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Onshore Oilfield Service Margins Falling, Says IHS

October 15, 2012
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Drilling demand from North America's shale boom, as well as the beginnings of a recovery in the Gulf of Mexico, revved the four biggest domestic oilfield service companies in 2010 and 2011, but this year has been a different story, according to a review by IHS Inc.

John Parry, who authored the IHS Herold report, "Oilfield Service Company Peer Group Analysis," reviewed Baker Hughes Inc., Halliburton Co., Schlumberger Ltd. and Weatherford International Ltd.

Domestic margins fell earlier this year, he said, in part because of "significantly higher costs" for some items, such as guar gum, which is used in hydraulic fracturing (fracking) fluids. Operators also faced pricing pressure for fracking services, and at the same time, have had to adjust to the costs and impacts associated with the ongoing relocations of equipment and personnel from natural gas to liquids-rich basins.

Those issues have been addressed by the oilfield operators in earnings conference calls this year (see NGI, July 30; July 23). A recent report by Tudor, Pickering, Holt & Co. also found that the North American oilfield services market "eroded" in 3Q2012, which may come into sharper focus when earnings season begins (see NGI, Oct. 8). And Standard & Poor's Ratings Services last month said margins could weaken for the service providers (see NGI, Sept. 24).

"Aside from cost pressures, these companies are continuing to adjust to the U.S. shift to oil shale from gas plays, with the most pressure being felt in the hydraulic pumping sector, which is the result of building excess pumping capacity," said Parry. "The good news for these companies is that, while margins in North America are being squeezed, profit margins outside of North America are showing sequential improvement, which are benefiting from improved activity in several regions aided by earlier targeted investments."

The aggregate operating margins in the first six months of 2012 eroded in North America but they improved elsewhere. The six-month results for the four operators analyzed showed a total of $24 billion in North American revenue, a 24% year/year jump, but operating income failed to keep pace, rising only 8.3% to about $4.8 billion. Outside of North America, aggregate revenue jumped 18% to $28.3 billion, and operating income climbed 42% to $4.6 billion.

"Measuring operating income as a percent of revenue further demonstrated the shift, as aggregate North American margins eroded to 19.9% for the 2012 six-month period, which was down from 22.8% in the same 2011 period," according to the study. At the same time, operating margins outside of North America in the first half of 2012 rose to 16.3% of revenue from 13.5% a year earlier. "The squeeze on the North America contribution is further evidenced by its reduction to 50.8% of total operating income in the first half of 2012, down from 57.6% in 2011," said the study.

"While we expect these companies to face tight margins in their North American operations for the remainder of the year, we also anticipate higher margins in other parts of the world to buttress those results and buffer the impact," said Parry. "In addition, these companies are highly innovative; they are not just sitting on their hands. Baker Hughes and Halliburton are developing replacements for guar gum, for example, and Schlumberger is preparing to market its advanced reservoir simulation software."

Parry said another contributor to the pressure on North American margins was a declining domestic natural gas rig count, which fell 18% in 2Q2012, which was 43% below its high in October 2011.

About two-thirds of Halliburton's North American margin compression year/year to 20.7% from 28.9% related to the impact of guar gum costs, which had climbed 75% from the first three months of this year. An additional 25% cost increase is expected in the third quarter for guar gum, IHS said.

"However, by 2013, Halliburton expects it will have worked the higher priced guar from its inventory and replaced it with more normally priced product. In the Gulf of Mexico, the company continues to see activity recover and second quarter margins were reported at near pre-moratorium levels. Halliburton's outlook for international markets has not changed. While slow, it is expected to grow steadily and to translate into long-term pricing improvement."

Baker Hughes also has been squeezed by guar gum costs, and it has been hit by competitive pressure pumping prices for fracking, which it has been unable to pass along to customers, said Parry. Meanwhile Schlumberger's North American fracking margins declined following higher product costs and lower pricing, but GOM deepwater activity "grew in line" with its outlook for the year and its operational performance remained strong.

Weatherford reported its highest revenues ever in 2Q2012 of $3.8 billion, even with pricing and cost pressures, said Parry. However the gains weren't from North America; the company had a 100% increase in activity year/year in Russian activity and another strong quarter in Latin America.

"Due to the uncertain global economic outlook and its impact on oil and gas commodity prices, particularly in North America, we expect the sharp shift in geographic operating income contribution will continue for the remainder of the year for these companies; a fact now borne out by subsequent guidance from some of these companies," Parry said. "Offshore activity will prove to be a partial buffer for these companies, as well as anticipated relief from the spikes in guar gum pricing."

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