Halliburton Company's (NYSE:HAL) management team recently addressed the investment community on a conference call following its less than stellar first-quarter results. On that call, the company provided investors with five interesting insights into the oil market. One theme runs throughout those comments: Times are tough, but better days lie ahead.
Competitors aren't behaving rationally
One very interesting thing Halliburton is seeing in the oil-field services market is the irrational behavior of some of its competitors. Company President Jeff Miller noted in particular:
[...] substantial pricing pressure in all of our product lines and a significant amount of service capacity is looking for work. Service company behavior has fallen really into one of three buckets. First, those who are still running their businesses to make a profit and returns for their investors; second, those who have decided that covering fixed cost is no longer important and therefore will take work to keep equipment busy and crews intact while operating at a loss; and third, those who are basically working at a price which covers only their cash costs. Ultimately neither model two or three is sustainable. We believe capacity adjustments are likely in a market like this.
Desperate times apparently call for desperate measures. However, as Miller pointed out, the behavior of many of its competitors is unsustainable, which could lead to their demise.
Miller later noted on the call that Halliburton is "still a returns-driven organization," and it will only cut its prices to the point where it can still earn an acceptable return. In cases where the return isn't acceptable, the company has chosen to let its equipment sit idle and let its competitors lose money, as it "would rather save our equipment for better times."
Not calling a bottom, but...
Miller also pointed out that the company is seeing some signs that the worst of the downturn could be over. He said, "we're not going to call the bottom, but historically, it's taken rig count three quarters to move from peak to trough." Given that oil prices began to roll over last July, we're just passing that three-quarter mark, which historically suggests that the worst, in terms of activity declines, just might be in the rear-view mirror.
Downturn has been fast
That historical pattern aside, there is one key difference with this downturn, according to Miller: "What is unique is the speed at which this is happening." This is as producers very quickly responded to lower oil prices by dramatically cutting capital spending, which resulted in a rapid decline in the rig count. This speed could shorten the duration of this downturn compared to ones the industry has experienced in the past.
The new wrinkle
Another thing that's new in this downturn is the fact that some producers are drilling, but not completing wells. It's estimated that about 4,000 wells have been drilled but not completed, which, for perspective, is a decent amount of wells considering that the industry drilled and completed 55,000 wells last year. Miller addressed this new development:
There's been a lot of discussion around [...] operators choosing to drill but not complete wells, and then defer production until commodity prices become more favorable. [...] It is our view that although inventory wells can exacerbate the short-term activity declines for completions, it essentially defers the revenue opportunity. When our customers decide to increase activity levels, this will be beneficial for Halliburton as they are likely to increase completions in tandem with new well drilling, which could accelerate our rate of recovery during the up-cycle.
As Miller notes, this practice by some producers to defer completions is leading to a deeper short-term decline in activity. However, it's really just deferring revenue for Halliburton, which it expects to be able to capture later at a better rate than today. Because of this, the company sees the potential for a real acceleration of activity since it will be able to complete those wells, plus participate in the drilling of new wells, once the up-cycle begins.
Still not much visibility
They say it's always darkest before the dawn, and that would seem to be true of the oil market recovery as well. Miller said, "it's a tough market out there, and we're not going to try to call a recovery. There are just not enough convincing data points out there at this time for me to make a conclusion."
The company is simply going to focus on trying to control what it can control. It's working to cut its costs so it can protect its market share with key customers. However, it's willing to forgo work if the economics don't make sense (and cents) for the company. As a result, it expects to come out ahead when the market does begin to recover.
There was one clear takeaway from Halliburton's comments: Times are tough, and the company can't yet call a bottom. However, a bottom appears to be much closer than before. And when conditions improve, it sees a real acceleration of activity, suggesting much better days lie just around the corner.