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New Year May Again Bring Coal To Stockings Of Oil Services Companies But Better Times Lay Ahead

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Next year promises to be another challenging year for the oil services industry, but as the saying goes, it’s always darkest before the dawn, and it’s possible to see better days ahead for the beleaguered sector. 

OPEC supplied some much-needed good news on Friday when it agreed to deepen supply cuts by 500,000 barrels a day through the end of the first quarter of next year to keep oil markets balanced and support prices. 

Compliance with the deal will be critical to determining how many new barrels come off the market, given that the OPEC and its non-OPEC partners, led by Russia, were already producing more than 400,000 barrels a day under the previous quota. Production data out of notorious cheaters Iraq, Nigeria and Russia, will be closely watched in the coming months.

The OPEC-plus partners will meet again before the deal expires at the end of March to determine whether to extend the agreement further. But for the moment, the deal should at least keep the international benchmark Brent oil price in its current trading range of around $65 a barrel, and the U.S. benchmark West Texas Intermediate (WTI) price around $60 a barrel.

That’s no small feat in an oil market that will see non-OPEC oil supplies surge again next year, more than satisfying growth in global demand, which has been slowing. The Paris-based International Energy Agency sees non-OPEC supply growing by 2.3 million barrels a day in 2020 — or more than twice its forecast for growth in global demand next year — led by increased output from the United States, Brazil, Norway and Guyana.

The oil services market has been unforgiving since the oil price collapse of 2014. Houston-based law firm Haynes and Boone LLP have tracked the filing of 190 oilfield services bankruptcies, including top-five player Weatherford, from the beginning of 2015 through September 30, 2019.

Oil services companies derive their revenues from producers, so when so-called upstream companies pump the brakes on investment, it hits the services companies like, Canary, particularly hard. 

The most recent data from Barclays shows growth in global upstream spending has slowed 3 percent this year to $399 billion, compared to 9 percent growth in investment in 2018. Oil companies have been finalizing 2020 capital budgets in hopes of getting more certainty about the macro-economic outlook. With oil prices getting a bump immediately following the recent OPEC meeting, the outlook has brightened a bit for 2020 investment levels.

That’s not to say producers will immediately ramp up capital spending after OPEC’s decision. Investors still want shale producers, in particular, to keep spending in balance with internal cash flows. But $60-a-barrel-oil is far better than $50, and it could help keep fracking and well-completion activity relatively stable despite the well-documented drop in the rig count. 

Still, 2020 could be another lost year. Oil services companies may be forced to wait until the 2021-2025 timeframe to see significant recovery — when shale production growth is expected to tail off substantially. 

The news service S&P Global expects capital spending on exploration and production to be muted in 2020 due, in part, to surging shale production here and slowing demand around the world. That projection is consistent with moderating oil prices and lower gas prices. 

The global rig count, which now stands at around 2,140, or nearly 5 percent less than at the end of last year, should remain at or near present levels due to lower upstream investment. That means oil services companies are unlikely to see margins increase next year.

Looking at the various market segments, consultancy Rystad Energy predicts a contracting shale industry will drag down oilfield service purchases by 6 percent next year. Offshore will fall 1 percent as oil companies cut activity at current fields and new exploration in an attempt to reduce spending. Other onshore activity can expect revenues to be reduced by around 5 percent as OPEC scales back investments to curtail output.

However, due to the existing backlog of uncompleted wells, some service segments may still realize positive revenue growth. Rystad predicts that subsea equipment, SURF (subsea umbilicals, risers, and flowlines) and offshore drilling will accelerate in 2020, but growth will fall from double-digits to single-digits. 

One should not expect a broad recovery story in 2020. All it takes to understand that is a quick look at either the trough that the PHLX Oil Service Sector Index (OSX) has been stuck in for several years, or the $12.7 billion non-cash write-downs that top player Schlumberger took on its third-quarter earnings.

It is also important to note that the oil services sector has been taking measures like cost-cutting and capacity reductions to improve performance regardless of the macro situation. Drilling services firms have announced plans to permanently retire roughly 1 million hydraulic horsepower of pressure pumping capacity in North America as they reduce costs and shore up pricing in a challenging oil and gas market.

In recent weeks, companies such as RPC, FTS International and Patterson-UTI Energy each have said they plan to scrap hundreds of thousands of such horsepower. The North American pressure pumping sector remains severely oversupplied, which has forced pricing to unsustainable lows. 

Meanwhile, onshore drilling companies in the United States are hopeful that the declining rig count in the second half of 2019 has stabilized and that demand for rigs will start to tick back up in 2020.

Drillers such as Helmerich & Payne (H&P) and Nabors Industries expect continued strong demand for the highest-specification rigs will keep the overall rig count stable, and could lead to a modest increase in the rig count in the first quarter of 2020.

Lastly, it’s no secret that the major oil companies and larger independents are seizing more shale acreage. These capital spending plans for these companies are not as restricted as their smaller counterparts. 

Exxon Mobil, Chevron and BP are ramping up development activity in the Permian Basin. Barclays sees North American spending by the three giants rising by 14 percent this year, with its preliminary forecast for 2020 showing a further increase of 5 percent to 10 percent. This can be counted on as stable demand for the oil services sector for years to come because these companies are banking hard on shale and the Permian for future growth. 

Oil services firms have also taken a page from producers’ playbooks by cutting costs to boost profit margins. Halliburton, for instance, is planning some $300 million in cost cutting in the coming months as it tries to navigate a challenging market due to reduced activity in its principal U.S. land business.

The bottom line is that when the oil cycle turns and global activity picks up, a leaner, more disciplined oil services sector will be in a much better position to take advantage of it. 

There is also a government policy aspect to recovery for oil services companies. The Trump administration’s tariffs on foreign steel and its trade war with China have hurt the sector, disrupting companies’ supply chains while dampening the overall macro outlook by threatening future oil demand. A resolution of the growing trade disputes, which Trump seems to be moving toward as the 2020 election approaches, would do much to alleviate pressures on the sector. 

All told, the pain won’t stop in 2020. Expect increasing defaults in the sector. Given the high yields and lack of capital-market access to meet maturing debt levels, the entire sector faces an elevated risk of default.

But the macro outlook is slowly improving, thanks to OPEC’s commitment to continue cutting supply and future slowdowns in production from shale — if not in 2020, then in 2021 and beyond. And don’t dismiss the chance of a pre-election trade deal with China spurring economic growth and oil demand, as taking prices along for the ride.

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