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Trend to 'Super Laterals' Buoys Schlumberger Outlook For U.S. Land

Schlumberger Ltd. posted a 31% sequential increase in its U.S. onshore drilling and measurements revenue during the third quarter, driven by a rising rig count and technology sales for super laterals, but the outlook for 2017 still remains hazy, CEO Paal Kibsgaard said Friday.

Following seven quarters of "unprecedented activity decline," the business environment stabilized as expected in the third quarter, "confirming that we have indeed reached the bottom of the cycle," Kibsgaard said during a conference call. North American revenue for characterization drilling and production groups increased 3% sequentially from "solid growth on land," which was offset by a decline in the Gulf of Mexico, Alaska and Eastern Canada.

What is too early to calculate are exploration and production budgets for 2017.

"We maintain that a broad-based V-shaped recovery is unlikely given the fragile financial state of the industry, although we do see activity upside in 2017 in North America land, the Middle East and Russia markets," Kibsgaard said.

In North America, overall revenue in 3Q2016 declined 2% sequentially, taking into account the acquisition of Cameron International Corp. (see Shale DailyAug. 27, 2015). Excluding Cameron, revenue for Schlumberger increased 1% sequentially, driven by higher activity in North America land, Middle East, Russia and Australia. Pricing improvements were limited, with most of the boost in land drilling activity in the United States driven by "small North American independents."

One encouraging U.S. business marker is the trend to drill longer horizontal laterals in the onshore, or "super laterals," which increases reservoir contact. Schlumberger, considered a technology innovator, drilled the Purple Hays 1H well for Eclipse Resources Corp. in the Utica Shale earlier this year, which set a record for lateral lengths (see Shale DailyMay 5).

"This emerging trend has already created a significant increase in the uptake of our high-end drilling technologies and has also provided our drilling group with a clear path toward profitability on land," said the CEO. "We have therefore shifted focus from maintaining presence to now gaining market share for our drilling business in North America land."

Fracture stages, which rose 17% sequentially within North America during 3Q2016, were driven not only by more drilling but also by customers "actively depleting" their drilled but uncompleted, or DUC well inventory, he said. That's a positive for opportunities in one of Schlumberger's biggest markets, the Permian Basin.

"Given the unique technology offering we have and the technical challenges of drilling these very, very long horizontals, we are able to get pricing, which is going to give us, I think, ultimately the returns that we're looking for," Kibsgaard said. "And this is why we are prepared to put more capacity into play on the drilling side for what's going on in West Texas."

Still at this stage of the recovery, "there is no clear path toward profitability, and this is why we are still maintaining presence and basically holding the fort until we believe we can justify putting more capacity into play going forward." The onshore fracture market "continues to be completely commoditized and significantly oversupplied with a large number of very hungry players. In addition, the significant increase in...volume pumper stages is already starting to create inflation on both products and distribution costs, which will further obstruct and delay the hydraulic fracturing industry's path towards restoring profitability."

Schlumberger's technology offerings remain key, he said. For instance, the PowerDrive Orbit drilling system, which was used in the Eclipse project, is sold out. And more new technology is being unveiled, with two first generation pilot rigs now being raised in the U.S. onshore. The complete version of the rig is set to be rolled out in 2017.

"Technology opportunities, both in the drilling side and on the completion side, is really why we are in this market," Kibsgaard said. "We're not in it for the commodity side of it. We believe that ultimately technology will play an even larger role in the North America land markets, and we continue to promote these capabilities and this part of our offering because we ultimately believe it's going to bring a lot more value for our customers."

Quarterly earnings fell 82% from a year ago to $176 million (13 cents/share) from $989 million (78 cents) on lower revenue and expenses related to the Cameron merger.

Excluding acquisition-related charges, adjusted profits were 25 cents/share. Total revenue declined 17% to $7.02 billion, with North American revenue overall falling 25% to $1.7 billion. Schlumberger generated $1.4 billion of cash flow from operations during the latest period.

Reservoir characterization revenue rose 5% from 2Q2016 to $1.7 billion, while margin increased 292 basis points (bp) to 19.1%. Drilling group revenue of $2 billion was flat sequentially while margins increased by 241 bp. Production group revenue of $2.1 billion also was flat sequentially, while margin improved 41 bp. Schlumberger delivered 19% decremental margins in the Cameron group and incremental margins above 65% for the other three groups combined, excluding impairment charges.

"Going forward, it is critical for us to recover the large pricing concessions we have made over the last two years to allow us to restore investment levels in technology innovation, system integration and operation quality and efficiency, which all key enablers of our customers' project performance," Kibsgaard said. "As indicated in July, we have during this quarter started pricing recovery discussions with a large part of our global customer base. While there is a general understanding from our customers that pricing will have to increase, there were no material movements during the quarter, but with the recent increase in oil prices, the basis for these discussions has now strengthened."

Schlumberger plans to only allocate "investments, operating capacity and expertise to contracts and basins that meet our financial return expectations in the same way our customers allocate capital to projects in their portfolios. Currently, a noticeable part of our contracts do not need these financial return criteria and this is our starting point for reestablishing sustainable customer relationships that will warrant allocation of our capital, capacity and expertise."

In addition to focusing on pricing recovery, the company plans to restore "proper payment schedules from our customers in line with the terms and conditions in our contracts to address the payment delays we today are seeing from many customers around the world."

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