It was a jungle out there for the Canadian oilfield services (OFS) industry in the third quarter of the current fiscal year ended September 30, 2015. For a group of 25 diversified, publicly traded Canadian OFS companies, combined revenue declined 38.5 percent from $6.6 billion in 2014 to only $4.0 billion this year.
Just one company, ShawCor, managed to increase revenue on a year-over-year basis. Average gross margin – revenue minus direct expenses for delivering the product or service – fell 6.6 percent from an average 27.0 percent last year to 22.3 percent this year. Only eight of the companies reported a profit for Q3, compared to 2014 when 24 of the 25 companies under review reported a profit in the same three month period. Two companies reported losses close to or exceeding total revenue because of write-downs of balance sheet assets, particularly goodwill.
Gross margin is a key performance indicator of the health of the OFS sector and the companies which operate in it. This is revenue minus direct expenses or cost of goods sold. The main components of direct expenses are cost of goods for products, fuel and labour for services, expendables, repairs and maintenance, field service operations and operations support infrastructure. Changes in the gross margin reflect pricing pressure from clients, as well as input costs such as parts, expendables, fuel and labour.
That revenue should decline this sharply on a year-over-year basis should come as no surprise. With oil prices down by half, drilling is down by half, the rig count is down by half and capital expenditures have fallen accordingly. Exploration and production (E&P) companies have told their shareholders they are enjoying service price reductions in the range of 15 percent to 25 percent across the board. The fact the average gross margin for the 25 companies under review is down on average only 6.6 percent in the face of intense competition and pricing pressure is a testament to the ability of managers to find ways to cut product and service delivery costs to accommodate customer demands for lower prices. Related: One Underlying Catalyst Behind Syrian Conflict And Paris Attacks
The financial performance figures analyzed in the following chart are:
• The ranking order based upon gross margin gain (loss) in 2015 versus 2014 for the three months ended September 30, with the order starting at the highest in descending order.
• 2015 Q3 revenue to September 30 and the percentage increase (decrease) versus the same period in 2014.
• Gross margin in 2015 for the period as a percentage of revenue. Gross margin is revenue minus direct expenses related to generating that revenue. They include labor, fuel, cost-of-goods sold for products, expendables used to generate the revenue, transportation to and from location, field service locations, support vehicles, direct repairs and maintenance and field operations personnel. They do not include fixed costs for sales and administration, interest expenses, depreciation or amortization.
• The increase or reduction in gross margin for 2015 versus 2014.
• OFS subsector classification using MNP’s proprietary coding system.
• Companies are color coded in order of year-over-year gross margin performance in two categories: those with gross margin gains (or losses less than 1 percent) in 2015 compared to 2014 (green), and a gross margin decline greater than 1 percent in 2015 compared to 2014 (red).
• Data is from company financial statements for the period ended September 30, 2015 filed on SEDAR. Related: Why OPEC Can’t Win The Oil Price War
The highlights of the foregoing are:
• The growth or shrinkage of gross margin is a key indicator of product or service pricing and the ability to pass on to clients rising costs as they occur. Fuel expense was lower in Q3 2015 and by summer most companies had made material adjustments on labour and their input supply chain. Extraordinary income (often with no direct expenses) such as cash from the cancellation of equipment contracts would contribute materially to gross margin. The fact that only three of 25 companies were able to increase their gross margin despite some costs like fuel being lower was representative of the intense pricing pressure the OFS sector faced in 2015’s collapsed oil price environment. Related: UK Banking On NatGas And Nuclear Over Renewables
• Of the six companies able to raise margins or hold them to within 99.4 percent of last year’s levels, the top two performers operated drilling rigs, well servicing rigs or both. This is indicative of how quickly rigs can collapse their field labor structure, something most other OFS companies cannot do. When the rig isn’t working, the crews come off the payroll. Drilling contractors are often protected with long-term contracts for newer or built-for-purpose equipment. The two companies which were able to materially raise their gross margin this year can thank their rigs. The other companies which were able to increase or hold their gross margins operated in production support services, additional non-oilfield markets, or international markets.
• Of the five companies that endured the greatest gross margin reduction, three (Canyon, Calfrac and Trican) are in the pressure pumping or hydraulic fracturing business. The other two operate in oilfield equipment manufacturing and sales (McCoy) and directional drilling (PHX). Companies in these businesses require highly trained field service personnel who often receive a base salary even when not generating revenue. Canyon recently announced it was changing its field service compensation model to reduce the risk of paying direct service delivery wages without generating revenue. Two of the pressure pumpers, Trican and Calfrac, reported negative gross margins, indicating every dollar of revenue cost more than 100 cents to generate at the field level. This is above corporate and administrative expenses and is obviously not sustainable.
• Only one of the 25 companies, ShawCor, increased revenue for the quarter. ShawCor is an international pipe protection company and was able to enjoy revenue from international contracts already in place when the downturn began late last year. The only noteworthy company that got close to duplicating 2014’s revenue was Enerflex, down only 5.7 percent on a year-over-year basis. Enerflex also enjoys significant revenues outside of Canadian markets.
One would hope that Q3 2015 would mark the bottom of the current downturn. However, a further serious reduction in oil prices in August when WTI flirted with US$38 a barrel took the wind out of an uptick in drilling which followed WTI exceeding US$60 a barrel in June. Canada’s active drilling rig count reached 221 in early August, however by the end of September this had fallen to 189. Having fewer rigs drilling in the fall than in the summer is clearly a factor of low commodity prices and is, in fact, countercyclical to historic Canadian drilling activity patterns.
Again, if there is any good news in these figures it is in the demonstrated adaptability of the OFS industry. Revenue fell across the board by nearly 40 percent. E&P companies advertised that they have been able to extract significant price reductions from their vendors, often in the 25 percent range. In the face of enormous financial challenges, the managers of these companies somehow achieved an average gross margin decline of only 6.6 percent. This has obviously been painful for suppliers and staff; however this is a matter of survival, not a popularity contest.
These companies cannot do this forever. They are under severe financial pressures from their capital providers, both equity and debt. Stock market values have plummeted and in some cases they are offside with their secured lending covenants. Vendors cannot work at little or no profit for any extended period of time.
But if there is some material uptick in oil prices and spending in the not-too-distant future, hopefully the core component of Canada’s upstream oil and gas industry services infrastructure will be there to help their clients exploit a recovery.
By David Yager for Oilprice.com
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