Why This Oil-Services Company Has an Edge

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While it may seem boring at a glance, the oil and gas services industry is an exciting place to be. With an increasing number of companies drilling for hydrocarbons in more costly and more complex unconventional plays, the demand for services firms to guide them from start to finish is very high.

And because of the complexity involved with drilling in unconventional locations, the need for cutting-edge technology is also greater than ever. On this front, one company is leading the charge.

Better technology, better profits 
The services sector is a beacon of innovation within the energy industry. Oil-services firms typically receive more patents each year than most of the large integrated oil companies. Moreover, a lot of the innovation by integrated majors has actually been the result of partnerships with services firms.

This is reflective of a broader shift toward a more technology-driven energy industry. The effectiveness of the traditional brute-force approach of extracting oil from unconventional sources is waning. More sophisticated and innovative methods are taking its place instead.

The large-cap firms are the main beneficiaries of this development, since they have the advantage of much bigger R&D budgets, with which smaller firms find it hard to compete. In this respect, Schlumberger (NYSE: SLB  ) has a clear lead, boasting what is easily the largest R&D budget among oil-services firms and even most of the integrated majors.

The oil-services heavyweight spent more than $1 billion on R&D last year, compared with competitors Baker Hughes' (NYSE: BHI  ) $462 million and Weatherford International's (NYSE: WFT  ) $245 million. And it looks like all that spending on developing better technologies is paying off. The company boasts more than 4,000 patents, as compared with Baker Hughes and close rival Halliburton (NYSE: HAL  ) , which hold roughly 3,200 and 2,900, respectively.

Let's look at how Schlumberger has been spending all that R&D money and how it earned all those patents.

Reservoir characterization 
This is an important part of Schlumberger's business. As the name suggests, reservoir characterization models help companies better understand a reservoir's key characteristics. They simulate how fluids behave within a reservoir under different assumptions to determine the optimal techniques needed to maximize production.

In this crucial business segment, Schlumberger leads the industry, offering solutions ranging from high-end seismic, wireline, and well testing services to a comprehensive earth modeling software platform. For example, the company's shale reservoir workflow uses breakthrough 3-D models to get a better understanding of shale reservoir quality, which can significantly reduce wastage in time, horsepower, water, and proppant.

Drilling technology 
Schlumberger also has a leading position in one of the most crucial aspects of oil and gas exploration and production -- drilling technology. Two recent acquisitions helped further cement this lead.

In August 2010, the company acquired Smith International, an independent manufacturer specializing in drill bits. While the $11 billion price tag was hotly debated, I think the acquisition was a smart one, given Smith's leadership position in shale drilling technology. Also, in March 2010, Schlumberger acquired Geoservices, a French oilfield-services firm that specialized in mud logging, slickline, and production surveillance operations, for $1.07 billion. Given the importance of mud logging technology in developing higher-quality drilling systems, this move also appears to have been a great one.

Both acquisitions helped solidify Schlumberger's drilling portfolio, which maintains leadership positions in most of the company's markets. While the primary reason for the acquisitions was to further integrate the company's drilling services, they also served to reinforce the company's positions in completion and well intervention services.

Deepwater technology 
Deepwater drilling services are another strong point for the company. With a ton of recent offshore deepwater discoveries, as well as sustained high oil prices, the supply demand balance for offshore deepwater and ultra-deepwater rigs continues to tighten. Leading offshore deepwater driller Seadrill (NYSE: SDRL  ) recently reported that it already has several requests for its ultra-deepwater newbuild drill ships as far out as 2014.

Schlumberger's deepwater drilling offerings are highly integrated, combining industry-leading drilling products with modeling software, as well as planning and execution capabilities. Given that Schlumberger was first in total customer satisfaction for the drill bits and integrated services category, it's no surprise the company maintains a dominant market share in global deepwater markets, especially in the Gulf of Mexico. And with the company projecting more than 200 new deepwater fields to come online over the next four years, demand for its integrated offerings should only continue to rise.

Final thoughts 
With demand for unconventional oil and gas exploration and production likely to remain strong for the foreseeable future, the future for oil services looks bright. Schlumberger -- and the larger, well-capitalized firms in general -- should do especially well, since drilling in these locations is characterized by a high degree of service intensity and requires tremendous technological expertise from start to finish.

While its competitors are nothing to scoff at, Schlumberger still maintains its technological lead in the sector. Through decades of research and development, it has solidified its capabilities in important areas like shale and deepwater drilling technologies. And while the future looks promising for the oil-services sector as a whole, I continue to prefer Schlumberger over the rest, though Halliburton is a very close second.

If you're an energy investor, one of the more exciting plays in the space is Seadrill. To learn more about the strengths and weaknesses of the company, as well as what to expect from Seadrill going forward, be sure to check out this brand-new premium report our analysts have put together. Get started.

Fool contributor Arjun Sreekumar does not own shares of any companies listed above. The Motley Fool owns shares of Seadrill. Motley Fool newsletter services have recommended buying shares of Seadrill and Halliburton. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.

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