Oil prices over the last quarter have challenged oil and gas drilling companies to watch their bottom line. In turn this has also challenged the oil and gas service industry. You may be familiar with such names as Schlumberger (SLB), Halliburton (HAL) and Baker Hughes (BHI). If I had to choose one of these three companies to invest in for 2014, I would pick Halliburton. It is not the largest, but of the big three it has done the best job in reining in its "cost of sales" over the last four quarters. Let's take a look at the company and then compare the track record of the big three over the last four quarters.
The company operates under two basic divisions:
- The Completion and Production Segment
- the Drilling and Evaluation Segment
Despite the smaller amount of wells, higher drilling efficiencies and improve profitability in North America cause "Completion and Production" operations to improve their income by 29% year-over-year.
Despite a reduction of activity for " Drilling and Evaluation" operations in the Western Hemisphere, operating income did improved by 5% year-over-year carried by strong growth in the Eastern Hemisphere.
Halliburton is not the only company to experience this, and it may be a pattern due to the efficiency of drilling. Baker Hughes recorded a 4% revenue increase this quarter when comparing year-over-year despite a 5% decrease in its rig counts in North America.
North American Outlook
The region is experiencing pricing pressure for hydraulic fracturing services. It has been an influx of "stimulation equipment" and much less natural gas drilling activity which has caused this.
Even though the rig count continues to drop compared to 2012, the efficiency in drilling is getting better partly due to the trend of "multi-well pads." The trend toward liquid rich basins and an improved fluid count per well abodes well for Halliburton. Services like "advanced fluid chemistries" will be needed.
As of September 30, 2013 it appears that 33% of the company's receivable comes from the United States. The United States is the company's largest regional market by far because no other country comes in with more than 10%.
In North America, the industry continues to see activity shifting away from natural gas toward oil and liquid-rich basins. Operators have been focusing on basins with better economics in order to optimize their budgets.
Halliburton's clients have switched to multi-well-paid activity which is a resulting in increased drilling and completion service efficiency.
While revenue and operating income increased by 16% so far in first nine months of 2013, that prosperity is expected to increase. Unconventional oil and natural gas development as well as deep water projects will contribute to activity improvements. Since the company is focused on expanding internationally this is where a lot of the capital investment is also taking place.
International revenue consisted of about 48% of the total and is steadily increasing as the company continues to grow itself internationally in order to create a more balanced global geographic approach.
Companies must spend money on upstream exploration, development and production programs in order for Halliburton do business.
What drives world drilling activity?
- Oil and natural gas prices
- the world economy
- Government regulation
- Global stability
What are multi-well pads?
With the development of horizontal drilling, came the creation of multi-well pads. Vertical wells require a separate pad for each well but horizontal drilling allows for multi-wells on one pad. This is made drilling much more efficient because once wells drilled a rig may only have to move 20 feet or so to drill the next one which also reduces truck traffic.
One company like Devon Energy Corp can be more efficient in its drilling because they are in close proximity to one another. In its region of Barnett shale in North Texas when existing pad contains 11 wells and two other pads have 21 and 36 on the same pad.
Even though it's been around for a couple of years, it is just as of late that at his popularity. This concept is now employed in about half the well activities across the US basins and it will continue to increase while oil companies move more into that practice.
This is one contribution to the flat US rig count, but could result in more rig activity into 2014. It's quite obvious that greater efficiency per well naturally lowers the number of rigs and operator needs to get a job done.
Observing the Competition
When we look at the big three competitors in this field, revenue patterns appear to be consistent over the last four quarters. For all three companies revenue dropped off the first quarter of 2013 and then picked up the second and third quarter, so there is no difference there.
Where we can really see a difference is when we look at gross profits as a percentage of revenue. When we look at the track record of the last four quarters, all companies have increased their gross profits as a percentage of revenue, but one stands out:
- Schlumberger: 3.3%
- Halliburton: 53.6%
- Baker-Hughes: 7.9%
Companies increase the gross profits as a percentage of revenue when they are able to decrease their cost of revenue.
Considerations in 2014
The global demand for hydrocarbons is directly tied into the health of the economy on a global scale. The economy in the United States is expected to grow by 2.8% in 2014, but this could be tempered when the Federal Reserve begins the tapering process which could eliminate up to $1 trillion in liquidity injections. If interest rates rise significantly because of this, it's going to put a damper on borrowing money for new projects. This could have an effect upon all three major oil and gas service companies.
The IEA Oil Market Report anticipates oil production to increase in 2014 by 1.7 million bpd as oil demand continues to grow. This is good news for the three big companies, but whether these predictions can be sustained will depend heavily upon not only the global economy, but also the development of unknown geopolitical situations around the globe. These all have an effect upon price volatility.
Author's Note: All figures in the charts from this article were gathered from yahoo finance. The author created all the charts.