If you want an idea of where the oil market is headed, the first thing you need to read is a conference call transcript from Schlumberger (SLB +0.51%). As the world's largest oil services company, it has connections with just about every producer out there, from the titan Saudi Aramco to the small mom-and-pop shops in the U.S. That extensive network gives the company a pretty good pulse of the market.
In Schlumberger's most recent conference call, there was a bit of optimism, albeit a muted one depending on which part of the market you look at. Here are five of the most revealing quotes that should give investors a pretty good feel for what will happen in the oil markets for 2017 and beyond.
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Cameron integration working in face of tough market
Making acquisitions in the middle of a down cycle is, in theory, the best time to do it because valuations are cheaper. The challenge, though, is incorporating this new business while revenue declines and management teams are trying to right-size the business. For Schlumberger investors, there was justifiable concern that the integration of Cameron International could hit a few snags. According to Scott Rowe, president of the Cameron Group, the integration of the two businesses has been going rather smoothly:
The integration of Cameron into Schlumberger has been an enormous task. Most of the heavy lifting of the integration is now complete. We achieved our year 1 target of $300 million of synergies in the first 10 months of the acquisition, and we fully expect to exceed the $600 million target for the second year.
The transaction was again accretive in the fourth quarter as well as accretive to the full-year results for Schlumberger. We booked $180 million of synergy-related business in the fourth quarter, with the majority of it coming from the Middle East. We will continue to have an integration team in 2017, and our focus will shift from cost synergies to growth synergies. Several technologies will be commercialized in 2017 that will drive incremental revenue and margins.
Schlumberger's integration isn't the only one worth watching in 2017. If the Baker Hughes (BHI +0.00%) and General Electric (GE 1.73%) merger happens, investors should also keep a close eye on whether the two can meet their ambitious synergy goals. The degree of difficulty with merging two very large services and equipment manufacturing companies, though, is higher.
North American offshore market looking tough
Investors looking at a recovery in oil and gas drilling activity have lots of reasons to think that 2017 will be a vast improvement over last year. If you dig into the details, though, there are certain pockets of the market expected to perform well while others struggle. One market that CEO Paal Kibsgaard pointed out as one to potentially avoid is the North American offshore market:
Offshore, revenue declined again sequentially as the rig count dropped further and pricing remained under pressure in spite of the significant technical operational challenges in this market. The resulting business environment is potentially becoming unsustainable for us and will either lead to a recovery in service pricing or a narrowing of our service offering, with redeployment of resources to markets that offer more adequate returns.
Production declines are taking hold
For a couple years now we have been waiting to see all of these capital spending cuts have a profound impact on actual production. For a while, it was hard to see those declines because OPEC was looking to grab market share with high production rates. With the pledge to cut production, though, those production numbers could change quickly. Here's Kibsgaard's breakdown of the situation:
On the supply side, non-OPEC production remains under pressure seen by the large year-over-year drop in North American production, which as of December had fallen by more than 600,000 barrels per day versus 2015. Over the same period, new production from the completion of long-term large projects in Brazil, Kazakhstan and Russia was offset by falling production from Mexico, China and Colombia to result in a year-over-year reduction of 900,000 barrels per day for non-OPEC production.
In terms of OPEC supply, production surged to record levels in the fourth quarter to meet the increase in demand and to offset the falling non-OPEC production. This lowered spare capacity down to 2 million barrels per day in November, which, at barely 2% of global production, represents a 12-year low. The OPEC agreement to reduce production by a significant volume of 1.6 million to 1.8 million barrels per day has now established a floor to the oil prices and should accelerate the tightening of the oil market going forward.
Image source: Getty Images.
Money is going to start flowing back into the system soon
Production companies can only put off these capital expenditures for so long until they start to really set up the industry for some trouble down the road. As Kibsgaard put it, this past couple years of underinvestment could really come back and bite:
Over the past two years, there has been very few FID [Final Invesetment Decision] approvals of new sizable oil developments. And outside of the Gulf countries, most of the international production is today depleting producible reserves with little or no reserves replacement. This is equivalent to borrowing barrels from the future.
As a result, the activity and CapEx required going forward to replenish reserves in order to uphold production for the medium to long term will be much higher than the current decline rates may suggest. This concerning trend cannot be reversed or mitigated by North America unconventional resources alone, which currently represents only around 5% of global crude production. The future supply challenges of the industry can only be addressed by a broad increase in global investment. Therefore, as international E&P cash flow improves in the coming quarters, we expect to see E&P investments accelerate in all main producing regions, leading into 2018.
Shale production has carved out a very comfortable portion of the market in the past couple years. To meet all the needs of the market in the future, though, we are going to need to maintain spending on those multi-billion dollar offshore projects. So investors that are worried about any company heavily tied to the offshore market, be patient.
All that low-cost production may be a bit of smoke and mirrors
If you look at exploration and production company investor presentations lately, you will see that many of them are touting incredibly low breakeven prices for a barrel of oil. While I'm sure that more efficient drilling practices have been a part of that, one thing that isn't mentioned is the incredible declines in costs from oil services companies. In fact, both Schlumberger and Halliburton (HAL +1.81%) have said on multiple occasions that they were doing services work at steep discounts and even financing drill work for a few producers.
This can only last for so long, though, because oil services companies need to make money, too. Kibsgaard alluded that time could be coming soon:
[W]e are now requesting pricing increases on contracts where the efforts we have made have helped bridge the trough of the cycle for our customers but where the contracts hold no promise of delivering the returns we would expect in the current improving business environment.
Anyone with investments in exploration and production companies should watch per-barrel cost trends over the coming quarters. It would not be surprising if we see those tick up in earnest as we see oil services companies like Schlumberger get their cut of profits back.
