I sit on a bunch of boards. I do not sit on these boards because I am a financial wizard. I’m the opposite. I keep the book “Finance for Dummies” at my elbow so I can look up things like EBITDA or Preferred Shares or Cost Accounting.

I was freshening my overview of cost accounting one quarantined day last week when I came across the death spiral phenomenon in cost accounting. This death spiral occurs when a company repeatedly eliminates products or services without reducing fixed costs. The concept refers to situations in which a company falls into a spiral of increased fixed costs and lower production volumes (I borrowed this definition from somewhere, but don’t remember where!).

My colleague David Hutchison and I were in the middle of merging our work on well servicing and coiled tubing, and I thought that this cost accounting death spiral thing looked a lot like the global coiled tubing market. Consider the following two graphs:

Here’s a sector that has become enamored with hugely expensive, large diameter coiled tubing service units – these cost up to $10M per spread – and they are used in the US to drill out 50-70 plugs that were set by a wireline truck during the frac job.  These big coiled tubing units tend to work great, but a $10M unit doing the work that a $1M well servicing rig could do almost as well (although more slowly)? How’s that going to look in a sub-$40 oil environment?

For the global coiled tubing market to rise in 2018/2019 investors had to build a lot of brand new, large diameter coiled tubing units for the US land market.  Most of the older, fully depreciated conventional coiled tubing units were sitting idle because well configurations had moved beyond the technical limits of the older units; horizontal laterals were simply too long for the original CT units.

So here we have a fleet of shiny new expensive, purpose-built coiled tubing units in the US and the market is collapsing on itself.  The charts above show the global coiled tubing service market, but the majority of the 2020/2021 downturn is due to the collapse of spending in the US.  The fixed costs of the US land coiled tubing industry are huge, but the number of jobs over which these units will be spread will be only 30% as large in 2020.  A cost accounting death spiral.

If a coiled tubing service company has no debt, they can probably weather through this downturn until the pursuit of natural gas reawakens the domestic oil industry in a year or two; but, if the coiled tubing service company has significant amounts of debt, be prepared for ownership to change hands.