For the past two years, three people internal to Spears & Associates have written columns in this space: David Otte, John Spears, and Richard Spears. But long-time friend of the firm, Jim Wicklund of Stephens Inc., posed such a great set of questions this week that we thought we’d let him have the floor as our first guest editorial writer. Here’s Jim’s big question:
In an industry where how owners judge, manage, and value their companies is in transition, how can the relationship between E&P and oilfield services evolve so that BOTH generate adequate full cycle returns to stay viable in today's world?
The face of the oil and gas industry has changed dramatically in the last decade. For years US E&P companies focused on growth… grow production as fast as you could, borrow and raise as much money as fast as you could, and build value for the future as fast as you could.
During this time, the US E&P industry could focus on growth because US growth was never enough to impact global markets or the price of oil. Also during this time, the US industry was dominated by independent oil companies; the majors spent their efforts offshore and overseas.
Then came 2014, when the US grew oil production by more in one year than any country had ever done in the 150+ years of the industry.
The global market responded by using the only mechanism available to rein in this growth, by lowering oil prices. 2015 through 2017 the E&P industry worked on adjusting its business to the new oil price paradigm and, with the help of the oilfield services industry, succeeded in setting new production records in 2018 at an oil price half of that in 2014. And again, the market tried to stunt growth with lower oil prices in Q4 2018.
But something else happened: The ownership of energy stocks moved from people focused on growth to people much more concerned with return on and return of capital. The result? The E&P industry – for the first time in eight years! – did not outspend cash generation.
Oil prices now have a different role: They function to suppress US production growth to a level that does not oversupply world oil. This transformation is in the early stages and is not likely to revert anytime soon. And now, that enforced discipline is being seen in the oilfield services industry as well.
Given this restraint, how should the oilfield services sector move forward?
Since 2002, the E&P indices are up 300%, but the OFS is basically flat, implying that all the value created by the OFS industry for the last two decades has accreted to the E&P industry. That must change.
The E&P industry has fragmented pressure pumping into its component parts, directly buying sand and chemicals, while carving out just pumping to the traditional players, eliminating $7 billion from service company frac tickets each year.
And land rigs now drill wells in a fraction of the time of 6-7 years ago, yet they have captured virtually no value for themselves, paid only the same day-rates for many fewer days. E&P companies seem intent on exploiting the low barriers to entry in the oilfield, hiring only based on the lowest price. OFS companies must generate adequate returns to maintain equipment and invest in new technologies, but if the E&P industry hires on lowest price, adequate returns are eliminated.
So, how does this paradigm change?
Major oil companies are now more than 10% of US onshore activity. This shifts practices of the industry, since majors are more suited to offshore and international services, which operate very differently than onshore US.
All this circles back to the big question: How can the relationship between E&P and oilfield services evolve so that both generate adequate full cycle returns to stay viable in today's world?
Right now, it’s still a question.