Oil Field Services Sector on Road to Recovery

A special IHS Herold Review on the Oil Field Services Sector issued in December indicates a healthier growth outlook for the industry in 2011, despite being hard hit by the Gulf of Mexico (Gulf) drilling moratorium in 2010. A general recovery is being driven by rising oil prices, unconventional drilling in North America and multiple opportunities offshore worldwide. The review, which compared key oil company financial performance for the first nine months of 2010 against sector performance for same period in 2009, included multi-service companies such as Baker Hughes, Halliburton and Schlumberger as well as offshore drillers Transocean, Diamond Offshore and Oceaneering International, among others.

"Many of the service companies, and in particular the offshore drilling companies, took a financial beating following the Gulf drilling moratorium. Companies exposed to the Gulf incurred costs related to redeploying assets and personnel to other opportunities, primarily onshore North America or international markets," said John B. Parry, principal energy analyst at IHS and author of the IHS Herold Review on The Oil Field Services Sector. "With the lifting of the moratorium, the industry has moved to a more offensive posture. While valuation of the underlying equities in the sector remain about 35 percent below their peak in 2008, we believe strong oil prices and higher exploration and production budgets will help drive growth in the oil field services sector in 2011; and current forward earnings estimates suggest a potential restoration to prior peak 2008 stock price levels by 2012."

Baker Hughes led the pack of multi-service providers, with a 38 percent increase in revenues ($9.9 billion in 2010 versus $7.2 billion in 2009) during the first nine months of 2010 as compared to the same period in 2009, followed by Halliburton, which posted a 17 percent increase in revenues for the same period ($12.8 billion versus $10.9 billion); and Cameron International, which saw its revenues rise 15 percent during the period ($4.3 billion versus $3.7 billion in 2009). Of the six leading companies covered in the sector, only National Oilwell Varco posted a revenue decline (six percent or $8.9 billion in 2010 versus $9.5 billion in 2009), but its earnings advanced 14 percent to $1.4 billion.

Shifting resources to meet strong demand for U.S. onshore drilling and other international projects helped many service companies turn the earnings tide back to a more positive flow. In its mid-year 2010 earnings conference call, Baker Hughes said, "In response to the Gulf drilling moratorium, we have deployed people and equipment to U.S. land operations and to international offshore markets where deepwater drilling continues, and in the third quarter confirmed that earnings are being penalized about $0.09/share as a result." But the company said that an improving North American fracture (frac) market and rising frac prices have led to a strong backlog for pressure pumping, with wait times of 90 to 180 days, and "we are investing in incremental frac capacity."

In its third-quarter 2010 earnings call, Halliburton said that for "North America, the shift into oil- and liquid-rich plays is going to lead to continued growth in overall activity for our U.S. land business…and lead to further price improvements and higher utilization rates." Halliburton also said it had transferred approximately 400 people from the Gulf to other regions in the U.S. and around the world, and that it had "also hired over 6,500 new employees in the U.S. since the beginning of the year, creating a significant number of new jobs."

As might be expected, multi-service providers fared better than offshore drillers, who either saw declines in revenue or marginal revenue growth. Oceaneering International was the only company in the segment who posted positive revenue and earnings growth of three percent and eight percent, respectively. Transocean, owner of the Deepwater Horizon rig involved in the Macondo incident, took the hardest hit, with a 19 percent plunge in revenue and a 28 percent drop in earnings.

While overall earnings growth for the sector is a positive sign for the industry, the IHS study noted, post-moratorium challenges still persist, since a return to drilling has been slow. This has fed a general decline in rig-utilization rates while new-build rigs continue to enter a sluggish market. These challenges and the significant impact on the Gulf of the federally imposed moratorium on offshore drilling issued in the wake of the spill were further illustrated in the IHS CERA Upstream Capital Cost Index (UCCI), which tracks costs associated with the construction of new oil and gas facilities, issued December 9, 2010.

According to the IHS CERA UCCI, upstream construction costs rose three percent in the past six months after bottoming out during the previous six-month tracking period - an increase the report attributed to oil and gas activities worldwide. In the deepwater, six rigs left the Gulf for projects elsewhere, but the remainder stayed under contract and sat idle while waiting out the moratorium. Service providers to the rigs were also severely impacted, according to the IHS CERA report: "Even in shallow water where the moratorium was not enacted, the number of new wells drilled has been sharply lower. The subsequent lifting of the moratorium does not mean a return to business as usual, however. The return to drilling will be slow as operators and rig owners move to meet newly enacted certification processes."

The IHS CERA UCCI report and the IHS Herold Review on The Oil Field Services Sector both noted that idle rigs and a backlog of new rigs leaving the construction fields will lead to a softening of the rig market for the time being.

In an earlier study this year, IHS noted that more sophisticated new-build jack-ups and floaters (semi-submersibles and drill-ships) were expected to swell the world fleet of approximately 675 units more than 10 percent by the end of 2011, excluding possible retirements. The current status indicates a count of 760 (35 percent floaters) by year-end 2011, with approximately one-half of these additions lacking a firm long-term contract commitment.

These rig additions may seem daunting to some, but others, like Diamond Offshore, may view them as opportunities. In its third-quarter earnings conference call, Diamond Offshore said, "With respect to adding to the fleet, we are always looking for opportunities. This company was built through acquisitions in the past, and we will continue to monitor anything that comes along…You can always upgrade a rig, but with some (older types), it's actually more economic to build a new rig."

"This attitude, along with an eye toward mergers and acquisitions (M&A) will be a feature of the sector moving forward," Parry said. "For these companies to continue to help meet the changing competitive and technological requirements, particularly for offshore drilling, we see ongoing consolidation as part of the mix. In 2009 and 2010, our energy M&A team tracked more than 80 transactions in the oil field services sector, valued at nearly $40 billion. We expect that number is likely to remain healthy in 2011."