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Far from an existential crisis, some oil majors are viewing the collapse in oil prices as an opportunity to become stronger. By reining in spending and focusing on only the best projects, the oil bust could push the oil industry to become more lean and healthy.
The Financial Times reported on the growing sense from oil executives that they are right-sizing their operations for the long haul. Speaking at IHS CeraWeek, several CEOs of major oil companies talked about having been forced to rethink their operations, cut costs, trim fat, and focus on value. In that sense, they could be beneficiaries of low oil prices. Once oil prices rise again, they could be making more money than ever before.
That would require an adjustment, but what if oil production companies can put the cost of adjustment onto someone else? Falling oil prices have allowed oil companies to cut the cost of drilling, finding savings in rig rates, the cost of equipment, well completions and other oil services. Those savings are great for ExxonMobil (NYSE:XOM), BP (NYSE:BP), or Total (NYSE:TOT) -- three companies that spoke at CeraWeek with a degree of optimism -- but the savings amount to huge losses for oil field services companies.
Halliburton (NYSE:HAL), Schlumberger (NYSE:SLB), and Transocean (NYSE:RIG) have been forced to slash the rates that they charge oil producers for their services. The U.S. rig count has declined by more than 50 percent since last year, and idle rigs are becoming the norm given the amount of drilling taking place. BP and Total just reported their earnings for the first quarter, and they beat analysts' estimates. Their refining units benefited from lower oil prices, partially offsetting a decline in revenue.
But for oil-field services companies, which earn their money on drilling activity and not the price of oil, they are feeling the pinch the hardest. All sorts of kit is being auctioned off at cut rate prices, as pipes, machines, and heavy equipment pile up in scrap yards.
"We have to take this challenging period as an opportunity to clean up our industry," Total CEO Patrick Pouyanne said at CeraWeek. If oil majors like Total, BP, and ExxonMobil manage to negotiate lower costs with their suppliers, allowing them to earn more money at a given price for a barrel of oil, the future could be much grimmer for oil field services. Gone are the days when a shortage of rigs bid up their price.
That means that even if oil prices rebound, as they have started to do, there is little reason to feel optimistic about the fate of the oil field services industry. Production companies will squeeze savings out of their suppliers. Moody's Investors Service published an analysis in early April that cast a dark cloud over services companies. The ratings agency said that the oil field services industry is heading for a "deep, protracted cyclical downturn." In mid-April Schlumberger announced that it would lay off 11,000 workers, which came on top of a previously announced plan to axe 9,000 workers. Baker Hughes said a few days later that it would lay off 10,500 workers.
Of course, when oil prices rebound drilling will pick up. More drilling activity will mean more demand for equipment and rigs, leading to a concomitant rise in rig prices. That will benefit the Schlumbergers and Transoceans of the world. But there is reason to believe the old days are gone, or at least not coming back anytime soon (even with a rise in oil prices). First, producers will lock in savings now, signing contracts that keep service rates fixed. Second, at least according to oil executives, upstream producers are streamlining their operations, trimming fat so that they will be able to produce more with less. The degree to which they can become more efficient remains to be seen, but having been forced to cut costs from low oil prices, the oil majors feel optimistic.
But leaner oil production comes at the expense of the service companies.
By Nick Cunningham of Oilprice.com. Oilprice has no position in any stocks mentioned. The Motley Fool recommends Halliburton and Total (ADR). The Motley Fool owns shares of ExxonMobil and Halliburton. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.