At some point – hopefully sooner than most think – the price of crude oil and natural gas will rise to levels reflecting full replacement cost, including the cost of capital. When this happens, the oilfield services (OFS) industry will get back to work at prices and activity levels not seen for what will soon be one and one-half years. Although which companies will participate in this recovery is not yet known, that there will be a recovery is assured. So what will it look like? Who will be the winners? If it doesn’t happen soon, will the wait be worth the effort?
Earlier this month the Canadian Association of Petroleum Producers (CAPP) issued a news release which made national and international headlines. CAPP indicated capital investment by its members in 2016 would be only $31 billion, a massive decline from $81 billion in 2014 and the largest reduction in CAPP’s history of data collection, dating to 1947. CAPP president and CEO Tim McMillan said in an interview with the Financial Post on April 7, “We have had the largest two-year reduction that we have had at any time since we started keeping track. It is reflective on what are we seeing on the ground in Canada.”
At MNP, we measure the total OFS opportunity as revenue from all sources, not just exploration and production (E&P) company capital expenditures (CAPEX). The total OFS revenue pie includes E&P operating costs on producing assets which already exist and OFS CAPEX, funds spent by non-E&P companies to grow their business. These two revenue sources show the OFS industry is materially larger than many realize.
To illustrate the importance of OFS CAPEX following is a table reporting what 20 of the larger publicly traded OFS companies spent on “property, plant and equipment” in 2014 and 2015. The numbers come from the consolidated statement of cash flows accompanying audited financial statements for the fiscal years ended December 31, 2014 and December 31, 2015. Some statements use the term “purchase of property, plant and equipment” and others classify this as capital expenditures. Either way, these are the funds invested by the OFS operators to upgrade or add assets to earn future revenue. The expenditures are financed internally by the company itself and therefore are investments completely outside of E&P company expenditures. They are important because much of the goods and services purchased is highly specialized and supplied by companies that would also be considered to be in the OFS supply chain.
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Source: Company reports SEDAR
1) Precision Drilling, Ensign Energy Services, Savanna Energy Services, Trinidad Drilling, Western Energy Services.
2) Black Diamond Group, Horizon North Logistics, North American Energy Partners.
3) Secure Energy Services, Trican Well Service, Calfrac Well Services, Canyon Services Group, Canadian Energy Services & Technology.
4) Gibson Energy, Keyera Corp, AltaGas Ltd., Inter Pipeline, Pembina Pipeline, Enbridge Inc., TransCanada Corp, Veresen Inc.
This data from the consolidated statement of cash flows contains no detail about the country in which the funds were spent. It also does not provide a detailed breakout of the nature of the assets, between capitalized maintenance for major upgrades and / or repairs on existing equipment or the purchase or fabrication of new capital assets. Most of these companies have operations outside of Canada and would source some or all of their CAPEX goods and services locally. Enbridge, for example, invested $10.5 billion in 2014 and $7.3 billion 2015. Much of their capacity expansion has been in the United States. Related: Oil Prices Up On Weaker Dollar, Declining Production
Conversely, non-Canadian OFS operators also build equipment in Canada. This is not included above. Nor is the CAPEX of a myriad of smaller or private OFS operators. In the estimates below, the 2014 and 2015 OFS CAPEX figures have been revised materially downwards to compensate for the many unknowns and estimates associated with the above data, as have the 2016 and future estimates. But a provision has been added for investments by non-Canadian, smaller or other non-E&P operators.
Expanding OFS CAPEX is reflective of a growing industry. The drillers were, for the most part, adding new generation drilling rigs required for faster and longer horizontal drilling. In construction and infrastructure, companies were adding bitumen ore-hauling trucks and remote housing. At the wellhead, OFS was adding frack spreads, coiled tubing units and wastewater handling and disposal assets. The largest single investment came from pipeline and midstream operators, which were building pipelines, processing plants and storage facilities for ever-growing crude oil and natural gas liquids production. All this was built to order under contract for E&P company clients or on spec in anticipation of future business driven by continued growth.
The correction from 2014 to 2015 is significant. A lot of the investment decisions were made in prior years and continued through last year because of momentum and committed capital. There will be another significant decline in 2016. How much capital will be invested by these companies in the future can only be an estimate based on unknown commodity prices, resulting in unknown E&P company CAPEX and demand for goods and services.
Using this information and CAPP figures, it is possible to build a reasoned estimate for 2016 and what the OFS macro opportunity might look like at some future point when commodity prices recover to a level which rekindles investment but does not approach the go-go days from 2010 to 2014. For the future case, the assumption is WTI stabilizes at about US$60 a barrel and AECO spot gas rises from current depressed levels to about C$2 per thousand cubic feet (mcf). This will be referred to hereinafter as the “recovery scenario.”
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1) CAPP Statistical Handbook for 2014, CAPP 2015 and 2016, MNP estimate for recovery scenario.
2) CAPP Statistical Handbook for 2014, CAPP 2015 and 2016, MNP estimate for recovery scenario.
3) Company reports (above) reduced for estimated Canadian investment only, plus estimate of other OFS CAPEX by foreign controlled companies in Canada and CAPEX by a multitude of other operators not included in the detailed analysis including the North West upgrader.
4) CAPP Statistical Handbook for 2014 and MNP estimates thereafter. In 2014 30 percent of spending goes to OFS, 33 percent in 2015, 37 percent in 2016 and 40 percent thereafter, reflecting growth in outsourced operating. MNP estimates for 2015 onwards are based upon declining operating costs because of lower service prices and flat production.
5) CAPP Statistical Handbook for 2014 and MNP estimates thereafter. In 2014 30 percent of spending goes to OFS, 33 percent in 2015, 37 percent in 2016 and 40 percent thereafter, reflecting growth in outsourced operating. MNP estimates for 2015 onwards are based upon production growth for oilsands projects still under construction, thus increasing operating costs.
The recovery scenario figure for conventional E&P CAPEX is based upon an estimate of how much free cash for reinvestment producers would generate with oil prices 50 percent higher than current levels and natural gas prices twice what they are today. In past years, E&P spending has been supported by significant equity and debt capital inflows. With today’s battered balance sheets, producers will not be able to borrow as much and equity markets will be unavailable to anyone except the top performers. E&P’s will invest 100 percent of their free cash to sustain production and grow it, if possible. Related: Forget Doha. The Fundamentals Are Moving In The Right Direction
Oilsands E&P CAPEX will be for sustaining existing assets only and some expansion of existing facilities and operations. The recovery scenario does not include any major new greenfield oilsands projects. However, this is expensive production that is hard on equipment. It costs a lot of money to stay in the business and keep existing producing assets and operations working efficiently.
OFS CAPEX is based on the assumption there will be no major additional assets required in the form of construction, transportation, drilling and service rigs, well servicing equipment, production infrastructure or pipelines to handle the anticipated level of business. However, there has been an addition of $4 billion for new oil, natural gas liquids and natural gas value-added processing facilities in the recovery scenario. Several new processing projects are being considered assisted by the injection of up to $500 million by the Alberta government to stimulate activity in this sector.
How much of E&P conventional and oilsands operating costs flow to OFS remains an estimate. There is no granularity in the CAPP figures, nor do OFS companies report how much of their business comes from the creation of new oil and gas producing assets and how much comes from sustaining existing production. The CAPP figures include the purchase of natural gas for heat in bitumen recovery, none of which would flow to OFS, plus the operation of company-owned assets such as oilsands plants. But it also includes well workovers and repairs, product transportation (including crude oil hauling) and plant maintenance, which is all business for OFS.
The data assumes 30 percent of the operating costs flowed to OFS in 2014, increasing to 33 percent in 2015, 37 percent in 2016 and 40 percent thereafter as E&P outsource more of their production operations to expert vendors to reduce total cost. With service prices down and production flat, the assumption is for conventional operating costs to decline from 2014 levels. But operating costs for oilsands will rise with output as the current projects under construction come on stream.
Two startling and sobering conclusions emerge from this data presented this way.
The first is the sheer enormity of the macro OFS opportunity in 2014. According to ARC Financial Corp., the value of all the oil and natural gas produced in Canada in 2014 reached an all-time record of $149 billion based on all-time record production volumes. The foregoing estimates how much money was invested by OFS to support E&P company activity in Canada at all levels to help make this production growth possible. While the $116-billion figure for 2014 above is only an estimate, that the total revenue opportunity for OFS is significantly larger than E&P company CAPEX alone is clear.
The other item that is clear is the size of the contraction of the OFS opportunity in 2016 and beyond. It is not unreasonable to estimate the size of the OFS revenue pie will decline by some $40 billion a year. Related: Half Of Kuwaiti Oil Production Offline After Massive Strike
The misery will not be evenly distributed. The majority - $24 billion - will come from a lack of new major oilsands projects. Companies which primarily supported this activity were fortunate in 2015 and remains so in 2016 because of work on existing projects. Sustaining capital investments will be significant. But the future order book is at or near zero and there are no indications this will change anytime soon.
Companies supporting OFS CAPEX in all forms will be the next group affected. The major investments in the construction of new field processing plants, production equipment, pipelines, drilling rigs, well servicing equipment will be largely complete in the recovery scenario. It is highly unlikely the service sector will invest anywhere near the same amount of capital in the future as it has in the past.
The companies least affected and those which will be going back to work as soon as commodity prices rise are those providing services for conventional activity; drilling completion workover. Because E&P companies that don’t replace reserves are effectively going out of business as their asset value declines, those which can will get back to drilling as soon as access to capital and development economics permit.
Canada is the fifth largest hydrocarbon producing jurisdiction in the world with output of 7 million barrels of oil equivalent per day of bitumen, conventional oil, natural gas liquids and natural gas. Whatever everyone hears and reads about a carbon-free world we are not going out of this business anytime soon. Regardless of the pace of growth, keeping what we have going is going to be big business and will remain the largest resource industry in the country by any measure.
However, it won’t be like it was. It is important for everyone in OFS to understand how different the future may be from the recent past.
By David Yager by Oilprice.com
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