There's no denying that costs have become a big problem in the oil industry. The cost of megaprojects had been spiraling out of control before oil prices collapsed last year as the supply curve in the industry had been on a steady inflationary climb for over a decade. However, with lower oil prices now expected to be the new normal, service costs are expected to drop, which could pose a problem for giants Schlumberger Limited (NYSE:SLB) and Halliburton (NYSE:HAL). That's unless, of course, they do some something to change the dynamic, which appears to be on the horizon.
A potential structural change
Schlumberger CEO Paal Kibsgaard hinted at a new way of tackling the industry's cost problems on the company's first-quarter conference call. In so doing he piqued the interest of an analyst, who pushed for information by saying,
I find the most fascinating thing about the call today is, you're willing to propose a range of different business models, take some incremental technology risk, and you talk about a new way of working together. ... You're sounding like a whole new business model of how service companies and oil companies will operate in the future? ...You're talking about a structural change in the industry.
Kibsgaard responded by saying,
I think it's going to be very important, for the overall performance of the industry, that all the players that have something to contribute, not only to the implementation and execution part of the work we do. But also to how we design the solutions of what we're looking to build and develop, that they're all invited to the table. And I would say still remaining humble. I think we, from the Schlumberger side, we have a lot to contribute, when it comes to supporting the design decisions that many of our customers take for major drilling and completions developments.
What Kibsgaard is suggesting is that Schlumberger wants a bigger voice in the initial decisions that go into designing an oil and gas project. Instead of simply being hired to carry out the oil company's vision, it wants to help design that vision as it has greater expertise with the details of what works and what does not so that it can help its customers make better decisions earlier on in the process. In so doing, it should save its customers money in the long run.
Collaboration is key
Kibsgaard would later point out:
We believe that the industry needs to think differently, in order to reduce project costs and increase project value. And we see closer collaboration between operators and the large service companies as a key element in achieving this goal. And this closer collaboration should also include more performance-based contracting models, which we are fully prepared to enter into.
As Kibsgaard points out, he envisions closer collaboration between oil companies and large service contractors Schlumberger and Halliburton as being the key to reduce costs and boost project value. It's a model that would have upside to service contractors in the form of performance-based contracting models where achieving cost or timeline goals would likely trigger a performance bonus. That upside would keep service margins intact while costs elsewhere are reduced.
It's collaboration that Halliburton also stressed on its conference call. President Jeff Miller noted that while its customers were asking for price discounts to deal with weaker oil prices, it is also having a discussion "around efficiency and contracting, which is how to better work with Halliburton to take system costs out of drilling." It's this collaborative effort to focus on costs that don't need to be spent that could drive long-term improvements in the sector.
With no clear line of sight to higher oil prices, Schlumberger and Halliburton are looking for ways to change the way the industry operates in order to get costs to come down permanently. To achieve that goal, both companies want to work more collaboratively with oil companies to find solutions that will drive out costs, but without impacting their bottom lines. It's an effort that could be a real winner for both service giants and oil companies.
Matt DiLallo has no position in any stocks mentioned. The Motley Fool recommends and owns shares of 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.