The oil-field services sector is in the tough position of being the first to get hurt when oil prices plunge and the last to profit when a recovery finally happens. That lag has always existed, but this time it seems like an endless nightmare for oil services companies, both small and large.
The most obvious evidence is the recent bankruptcy of Weatherford International, the sector’s fourth largest player. Weatherford is a genuinely diversified global outfit with a hand in just about every significant business sector across the oil and gas industry.
To be sure, Weatherford’s extraordinary debt load of $7.7 billion was somewhat unique, but the forces depressing its finances were not. Share prices for bigger, stronger rivals like Schlumberger, Halliburton, and Baker Hughes are trading at multi-year lows with dismal earnings outlooks.
Below the top tier, there is even more carnage. More than 170 service companies have declared bankruptcy since 2015, according to estimates from accounting giant Deloitte, and the sector remains stressed by a problematic combination of lower revenues and lower margins.
Deloitte estimates the sector as a whole has lost $96 billion over the last four years, its most prolonged period of losses ever. Upstream operators have driven losses in the service sector with their focus on capital discipline and cost control measures.
Don’t expect any relief for the embattled service sector anytime soon, either. Oil and gas producers will largely remain on the investment sidelines so long as oil prices stay in a constant state of extreme volatility. Service firms perform contract work — drilling wells, providing equipment, as wells as providing engineering services and building critical energy infrastructures like refineries and LNG terminals — for producers. So long as their customers aren’t spending, their revenues will remain depressed.
Benchmark Brent oil prices fell to around $64 a barrel on Friday — suffering their worst weekly loss of the year so far. The price plunge comes despite a host of bullish factors in the market, including tightening fundamentals, rising geopolitical tensions, attacks on infrastructure, sanctions on Iran and Venezuela, and ongoing supply cuts by OPEC.
We should be talking about oil prices at $100, not fearing a drop below $60. The markets, however, are fixated on fears of a global recession stemming from ongoing trade issues. The latest bad news on the trade front is the Trump administration’s threat of new tariffs on Mexico unless that country curbs the flow of illegal immigration.
Harsh tariffs and sanctions have become hallmarks of the Trump administration’s foreign policy, and they are wreaking havoc on investor sentiment in financial and commodity markets.
Less uncertainty, more economic stability, and higher oil prices would help oil services companies, which have been critical to the US oil boom of the past decade. Headwinds for the sector go beyond oil prices and include bottlenecks that limit oil-field activity, particularly in US shale plays. Those include labor shortages and overcapacity of equipment like drilling rigs that are hurting these companies ability to gain any pricing power over producers.
Producers appear committed to capital discipline, particularly with investors demanding bigger shares of the profits in the form of dividends and stock buybacks. Cost-obsessed producers won’t sacrifice a penny to service contractors at any point in the supply chain. Producers have even started to move into the service sector, becoming direct competitors to some of their past partners. In the shale sector, some producers have started to source sand for fracking themselves, removing the middleman to reduce expenses.
Unfortunately, Weatherford shows the dangerous path forward for many debt-laden oil service companies: Chapter 11, or, worse, Chapter 7 bankruptcy. The service sector loaded up on debt when oil prices were over $100, and producers were overspending on all sorts of schemes, including mega-projects with breakeven prices close to triple digits. Those days are unlikely to return.
Moody’s reckons that the service sector’s debt has skyrocketed over the past decade, reaching more than four and half times EBITDA on average compared to one and a half times EBITDA in 2007. Capital markets have closed for many companies, which means rationalization is the only way many in the sector survive.
Austerity will become the name of the game as service companies take a page from producers’ playbook. Mergers and acquisitions should increase as companies realize that surviving the downturn is only possible by cutting costs and combining forces to claw back pricing power from producers.