The oil and gas market has changed by leaps and bounds in the past few years. It wasn't that long ago that oil from shale drilling was a token idea that few thought would have a significant impact on global production. Nowadays, it's not just a part of the equation but a dominant force. For oil services companies like Schlumberger (NYSE:SLB), that means changing the way it does business.
Schlumberger's calls are some of the best ways to glean an understanding of the oil market today. The company's size and global reach give it unparalleled insight into the global market. So when its management says something or modifies the way it does business, it's worth exploring. Here are several quotes from the most recent conference call that describe both its outlook for the industry and how it's adapting its business.
The times they are a-changin'
Ever since oil prices bottomed out in early 2016, any gains in production and spending have been heavily concentrated in North America and particularly in shale. The ability to quickly bring new shale wells on line has allowed U.S.-based producers to capture a lot of additional market share. It has also effectively kept international investment levels low.
But according to Patrick Schorn, executive vice president of new ventures, that tide is shifting as Schlumberger now sees 2018 as the year that the international market picks up in earnest.
In 2018, the international market will return to growth for the first time since 2014 and the projected activity growth is now leading us to start the reactivation of equipments to meet new contract start-ups. In addition to this, we're also starting to reposition equipment in the International Areas in general and to Russia in the Middle East, in particular, where activity is strongest and where we can secure the best returns. Both the reactivation and repositioning will result in increased short-term costs, which we except to absorb in the first quarter of this year.
Getting out of a formerly high-value business
Aside from being a more internationally focused company, Schlumberger has also had a long-standing reputation as a technology-driven oil services company that makes customers pay a premium. One of these technology-differentiated offerings was its WesternGeco seismic acquisition. Historically, this had been a high-return business, but success also depends on a high level of investment in exploration.
That hasn't been the case lately, though. Consequently, Schlumberger has elected to exit the business and took a multibillion-dollar writedown this past quarter. But in every loss is an opportunity, and CEO Paal Kibsgaard believes there is a new approach that will meet management's target rates of return.
[R]apid advances and high-performance computing data analytics and machine learning have enhanced the value of seismic, imaging and visualization, enabling us to extract significantly higher value from our previous acquired data.
Going forward, WesternGeco therefore adopts an asset-light model built on our strong multi-client, data processing and interpretation businesses, and further supported by our close partnerships with a leading company in cloud and high-performance computing. As a result, our reconstituted seismic business will going forward require half the capital investments and yield twice the free cash flow conversion and making it accretive to the cash returns of the company.
North America continues to take market share, but not from whom you might think
A brief glimpse at financial news about the oil market over the past few years gives one the impression that it's a fight between OPEC and shale. The market has moved by double digits every time OPEC's made an announcement about production targets, while the rest of the coverage has scrutinized how much shale can withstand low prices.
Based on this, you would assume that OPEC and shale were trying to take each other's market share. According to Kibsgaard, however, oil prices have been strengthening lately because of market share declines elsewhere.
[W]ith a positive oil market sentiments and the increased availability of cash, we expect another year of robust growth in North America shale oil production, which will be required to maintain the balance in the global oil market.
The reason for this is that the aging production base in Latin America, Africa and Asia continues to show underlying production decline after three years of unprecedented underinvestment.
It's basically been an underinvestment period since 2014, but many longer development cycle projects have yet to come to market. Schlumberger estimates about 2 million barrels per day of these projects will see first oil in 2018 and another 1 million barrels per day in 2019. As the backlog of development projects diminishes, it's likely that we will soon see a much tighter oil market without significant investment.
It's time for Schlumberger to shine
Halliburton has been the talk of the oil services industry because of its high exposure to the North American market, especially thanks to management's decision to double down as the go-to oil services company for shale drilling. While Schlumberger has made some considerable efforts to put together a competitive offering in North America -- as highlighted by the recent purchase of Weatherford International's pressure pumping business -- the company is at its best when the rest of the world is investing in oil and gas.
The fact that the international market should pick back up again is good for Schlumberger. Not only is it the largest player in the international market, but the company generates much higher rates of return. Here's Kibsgaard explaining why the international market is so important.
The return to broad-based growth in international market represents a significant boost to our earnings power due to our unrivaled leadership position in all parts of this market in terms of both market share and profitability.
The significance of it is best illustrated by the fact that we generate four to five times higher earnings for each incremental customer that was spent in the international market compared to the incremental customer dollars spent in North America. So after three very tough years, it is now clear that the tide is clearly turning in favor of Schlumberger.
Shifting tides, shifting strategy
The market is now on the upswing, and as a result, companies need to shift their approach. Even though Schlumberger has been cutting its head count and taking several billion in writedowns, it has also been vigorously acquiring new businesses to expand its offerings. Today, though, Kibsgaard says that tactic has changed.
We plan to tackle the 2018 activity growth without an increase in CapEx from the $2 billion levels seen in 2016 and 2017 as we again start to benefit from improved asset utilization on the back of our transformation program. These investments will be lower in 2018 as we focus on monetizing the strong library we have already bid.
And for SPM [Schlumberger Production Management], we have reached the end of our counter cyclical business development program and are now shifting our full attention toward project execution. This means that capital investment levels will be down in 2018 and that our SPM business will generate positive free cash flow in the coming year.
For investors who are intently focused on capital allocation, this is good news. Now that asset values are on the upswing, Schlumberger wants to slow its spending and be less active in the mergers and acquisitions market.
What a Fool believes
Whether you are an investor in Schlumberger or not, it is simply too big and too influential in the oil market to ignore what its management both says and does. It's clear that, based on the company's moves in recent years, that we can't think about the oil and gas industry the same way as we did pre-crash. Some services that were once considered highly valuable (seismic acquisition) are hemorrhaging cash while seemingly commodity services (pressure pumping) have become much more important.
With a larger presence in North America and the upcoming increase in international activity, Schlumberger's actions could prove to be incredibly lucrative. The question remaining is how much of the company's existing business still needs to conform to new market dynamics. The company has incurred a lot of writedowns and impairments in recent years. If those continue, much of the gains from these recent trends could be wiped out.