OFSE sector revenues continued their downward path in the fourth quarter 2015. And with operators adjusting to the lower price outlook, OFSE margins are now also coming under pressure.
Quarterly perspective on oil field services and equipment: March 2016
Oil Field Services & Equipment (OFSE) sector revenues continued their downward path in the fourth quarter 2015. And with operators adjusting to the new lower price outlook and aiming to be profitable at $50/barrel oil, OFSE margins are now also coming under pressure—having so far remained fairly steady, to the surprise of many operators. The situation is putting even the biggest companies under pressure, with Schlumberger reporting its first quarterly loss in 12 years of trading.
Revenue contraction continues to cause the most damage, falling by 32.6 percent versus Q4 2014—an acceleration on the third quarter annual comparison, which showed a 27.9 percent drop. Declines in all the main sectors accelerated, with companies in the services category falling 44.3 percent on the year, compared to a 38.1 percent in the third quarter. Assets were down 30.3 percent, and equipment 37.7 percent. Quarter on quarter comparison showed an overall revenue decline of 7.0 percent in the fourth quarter, up from 5.3 percent in the third. These revenue falls correlate closely with capex cuts.
The declining crude price over the last few months is a continued source of concern, which we expect will lead to further capex cuts this year, especially in the North American onshore market. Brent dropped from $44.6/barrel in November to $33.5/barrel in February—although it should be noted that at the time of writing the oil price had risen from $25/barrel to $36/barrel in two weeks. Forward prices have also come down further, indicating a lower for longer scenario may well be in the offing, leaving many companies bracing themselves for a prolonged downturn. The first casualties are now coming in, with the UK North Sea’s First Oil Expro going into administration in
mid-February and rumors of growing insolvency across US LTO. “2016 E&P investment levels will fall for a second successive year and any significant recovery in our activity levels will be a 2017 event,” said Paal Kibsgaard, Schlumberger CEO, in his Q4 earnings statement.
The situation is now threatening OFSE margins, which have held up remarkably well over the past four quarters. In particular, assets, which had seen a remarkable rise in margins in the first half of 2015, fell by 2.3 percent—although this is still a 4.3 percent premium to Q4 2014. Services and equipment margins have fared less well, standing at 7.1 percent and 7.3 percent below Q4 2014. As easy cost reduction measures are exhausted we expect margins to come under further pressure in 2016.
Oil prices declined in recent weeks, and forward curves also shallowed (Exhibit 1)
Oil prices are maintaining their downward path, with
Brent dropping from $44.6/barrel in November to $33.5/barrel in February—although it should be noted that
at the time of writing the oil price had risen from $25/barrel to $36/barrel in two weeks. But perhaps the
biggest price impact has come from falls further forward.
Although forward prices still remain firmly above prompt,
the flattening of the forward curve seen in the third
quarter 2015 accelerated in the fourth, reflecting weaker
sentiment over a longer timeframe. While front month
Brent lost just over $10/barrel, 2020 prices dropped to
$49.0/barrel from $62.3/barrel—almost $14/barrel.
The forward price falls appear to be the market pricing
in the longer term implications of the resistance of US
shale output to lower prices, which means that any move
above $50–60/barrel would be likely to result in rising
output once more. US onshore supply has declined only
slowly since May last year, although the latest figures
show some acceleration.
Another reason for the longer term falls could be growing
signs of a fundamental rift in OPEC between Saudi Arabia/GCC
and Iran/Iraq, with the latest ceiling agreement of 31.5
million barrels/day not including the two Shia-majority states,
which appear set on increasing their market share. Little
more is expected from the recent agreement between
Russia, Saudi Arabia, Qatar, and Venezuela, although it provided
the first sign of cooperation outside OPEC since the price
On the demand side, the US market is expanding,
with 2015 road mileage 4 percent above its peak in
2007, although gasoline consumption remains lower
due to improved fuel economy. Parts of Europe even
saw a return to transportation demand growth in 2015,
after many years of decline. But continued weakness
in emerging markets—notably China and Brazil—is
maintaining concern about medium-term demand
development. And the removal of subsidies in some oil
dependent economies has seen a contraction in their driving demand, while others, including China, have not
passed on all the falls or have used the crude price drop
as an opportunity to add taxes.
Capital expenditure—stabilizing trend from Q2 continues (Exhibit 2)
While capex is significantly lower in Q4 2015 than 2014, it
has remained relatively steady since the second quarter
2015 at just over $60 billion per quarter. However, we
anticipate further falls in capex of 15–20 percent this
year as operators take on board the latest price falls,
particularly in US onshore where we expect a fall of up to
While majors are better financed than independents,
they are still expected to cut another 15–20 percent
from capex in 2016 by postponing projects. NOCs are
expected to cut the least at just 8 percent, and that’s
not including the higher spending GCC NOCs, although
there is still a push back on prices, which is also being
reflected in lower OFSE revenue.
Rig counts (Exhibit 3)
Rig counts have accelerated their downward trend after
moderate falls in the third quarter and a slight hiatus in
the second. Lower prices mean further falls are expected
in Q1 2016. Without a price recovery, Baker Hughes
said it expects the global rig count to fall by another 30
percent in 2016, on top of the 46 percent it registered last
Offshore the number of rigs dropped 26 percent in 2015, with
the relatively high cost mature Western Europe region—especially the UK North Sea—most affected, while
the lower cost Middle East has seen less of a downturn.
Some industry groups in the North Sea have been
appealing to operators to get costs down by trying new
approaches, or run the risk of the service base moving
overseas or closing as orders dry up.
North America once again dominated the fall in onshore
rig numbers, which are down 14 percent in Q4 and
60 percent since Q4 2014.
Recent OFSE market performance
During Q4 2015, OFSE revenues were 32.6 percent
lower than in Q4 2014, and down 7.0 percent on the
third quarter 2015, driven by a continuing decline in rig
activity and persistent pricing pressure, together with
a broad range of activity disruptions, project delays, and cancellations. The largest declines were posted
by services, which fell 44.3 percent, and equipment
companies (down 37.7 percent). Falls across all sectors
were bigger than the yearly falls seen in the third quarter,
when services fell 38.1 percent, assets 24.3 percent, and
equipment 30.3 percent.
The falls in services have been greater than other
categories so far due to the shorter term nature of
contracts and a greater price sensitivity, whereas FPSO,
rigs, and other assets tend to be on much longer term
contracts. This means we expect falls in assets and
equipment categories to increase as the sector plays
out over a longer cycle, while services may have already
seen the biggest falls.
Sequentially, the decline of 7.0 percent was also faster
than the 5.3 percent seen in the third quarter, while both
falls outpaced the relatively steady capex numbers,
reflecting a lag from bigger capex cuts earlier in the year,
many of which were made on an annual basis and evenly
spread across the year.
EBITDA margins for all categories fell compared to the
third quarter, and were down 4.1 percent on average
against Q4 2014, although asset margins were still higher
at 4.3 percent above—having shown an unexpected
countercyclical rise in the first half of 2015. This was most
likely due to efficiency improvements outpacing revenue
falls, although that now seems to have reversed with a
quarterly fall of 2.3 percent. OFSE efficiency gains can
only go so far, and so revenue falls are now increasingly
affecting margins, which we expect to continue.
Falls in equipment and service margins have outpaced
those in the asset category, along with those of EPC
firms, which saw a recovery last quarter from very low
levels in Q2, but fell back again slightly in Q4. This
quarter’s falls mean margins across all categories are
beginning to be more reflective of market austerity.
Services: Oil field services companies saw Q4 2015
revenues decline 44.3 percent compared to Q4 2014,
and 9.4 percent on Q3 2015. Margins are down by 7.1
percent on the year and 2.9 percent compared to Q3,
after holding up surprisingly well earlier in the year as
service companies quickly cut costs. “We were able to
maintain operating margins due to a relentless focus on
cost management,” said Halliburton’s CEO David Lesar
in his Q3 earnings statement. But now the low hanging
fruit has gone and operators are still looking for cuts.
Equipment: Equipment companies saw Q4 2015
revenues decline by 37.7 percent from Q4 2014, and
sustained an 8.2 percent sequential decrease from Q3.
While a backlog of orders ensured revenues in 2014, the
fall off now continues to cause a steadily rising revenue
decrease. EBITDA margins for Q4 2015 were 11.5
percent on average, down 2.8 percent from Q3 2015,
standing 7.3 percent below the same quarter in 2014.
The high fixed cost base of equipment manufacturers
has prevented them from reducing their costs in
proportions similar to the services companies. This
indicates there will be further margin erosion as revenues
continue to decline.
Assets: Q4 2015 revenue for this group fell 30.3 percent
from Q4 2014, a bigger fall than the previous quarter’s
24.3 percent. Revenues declined sequentially by 6.8
percent, similar to the quarterly fall in Q3, which suggests
that the downward trend may be starting to stabilize.
Margins dropped 2.3 percent on a quarterly basis, but
remain 4.3 percent above fourth quarter 2014. But
despite this strong margin and relatively strong revenue
performance compared to other categories, returns to
shareholders since late 2014 from the asset category
were by far the worst (Exhibit 5).
EPC: EPC companies saw Q4 2015 revenues decline
11.9 percent from Q4 2014, and 3.9 percent from Q3
2015. EBITDA margins were about 6.9 percent on
average, down 0.5 percent compared to Q4 2014, and
2.1 percent lower than the third quarter, which was not
far off Q4 2014 levels.
Key OFSE sector trends
1. Margins squeezed as operators get down to detail
It has taken until Q4 2015 to see a marked fall in margins
because operators are only now entering a third stage
of cost savings, which is proving more difficult to absorb
than the initial rounds, as it focuses deeper into what
drives costs in the O&G supply chain.
Most of the cuts so far have been by activity reduction
(opex, capex), which OFSE companies have largely
managed to absorb through cost savings, including
more modular offerings with standardized components.
Operators then worked with OFSE companies to cut
cost, going through efficiency programs in more detail in
an attempt to take more control of costs, with “design-to-value”
and “should costs” flavor of the day. Now there
is a third wave, particularly with equipment suppliers,
where activity is being driven down so much that
efficiency savings are not sufficient to cover revenue falls
and support margins. How well OFSE companies are
able to cope will depend on how far advanced their own
efficiency programs are.
Some of the service companies are behind in these
programs, and the US onshore, in particular, lacks
sophistication. US LTO price and activity reduction are
well underway, but the efficiency wave still has some way
to go especially in onshore services. OEMs are always
ahead of the cycle in terms of their demands.
2. Bankruptcies as cash flow fails to cover costs
In cases where cost bases cannot be cut sufficiently,
the first OFSE bankruptcies have taken place. Houston-based
contract rig operator Vantage Drilling filed for
bankruptcy protection in early December after reaching
a deal on a debt-for-equity swap with its lenders and
bondholders. Hercules Offshore, a jack-up rig contractor
with most of its fleet in the shallow waters of the Gulf of
Mexico, went into Chapter 11 in August, but after
securing a $450 million loan managed to re-emerge
in November, becoming one of the first oil and gas
industry players to successfully restructure in the energy
downturn. More recently, Paragon Offshore filed for
bankruptcy on February 14 following missed bond
payments in January.
It makes sense that rig owners would be the first ones to
go under because of the long investment cycle, which
has left some companies with a lot of debt. Last year
could be the leading edge of what may be a number of
bankruptcies, as companies seek to shed or restructure
debt. This may help explain why the asset category has
performed so badly in shareholder returns.
A lot of rigs are still at pre-price decline day-rates, so
as they come off contract it becomes more difficult
for offshore rig owners to maintain cash flow. As price
recovery takes place the recovery may take a little while
to benefit them, while in North American onshore where
activity is more fungible, we might expect to see margins
recover a little more quickly.
3. Bankruptcies, M&A rebalancing market by removing capacity
With far too many rigs and other assets in the market,
it will require capacity to be reduced by scrapping less
competitive rigs to rebalance supply and demand.
However, many of the companies in most trouble are
those that invested heavily over recent years in new
fleets, some of which may end up being sold cheaply to
more cautious companies.
Leaders of Transocean, Noble Corporation, and Rowan
Companies have all said they are looking for bargains—to
both eliminate competition in a saturated rig market and
to pick up new rigs at low prices. Vantage, along with
Pacific Drilling, have a young fleet that would be valuable
to larger rivals, particularly those with older rigs. However,
at the moment no rigs are being bought, perhaps as
there are no contracts to send them to. As companies
with heavy equipment across the OFSE landscape (e.g.
rigs, pressure pumping) restructure, it will be critical to
watch how much capacity comes out of the market via
scrapping or retirement.
4. Consolidation in oil service and equipment changes the face of the industry
A rash of mergers and acquisitions over the last
two years and the first of a number of anticipated
bankruptcies is altering the shape of the OFSE sector.
The merger of Halliburton and Baker Hughes at the end
of 2014 has been followed by others over recent months, notably Schlumberger’s acquisition of Cameron for $14.8
billion—in contrast to lackluster M&A activity among
upstream oil and gas companies in 2015. If the trend
persists, the OFSE sector will be more consolidated than
In 2015 OFSE M&A deals were valued at $25 billion,
according to Derrick Petroleum, although there were
only $3 billion of deals in the final quarter of the year, as
participants backed off in the face of even greater oil
price falls in order to reconsider their options. While the
total was down on 2014, which saw a record $71 billion
change hands in 169 deals, it remains above 2013 and maintains momentum. This was in contrast to M&A
among operators, which slumped to just $144 billion
in 2015, the lowest since 2008, as buyers backed off.
There were $35 billion of deals that were announced but
cancelled in 2015—illustrating the level of uncertainty
among investors. Without the $82 billion Shell-BG deal
in Q2 2015, the remainder amounted to only $62 billion—significantly below even the 2008 total. Against the
background of a contracting industry, the divergent trend
could significantly alter the balance of market power
between operators and OFSE companies once the price
slump is over.