As falling crude oil prices prompt massive cuts to capital expenditure budgets, producers are asking oilfield services and equipment providers to slash their prices. However, the task may be too much for the struggling services companies to endure as the hard-hit sector fights to survive the latest downturn, analysts said.
"Coming into 2020, the service sector had been struggling with low margins, over-supply, and weak investor sentiment," said Mhairidh Evans, principal analyst in Wood Mackenzie's upstream supply chain research team. "Any optimism regarding an uptick in 2020 has been unequivocally crushed," she said in a March 24 note to clients.
Dashing any sector optimism, producers across the gamut — from independent producers to integrated majors, both public and private companies alike — are slashing budgets to protect balance sheets and maximize near-term cash flow generation as oil prices crumble under the weight of increasing supply and decreasing demand. Tudor Pickering Holt & Co. analysts on March 13 urged oilfield services companies to "rapidly follow suit."
But the services industry, "which does yeoman's work in helping upstream companies efficiently find and develop their natural resources," will have a difficult time righting itself as producers ask them to slash their costs by 20% to 30%, even though most oilfield services companies' EBITDA margins are well less than 20% to 30% today, Tudor Pickering Holt said in a March 24 note to clients.
Evans said some pressure pumpers in the U.S. land market already reduced prices by as much as 20%, while rig rates have dropped by about 15%. With only a handful of major projects both on land and offshore possibly moving forward this year, "We question how much further [oilfield services] pricing can reduce," Evans said March 24.
Already operating at thin margins, oilfield services companies "may have difficulties staying afloat if they further cut prices," McKinsey & Co. analysts said March 16.
The outlook for the sector has become increasingly pessimistic as West Texas Intermediate crude futures settled the March 31 session at $20.48 per barrel, while Brent crude oil futures settled at $22.76/bbl, each down more than 65% year-to-date.
"Oil prices will be $15 [per barrel] before OPEC or Russia cries uncle," said an unidentified oil executive in an industry survey released by the Federal Reserve Bank of Dallas on March 25.
While understanding the need for producers to "slam the brakes on capital spending in a sub-$30 oil price world," analysts with Tudor Pickering Holt said in the March 24 note, the oilfield services industry "simply doesn't have much more to give [in terms of pricing concessions], and we suspect that there will be some (structural) unintended consequences which emerge this year and beyond."
Oilfield services companies are no strangers to severe responses in the face of devastating market conditions. Amid the current downturn, companies are cutting budgets and are already making some of the "structural" changes analysts anticipate.
Schlumberger Ltd., the world's largest public oilfield services company, plans to cut capital spending by up to 30% from the 2019 level of $1.7 billion, with almost all of the cuts coming from its North America land operations, President and CEO Olivier Le Peuch said March 24. Schlumberger executives and senior managers also will voluntarily take a 20% cut in their pay beginning April 1, the Houston Chronicle reported March 31.
Likewise, Baker Hughes Co. could cut its 2020 capex by as much as 30% year on year, according to Jud Bailey, the company's vice president of investor relations.
Services companies are also stacking or scrapping equipment as excess capacity is also an issue, Evans said. "Companies holding onto idle assets 'just in case,' will quickly think again," she said.
Further, as activity declines and companies shrink their operational footprints, employment is contracting. Le Peuch said Schlumberger is moving ahead with facility and workforce reductions that, when complete, will save more than $300 million on an annualized basis compared to the run rate in the third quarter of 2019. Halliburton Company Asset Management Arm, on March 23, began a 60-day mandatory furlough for 3,500 employees at its North Belt campus in Houston.
"Long story short, we see the collective employment of our [oilfield services] research coverage universe shrinking by at least one-third by year-end 2021, which equates to [100,000+] jobs gone," the Tudor Pickering Holt analysts said March 24.
The analysts expect severe harm to the services companies as they stare "down the barrel of [about] 50% capex reductions (y/y) this year from the U.S. upstream industry."
The sector will experience short-term pain, Evans said, which "could ultimately create a more sustainable business for those that survive the downturn."