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.

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.

Pressure Pumping Overview

Oversimplified Explanation of Fracking (Hydraulic Fracturing) and Why It Is Important

Historically, oil is the decomposition of organic matter over thousands of years under higher temperature and pressure when buried in the earth’s crust. There are pockets of oil within source rock (the “source” of the oil) – hydrocarbons will form in layers of earth while slowly seeping into reservoirs that are sealed where they will be trapped. These oil reservoirs are where oil has traditionally been extracted from.

As you may surmise, fracking means that oilfield services companies will “fracture” the source rock by blasting it with proppant or frac sand (using hydraulics – or high pressure injections of fracking fluid). Making fissures in the source rock means that they skip the step where they wait for the oil to seep to the reservoir over thousands of years, making billions of barrels of oil now economically extractable. Fracking is part of the oilfield services product suite under stimulation.

Fracking technology continues to improve and has significantly bolstered the oil reserves of many countries. Fracking is now well understood and a repeatable, quick cycle process where the estimated amount of oil produced is very accurate. As such, it has boosted a declining US oil production industry to the point where the US has re-overtaken Saudi Arabia and Russia as the biggest oil producer on the planet with over 12 million barrels per day of production.

This has also led to the revitalization of aging and declining fields that once had their heyday back in the oil booms of the 70’s. If you remember the Permian in West Texas from Friday Night Lights and how the small towns in the area suffered from recession after the oil crashed and has since dried out, you may be surprised to hear that the Permian is now one of the largest oil producing areas in the world well ahead of most countries ever since they found out how to exploit the source rock.

Fracking, at present, is still very much a North American technology. Although shale exists in Europe and massive shale fields have been found, geological differences and the lack of investment owing to regulatory constraints around environment and disruption of locals (making it politically difficult) have impeded major drilling programs to date, which in turn does not allow companies to go up the learning curve and making it a more efficient process. China and Argentina have also uncovered massive shale fields in the Chongqing Basin and Vaca Muerta field, respectively.

Initially, the lack of groundwater and difficult geology (as well as the lack of international energy companies such as Shell or BP in the resource) made the Chongqing Basin a headcase to exploit. However, there have been massive inroads made by the supermajor state owned companies in the area, supported by nimble movement in infrastructure build (to move the exploited gas out of the area), and the basin is riding the learning curve quickly, making it a major asset for Sinopec and Petrochina.

Nonetheless, fracking remains a North American shale industry stalwart. Halliburton has the biggest global pressure pumping fleet and Trican has the largest Canadian one.

Trends in North American Fracking

In the past, movement in wells drilled and the rig count was synonymous with increases in oil and gas production. Before the Shale Revolution, conventional North American oil and gas was declining and dying a slow death while rigs were out of use.

Now, although rigs and wells drilled have picked up again, it is not nearly commensurate to the production skyrocketing – and this is because shale exploitation is a far more intense activity than conventional oil extraction.

So well intensity rises as oil producers drill deeper and longer wells to exploit as much source rock as possible (frac stages per well also increasing). Tons of proppant/frac sand used per well rises while wells drilled does not need to move as much. In fact, for gas production, production has actually been rising despite fewer wells drilled – testament to how quickly technology has moved.

The catch is that the rigs used and the pressure pumpers used must also be technologically more advanced. So “super-spec” rigs and pressure pumpers with capabilities that can serve shale are far more useful than their predecessors. Oilfield services companies with older fleets not suited for high-intensity work are at a disadvantage.

Pressure Pumper Stocks Financial Analysis

When evaluating pressure pumpers, the same line items are important to most other industrials businesses, except the revenue is very highly correlated to the price of oil – but even more highly correlated with the capital expenditures of exploration and production companies. So as an oilfield services equity research analyst, you will find yourself reading the earnings calls and updates in investor presentations from upstream producers such as EnCana or Concho Resources to see what their budgeted capex spend is based on the price of oil. If they are going to be drilling, this is a positive for oilfield services companies.

Revenue per Job for Pressure Pumpers

Revenue is received for contracted jobs, which could be per day or for a certain well or number of wells. Pressure pumpers will assign crewed fleets to work on those jobs and investors will look at the average revenue per job. Obviously, the number of jobs if growing volumetrically is important as well as it shows how much business is being won.

The more intense the job the more revenue there should be.

Fleet Horsepower for Pressure Pumpers

Pressure pumping is a commoditized business – you crack rocks and exploit oil. As such the bigger the fleet the better positioned a company is to take on higher volume as they will not have to order new equipment. However, when times are lean, idle horsepower is can be disadvantageous to maintain if it is not being deployed and making money fort he company. Also, horsepower does not tell everything you need to know about the fleet because as alluded to above, the trend is moving towards high intensity fracking, which means that obsolete equipment may be better suited for the scrapyard and will not be a big revenue generator for the company.

Horsepower, being a commoditized business, should be evaluated in the context of supply and demand. Depending on how much horsepower producers need for their oil and gas projects, there can be a horsepower surplus or deficit. So you would sum up the total HP across all industry participant fleets versus how much the producers need. The US is a fragmented and efficient market, so when there is a surplus, you can expect pricing per job to fall while during deficits, there will be price inflation IF producers are determined to drill anyway (if it still meets their return hurdles).

Most metrics are in line with other oilfield services companies.

Other Oilfield Service Lines

Cementing – The process of binding well casing to the well to stabilize it. Steel pipe is layered into the well as the walls and cement is poured down the pipe and permeates behind the steel pipe to create a wall or barrier. This is important to keep liquids from one zone from seeping into another and compromising the well.

Pressure Control and Artificial Lift – Via coiled tubing – coiled tubing is a continuous length of steel pipe that is spooled onto a large diameter reel. This is used to drop tools down the well and blast liquids and gas into and out of a pressurized wellbore to optimize well performance.

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, acids, solvent and CO2 (carbon dioxide) – all of which have effects in terms of changing pressure and viscosity of the oil and water in the reservoir.

Schlumberger is the leader in artificial lift.

Evaluation and Engineered Solutions – 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.

Engineered solutions can be for various stages of oilfield operation life cycles for wells and pipelines. This overlaps with engineering consulting in  engineering, procurement and construction work.

It is a favorable and highly valued business as there is far less capital required. Engineers will provide advice across commissioning, operations and abandonment to ensure operations are running efficiently and to minimize downtime.

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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