Soaring oil and gas prices have dramatically changed the power dynamic between oil companies and the contractors who provide drilling services to the industry.
The oil services sector was hardest hit by the pandemic-induced crash of 2020, which forced many companies – including the Weatherford power plant – into bankruptcy.
But the steady rebound in oil prices, spurred by Russia’s invasion of Ukraine in late February, has caused a massive reversal of fortunes.
With oil prices trading above $100 a barrel and markets facing a supply crunch, the oil services industry is eyeing a strong, multi-year bull cycle as demand grows for the equipment needed to drilling and fracturing new wells.
For the first time in nearly a decade, service providers have the power to raise prices for their oil customers, and it looks like that power dynamic could be in place for quite some time.
During the recession, the service industry carried out extensive rationalization – laying off staff, reducing operations and scrapping underutilized equipment – to reduce costs. This means that there is no more excess capacity in the drilling market, so when the demand for services increases, there is a limited supply to meet the need.
In some cases, capital expenditure cuts in recent years in the oilfield service industry mean that some equipment is simply not available – at any cost.
This is especially true in the hydraulic fracturing sector. Competition for fracking fleets in the Permian Basin and other shale plays is fierce.
According to Baker Hughes
But the industry is also facing the toughest supply chain and inflationary environment it has seen in several decades as markets recover from the pandemic. There is widespread inflation and pressure on the supply of critical materials, commodities and labour, which the sector passes on to its oil company customers.
The result is that more money has to be spent to expand oil and gas production in this inflationary environment. In North America, Halliburton raised its grower spending growth forecast to 35% this year from 25%. But this revision reflects inflation as much as the producer’s plans to increase drilling rates.
In other words, today’s producers get less for their money.
JP Morgan analysts say inflation will hit the US onshore shale-focused sector the hardest. They expect the average publicly traded E&P company to increase spending by 20% over last year, but see a corresponding increase in production of only 3%.
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Much like the global oil and gas supply situation, there is no silver bullet to tightness in petroleum services and equipment.
The sector has been badly burned by overbuilding and excess capacity over the past decade, and it’s likely to keep operations lean going forward. Most of its publicly traded E&P clients adhere to capital discipline, directing record amounts of free cash flow to shareholders rather than new investments. And most service companies are following their lead.
As Halliburton CEO Jeff Miller puts it, this will be a “margin cycle, not a build cycle”, meaning the oil services sector will reap the benefits of rising prices. raw materials and strong profit margins without a commensurate increase in their capital expenditures.
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All of this points to higher equilibrium costs for oil companies, which will need a higher oil price in the future to make their investments profitable in this environment.
And it almost guarantees that today’s exorbitant oil and gas prices are not a passing fad.