Halliburton Co. reported Wednesday that its profits fell in 3Q2012 from a year earlier in part because of inflated raw materials, but the company also took a sharp hit from the decline in U.S. onshore drilling, which likely won’t accelerate until next year, company executives said Wednesday.

North American margins fell in the three-month period below the company’s guidance forecast a month ago to slightly more than 15%. In 1Q2012 margins reached almost 27%. North American operating income fell 30% in the latest quarter from 2Q2012, in part from onshore oilfield service pricing pressures.

The U.S. oil-directed onshore rig count rose 3% sequentially from 2Q2012, but the gains didn’t offset a double-digit decline in onshore domestic natural gas rigs. In addition, Halliburton’s decision earlier this year to stockpile guar, a hydraulic fracturing (fracking) necessity that mostly is grown in India, also backfired as prices fell sharply (see Daily GPI, July 24).

“Our North America revenues were down 5% compared to the prior quarter as a result of the lower U.S. land rig count, contract renewals that result in lower stimulation pricing and activity disruptions associated with Hurricane Isaac,” Lesar said during a conference call. “The U.S. land rig count declined sequentially by 68 rigs, or approximately 4%, as operators continued to decrease their gas-directed activity.

“The oil-directed rig count was up 44, or 3%, this quarter as customers continue to shift their budgets toward basins with better economics. However, this increase was insufficient to offset the 18% reduction in gas rig count.”

The rebound in Canadian activity from the spring breakup also was “significantly less than industry expectations,” said the CEO. Compared with 3Q2011 levels, Canada’s rig count fell 26%, or by 116 rigs, and Halliburton expects activity levels to remain “subdued” through the end of the year.

Strategy and Corporate Development chief Tim Probert noted that the company had a “headwind of approximately 600 basis points in our North American business” in 3Q2012, which he attributed in part to the guar costs. However, “customers have reined in their spending in the back half of the year, resulting in a decline of 172 rigs since the beginning of the year.

“Spending reductions have been more concentrated in large cap public companies since the end of the second quarter.” The large caps “are indicating to us a return to historical levels of activity in the first quarter as 2013 budgets get underway.”

It’s not all just a drop in rig activity, however. Drillers are becoming more proficient — and more efficient — at hitting their targets.

“I think the rate of drilling efficiency in the second half of the year has probably exceeded expectations,” he said. “And as a result of that, we’ve seen essentially this construct of many companies essentially running at a budget as we glide in toward the end of the year…That, clearly, is contributing to the slowdown. I think the indications we are getting clearly is that we will see that increase as we get into 2013. I don’t think we’re naive enough to think that it happens on — in the first week of January because it won’t. So it will be a spaced event as we go through the first quarter…”

Across North America, said Lesar, “we have seen customers curtail spending compared to the first half of the year and believe they will continue to decrease activities to operate within their capital budgets for the remainder of 2012. Couple this with expectations that our customers will take significantly more holiday downtime than prior years, this could have an even more-than-normal negative impact on the rig count as we approach year-end.”

“We’ve also seen increased pricing pressures in the oil and liquids markets as we renew existing simulation contracts and win new work,” noted Lesar. “The continued migration of hydraulic horsepower into the oil basins has resulted in these areas being in especially crowded place for stimulation equipment today, with the natural outcome being overcapacity and pricing pressure.

“We expect this pricing pressure to persist through early 2013 as we renew our existing contracts. But in response to giving fracturing price concessions, we have negotiated pull-through of additional product lines. Several smaller stimulation companies have recently reported losses or breakeven levels of profitability. This has historically been a good indicator that the market is close to or at the bottom of spot pricing deterioration.”

Halliburton’s stimulation fleet remains “highly utilized…as we negotiate fracture contract renewals, and we’ve been able to increase our percentage of 24-hour crews. Many of our competitors simply do not have the infrastructure in place to meaningfully grow their 24-hour operations.”

Lesar told analysts that “the successful company will be the one [that] could help lower our customers cost per boe for drilling and completing unconventional wells. This is going to require three capabilities: an efficient pumping fleet, which we clearly have, especially as we expand our ‘Frac of the Future’ footprint; two, better well engineering and fracture design to drill more efficient wells, to only fracture the most productive zones; and three, fluid systems that maximize reservoir response.”

Halliburton’s Gulf of Mexico operations had “some impact” from Hurricane Isaac but “the timing of certain projects was the primary driver of profitability this quarter,” said Lesar. “We are optimistic about the work that we have secured for new deepwater rigs arriving in the Gulf and expect that this will translate into higher market share relative to our historical levels. We’re also optimistic about anticipated fourth quarter activity and believe we are well positioned to continue with strong growth in the Gulf in 2013.”

The “next couple of quarters” are expected to be “pretty bumpy,” said the CEO. “While we have an understanding of the price impact of our contract renewals, there remains significant uncertainty around customer activity levels throughout the fourth quarter, both in terms of rig programs and extended holiday downtime. Activity may be further impacted by the muted recovery in Canada by typical weather-related delays and by customers’ decisions to drill but not complete wells. At this point, we believe the downside pressure to the fourth quarter outweigh in the upside, and we will take the necessary steps to adjust our operations.”

Halliburton has been “running our people and equipment flat-out for the past several years. So if this short-term drop in activity happens, we will not chase the lower price transactional work to keep our crews busy or to gain market share. This is something we traditionally would have done. We will instead stack our equipment and reduce labor costs by working with our employees to minimize the temporary impact of these disruptions.”

The company is taking a different approach because management believes “these issues are transitory and we do not want to take the risk of lowering the pricing baseline for a problem that we will expect to go away in a couple of quarters, or to have our customers believe that such pricing would be the new normal going forward.”

Halliburton is forecasting “modest” oil rig growth in 2013, assuming commodity prices continue their support, said Lesar.

“However, to return to the utilization levels we saw in 2010 and 2011, the industry will require some degree of recovery in the natural gas market.”

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