that that is underutilized today, utilization improvements and fixed cost absorption are expected to cause margins to rebound in advance of pricing power, based on the analysis.

"We also believe that a portion of the idle, stacked, and even marketed-but-underutilized fleets we expect to remain in the U.S. marketed supply post-downturn will need a material amount of cash per spread reinvested in them," $10-20 million or more, to get back to work or remain working, which would require pricing "to inflect higher in advance of marketed utilization reaching the 80-85% ballpark," O'Leary and his colleagues said.  "Whether it's heavy attrition, rehiring crews...increasing well intensity, high utilization, or more likely a combination of these items, we believe the completions end market has the clearest path to margin/pricing improvement once we progress into the forthcoming upturn.

There just aren't a lot of wells being drilled, RigData said. Researchers estimated that the ongoing rig count collapse cut sharply into the U.S. well count, which fell in the first quarter from the fourth quarter by 43%, or by 1,577 wells. Hardest hit of the major unconventional plays was the Fayetteville Shale in Arkansas, where zero wells were drilled in 1Q2016, while at the other extreme, the Barnett Shale in North Texas saw zero change quarter/quarter (q/q).​

"Among the unconventional oil plays, the Permian Basin's Wolfcamp and Wolfberry fared best with q/q drops of only minus 11% and minus 20%, respectively," RigData researchers said.

As always, it's the better balance sheets that will get the better OFS operators through.

"Should the eventual oil price recovery slip three to six months versus our current macro expectations, smaller over-levered completions players could find themselves in a world of hurt as they traverse through this period of all-time low U.S. onshore activity," TPH analysts said.

BMO Capital Markets analyst Philip Jungwirth is in agreement with other analysts in his expectation that nothing will pump up the OFS sector until exploration and production (E&P) companies get back to work. The current oil price is nowhere near a good starting point.

"We conclude a low to mid-$60/bbl West Texas Intermediate price is sufficient for U.S. E&Ps to meet their share of oil demand growth, assuming about 120% reinvestment rates, which is the midpoint of that incurred before and after the shale era," Jungwirth wrote. "If E&Ps spend to cash flow, we think this could be increased to $65-70/bbl."

BMO analysts estimate that E&P capital expenditures for unconventional projects "would need to double from 2016 levels, likely translating to OFS cost inflation, in which a 20% increase would reduce growth rates by almost two-thirds for a given reinvestment rate."

The bottom line is simple. Continued global oil demand growth "will require oil prices well above strip for U.S. E&Ps to meet the call on shale," Jungwirth said.

BMO's Michael Mazur added that the anticipated direction of crude prices going forward likely is the "best indicator" of future OFS performance.

"Generally, we expect oil prices to remain weak, although volatile for the next couple quarters before moving toward balance in the second half of 2016," Mazur said. "We do not anticipate a meaningful recovery in crude until a supply deficit is reached in 2017, when the impact of reduced U.S. production and declines in non-OPEC supply should push prices higher."

Wunderlich Securities Inc. analyst Jason Wangler said the OFS sector is under pressure both on utilization and pricing, as borne out in recent comments by producers and the OFS companies. Producers, he said, "continue to push on the OFS names for additional price relief and we heard anecdotal evidence of this occurring even in the last month. Obviously, the rig count remains at all-time lows and will likely head even lower in the coming weeks which puts utilization in a bad spot and pricing pressures remains in a space where margin is already hard to find."

According to Douglas-Westwood Ltd.'s (DW) forecast for the world oilfield services market, capital spending fell by 38% in 2015, with adjustments to outlay likely to be another 10% at least this year. North America was hit the hardest.

"The North American onshore market has undoubtedly taken the brunt of the industry downturn, with OFS expenditure falling 58% in 2015 alongside a 62% decline in onshore rig count and a 47% fall in onshore wells drilled," DW researchers said. "Recent analysis by Haynes and Boone indicate a total of 46 North American oilfield services companies have filed for bankruptcy since the start of 2015 -- a number which DW expects to grow over the next six-12 months."

Offshore North American spending also was hard hit by the downturn, with a 66% decrease in shallow water wells drilled. However, expenditures were supported by deepwater spending, where high day rate rigs remain on contract, resulting in an offshore OFS expenditure decline of only 19%.

"Post-2016 spend will decline consistently through to 2020 as these rigs come off contract, significantly reducing the average day rate of rigs drilling," DW said.

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