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Our work would indicate that the cost of drilling and completing a well in the US has risen15%-20% on average over the past year. This assumes no change in well design or operating efficiency, at a time when rig count has basically doubled.

However, with drilling activity down over the past 3-4 months, the question being asked today is whether oil service pricing is set to plateau or perhaps go down as we move into 2018. Here we’re showing three charts which suggest otherwise: well costs are poised to continue rising next year.

First, let’s look at how service firms’ input costs have been changing relative to their selling prices. Each quarter the Dallas branch of the Federal Reserve surveys business conditions in the oil and gas sector (E&P companies as well as oil service firms). Looking at just the service firms, the chart below shows that on a net basis more respondents have reported an increase in input costs than have reported an increase in their selling prices.

This suggests (1) that oil service price increases seen so far this year have done little more than cover their increasing costs, and (2) that profit margins for these firms are little changed since drilling began to recover in mid-2016 and remain under pressure. 


Oil & Gas Support Services Firms Current Quarter Versus Previous Quarter

The next chart shows that since the start of last year more respondents on a net basis have reported an increase in equipment utilization than have reported an increase in their selling prices. Higher utilization would positively impact service firm profitability by improving the absorption of fixed and indirect costs, and lower utilization would reverse this effect. If price increases have not moved in conjunction with equipment utilization since the start of last year, this suggests that flat-to-lower utilization may not negatively impact service pricing going forward. Oil & Gas Support Services Firms Current Quarter Versus Previous Quarter

The next chart shows that since the start of last year more respondents on a net basis have reported an increase in equipment utilization than have reported an increase in their selling prices.

Higher utilization would positively impact service firm profitability by improving the absorption of fixed and indirect costs, and lower utilization would reverse this effect. If price increases have not moved in conjunction with equipment utilization since the start of last year, this suggests that flat-to-lower utilization may not negatively impact service pricing going forward.


Oil & Gas Support Services Firms Current Quarter Versus Previous Quarter

On the other hand, the Dallas Fed survey shows that since the start of last year the trends in equipment utilization and capital expenditures among oil service firms have been very similar. (Just to get technical, there is a .86 correlation between capital expenditures and equipment utilization, lagged one quarter). The spending was probably necessary in order to put equipment back in the field, and the tight correlation between utilization and capex suggests that capex will fall going forward in response to a downturn in activity/utilization.  Oil & Gas Support Services Firms Current Quarter Versus Previous Quarter

On the other hand, the Dallas Fed survey shows that since the start of last year the trends in equipment utilization and capital expenditures among oil service firms have been very similar. (Just to get technical, there is a .86 correlation between capital expenditures and equipment utilization, lagged one quarter). The spending was probably necessary in order to put equipment back in the field, and the tight correlation between utilization and capex suggests that capex will fall going forward in response to a downturn in activity/utilization. 


Oil & Gas Support Services Firms Current Quarter Versus Previous Quarter

Taken together, the charts suggest that coming off the bottom of the 2014-2016 cycle oil service firms chased revenue growth through increased utilization. With more activity, they were able to absorb fixed costs better and see improved profits. Going forward, as activity growth slows, the service sector is likely to adopt the strategy of chasing profit growth by trading off lower utilization for increased pricing.   What does this mean? Higher service company prices will push oil companies to keep looking for new ways -- via technology, contracting, etc -- to keep breakeven prices from rising and ROI from falling. On the flipside, improved profitability will make service company investors happy… at least until it draws new capacity into the industry. But that’s a story for another day. 

Taken together, the charts suggest that coming off the bottom of the 2014-2016 cycle oil service firms chased revenue growth through increased utilization. With more activity, they were able to absorb fixed costs better and see improved profits.

Going forward, as activity growth slows, the service sector is likely to adopt the strategy of chasing profit growth by trading off lower utilization for increased pricing.
 
What does this mean? Higher service company prices will push oil companies to keep looking for new ways -- via technology, contracting, etc -- to keep breakeven prices from rising and ROI from falling. On the flipside, improved profitability will make service company investors happy… at least until it draws new capacity into the industry.

But that’s a story for another day.