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Oilfield Services Primer


Oilfield services (“OFS”) are the companies that assist energy companies with solutions throughout the value chain (from upstream production to transportation to marketing). Oilfield services include:

  • Seismic
  • Reservoir Characterization
  • Drilling
    • Land/Onshore
    • Shallow Water
    • Offshore
  • Pressure Pumping
  • Fluids
  • Well Completions
  • Well Stimulation and Perforation
  • Well Casing and Cementing
  • Engineering, Procurement and Construction
  • On-Site Lodging

Global Oilfield Services Companies

Major Companies: Schlumberger, Halliburton, Baker Hughes (A General Electric Company), National Oilwell Varco

These oilfield service giants provide a large spectrum of oilfield services and are considered best in class. Major oil companies will almost always use them to minimize margin of error and for their vast information reserves.

Seismic

Major Companies: TechnipFMC

Drilling Contractors Overview

Drillers lease their rigs out to oil and gas companies for a daily rate (dayrate), which are very high during booms (E&P companies want to drill more wells and bid up prices for limited rigs) and very low during busts (no one wants to drill wells and oil companies ask for renegotiated rates).

Land and offshore drillers are completely different markets – offshore rates are much more expensive, but maintenance is also much more expensive. Offshore oil, being relatively high on the cost curve, is also more susceptible to a downturn which leads to restructuring.

Idle rigs are expensive to dock and if the company that owns the rigs finds docking to be uneconomic, the rig is sent to the scrapyard.

Drilling rigs are large, mechanical capital stock that undergo downtime via planned and unplanned maintenance. Reliability is important to look at as an investor. Rigs do not operate 365 days a year, so a premium should be paid for newer, quality rigs. A way to evaluate this is by looking at the historical utilization of the rig.

Offshore Drillers Distressed Debt

As offshore drillers are often very levered with dubious capital structures, they are a staple of distressed debt investors.

Creditors care a lot about the existing fleet to gauge what cash flows are going to be like for servicing debt. First, they will look at how long each of the rigs are contracted out for and what rate they are contracted at. There are many nuances to these contracts – for instance, a take-or-pay contract may mean that the driller is paid by the oil producer regardless of whether the rig is utilized – however, there may be a higher rate if it is utilized.

These cash flows themselves are not guaranteed – the lessee/oil company may be even less creditworthy than the driller, and if the driller is already in distress it should not be a tight market with high demand for offshore rigs.

The drilling industry is extremely cyclical and prone to bankruptcy. A debt to equity ratio of 1.0x is usually the floor for investor comfort.

DrillCo Important Metrics and Figures

Active Rig Count

The most well-known rig count is conducted by Baker Hughes. The active rig count suggests bullish oil activity as it means that producers are looking to increase production. This relationship has changed since shale oil and gas became less of a fringe method as individual rigs become increasingly advanced – drilling deeper and more wells per rig, so a declining rig count does not necessarily mean declining production. However, a rising rig count is strictly positive from a producer sentiment perspective.

As the major onshore drillers are predominantly North American companies, this is segregated into Canada, US and International rigs – all which can be analyzed separately.

For an individual driller, such as Precision Drilling, their active rig count is important in illustrating activity.

Rig Fleet Size

For individual drillers, the total size of their fleet can indicate capacity that can be brought online, or show the extent to which rigs are being idled – which costs money to maintain. The rigs can be segregated into different tiers – for instance Tier 1, Tier 2, and Tier 3, with the top tier rigs being mobile and able to drill the longest and deepest wells. Looking at the rig fleet and how much of the fleet is new and desired by producers versus more obsolete rigs is important for analysts.

Rig Utilization

Active Rigs/Total Rigs

A higher utilization rate is better from a returns perspective as it means that rigs are not being idled and returns on capital are higher.

Rig Operating Days

This represents the cumulative number of days all rigs are in operation. This, along with the average invoiced day rate is a good proxy for revenue. As such, the more operating days the better.

Drilling Day Rates

This is the rent the driller charges a producer for operating the rig for one day. Different rigs will have different day rates depending on how technologically advanced the rig, what geography it operates in and how long it is contracted out for. Land rates are lower than offshore rates.

Operating Days/Wells Drilled

The shorter the better, as it implies a more efficient fleet drilling wells in a faster time. This will usually be associated with higher specification/Tier 1 rigs.

Meters/Wells Drilled

The longer the better, as it implies a more efficient fleet drilling deeper therefore yielding more oil per well. This will usually be associated with higher specification/Tier 1 rigs.

Land Drilling

Major Companies: Precision Drilling, Nabors, Patterson-UTI

Offshore Drilling

Major Companies: Seadrill, Hercules Offshore, Transocean

Completions & Production

This is the process of making a well ready for production.

Stimulation – Optimizing reservoir flow via pressure pumpers and chemicals. In the OFS space, Halliburton is widely known to be the undisputed leader in pressure pumping. Chemicals used for stimulation include water (and steam), carbon dioxide (CO2), nitrogen, natural gas and solvents. As engineers figure out how to most cheaply extract oil, they gravitate towards methods that use less energy either via steaming or generating pressure, as that requires electricity.

Cementing – The process of binding well casing to the well to stabilize it.

Pressure Control – Via coiled tubing

Artificial Lift – Artificial lift is the process of increasing pressure in the reservoir (artificially beyond its natural pressure) to bring oil to the surface. When a well is initially exploited, the natural pressure pushes oil to the top. Once enough oil rises and this pressure depletes, artificial lift is required.

Artificial lift can be performed using gas (gas lift), water, solvent and CO2.

Schlumberger is the leader in artificial lift.

Evaluation – Including field modeling and reservoir modeling – combined with the expertise of major oilfield service companies, this data is essential for placing rigs optimally and reducing costs.

Wireline – Logging services that provide formation evaluation and reservoir fluid.

Oil & Gas Well Drilling & Completion Process

First, the well is drilled by the drilling contractor’s rig. A drill bit (the thing that grinds the rock) is attached to the drill stem. The drill stem is assembled by a service crew and is comprised of 30-45 foot drill pipes.

The drill bit is rotated to drill into rock. Advanced rigs will allow for more flexible or targeted drilling, including directional and horizontal drilling.

Drilling fluids/drilling muds are pumped down to the drill bit and ejected via jets on the drillbit – these fluids wash up the drill cuttings (the waste rock that results from drilling) so that they do not interfere with the drilling process.

As the hole deepens, the drill stem is extended by attaching more drill pipes. Once the hole is sufficiently deep, the service company lowers steel casing (large diameter pipe), which is cemented against the well’s walls to preserve the integrity of the structure and make sure the hole is not contaminated.

Once the well is fully cased, anti-corrosive production tubing is run through the well (sour oil is acidic before it is refined for sulphur). The well is now completed and production can begin.

Investing and Valuation of Oilfield Services

Valuation of Oilfield Services Firms

Oilfield services firms are widely valued on an EV/EBITDA or Price/Earnings basis, unlike many oil producers as they have a business model that is directly independent of commodity prices. However, the industry is extremely cyclical and indirectly very affected by oil and gas prices, to the point where they may have higher oil betas than oil and gas producers.

Factors that affect valuation multiples include regional capital expenditure budgets by oil and gas producers – for instance, if a driller has most of its rigs in the Permian and Permian companies are increasing activity, this is bullish, oil prices – especially longer dated futures, and track record/management – Schlumberger has historically traded at a premium to its peers.

A lot of investors look at oil and gas stocks as a way to bet on the oil price. Levered oil and gas stocks add more torque to the oil bet. However, the stocks that tend to have the most torque to oil prices and live and die with the cycle are oilfield services companies.

As an aside, none of the aforementioned sectors are as good of a way to bet on the oil price as betting on the oil price itself via an ETF or futures, levered or otherwise as companies have various corporate effects that are independent of the oil price.

Investing in oilfield services or E&P companies should follow the same investing logic as any other company – whether or not there is a sound business model supported by a reasonable valuation. However, the oilfield services industry is so cyclical that investors have no choice but to look at what the market is saying.

Looking at an overlevered and high cost oil and gas company is not prudent in betting on a rising oil price as a run up in oil prices may see higher margins initially, but will likely see cost pressure due to incremental labour costs (oil workers are not cheap) and improved pricing power by oil service firms. If a company is poorly managed in a low cost environment, they are likely to be poorly managed when the price goes up as well.

Leading Indicators for Oilfield Services

When looking at sentiment for oilfield services companies, it is important to read the earnings calls and other corporate communications of oil and gas explorers as they give an indication towards their capital expenditures and drilling programs. If explorers and producers are looking to spend, this means that oilfield service companies will see a pickup in activity.

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