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Can Oilfield Suppliers Save Themselves?

Few sectors have ever fallen farther over any extended period than oilfield suppliers have since the beginning of the current industry downturn in June 2014. Relative to the broader market, the sector’s decline may be unprecedented.

Six years ago, Saudi Arabia took the step felt around the world when it declared it would no longer hold millions barrels of production off the market in support of global oil prices in excess of $110 per barrel.

The market’s response was swift. Crude was near $60 within a year, and the supplier sector, as measured by the Philadelphia Oil Service Index (OSX), was off 35%. The tailspin had begun.

In each of the next two years, the OSX was down 15.7% and 22.3%, respectively. The following year, fueled by unfounded faith in the U.S. shale-oil story and a strengthening forward curve, the OSX managed a 14.8% gain.

But as suppliers moved to cut-throat pricing in response to overcapacity, the index fell by 45.6% the next year. But that wasn’t the worst of it. With oil demand waylaid by the Coronavirus pandemic, the index is down by an almost-impossible 59.2% in the most-recent 12 months ending June 30 of this year.

All tallied, over the six years the OSX is down 89.3%—even as the broader S&P 500 Index is up by 60.4%. The OSX, launched in 1996 at a base value of 75, hit its all-time low of 21 on March 18th. At one point in the rout, a price in the single-digits was not out of the question.

Over the same period, Brent crude is down 63% and Henry Hub natural gas is off 65%. The S&P E&P Index (XOP) is down 83.9%.

While there’s been plenty of bad luck to go around, it can’t explain the intractable refusal of many in the supplier community to do much other than wait with crossed fingers. The main culprit is an almost mystical belief that somehow, someway cast-strapped customers—after deftly exploiting suppliers’ commitment and sacrifice—will eventually start paying premiums for the very same products and services they’ve worked so hard to commoditize.

One problem is a lack awareness. Too many executives at suppliers seem to believe that the huge footprints their companies developed during the 2003 – 14 “oil-scarcity” boom will be required going forward. Nothing could be farther from the truth.

This reality shouldn’t come as a surprise to anyone paying attention. In fact, EnergyPoint began sounding the alarm in 2017. But prior to this, the sector had its own canary in the coal mine pointing to the unsustainability of these business models.

In 2014, Weatherford International was the fourth largest oilfield supplier on the planet, behind Schlumberger, Halliburton and Baker Hughes. The company spent untold billions building a full-service global provider designed to ride the oil and gas industry into the twenty-first century. In reality, with me-too strategies and too many lackluster offerings, the company was never really more than an also-ran.

When the industry downturn took hold in 2014, the veil fell. Beginning in 2015, Weatherford began a streak of 21 consecutive quarters of net losses totaling more than $14 billion. The coming quarter will likely be the 22nd.

When the fourth-largest supplier to an industry that spends half-a-trillion dollars per year fails—in very public fashion—to earn a profit for five years running, the entire sector needs take a hard look at the road forward.

Those that do will find that unless suppliers—even those that emerge from bankruptcy with clean balance sheets—start to truly differentiate themselves from peers, their prospects remain dim. Yes, maybe a price spike here or there will materialize. But suppliers need greater simplicity and foresight in their strategies if they are to survive over the long term. They also need to think (and act) differently.

The byword in the sector must be focus; the tools fact-based decision-making and unemotional methods. While it can be risky to toss old ways of doing things without adequate analysis, crises have a way of diminishing resistance to needed change. Jettisoning legacy businesses becomes more palpable, and outdated norms are more easily challenged. Sacred strategies fall away.

The companies that make the necessary changes and ultimately survive will see opportunity. The global petroleum industry may be on its heels, but it remains immense. Despite the move toward decarbonization, the world will need oil and gas for decades. The evidence? Even during the peak of this year’s downturn, demand for oil dropped by only 20%.

In addition, supermajors like ExxonMobil, BP, and Shell have huge existing reserves that will take decades to produce. State-owned giants like Saudi Aramco and Petrobras have even more. They will all spend more to add to reserves. In North America, the industry will be smaller but far from vanquished.

In the end, the smartest players will capitalize on existing skills, assets and market positions by sticking to what they do best. Those that structure themselves to be profitable in the industry as it stands today—through smart downsizing and consolidation, leaner operations, stronger balance sheets, greater focus on customer satisfaction, and even selectively moving into other energy-related fields—have the best chance of surviving.

Eventually, some will even prosper.

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Surviving the Promises of Technology

Over the years technology has played a heralded role in the oil and gas industry. It still does today. Pick up any trade publication and chances are you’ll find at least one well-worn tribute to its importance.

Yet, the fixation on hi-tech hasn’t been without problems. It’s even been value-destroying at times. We’d argue the industry’s intractable struggle with financial returns is due, in part, to spending on technology that isn’t justified.

Claims over the supremacy of new technologies abound. But as long as promotion trumps performance, oilfield customers will remain wary. As one astute observer puts it, “All new technology seems to be deemed ‘commercial’ these days until proven otherwise.”

Many suppliers don’t understand the tie between expectations and customer satisfaction. So they oversell their technical know-how. When performance does not match promises, the result is bad publicity and customer defections.

The idea that industrial science might be more siren than savior is not a new one. Jim Collins, in his influential management book, Good to Great, points out that most companies known for their use of technology don’t see it as a driving force behind their success. Rather, it’s an accelerator of success.

One problem is that smarter process is often mistaken for better technology. For example, although high-tech products and services played a role in the shale boom, more adroit versions of existing processes like horizontal drilling, PAD wells, and hydraulic fracturing are the real enablers. Multi-stage fracking, extended laterals and other design innovations keep the gains coming.

Even the best technologies carry risk. Providers regularly alter, and sometimes abandon, their top offerings. Worse, they abuse their leverage. Proprietary offerings are especially dicey since ugly incentives arise when customers lack options. Customers are often left spinning.

M&A is a big risk. In 2017, GE acquired Baker Hughes to create BHGE. At the core of the deal was GE’s Internet of Things (IoT) Predix system, which promised better detection and prediction of wear and tear on equipment.

The conceit was that Predix would boost performance via better collection and analysis of real-time data. Access to GE’s R&D and expertise in other industrial sectors was another selling point.

But less than a year later, GE backpedaled and announced it would divest of its interest in BHGE. This broke the critical tie to GE. In a later twist, GE announced it would also divest much its industrial IoT business.

Fortunately, the unraveling of the BHGE technology pitch arose so fast most customers never had a chance to take the bait. But the deal captures the hazards involved.

Similar risks exist in other industries as well. And the outcomes are often the same. The situation facing owners of John Deere tractors is particularly telling.

Deere is the market leader in agricultural  equipment. Like many companies, it now adds vast amounts of connectivity and embedded intelligence to its products. Customers pay premiums for these features, which purport to reduce maintenance costs, downtime, fuel usage, etc. There’s even automation to handle steering. 

So, what’s not to like?

Well, Deere now charges premium—some say draconian—maintenance fees for tractors that farmers previously serviced themselves. The connectivity features are even used to remotely lock equipment to enforce compliance.

Customers are incensed at the loss of control, and online chat rooms now teem with farmers seeking workarounds. Deere says their products are too sophisticated for customers to maintain themselves. We say, Welcome to the revolution.

Ownership and use of data are the other elephants in the room. Terabytes of maintenance data from across an industry are valuable. But suppliers collecting highly detailed operational data from customers carries greater risk. E&Ps seem particularly vulnerable.

Conundrums over technology and its value are not new to the oil patch. And reasons for caution have existed for decades. But a changing world requires customers think more critically and prospectively than ever. Those who don’t could find themselves boxed in.

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Yes, It Pays to Keep Customers Smiling

Yes, it pays to keep customers smiling. Even in the midstream.

As midstream activity quickens in North America, customers are showing preferences for providers with strong operating and project-development skills. Professionalism also matters.

The need for solutions is diverse and widespread. Constraints in West Texas―ground zero of U.S. shale-oil production―crimp output. Natural gas in Appalachia needs conditioning and more outlets. Gulf Coast petrochemical and LNG facilities demand feedstock. Canadian producers beg for market access.

EnergyPoint Research’s latest midstream customer satisfaction survey suggests a handful of companies are taking the initiative to solve these and other problems.

Leading the pack is MPLX–MarkWest Energy (MPLX), which finished first overall with customers. The company ranked highest in total satisfaction, onshore gas gathering, HSE practices, Permian Basin and Texas Intrastate.

Enable Midstream (ENBL) was runner-up, ranking first in gas storage and in the Ark-La-Tex. Plains All American led in operations, onshore crude gathering, NGL transportation and storage, project development, and in the Onshore Gulf Coast. It took the third spot overall. Rounding out the top five were Andeavor Logistics (part of MPLX) and Crestwood Midstream (MPLX).

The survey reflects findings from more than 3,200 evaluations by qualified respondents at companies using midstream services. A total of 28 U.S. and Canadian midstream companies were included in the survey’s final results.

Opportunities for midstream companies abound.

Take West Texas, where oil traded at a crippling $15 discount to WTI earlier this year due to bottlenecks. Plains All American was one of the first to offer a solution, expanding capacity of its Sunrise Pipeline from West Texas to Cushing by more than 300,000 barrels per day. The expansion was larger, and came on line sooner, than forecast.

Meanwhile, MPLX-MarkWest is breaking new ground in the Northeast. The company—which purchased Andeavor in October—is adding badly needed processing and fractionation capacity to service expanding Marcellus and Utica production.

Customers have clearly noticed. So have investors.

Unit prices of the five highest rated companies have handily outperformed peers. Year-to-date, the group has delivered an average return of +13.5%. In contrast, the Alerian MLP Index (AMLP) is down 9.1% over the same period.

This isn't the first study to suggest satisfied customers are good for financial performance—just the latest. The tie between customer ratings and shareholder returns is well documented.

The reasons are simple—customers prefer working with providers that consistently meet their needs and exceed expectations. In competitive markets, these favored suppliers get the last look. And they win the ties.

The result is faster growth, higher margins, stronger cash flow, and greater visibility to the business. Everybody wins—customers, midstreamers and investors.

Other companies rating first in at least one category in the survey include:

— Archrock in gas compression services and the U.S. Rockies & San Juan Basin;

— Enterprise Products in NGL fractionation, gas processing and treating, and gas and NGL purchasing;

— EQT – Rice Midstream in the Appalachian – Marcellus region;

— Inter Pipeline in systems and administration;

— Keyera in Canada;

— Phillips 66 Partners in the Mid-continent region, and;

— Williams in the Gulf of Mexico

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Hope Is Not A Strategy

Imagine a contest between two horses. History suggests one of the animals, having lost the majority of its races against the competitor, is the slower of the two. You are given even odds. Would you bet on the slower horse?

The answer, of course, is no. Only a glutton for punishment would take even odds on a horse that is reasonably expected to lose.

Now imagine an opportunity to invest or work in one of two segments of the oil and gas industry. One segment, the longtime laggard, has the same chance of outperforming the other—in terms of rewards and opportunity—as does the slower horse of beating the faster. Would you invest your time, money and resources in the laggard? Would you recommend others do so?

Again, for most of us, the answer is a resounding no. Only a dupe or wide-eyed romantic would invest in a segment that’s expected to so regularly come up short.

But here’s the hard truth—those who bet on the oilfield supplier sector year in and year out do just this.

Think we’re exaggerating? We’re not.

Consider that stocks of oilfield suppliers as measured by the PHLX Oil Services Index (OSX) are at the same level as in 2000 when WTI crude was near $30 per barrel. Today, WTI is near $70; yet only a fraction of suppliers are making money.

The OSX is down almost 40% since 2013, while the NYSE Arco E&P Index (XOI) is up approximately 20%—a huge performance gap over a period that includes both good times and bad.

It’s the performance of suppliers over decades, however, that’s so especially damning.

To illustrate, we calculated a range of annualized returns for suppliers and E&Ps going back more than 20 years. For the year 1998, this included 21 discrete periods, ranging from one to 21 years in length. The year 1999 included 20 discrete periods, the year 2000 included 19 periods, and so on. We then compared supplier and E&P returns for each period.

What we found was sobering. Out of 231 discrete periods since 1998, suppliers have underperformed the E&P sector an astonishing 64.9% of the time. This means a random investment in the oilfield supplier segment made at any point since 1998 had an almost two-thirds chance of generating a lower return than a similar investment in E&Ps. In 20 of 21 period lengths, supplier returns underperformed those of E&Ps more than half the time.

The compounding effects have been devastating. In terms of real dollars, $1,000 invested in the oilfield supplier index in 1998 would be worth approximately $1,250 today. By comparison, a similar investment in the E&P index would be worth $4,700.

What’s driving the underperformance of the supplier sector? Too much emphasis on the short term for one thing, including large periods of time focused on merely surviving. There’s little commitment across cycles to being above average, much less exceptional. The indispensable-provider model— whereby which customers willingly pay premiums for better execution and quality—is not embraced by most decision-makers in the segment.

The upshot is that customers—who aren’t overly pleased with oilfield products and services in general—see suppliers as interchangeable. With few standouts, vendors are endlessly pitted against each other until the most favorable terms possible emerge. Some suppliers push bundled offerings at low prices, hoping one or two profitable lines offset losses elsewhere. They rarely do.

Many industry executives are too far removed from customers to understand how their companies are perceived. An addition to advice and funding from investment banks, private equity and others with short-term interests doesn’t help. The result has been a damaging influx of expansion- and survival-capital in a segment that, in many cases, can’t handle it and doesn’t deserve it.

In the U.S. alone, a total of 167 oilfield service companies filed for bankruptcy from the first quarter of 2015 through the first quarter of 2018, according to the law firm Haynes and Boone. Over half were in Texas, where many of the industry’s most experienced operators reside.

Houston-based Weatherford International (WFT) could be the poster child for the segment’s unavailing ways. Based on the idea that customers wanted a fourth global supplier to provide the range of products and services that go into a well, Weatherford set out in the mid-1990s to join the ranks of Schlumberger (SLB), Halliburton (HAL) and Baker Hughes (BHGE).

The company’s growth-through-acquisition strategy was an investment banker’s dream, feeding off the premise that customers would be willing to look past inconsistent quality in return for lower rates. The conceit, which Wall Street analysts happily validated, led others to emulate.

But it turns out the market didn’t need another integrated provider, especially one so sold on the belief that price and size mattered more than quality and performance. In 2016, Weatherford’s long-time CEO, Bernard Duroc-Danner, was forced to step down, but not before the market laid bare the company’s widespread failings. Today, the company’s stock is down 94% from its high. It continues to labor under heavy debt.

Despite the lessons of Weatherford and others like it, there’s little reason to believe the segment is prepared to break the habits of the past. Many are still gripped by an almost-inexplicable inertia, one driven by a conviction that cut-rate pricing and middling quality remain the answer, even as debt levels continue to rise.

This ethos hangs like a millstone over the sector and its reputation. As one ex-executive from a capital equipment manufacturer recently mused, “Why would you ever invest in the oilfield supply segment given how often it’s in the tank? Even when times are good, money pours in at rates that depress margins. On average, it’s a terrible business.”

To survive—much less prosper—suppliers need to be better, shrewder and more disciplined. Crushing odds await those who can’t.

Many will endeavor to reduce costs further by downsizing or combining with others. Others will try to innovate their way out of their predicament, a strategy that will work for some but fail for most.

A handful of companies will permanently up their games. They’ll embrace quality, execution, stability and customer focus as central tenets. This is the group from which most winners will emerge. Whether they can lift the performance and esteem of the entire segment remains to be seen.

Top-rated companies in EnergyPoint’s surveys like Ensco, Helmerich & Payne, Core Laboratories, Gardner Denver (GDI), Newpark Resources (NR), Derrick Equipment, MarkWest Energy Partners (MPLX) and Plains All-American (PAA) seem poised to outperform. They are the rare area of opportunity—for investors and employees—in the segment. They run their businesses knowing good times don’t last forever. As competitors fall away, they take up the slack bit by bit, steadily growing market share and earnings—usually organically. All the while, they build expertise, invest in their brands, and guard their reputations.

There’s also an enduring commitment to excellence. It’s who they are. Some have been rated number one by customers for consecutive years, a feat easier to achieve when much of the competition lacks the will to be anything other than “in the business.” In the process, they’ve delivered portly rewards in a grudging sector.

Still, these are the exceptions. The vast majority of industry suppliers have no objective customer satisfaction data  or related performance metrics about themselves or their competitors. Nor have they much interest in building the kind of culture that values such data. The sector’s customer scores reflect the deep indifference.

It’s not clear what oilfield suppliers don’t get about how higher levels of quality and customer satisfaction lead to stronger financial performance. But clearly, they don’t get it.

Consider that stocks of suppliers have risen less than 25% over the last 20 years despite the fact the value of oil and gas produced globally has grown 370%. How is this disparity so easily ignored by executives, the markets, employees, and others? No industry can thrive when its supplier base languishes like this.

It’s been said that hope is not a strategy. Yet, hope—that suppliers will finally and magically get the credit they deserve, that commodity prices will be more cooperative, that competitors will capitulate, etc.—has fueled the space for decades. Isn’t it time we acknowledge this illusory mindset isn’t working?

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Can U.S. Shale Keep It Up?

The New York Times recently published an Op-Ed on the American shale industry that garnered significant attention within the oil and gas community. The piece was written by Bethany McLean, co-author of The Smartest Guys in the Room—the book-turned-documentary that many consider to be the definitive account of Enron and its unraveling.

Much of the attention, including some criticisms, related to McLean’s piece centers on its title: “The Next Financial Crisis Lurks Underground.” The author herself admits this likely overstates things, and anyone who reads the piece will find that its not her central thesis.

The real message of the article is that growth in America’s shale-oil production may not be sustainable. On this count, McLean could be on to something, at least in terms of questioning the financial returns of the companies leading the revolution.

There’s no arguing that the oil and gas industry has a spotty track record when it comes to financial stewardship. In the 1980s, E&Ps were considered the “drunken sailors” of the public markets, spending beyond their means with little regard to the amounts of capital they consumed. There are plenty of reasons as to why this was the case, but the “wildcatter” mentality that existed and was rewarded for so many years in the industry clearly had something to do with it.

Eventually, after years of prodding from fed-up investors, large E&Ps led by the likes of Exxon (NYSE: XOM) got religion, installing leaders with greater financial sophistication and discipline. Today, the largest companies remain relatively attentive to the fundamental issue of returns.

But it’s small and medium-sized E&Ps driving the shale revolution. These companies seek to simultaneously grow production while proving up reserves. For many, the end game is the eventual sale of their companies to larger players, who are typically more focused on developing proven assets than finding new ones. As a result, for many shale operators, it’s the “kicker” at the end that dictates returns.

But here’s the rub: we’re not aware of any analysis that shows these premium exits are sufficient in number or magnitude to boost the segment’s overall returns enough to offset losses from restructurings and bankruptcies, which can soar when oil prices don’t cooperate. If for every EOG Resources (NYSE: EOG) and Pioneer Natural Resources (NYSE: PXD) there’s a bookend Linn Energy (OTC: LNGG) or Chesapeake Energy (NYSE: CHK) poised to reveal itself, are long-term shale-oil projections too high? And if so, isn't crude underpriced?

Moreover, as McLean points out, sales of private-equity backed shale companies are often to other private equity firms. It’s a game of musical chairs in which any excesses remain obscured—that is, until the music stops.

There’s also the question of how to define the shale industry. If you include the oilfield supplier and midstream segments, it’s almost certain that the shale industry isn't covering its cost of capital. We wrote about the low returns in the oilfield supplier sector late last year. Sadly, things haven’t changed much since.

A comparison of E&P stock-price performance versus suppliers illustrates the point. Since July 2014, when oil prices began their free fall, E&P indexes are down approximately 13% while oilfield suppliers indexes are down approximately 56%. E&Ps can’t continue to survive indefinitely on the backs of suppliers.

Old-fashioned myopia is also a problem. Many shale operators like to portray themselves as well-oiled machines built for growth with roads before them that are straight and clear. But the truth is certain risks are often ignored or wished away when the focus is on growth above all else.

The current problem with insufficient “takeaway” capacity in the Permian Basin is a good example. In most E&P companies, the responsibility for procuring the pipeline capacity needed to move produced oil and gas to market falls outside of the operations and supply-chain functions. As a result, pipeline capacity can be taken for granted by those responsible for operations.

Even when pipeline limitations are known, decision-makers tend to believe they will get resolved. But in areas of concentrated drilling with many players, that’s often not the case. The result is unexpected curtailments to production—and a damming effect on returns.

All this suggests the need for more complete information. If McLean’s suspicions are correct, it wouldn’t be the first time the propensity to drill first and ask questions later came back to bite the industry. Either way, the assumption of continued growth in the shale industry is too important and too pervasive to be underpinned by anything other than transparently sound economics.

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For Oilfield Suppliers, It’s Adapt or Die

Crude prices are rebounding from their collapse that began in 2014. But for upstream suppliers, it’s no time to celebrate.

Despite improved conditions, it’s going to take more than $60 crude to rebalance the oilfield. Structural oversupply—too many players chasing too few dollars—is the problem.

Redesigned processes mean onshore operators are much more productive. They spend far less on products and services to produce a single barrel of oil than just three years ago.

Conditions are no better offshore. Drilling contractors, ignoring lessons of the past, borrowed heavily to build new rigs (many on spec). As a result, fleets of capable-but-costly rigs now flood the space. Only the best get to work.

The buyer’s market has in many cases pushed prices for oilfield products and service to the bleeding edge. Suppliers are able to keep their doors open, but just barely.

Nowhere are the effects of oversupply more evident than in vendors’ financial results. Beginning in 2015, operating margins fell rapidly, eventually turning negative. A string of debilitating losses followed.

There’s little reason to believe things will improve soon. According to John Van Leeuwen, head of Lion & Stutz’s consultancy business, “While older, less efficient equipment has been left in the back lot to rust, it’s not enough. Too many oilfield suppliers are still willing to price near breakeven to stay in business. Without a material oil price increase, the only solution may be further bankruptcies.”

Unfortunately, suppliers are hindered by struggling customers. As oil prices fell, E&Ps were slow to adjust to the new reality. Heavy losses and rising debt levels ensued. To make ends meet, they demanded (and received) deep price cuts from suppliers. There’s been little relief since.

To some extent, the industry is paying the price for the decade of good times leading up to 2014. As oil rose from $30 to over $100 during the period, suppliers enjoyed unprecedented growth and profitability. To the professionals and workers drawn to it, the oilfield was the gift that kept on giving.

When prices collapsed in 2014, the industry was ill prepared to properly read the tea leaves. Namely, it was too slow to recognize the severity of the downturn.

It was also too quick to predict recovery. Wide-eyed optimism eventually led to today’s huge inventory of drilled-but-uncompleted (DUC) wells in North America.  Most of these will begin producing over the next 18 months as completion bottlenecks are eliminated and costs fall. The looming surge in production sits like a wet blanket on oil prices through 2019.

Meanwhile, investors have soured on the sector—even as the broader market hits new highs. The skepticism is understandable. E&Ps have shown little discipline, with production taking priority over returns. A new fixation on breakevens has done little to restore confidence.

It’s not hard to see where things are going. Given the languor of commodity-prices and the general frailty of the industry, suppliers need to resize and reprioritize if they are to survive. 

Many still operate in a different era. They are too broad in scope and overly dependent on debt. They also underinvest, utilize aging systems, and struggle to attract qualified employees. As currently structured, few suppliers stand a chance of consistently covering their cost of capital. And customer satisfaction badly trails other sectors.

In the face of today’s oversupply, some suppliers will choose to roll the dice and expand their organizations in new directions. Flying leaps into the unknown will be sold as shrewd moves. In most cases, the hoped-for results won’t pan out.

For example, Schlumberger (SLB) acquisition of Cameron Int’l has been a costly effort to link disparate well-site processes via a single neural network. While alluring, the strategy has met skepticism from customers loath to commit to expensive platforms that limit their options. It’s not clear the hurdles can be overcome.

Schlumberger is also aggressively blurring the lines with customers. By pursuing greater numbers of production-sharing arrangements, even as it ramps up direct E&P investments, it’s taking on conflicts-of-interest and commodity-price exposure it doesn’t need. It’s a risky strategy that could damage the company’s reputation.

The smarter path for most suppliers is to develop tighter focus while lowering costs. This means selling, spinning off, combining or shutting down underperforming units. For some, choosing between the dynamic, but volatile, North American market and slower-moving, but larger, international markets is another potential decision point.

The best outcome would be a greater number of specialized venders. Such organizations generally excel in quality, service and financial performance. They also tend to rely less on debt, making them better able to weather industry cycles. Companies like Core Laboratories (CLB), Oceaneering (OII), Dril-Quip (DRQ), Newpark Resources (NR), Frank’s International (FI) and Pason Systems (PSI.TO) already fit this bill.

The financial performance for this breed of supplier is telling. Since 2013, the group’s margins, profitability and returns have been well above those of peers. And their stock-price declines over the same period are less than half that of the Oil Service Index (OSX).

In the end, the advantage lies with suppliers that accept that the market is oversupplied, understand that it will likely remain so for years, and adapt accordingly. For some, this means a more narrow scope. For others, it means improving quality. For others, it means wringing out costs via consolidation. Regardless of the approach, it’s time suppliers get real about the road they face.

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Consumers Are Happier at the Pump Than You Might Think

Listening to experts, one could be forgiven for assuming the traditional automobile and the lifestyle it supports are fast-approaching expiration. Nary a day passes when a prognosticator of some sort doesn’t try to convince us that the internal combustion engine and the petroleum products that feed it are officially passé.

The only problem? Somebody forgot to tell the American consumer.

If trends hold, 2017 will set a record for annual vehicle-miles traveled in the U.S. This will also mark the third year in a row of record road travel, reversing declines stemming from the 2008 financial crises and the historically high petroleum prices that followed.

Regardless of what the pundits might say, 99.9% of this year’s road miles will occur in vehicles powered by gasoline and diesel engines. And the vast and exceedingly efficient network of fuel retailers that dot the nation’s roads and highways help make it all possible.

Results from EnergyPoint Research’s latest Gasoline Retailers Customer Satisfaction Survey suggest motor-fuel retailers enjoy some of the highest customer satisfaction ratings in the energy chain. Moreover, we’d wager the ratings of the top-rated companies in the survey rival those of the best retailers in the nation.

The segment’s higher standing with customers is in part due to the variety of available formats. Today’s customers can choose from branded gas stations (i.e., those affiliated with a large oil company and/or refiner), independent convenience-store chains, or grocery and big-box retailers.

To be sure, the top-ranked names in each of these formats are doing many things right in the minds of consumers. Among convenience stores, QuikTrip rates highest, driven by high marks from customers in the Southwest and Southeast regions of the country. The company also garners strong scores for ease of transactions and the condition of its stores.

Among branded stations, BP rated first overall. Scores for its commercial and fleet programs, as well as for highway travel, led the way.

Mega retailer Costco took top honors in the fast-growing grocery and big-box segment. The company garnered across-the-board ratings in several regions with special accolades in the West. Its pricing and value stood out nationally.

Of course, strong overall customer satisfaction doesn’t mean all aspects of consumers’ refueling experiences are positive. Some regions of the country enjoy higher satisfaction than others, while certain formats are more attractive to customers depending on needs. As a general rule, customers also remain more satisfied with fuel quality than fuel prices.

Retailers performance was highest in the West and Southeast. Especially high levels of satisfaction for fuel quality were registered in the West notwithstanding the fact consumers pay more for special formulations in the large market of California. Both regions rated high for service quality.

Among formats, grocery and big-box retailers record particularly high levels of customer satisfaction. Lower prices play a major role, as do the quality of facilities. Overall, Costco and Kroger lead this group. Walmart/Murphy USA, Sam’s Club and Meijer follow.

Traditional branded gas stations came in with relatively low scores in all attributes with the exception of fuel quality. Lacking the service culture of convenience stores and the emphasis on value of grocery stores and big-box competitors, branded stations seem caught in the middle.

Despite the demonstrated strength of top-performers, overall scores for the 34 retailers included in the survey declined modestly from 2016. The largest dip was in the category of food and merchandise, followed by service quality. Store facilities is the only category to show improvement.

Of the 18 sub-attributes measured in the survey, the friendliness and courtesy of store employees rated highest with customers, while pricing for food and merchandise rated lowest. Pricing for gasoline also rated relatively low overall.

As in any segment of the economy, gasoline retailer customer satisfaction levels can and do vary by competitor. Still, as a whole, the group’s success at fueling America’s mobile lifestyle is nothing short of remarkable.

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Offshore Drillers Begin to Emerge from Stormy Seas

After almost three years of flagging demand, offshore drillers are seeing the first signs of a turnaround. Down over 40% from its cyclical peak, global offshore rig count appears near bottom. And bidding activity for future work is accelerating as both drillers and operators re-calibrate to make projects work at lower commodity prices.

Not all of the emerging work will be high day-rate in nature. In the short term, well interventions, sidetracks, and plug and abandonments will represent more demand than usual. Longer term, more lucrative term drilling will be driven by still-materializing cost reductions, including savings from greater standardization and smarter preventative maintenance.

Even a modest upturn will be welcome. After OPEC’s decision to open the spigots in 2014, drillers scrambled to adjust to the abrupt change in market conditions. News of reorganizations, asset sales, fleet reductions, rig-delivery delays, and recapitalizations came to dominate the sector. On average, share prices of the largest providers fell a staggering 79% over the period.

The segment still faces some headwinds. Day rates will remain under pressure at least through 2017. And offshore discoveries—the lifeblood of future drilling—are down almost 60% from 2014 levels. Offshore reserve additions totaled only 2.4 billion barrels last year.

While these factors auger well for oil prices longer term, they suggest more tepid demand growth in the mean time. For those projects that do materialize, new rigs coming out of shipyards will ensure competition remains stiff.

Still, some contractors will benefit more than others as offshore work increases. The following metrics and resulting scoreboard can help determine which are best positioned:

Stock-price Performance: The ability of a driller to operate effectively during times of change is important. Stock-price performance since Q2 2014 is a proxy for how companies handled the steep decline in oil prices.

Return on Assets: ROA measures the effectiveness of a company’s management, strategy and operations. While ROA can vary based on how aggressively a driller retires or writes down assets, it’s worth watching.

Debt-to-Equity Ratio: A high debt-to-equity (D/E) ratio limits flexibility. Moreover, management teams focused on servicing debt are less focused on other aspects of the business.

Backlog Ratio: This measures backlog relative to the book value of a driller’s fixed assets (mostly rigs). A higher ratio connotes greater visibility to the business. The ratio is a financial proxy for customer preference and faith in a driller.

Customer Satisfaction: EnergyPoint Research’s independent customer satisfaction scores can be strong indicators of future financial performance. The reasons are self-evident: customers contract with their preferred drillers more often, for longer periods and at higher rates.

Customer Satisfaction Trends: Market changes affect performance. This metric captures driller trends in customer satisfaction since oil prices began weakening in Q2 2014.

The scoreboard’s “INDEX” column is the average of driller rankings across the six metrics, with customer satisfaction metrics receiving double weighting. The results suggest Ensco (ESV) and Noble (NE) are currently the best positioned for an upturn. Transocean (RIG), Diamond Offshore (DO) and Rowan (RDC) follow.

Ensco and Noble outperform in customer satisfaction, while Transocean and Diamond benefit from strong backlogs. Leading ROA and stock-price performance, as well as balance-sheet strength, drive Rowan’s standing.

Atwood Oceanic’s (ATW) scorecard is burdened by its customer satisfaction trend and lower ROA. However, the company retains low leverage and the resources to rebound. Seadrill’s metrics reflect a company in distress with rankings in the bottom half of each dimension.

So, why overweight customer satisfaction? Because when customer satisfaction moves in a particular direction, operational and financial performance tend to follow.

As a general rule, customer perception of a driller’s job quality, performance and reliability, and service and professionalism go a long way toward predicting overall customer satisfaction. Although drillers as a group have done a relatively good job in these areas, there is room for improvement for individual drillers.

Below is a summary of these key customer satisfaction dimensions and why they matter:

Job Quality: A measure of organizational and procedural effectiveness. Job quality influences overall satisfaction because is reflects whether contractors meet expectations.

Performance & Reliability: Performance and reliability measures the dependability of personnel and assets. Contractors that proactively address shortfalls enjoy greater customer loyalty.

Service & Professionalism: Highly rated contractors tend to be more selective in their hiring and have higher rates of employee retention. A drive to maintain long-term customer relationships is also pervasive in these companies.

Few can say what the future holds precisely for offshore drillers. However, with conditions improving, it’s a good bet drillers mastering the things that matter to customers will see their opportunities grow and financial results outperform.

[dougsheridan-blog]

Fulfilling the Promise of Weatherford

It is said what CEOs most enjoy is a challenge with outsize reward. If so, Mark McCollum should be ecstatic. As the incoming CEO of Weatherford International, he is now tasked with resurrecting one of the more perennially promising, yet frustratingly underachieving, companies in the oil patch.

McCollum’s predecessor, long-time CEO Bernard Duroc-Danner, built an organization with a global presence and broad portfolio. However, the company found itself adrift in recent years as a string of financial losses and shifting strategies undermined employee morale and depleted investor confidence.

Weatherford’s problems are not for lack of market interest. For years, customers mostly engaged with the company due to its pricing—which falls between larger integrated competitors and smaller regional suppliers. The result was a steady diet of lower-margin business.

While this positioning was far from ideal, it kept the company in the game. It also kept it its products and services in front of customers. All the while, Weatherford’s promise remained its biggest asset as the company worked to build capabilities and a track record to rival its peers. Unfortunately, fulfillment of the promise never arrived.

What did arrive in 2014 was the worst industry downturn in a generation. And by Fall 2016, Duroc-Danner was out. In the ensuing months, the board and interim CEO, Krishna Shivram, moved to stabilize the company and restore confidence. A combination of equity offerings, debt restructurings, strategic partnerships—and a business mix tilted toward North American land—all helped improve the company’s footing.

It’s not clear the direction McCollum will take the company from here. Shivram and the board introduced a tentative strategy centered on well construction and production optimization. Although Weatherford has an existing portfolio of offerings in both segments, recent customer ratings suggest certain lines need some polish.

Still-evolving opinions as to what the next-generation supplier should look like further cloud the picture. The Schlumberger-Cameron and GE Oil & Gas-Baker Hughes mergers suggest a model that melds equipment and services into a seamless network capable of generating streams of data meant to improve performance.

At the other end of the spectrum is Halliburton, which seems to almost scoff at the notion that deep integration between services and equipment is the answer. Instead, its “asset-light” strategy seeks to create a nimble and adept competitor focused on delivering a range of products and services in an increasingly efficient manner.

We suspect McCollum, as a co-architect of Halliburton’s strategy, will craft an approach favoring capital efficiency over integration. If so, expect the company to deemphasize  its recently announced partnership with Nabors. More importantly, anticipate a company with fewer irons in the fire competing on the strength of its individual products and services. In other words, less breadth and more depth.

The market place would doubtlessly benefit from a more independent-minded Weatherford—one that’s primed to compete. For too long, the company has positioned itself as a copycat alternative to the larger global integrated suppliers. A steady hand at the helm and a more clear sense of mission might be just what customers need in order to view the company in a new light.

[dougsheridan-blog]

Integrated Oilfield Suppliers Plot Divergent Paths

As the oil and gas sector stirs with a renewed sense of purpose, several of its largest and most influential suppliers are pursuing distinctly different strategies. At stake isn’t just which products and services will propel the industry forward, but the longer-term balance of power between providers and customers.

On one end of the strategic spectrum sit Schlumberger ($SLB) and GE Oil & Gas ($GE). With the help of recent acquisitions, both companies hope to meld oilfield equipment and services into a seamless new network, one capable of generating and interpreting streams of data for use in improving performance across all phases of a well. If successful, the impact could be far-reaching.

Of the two, Schlumberger’s plan appears the more ambitious. Catalyzed by the purchase of Cameron earlier this year, it’s also farther along.  At the heart of the strategy is a drilling and production system designed to link and optimize previously disparate products and services via a proprietary operating system and platform. It’s innovative stuff—think Apple iOS for the oilfield.

For GE, its direction stems from opportunities afforded by its pending merger with Baker Hughes. But in this case, the vision’s less about software than The Internet of Things. The company plans to link its products and services—from downhole motors to field production equipment—via reams of data generated by always-on chips and sensors. The linchpin will be GE’s Predix system, which, among other capabilities, purports to better detect and predict wear and tear on equipment.

It’s an open question whether either strategy will succeed.  But knowing how customers view the companies’ current efforts might offer some hints. To this end, EnergyPoint’s data suggest Schlumberger+Cameron holds the advantage—in satisfaction ratings, trends and gaps. What isn’t clear is if this is enough to overcome customer resistance to a closed protocol.

If Schlumberger and GE are pushing for transformational change, Halliburton and Weatherford seem more comfortable sticking with what brought them and the industry to this point. This is not to say either company views automation and connectivity as irrelevant. They don’t. It’s just that neither seems to see them as central to their near-term success.

A year ago, Halliburton was arguing earnestly that a combination with Baker Hughes was the answer. Today, the company appears content with what it has. This makes sense.  It’s products and services are popular with customers, and the industry is primed for upturn—a good combination. Moreover, with a new asset-light strategy, a more nimble and adept competitor is emerging. Performance should follow.

In the end, events at Weatherford might prove the most consequential, at least in the near term. The resignation of Bernard Duroc-Danner—the company’s longtime and perennially snake bit CEO—offers opportunity for a reboot. Interim head Krishna Shivram brings Schlumberger smarts and a strong financial background. He also brings a tighter vision. Weatherford as an a-la-carte provider in the vein of the late great Smith International has always made sense to us. Either way, improvement seems in the cards.

For the foreseeable future, oilfield customers will likely be drawn to supplier models that incorporate less automation and connectivity than envisioned by Schlumberger and GE. The improvements in efficiency and productivity made possible by today’s technology are just too compelling.

That said, markets benefit when suppliers compete based on a mix of visions. It spurs innovation and provides greater choice. So, in this sense, maybe it’s the industry overall that comes away a winner.

[dougsheridan-blog]

GE Deal Offers Baker Hughes a New Beginning

GE Oil & Gas ($GE) and Baker Hughes ($BHI) recently shocked the oil and gas world with the announcement the two companies will come together to create the industry’s number two supplier. From a financial standpoint, the transaction is effectively an acquisition of Baker Hughes by GE. In practical terms, it’s more like a merger.

Both companies will contribute their respective businesses to a new publicly traded entity (“New” Baker Hughes). GE Oil & Gas will also contribute $7.4 billion in cash, which in turn will go to Baker Hughes shareholders in the form of a one-time dividend. GE will own 62.5% of the new company and run the overall show. Baker Hughes shareholders will own the remaining 37.5% and will be represented in the boardroom with four of nine director seats.

The deal ends a long and arduous journey for Baker Hughes, one marked by shifting strategies and semi-bootless tactics. First was the move away from its famously decentralized business model. Then came the acquisition of BJ Services and entry into pressure-pumping. Next was the bid by Halliburton (HAL) and the ensuing regulatory limbo, followed by headcount reductions and yet another strategy shift after the deal fell through.

Now the GE deal represents a new beginning for Baker Hughes stakeholders, including employees. Outside of certain corporate  and back office functions, we expect much of Baker Hughes’ management team and operating personnel to be retained. In fact, given the lack of overlap between the two companies, it’s hard to see how it turns out otherwise.

By all accounts, there will be plenty to keep the staff busy. Effectively combining Baker Hughes’ business with GE Oil & Gas will be no simple feat. The idea is to create “best-in-class physical and digital technology solutions for customer productivity.” It’s intriguing — and easier said than done.

A key aspect of the plan is connecting the GE Store to Baker Hughes. In theory, this means Baker Hughes can tap the vast capabilities of GE and its various operating groups. Everything from advanced materials used in its aviation business to the support of its energy infrastructure group are on the table.

That the GE Store tie can lead to a competitive advantage in the oil patch is debatable. In some ways, the concept is simply a reimagination of the same cross-pollination angle many conglomerates pursue. While there are upsides to the strategy, it’s far from conclusive that a dependence upon affiliates produces outcomes superior to those afforded by a diverse and competitive supplier base.

It’s also unclear whether either company currently has much to teach the other when it comes to satisfying customers. Except for strength in a handful of areas (e.g., flow control equipment for GE Oil & Gas, and downhole products and services for Baker Hughes), the number of categories in which either company currently tops the rankings in EnergyPoint’s surveys is surprisingly small given the size and scope of both organizations.

Whether the new company succeeds in altering the competitive landscape will, in part, depend on the strength and execution of its digital strategy. There’s little question the industry is ripe for upgrade when it comes to connectivity and automation. That said, it’s no small task to do so. And it will likely take years before any significant impact is felt on the broader industry.

GE’s Predix industrial operating system — capable of collecting, storing and analyzing performance data on a range of products — could provide an edge. The system purports to predict and report maintenance issues more quickly and reliably than standard industry methods. It also has the added benefit of a relatively large installed base.

Still, it’s not clear Predix or any other GE operating system will provide the level of integration rival Schlumberger-Cameron (SLB) is pursuing. If successful, Schlumberger-Cameron’s closed-system programming will produce an operating system that ties together —and manages in real time — key processes from drilling through production.

Combine this with EnergyPoint data that indicate Schlumberger-Cameron products and services tend to rate higher with customers, and it appears GE-Baker Hughes already has ground to make up if it wants to dictate how the industry’s products, services and software drive performance going forward.

[dougsheridan-blog]

The Oilfield’s Highest Rated Suppliers

Since 2003, EnergyPoint Research has published its annual independent customer satisfaction ratings and rankings of oilfield suppliers. While each year offers its own set of surprises as companies move up and down the ranks, an elite group of suppliers has consistently remained at the top. These are the industry’s superstars. For them, customer satisfaction is more than just a nice idea, it’s a vital part of who they are.

Below are the ten highest-rated oilfield suppliers in EnergyPoint’s surveys over the last several years (listed alphabetically), and our thoughts on why they are so well regarded by customers:

Core Laboratories ($CLB) – A no-nonsense organization that takes its mission to help customers understand what’s down below seriously. Highly rated in the area of performance and reliability for many years, Core Lab’s clients particularly appreciate how its scientists and other employees grasp the nuances of their needs.

Derrick Equipment (Private) – Focused, focused, focused. A family-owned operation with ties to the oil and gas industry dating back to the 1950s, Derrick’s ongoing efforts in innovation center on the solids-control process. Whether the application is onshore or offshore, both operators and drilling contractors swear by its equipment and people.

Ensco ($ESV) – By working to understand customers’ needs and deliver on expectations with “military-like” precision, Ensco has remained at or near the top of our offshore drilling ratings since 2006. One of the few offshore contractors to recognize early on the advantages of a more standardized fleet.

Gardner Denver (owned by $KKR) – The reliable pumping and circulation of well-site fluids is vital to today’s stepped-up drilling processes. When mud pumps are down, rigs are also down. For five straight years, survey respondents have given Gardner Denver high marks for the performance and durability of its equipment.

Helmerich & Payne ($HP) – It’s hard to think of a company that’s played a larger role in the shale renaissance than H&P.  Its innovative FlexRig design changed the rules of the game in one of the more ramshackled segments of the industry. With an unmatched devotion to process and improvement, customers get top performance on a consistent basis.

MarkWest Energy Partners ($MPLX) – Recently purchased by MPLX, MarkWest brings a legacy of strong customer satisfaction and responsiveness in a segment not known for either. In EnergyPoint’s latest survey, the company rated first in total satisfaction and five additional midstream segments.

Newpark Drilling Fluids ($NR) – Many oilfield customers will do almost anything to have the right drilling fluids and services on site. Some have even been known to eschew already-paid-for fluids provided as part of integrated competitors’ bundled offerings in favor of Newpark’s products and services.

Oceaneering ($OII) – The company’s remotely-operated vehicles (ROVs) remain the gold standard in the offshore. An ability to meet customers’ requirements in some of the most demanding environments on Earth certainly plays a major role. So do its quality-control and inspection processes.

Rowan ($RDC) – Rowan entered our surveys in 2006 as a top-rated contractor on the strength of its customer relationships. Ten years later, the company continues to garner accolades. Its capabilities in HPHT and high-specification drilling remain its calling card, even as it expands its reach into ultra-deepwater markets.

Vallourec ($VK.PA) – Whether it is overall satisfaction, product quality and performance, or availability and delivery, the market place’s appreciation for Vallourec runs deep. Oilfield customers are particularly impressed with the degree to which the company’s tubular goods are delivered on-time and as-ordered.

It’s no secret that much of what the oil and gas industry has accomplished over the last decade is the result of the hard work, ingenuity and commitment of its suppliers. In fact, it’s why the industry continues to depend on them so heavily.

It’s also no secret that, like any industry, some suppliers stand out as being particularly good at what they do. EnergyPoint’s data suggest these ten are the best of the best.