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Push to keep production costs down threatens oilfield service sector's recovery

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Push to keep production costs down threatens oilfield service sector's recovery

Exploration and production companies are ramping up project plans after years of underinvestment, but their drive to keep drilling costs down to between $35 per barrel to $40/bbl threatens the recovery of oilfield service companies that are just beginning to realize profits after a three-year downturn.

PRICE Futures Group analyst Phil Flynn said the underinvestment in the oil market is starting to materialize. "When oil [prices] tanked amidst the glut, we wrote that we were sowing the seed of the next shortage and that it would show up faster than people think. The oil glut is gone and now people are waking up to the fact that we may not have the capacity to meet demand in the coming years," he said in a May 2 note.

Underinvestment in rig fleets has led to attrition, which has put the oilfield service sector "in really bad shape," Simmons & Co. analyst John Daniel said. From a capital equipment standpoint, the market needs higher pricing, he said at the Association of Energy Service Companies winter meeting in San Antonio in February.

Facing the prospects of shrunken supplies, and with the price of West Texas Intermediate crude oil rising above $70/bbl, exploration and production companies are moving forward with projects but remain committed to keeping the cost of recovery low.

Shell Offshore Inc., a subsidiary of Royal Dutch Shell PLC, announced April 24 the final investment decision for the Vito project, a deepwater development in the U.S. Gulf of Mexico, outlining expectations for a break-even price of less than $35/bbl.

"I would contend that there aren't many service companies going to be able to maintain a service fleet, be competitive with wages, maintain good safety programs, and keep top workers at [the] kind of price ranges" that E&P companies are targeting, of around $35/bbl to $40/bbl, said Kenny Jordan, executive director for the Association of Energy Service Companies.

Oilfield service companies have improved efficiency and cost-effectiveness and have reduced costs that make production profitable at $40/bbl to $50/bbl, Peter Miller, executive chairman of Houston-based product distribution company Distribution NOW, said at the association meeting. Miller noted that because of what oilfield service companies have done to be more cost-effective, the cost for a rig has dropped from about $600,000 in 2014 to about $380,000 today.

Operators continue to pressure oilfield service companies for low rates, so while there is a lot of revenue, margins remain slim, industry experts said.

Oilfield service companies are just now starting to recover from two to three years of "pretty bad margins," Jordan said in a recent email. "There has got to be a point at which they replenish some of their bank account reserves that they have had to dip into over that period of time."

Although recovery is underway, oilfield service companies are struggling in the new market upturn. Finding experienced labor that is willing to return to the industry after the downturn has been challenging, and the ability to pay a competitive wage is limited by E&P spending constraints. The costs to maintain compliance with safety reporting to third parties is getting higher by the day, and at some point, companies will see price increases for any manufactured equipment as the result of steel tariffs, Jordan said.

"I think you'll see companies having to deal with supply chain issues also trying to find competitive pricing to what they have been seeing," he said.

Spending discipline among E&P companies could force consolidation within the oilfield service sector as experts contend that the sheer volume of companies in the space limits price mobility.

"The prices for their supplies and their own services are starting to rise, so there has got to be, at some point, some give-and-take by the E&P companies for pricing relief," Jordan said. "I'm not saying [oilfield service companies cannot build profits] ... but there will be fewer companies doing the service work if that [$35/bbl to $40/bbl price range] happens."