The price of oil has been under tremendous pressure this year because producers are pumping an abundance of it into an oversaturated market. This price weakness has had a trickle-down effect on the entire industry and is putting a lot of pressure on the margins of oil-field service companies, especially the likes of Halliburton (NYSE:HAL) and C&J Energy Services (NYSE:CJES).
Here's what's causing the most stress for these companies right now.
Drilling is doing fine
On Halliburton's third-quarter conference call, Halliburton President Jeff Miller spent some time detailing the current market conditions in the company's core North American market. He started off by saying:
Now, what's on everyone's mind is North America. So let me give you a little more granularity on North America by division. Our drilling-related businesses have been much more resilient than our completions-related businesses. In fact, drilling division margins increased this quarter to 10%, and this is including the 400 basis point impact of the added cost that we are carrying in anticipation of the Baker Hughes (NYSE:BHI) acquisition.
Here, Miller breaks down the company's two main businesses: Drilling and completions. He notes that the drilling business is doing just fine as evidenced by margins, which were up last quarter despite the fact that the company is carrying a bit more costs than it would otherwise because of its pending merger with Baker Hughes. One reason drilling is strong is because oil companies are still drilling a lot of shale wells.
That said, the problem lies in the trend where producers are not completing all of those wells. In North Dakota, for example, there are currently more than 1,000 wells that have been drilled, but not completed. This is because producers are waiting for better oil prices before completing these wells largely due the out-sized portion of cost of bringing a new well online, with completions representing upwards of two-thirds of the overall cost.
Pressure is under stress
Because of this, Miller noted:
Obviously, the most stressed part of our business is pumping. Now, this is the business that we know the best. It's the business that recovers the fastest. It's the business that recovers the most sharply, and we know what that path looks like. It looks like this. It looks like staying with the fairway players in the basins that we know. It does not mean chasing every stake. It looks like staying with the customers that are loyal, even if that means working at a price that we don't like, collaborating on our path forward that lowers their costs per BOE to a place where we can both be successful, and it looks like staying with the overall strategy to focus on long-term returns; meaning, we see a path to profitability.
Halliburton's pressure pumping business, or the actual fracking, is under the most stress right now due to a couple of factors. As noted previously, oil companies are drilling, but not completing thousands of wells, which is hurting volume. However, another big issue is that the producers that are fracking are seeking a big discount, which is really eating into margins.
This trend also had a big impact on C&J Energy Services during the third quarter, which noted in its third-quarter earnings release that its completion services segment was very weak due to a decline in activity levels and increased pricing pressure. Its hydraulic fracturing services segment in particular was deeply affected after C&J Energy Services aggressively reduced pricing with one of its most active customers in order to maintain that relationship.
Halliburton, likewise, cut its prices to levels it didn't like in order to maintain some key customer relationships. That said, while this is causing the company to operate this segment at a loss right now, Miller does see better days ahead. He said:
This is a very simple solution, but simple does not mean easy. So if you are looking for a silver lining here, the most competitive piece of the business, pumping, is the one that we know the best. It's the business that recovers the fastest and the most sharply, and you can be confident that we have the team that gets it done.
In other words, Halliburton's solution to fixing its stressed pressure pumping business is simply to operate well and then wait for the recovery. That's because when the recovery comes, it will be very sharp, due in part to the growing backlog of wells just waiting to be fracked once oil prices hit a certain level. In addition to that, Halliburton's upside would be even more magnified assuming it closes its merger with Baker Hughes, which also has a large North American completions business.
Pressure pumping in North America is under a lot of stress right now, which is putting downward pressure on the margins of Halliburton, C&J Energy Services, and Baker Hughes. There isn't a lot these companies can do right now, other than serve their customers well and wait out the storm. That said, once the storm clouds begin to dissipate, it will relieve a lot of the pressure on pumping margins because there's such a large inventory of wells just waiting to be fracked. That's a silver lining to be sure, but one that's not yet visible on the horizon.
Matt DiLallo has no position in any stocks mentioned. The Motley Fool owns shares of and recommends 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.