Prices for oilfield products and services have begun to increase following a multi-year slump, said to be lifted in part on more market power as consolidation in the industry continues.
The long-awaited boost in pricing for oilfield services (OFS) comes with a rise in merger and acquisition (M&A) activity, as explorers pare their well activity with efficiencies and cost cutting.
“Consolidation is finally occurring in the land of pressure pumpers,” said Evercore ISI’s analyst team led by James West.
Most of the M&A this year has been among producers, notably the mega-merger between Occidental Petroleum Corp. and Anadarko Petroleum Corp. However, completions experts C&J Energy Services and Keane Group Inc. plan to combine their businesses, which executives called a “merger of equals.”
“Executive teams recognize that having scale can provide a superior competitive advantage and we expect others to follow suit,” West said. Wall Street investment strategist Michael Mauboussin, who directs research for BlueMountain Capital Management, “said it best,” West noted.
“Companies that act early in an M&A cycle tend to generate higher returns than those that act later,” Mauboussin said. “The first movers enjoy the benefits of a larger pool of targets and cheaper valuations than companies that buy later in the cycle.”
Rystad Energy’s Audun Martinsen, head of oilfield service research, said with oil and gas investments on the rise, “so too is the pricing power of service companies. After losing pricing power in 2015 and 2016, oilfield service companies have since regained some of the lost ground, thanks first and foremost to industry consolidation among players that has concentrated the market over the past couple of years.”
Martinsen expects OFS pricing power to strengthen further, “as orders are anticipated to rise across the supply chain, coupled with capacity adjustments intend to avoid oversupply in 2019 and 2020.”
Rystad recently did a deep dive on market consolidation within the energy industry to determine the factors affecting the long-beleaguered OFS sector. As oil prices plummeted in late 2014 and into 2015, many exploration and production (E&P) operators slashed investments -- but not all of them.
Many of the majors and well-heeled, large independents were able to invest when opportunities arose, while the smaller E&Ps “simply had to batten down the hatches and wait for the storm to pass,” Rystad noted. As a result, the OFS client universe shrank.
“This trend continued in 2016, but in 2017 and 2018 more E&Ps could finally finance their ambitious operations growth through improved operational cash flow, leaving market concentration levels in 2018 on par with those seen back in 2014,” Martinsen said.
The OFS sector became more fragmented in 2015 and 2016, which Rystad found was apparent when indexing the various size-classes to examine their evolution since early 2014.
The analysis determined that top OFS operators Schlumberger Ltd., Halliburton Co., Baker Hughes, a GE Company, and TechnipFMC, as well as the next 10 largest operators, “outgrew the next 10 largest service companies until the fourth quarter of 2015, at which point they began to lose market share to smaller players.”
Market concentration in 2017 and 2018 increased within the OFS industry following some major mergers. As important, Rystad found, the top four OFS operators won back market share from the next tier of players, whose customer bases then were reduced.
“Even though the oilfield service market has become more concentrated at the same time as the buyer side has become more fragmented, there are also other factors which impact pricing power,” Martinsen said.
“Some segments, despite being more concentrated, are still heavily challenged by oversupply, forcing companies to adjust their capacity before prices improves.”
Analysts Praveen Nara and J. Marshall Adkins of Raymond James & Associates Inc. also weighed in on the OFS sector, noting that before the latest U.S.-Iran crisis, the oil service indexes had fallen nearly 20% overall in the past few weeks.
Oil prices increased significantly in the past few days on news in part of geopolitical turmoil in the Middle East. However, if prices were to reset in the mid-$50s again, the decline would “effectively removed a significant portion of U.S. E&P cash flows that would have likely boosted U.S. oilfield activity in 2020,” Nara and Adkins wrote in a note.
Meanwhile, U.S. E&P capital expenditure expectations have fallen by around 15% during June, the duo noted..
“Unfortunately, for many oil service companies this E&P spending reduction particularly impacts segments that are already competing in oversupplied markets. As such, a corresponding reduction in 2020 activity expectations will make it difficult for many oil service companies to post any meaningful earnings improvements in 2020.”
Put another way, said the Raymond James team, “consensus 2020 U.S. oilfield service estimates are about 20% too high if we are now in a permanent $55/bbl oil world. That means that while service stocks may now appear cheap on 2020 consensus expectations, these estimates will be too high if current oil prices hold.”
Assuming there is even a 5% reduction in 2020 capital spending by the domestic E&P sector, the rig count could decline by another 50 rigs this year, versus Raymond James expectations for a 50-rig increase, and by another 50 rigs in 2020, versus forecasts for a 200-rig increase.
If the rig count were to decline, “that would translate to the U.S. fracture count falling by another 20-25 fleets in 2020 year/year,” versus consensus expectations for a 50-70 fleet increase in 2020 U.S. fracture demand.
“Keep in mind, consensus expectations prior to the carnage was to see a 5-10% increase in U.S. oilfield activity year/year, which would have likely led to modest pricing power in many segments,” Nara and Adkins said.
The market would be self-correcting, they noted. Lower oil prices would equal lower U.S. drilling activity, which would lead to lower oil supply growth.
Recently Moody’s Investors Service in its outlook for the global OFS industry said it remained stable. Credit ratings analysts in March had revised the global outlook to stable from positive.
“The stable outlook for the OFS sector reflects our view that the industry’s overall growth will be muted in 2019-2020, mainly because of restrained capital spending among North American E&P companies,” the Moody’s team said.