Drilling technologies have transformed the competitive landscape within the oil and gas industry and altered the traditional pricing relationship between crude oil and natural gas, but there's still plenty of room for horizontal drilling and hydraulic fracturing (fracking) services to grow, according to Standard & Poor's Ratings Services (S&P).
Credit analysts Marc D. Bromberg, Stephen Scovotti and Alan M. Levin published an indepth review of how horizontal drilling and fracking have reshaped the domestic energy landscape. They believe the dual drilling technology remains on a growth path, although it might be a little bumpy.
"We expect this growth...will be accompanied by further regulatory oversight of fracking regarding environmental and health concerns," said the trio. "While horizontal drilling and fracking in international locations haven't been as widespread as in the U.S., we foresee international horizontal drilling and fracking expansion to be areas of growth for the industry.
"Over the next six to 12 months, the energy industry "is poised to continue adding drilling capacity," said Scovotti. "However, due to the overcapacity of pressure pumping equipment, oilfield service companies that provide pressure pumping services are likely to see lower pricing for their services."
For companies that offer fracking services, margins "could continue to weaken from very high levels given the overcapacity that exists in the industry," said the S&P team. For exploration and production (E&P) companies, "this overcapacity will mean lower completion costs and possibly improved profitability."
"Among fracking suppliers, we believe margins will likely decline through 2013, but we currently think that the slide in itself, coupled with a diversity of service offerings from the largest providers, are not likely to lead to rating changes. On the other hand, we think lower completion costs should boost profitability for many E&P players..."
Schlumberger Ltd., Halliburton Co. and Baker Hughes Inc. "are three of the largest fracking providers, but they benefit from participating in a variety of service activities," said the analysts. Our overall credit outlook for these providers remains favorable, given the diversity of their cash flows. We expect these companies to maintain dominant positions in overall oilfield services."
Companies that rely on fracking for most of their earnings and cash flow, especially pressure pumping equipment providers, should experience much more volatility, said the analysts. Earlier this month Calgary-based Gasfrac Energy Services Inc., which has been attempting to build market share in the fracking market with its waterless technology, said it had ousted the CEO and COO and had begun an operational review(see NGI, Sept. 17).
"We believe smaller providers -- those with exposure to just one or two basins -- will be particularly vulnerable," said the S&P analysts. "These companies have historically worked on jobs that their larger peers overlooked because they tend to be small and of relatively short duration. However, an oversupplied market could cause the larger players to take on smaller jobs as a way to put their underutilized crews to work. This could increasingly challenge smaller companies and put downward pressure on their [gross earnings] margins."
The chemicals used in fracking "pose some environmental risks," the analysts said. "We believe the usage of these technologies will continue, particularly in the U.S., but it will be accompanied by further regulatory oversight regarding environmental and health concerns."
E&P operators have benefited from the dual technology because it's led to "several drivers of profitability, and therefore, credit performance," said S&P. "Completion costs for wells have declined recently, but to varying degrees based on region. While the supply and demand picture is different for the gas and oil industries, a decline in completion costs typically bodes well for companies' profitability."
The analysts see continued production increases ahead for oil. "Production in the Bakken basin, which represents the vast majority of production in the...region, was 594,000 boe/d in June. We believe that production in the Bakken could exceed 1 million boe/d by 2015. In terms of oil production, fracking and horizontal drilling have become so material that some economists believe the U.S. will be able to slowly cut back -- and possibly one day stop -- importing oil from abroad."
The natural gas potential is circumscribed by the absence of increased demand. "The lack of export capacity in the U.S. for natural gas means the output of the increased gas production is likely to stay within North America, at least for the next few years, which will likely uphold a wide divergence between oil and gas prices. Based solely on an energy-equivalent basis, we think the oil to natural gas price ratio should be approximately 6 to 1. However, the ratio began to widen in 2009 -- in sync with the increased usage of these technologies. Today, the ratio is approximately 30 to 1."
If natural gas demand does not catch up to the current supply, the United States could remain oversupplied for the next several years and pose "very different implications for oil and gas players," the analysts said.
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