To right their course, supermajors pass the pain on to oil field services

By Saqib Rahim, Nathanial Gronewold | 05/04/2015 08:44 AM EDT

Big Oil wants to slash costs this year, and that will mean putting heat on the companies that do much of its technical work.

Big Oil wants to slash costs this year, and that will mean putting heat on the companies that do much of its technical work.

The world’s largest international oil and gas companies, the "super majors," have faced nearly a decade of rapidly escalating operating and equipment expenses, but rising oil prices and ever escalating profits over the same time period concealed or offset the effects of an expensive business climate. "Mega projects" like LNG export platforms being built in Australia have been particularly susceptible to cost overruns. Offshore drilling became more expensive than ever as rigs chased ultra-deepwater resources.

Now, with much lower oil prices, companies are telling investors that they see in this price crash an opportunity to roll back the cost inflation in oil field expenses and bring the economics down to levels where companies easily turned in profits with crude at $60 to $70 per barrel. Narrowing the gap between costs to produce oil and the oil price means further pressuring oil field service companies and offshore rig operators to cut their prices deeply.


The oil service sector needs the business, and the oil majors say they will take advantage of that as they try to get leaner through the downturn.

"Across our spend, we’re actively engaged with the various service providers," said Jeff Woodbury, Exxon Mobil Corp.’s vice president for investor relations, in an earnings call last week. "And we are making some really good progress on capturing those savings, from raw materials, to services, to our rig rates, to fundamentally our construction costs."

Last week, Exxon Mobil, BP, Royal Dutch Shell PLC and Chevron Corp. all posted their latest quarterly earnings to analysts anxious to see how bad the hits were to their profits. Earnings were down, but less than many analysts feared.

A boost to earnings from refining operations helped but so did a newfound thriftiness. The companies confirmed that cost cutting continues, and the oil field service companies will bear the brunt of the pain, in particular Halliburton Co., Schlumberger Ltd. and Baker Hughes Inc., the three largest.

All of the major international oil companies have promised cost cuts of 30 percent or more this year, except for Exxon Mobil, which planned smaller cuts. And although the year is young, it’s a sign of how central cost cutting will be in the U.S. oil and gas business this year. Companies that built their businesses on $90 per barrel now must ask if they can hack it at $70.

Some will, and some won’t; some will stay in business, others will be bought out. But overall, analysts believe the tough environment will make the entire North American industry more resilient. In January, for example, Goldman Sachs predicted a 20 percent drop in U.S. horizontal well costs in 2015 (EnergyWire, Jan. 13).

Meanwhile, oil and gas producers’ budgets have fallen some 30 percent in response to oil prices, in line with forecasts. That has turned an oversupply in North American oil services into a drastic oversupply, and companies have had to cut their rates by about 30 percent just to keep business, according to data provider DrillingInfo Inc.

The combined results can be significant. Whiting Petroleum Corp., one of the top producers in the Williston Basin, said last week its Bakken/Three Forks wells now cost $6.5 million each, down from $8.5 million last year.

It credited "service company price reductions, operational efficiencies and new technology applications."

Shell last week pared its 2015 budget from roughly $35 billion to $33 billion. It said it sees plenty of room to cut costs this year in areas such as finance and information technology.

But Chief Financial Officer Simon Henry warned against cutting carelessly.

"If you cut costs too much and with too much gusto today, you almost always regret it tomorrow," he said.

But expenses must fall if oil prices won’t rise substantially back to the range of $100 per barrel, and most are assuming they will not. Chevron said it’s already negotiated about $900 million in savings by talking to its current suppliers and that more negotiations are in progress.

New business models needed?

Meanwhile, the service industry has to figure out what to do as drilling activity tapers. The U.S. rig count has fallen by about half since its November peak, according to Halliburton.

On one hand, that reflects greater efficiency by energy producers — the ability to get more oil and gas, despite fewer rigs. On the other hand, it also means slower business for oil services.

"The pace and magnitude of the activity reductions, particularly in North America, has been almost unprecedented, and we have to go back to the mid-1980s to find anything similar," Schlumberger Chairman and CEO Paal Kibsgaard said last month.

Schlumberger has been helping companies cut their well costs, but Kibsgaard said new business models may be in store.

For example, he said, Schlumberger is now offering some of its more expensive shale technologies for free up front. Then, if the technology works and delivers more output, Schlumberger gets to enjoy some of the additional production — as does the energy company.

It won’t be for everyone, but such new business models may be necessary to get the industry through times like these, Kibsgaard said.

"The current financial challenges will not disappear, even if oil prices were to recover to the levels seen in recent years," he said. "The industry is therefore forced to seek new ways of working together to reduce costs and create more project value."

Offshore rig operators are feeling pain, as well. Noble Corp. told investors last week to expect tough times ahead, though executives there expressed confidence that its good contract backlog and more modern fleet of offshore vessels will help see the company through. Ensco said a recent debt restructuring will help that firm "navigate through the current down-cycle and capitalize on a future upturn in the market," said CEO Carl Trowell in a statement.

All the while, wallets are getting tighter.

U.K.-based BP PLC is plotting a survival strategy through this current downturn along the same lines as its supermajor peers.

Saying his firm is now operating on the assumption of a "sustained period of lower oil prices," BP’s Chief Financial Officer Brian Gilvary told analysts that cost-cutting through squeezing suppliers and service providers was its No. 1 priority now. BP is also busy downsizing itself slightly, Gilvary said, slashing spending and personnel "right across the corporation."

"We’re looking at everything," he said.

Production still rises

Oil production, meanwhile, is anticipated to continue climbing even as expenses are pared, but more slowly. Early last week, Italian energy firm Eni confirmed that this is the approach they are taking, as well — pushing down expenses while pursuing this year and next "production growth in line with our forecasts," said Eni CEO Claudio Descalzi.

Gilvary at BP said that an acquisition was not in the cards for BP. Efficiency and affordability is the key. Getting the right balance of cost cutting while seeing new production come online hasn’t been easy, and Gilvary said it’s been "quite a painful process that we’re going through."

BP turned in a financial performance better than many observers had expected. The company reported an "underlying replacement cost profit" of $2.6 billion for the first three months of this year, compared to $3.2 billion for the same period in 2014 when oil prices were much higher, a decline of nearly 20 percent. The company actually performed better on the same basis than it did at the final quarter of 2014, when it reported profits of $2.2 billion.

Gilvary repeated the 30 percent expense reduction target. Cost cutting in some subsea segments may come in closer to 40 percent.

Companies that maintained their refining and marketing divisions were boosted a bit from the crude oil price collapse by those divisions during the first quarter of 2015, BP and the French energy giant Total among them. Eni, as well.

Refineries benefit when oil prices fall faster than pump prices, and cuts to prices at the pump eventually spur more consumption of fuels, benefiting refining companies even further. The effect is the opposite when crude prices are up — refining companies can’t raise prices too high too quickly for fear of sparking a consumer backlash, narrowing profit margins. Last week, Valero said it recorded its best first quarterly financial performance yet.

ConocoPhillips, which now styles itself as the largest independent upstream exploration and production company, no longer enjoys the luxury of leaning on refining and marketing to help in a challenging upstream business environment. The company’s recent financial performance brought this vulnerability to stark relief. ConocoPhillips spun off all of its refining business a few years ago, forming the independent Phillips 66.

Last week, ConocoPhillips reported first quarter 2015 earnings, as well. The hit it has taken so far has been steep: The company estimates earnings of just $272 million for the period, down from $2.1 billion in the first quarter of 2014, a drop of about 87 percent.