The "Big Three" in oil-field services -- Schlumberger (SLB -0.89%), Halliburton (HAL 0.34%), and Baker Hughes (BHI) -- reported strong fourth-quarter and 2014 earnings. All three beat consensus Street estimates. But the stunning 55% collapse in crude oil prices in the last six months raises questions about how these giants will perform in the future.
WTI Crude Oil Spot Price data by YCharts
With 2015 looking uncertain for the industry, here's what you need to know about these companies.
As backlog dries up, expect shrinking revenues
The Big Three pulled off record revenue generation in 2014 despite falling crude oil prices. The reason? A substantial backlog of projects -- especially in North America -- helped them maintain operational momentum. Oil producers generally award multiyear contracts to service companies, with a large majority undertaken by one of these three. These producers, having already made the initial investment, would like to see oil flowing as most of them are desperate for cash flow.
New investments by producers will, however, drop off while the oil price environment remains bleak. And that will directly threaten the revenue generation capabilities of service companies. During its fourth-quarter conference call, Halliburton management revealed that price-discount discussions started late last year, and that it expects price reductions across all product lines.
Greater exposure to North America means greater risk
An accelerated drop in the U.S. rig count in the past few weeks, along with oil producers' slashing capital budgets by up to 30%, suggest drilling activity levels are falling in North America. According to most analysts, the current price of crude oil--about $50 per barrel--is less than the marginal cost of production for most shale plays in the United States. If this price level continues for the next couple quarters, new drilling projects in which the marginal cost of production is above $65 per barrel will not likely take off.
Fewer new projects in North America will be problematic for service companies, which all derive their biggest chunk of revenue for this market. Below is the geographical breakup of 2014 revenue for the Big Three.
|
Company |
North America |
Latin America |
Middle East/Asia |
Europe/CIS/Africa |
|---|---|---|---|---|
|
Schlumberger |
33.2% |
15.8% |
24.4% |
25.7% |
|
Halliburton |
53.8% |
11.8% |
17.7% |
16.7% |
|
Baker Hughes |
49.2% |
9.1% |
18.1% |
18% |
Source: Company filings. Adding up may not come to 100% due to eliminations and rounding errors.
It's no surprise North America is the most lucrative segment, as unconventional drilling techniques offer greater avenues for revenue generation. With constant technological innovation such as improved well designs, more laterals per well, multistacked wells, and superior completion techniques, production volumes per well increased significantly, which brought down the cost per barrel as well. But that also meant increased service intensity per well for service companies, which drove revenue and margins solidly for the Big Three:
SLB Revenue (Quarterly) data by YCharts.
Additionally, projects in Europe are also in danger, particularly those in the North Sea. According to premier oil research firm Wood Mackenzie, £2 billion (approximately $3 billion) of North Sea oil projects are at risk, thanks to low oil prices.
The chart above shows Halliburton and Baker Hughes are more exposed to these markets than is Schlumberger.
The Middle East and Latin America might provide a cushion
The Middle East, on the other hand, has witnessed rising activity in recent years -- Baker Hughes data shows a 61% growth in average rig count since 2009. With OPEC maintaining its quota of daily production, it's safe to assume drilling activity levels in the Middle East won't come down in the near future.
In short, the company with greater exposure to the Middle East and Asia will have a wider buffer against declining activity.
In a low oil-price environment, Latin America could benefit, too. Production costs in Mexico and Venezuela are much lower than those in Canada. This might spur greater development in Latin America. Mexico is scheduled to conduct oil-field auctions this year, with 14 blocks in the first phase. The cost of production in the shallow-water fields is about $20 a barrel.
Schlumberger, with a higher exposure to the Middle East and Latin American markets, seems to be the winner again.
The takeaway: In the long run, services companies are shielded
The International Energy Agency forecasts world oil demand to hit an all-time high of 94.4 million barrels per day by the fourth quarter of 2015. Current supply is a tad less at 94.3 million barrels per day.
While the level of supply growth remains to be seen, it's clear there's hardly any slowing of demand in the long run. Prices may not breach the $100 mark again anytime soon, but drilling and exploration should be robust beyond 2015. This is definitely good news for services companies.
Crude prices have yet to stabilize due to a number of uncertain variables. But, as fellow Fool Adam Levine-Weinberg wrote, oil prices will stabilize around the marginal long-run cost of production. Oil-field services companies will be better placed to negotiate pricing with suppliers and customers alike.
