Soaring oil and gas prices have dramatically altered the power dynamic between oil companies and the contractors that provide drilling services for the industry.
The oil services sector was hardest hit by the pandemic-induced crash of 2020, which forced many firms – including powerhouse Weatherford – into bankruptcy.
But the steady rebound in oil prices, turbo-charged by Russia’s late February invasion of Ukraine, has prompted a massive reversal of fortunes.
With oil prices trading over $100 a barrel and markets facing a supply crunch, the oil services sector is looking at a robust, multi-year upcycle as demand surges for the equipment needed to drill and frack new wells.
For the first time in almost a decade, service providers have the power to raise prices on their oil company customers, and it looks like this power dynamic could be in place for some time.
During the downturn, the service industry performed extensive rationalization – laying off crews, downsizing operations, and scrapping underutilized equipment – to reduce costs. That means there is no longer excess capacity in the drilling market, so when demand for services surges, there is a limited supply to fill the need.
In some cases, capital spending cuts in recent years in the oil services sector mean that some equipment is simply not available – at any price.
That is particularly true in the fracking business. Competition for fracking fleets in the Permian Basin and other shale plays is fierce.
Halliburton
HAL
, the largest hydraulic fracturing fleet in the U.S., said the unit is completely booked for the rest of the year.
According to Baker Hughes
BHI
data, the U.S. rig count is up 20 percent since the start of the year and roughly 60 percent over the previous 12 months. The surge in drilling, led by privately owned E&P firms, is jacking up margins and profits for oil services companies.
But the industry is also dealing with the most challenging supply chain and inflationary environment it has seen in several decades as markets recover from the pandemic. There is broad-based inflation and supply pressure for critical materials, commodities, and labor, which the sector is passing on to its oil company customers.
The upshot is that more money must be spent to grow oil and gas production in this inflationary environment. In North America, Halliburton raised its forecast for producer spending growth to 35percent this year from 25percent. But that revision reflects inflation as much as producer plans to increase drilling rates.
Simply put, producers today are getting less bang for their buck.
JP Morgan analysts say inflation will hit the hardest in the shale-focused U.S. onshore sector. They expect the average publicly-traded E&P company to increase spending by 20percent compared to last year but to have a corresponding production increase of just 3percent.
Bakken shale-focused Continental Resources
CLR
recently increased its 2022 capital budget by an additional $300 million to $400 million but said as much as $150 million of its CAPEX would be consumed by inflation.
Much like the global oil and gas supply situation, there is no quick fix to the tightness in oil services and equipment.
The sector was severely burned by overbuilding and excess capacity in the past decade, and it is likely to keep operations lean from now on. Most of its publicly-traded E&P clients are adhering to capital discipline, directing record amounts of free-cash-flow to shareholders rather than to new investments. And most services companies are following their lead.
As Halliburton CEO Jeff Miller puts it, this will be a “margin cycle, not a build cycle,” meaning the oil services sector will reap the benefits of higher commodity prices and robust profit margins without commensurate increases to their capital expenditures.
Top player Schlumberger
SLB
set the tone recently by announcing a 40percent increase to its 2022 dividend while keeping its CAPEX plans unchanged.
It all points to higher break-even costs for oil companies, which will require a higher oil price in the future to turn a profit on their investments in this environment.
And that all but guarantees that today’s sky-high oil and gas prices are no passing fad.
