Lower capital expenditures, fewer wells and longer lateral lengths are helping oil and gas exploration and production (E&P) companies turn their balance sheets rightside-up, but oilfield services firms are getting left out in the cold.
One of the dirty little secrets of the American shale oil and gas boom of the past four years has been that most E&P companies drilling in the shale are cash flow negative. Horizontal wells in tight rock are expensive to construct and their hydrocarbon flows tend to fall off more rapidly than conventional wells. Maintaining an unconventional well's production levels involves many resources – pumping horsepower, chemicals and water – that tapping into a high-pressure underground reservoir of oil simply doesn't require.
Market forces and investor expectations also prevented E&P companies from generating as much cash as they could have. Many of the shale players, taking advantage of new technology in relatively untapped basins like the Permian and Bakken, had aggressive growth plans, which meant plowing all of their cash back into drilling operations. Their investors, some of them still smarting from the last oil crash in 2014-15, required shale companies to hedge the price of oil. While their hedging strategies are protecting them against downside risk, it also limited the upside they could capture when the price of West Texas Intermediate shot up over $75 per barrel in October 2018.
Lately, investors and boards of E&P companies have asked the drillers to become more disciplined with their cash. In the commodities world, oil is considered a risk asset – something that speculators go long on when they expect strong economic growth – while ‘havens' like gold are in demand when expectations for growth darken. Despite the melt-up in U.S. equities, fixed income markets are still reflecting a widespread outlook that global economic growth will slow. Demand for sovereign debt remains strong to the point of negative yields in the Eurozone, and in the United States, three month and 10-year Treasuries have been inverted for a full quarter now.
So E&P companies are being asked to do more with less. EOG Resources (NYSE: EOG), for example, has switched to a ‘premium' strategy in which it only invests in assets capable of generating a 30 percent return on capital employed. Lateral lengths of horizontal wells are growing as shale players try to improve their hydrocarbon yields per well, reducing the demand for equipment and transportation services.
Finally, there are simply significantly fewer oil and gas rigs in North America. The Baker Hughes Rig Count for the week ending June 28 recorded 1,091 total rigs in North America, down by 128 rigs from the same week in 2018. Texas has 66 fewer rigs than a year ago; Oklahoma has 34 fewer.
There's less work for oilfield transportation companies to go around, and the major publicly traded carriers that managed to hold on to their market share as competition rushed in during the boom did so largely on the back of steep price reductions. Their stocks have taken a beating.
The largest private trucking fleet in the oilfield services segment belongs to Halliburton (NYSE: HAL), which had 5,382 tractors in 2018, according to Transport Topics. Shares of HAL have been crushed since last summer, losing 59 percent of their value.
"As expected, the first quarter activity levels in North America were modestly higher compared to the first quarter of 2018, and we experienced pricing headwinds throughout the quarter," said Halliburton chairman, president and chief executive officer Jeff Miller, announcing the company's results for the first quarter of 2019. "We believe the worst in the pricing deterioration is now behind us. For the next couple of quarters, I see demand for our services progressing modestly."
Shares of Schlumberger (NYSE: SLB), which had 3,652 tractors in Transport Topics' 2018 list, have fallen 49 percent in the same period. Schlumberger's chairman and chief executive officer Paal Kibsgaard predicted that financial constraints would slow the growth of North American shale production in the back half of 2019.
"Conversely in North America land, the higher cost of capital, lower borrowing capacity and investors looking for increased returns suggest that future E&P investment levels will likely be dictated by free cash flow," Kibsgaard said. "We therefore see E&P investment in North America land down 10 percent in 2019. In addition, rising technical challenges – from parent-child well interference, step-outs from core acreage and limited growth in lateral length and proppant per stage – all point to more moderate growth in U.S. shale oil production in the coming years."
Basic Energy Services (NYSE: BAS) and its 1,868 tractors dropped even faster and further, losing 84 percent of its value since October 2018.
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