For those looking for something to blunt the seemingly unstoppable growth of American tight-oil production, look no further than the battered state of oil services and equipment providers.
While shale producers have shifted from survival mode to thriving as a result of the steady rise in the price of oil, the services sector continues to struggle under forced efficiencies and low day rates.
Oil-field services contractors bore the brunt of the three-year oil price downturn, accounting for the bulk of an estimated 450,000 layoffs while accepting cut-rate prices from producers for their work and equipment – sacrifices that allowed their clients to survive the commodity collapse.
Make no mistake, when producers boast of “efficiency gains” made to outlast low prices, they are primarily referring to cost-cutting achieved by squeezing contractors for lower day rates on services like drilling and well completions, providing fracking sand and connecting new wells to pipeline systems.
While rates for service companies have increased some, they’ve not kept pace with increases in the price of oil. U.S. oil prices have nearly doubled – the price of West Texas Intermediate rising from below $30 a barrel in early 2016 to a three-year high of $61.77 this week – boosting producer revenue and cash flow along the way. The good times, however, have not yet fully filtered down to the service sector with producers continuing to enjoy discounted day rates despite increased demand and a tightening labor market.
The recent performance of Nabors Industries, one of the largest land drillers in the country, is a good example. Nabors reported a net loss of $121 million for the 2017 third quarter, exceeding a $117 million loss the company posted for the same period the year before – a time when oil prices and drilling activity were much lower. Despite an increase in demand for its rigs, which rose from 22% a year ago to 49% in the third quarter of 2017, Nabors’ reported a significant decrease in the daily profit margin on those rigs, from $8,480 to $5,296 per day.
The plight of Nabors is representative of the entire sector. Despite rising oil prices, increased demand for drilling and well-completion services and a limited workforce, the prices service companies have been able to command have not kept pace. The carnage is worse further down the chain where hundreds of smaller, privately-owned contractors have been pushed to the breaking point by low service fees. According to the law firm Haynes & Boone, 148 oil services companies with more than $40 billion of debt have filed for bankruptcy since 2015. Consolidation is rampant across the fragmented sector as firms scramble to keep the lights on and keep drilling.
As this rationalization plays out in 2018, it should become clear that the current producer-contractor relationship is not sustainable. The state of oversupply in the oil-services sector won’t last forever. Labor is already tight and struggling contractors can’t afford to hire highly-trained personnel and re-equip without renegotiating their fees. For three years they’ve been unable to invest because of low oil prices. Producers seeking to ramp up will find that contractor capacity is either insufficient or altogether absent to meet rising demand. The chickens are coming home to roost.
Some producers have already acknowledged the issue. Permian Basin-focused Callon Petroleum cited oil-field services shortfalls when it lowered its production guidance recently. Likewise, Continental Resources has said a shortage of experienced fracking crews was hampering its ability to produce at full capacity in North Dakota’s Bakken. Other producers across the major shale plays say the lack of capacity means they can’t complete all the wells they would like to in the timeframes they seek, leading to a backlog of drilled-but-uncompleted wells (DUCs). In the Permian, the number of DUCs has reached record levels, more than doubling in the past year.
It won’t happen overnight, but the leverage in contract negotiations is increasingly shifting to the oil-services companies, which are now well positioned to request higher fees. Producers and contractors have historically sought to capitalize on the others’ weakness – it’s unlikely the next chapter will be any different. Before the price of oil collapsed in 2014, the biggest complaint among producers was the high rates being asked for by the service companies. But given shale’s vast potential, it would be wise for producers and contractors to put any enmity behind them.
One option is to add an oil price component to contract rates that have historically been fixed. Some producers are already looking at the idea of allowing fees for service companies to fluctuate within a set range along with the price of oil. With upstream spending expected to increase 20% this year and shale producers promising investors robust growth, companies are going to need the beleaguered oil-services sector in tiptop shape to keep the shale miracle going.