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Schlumberger Limited (NYSE:SLB)

Q2 2010 Earnings Call

July 23, 2010 9:00 am ET

Executives

Simon Ayat - Chief Financial Officer and Executive Vice President

Malcolm Theobald - Vice President of Investor Relations

Andrew Gould - Chairman and Chief Executive Officer

Analysts

William Sanchez - Howard Weil

Alan Laws - BMO Capital Markets U.S.

David Anderson - Palo Alto Investors

William Herbert - Simmons

Geoff Kieburtz - Weeden & Co. Research

Daniel Pickering - Pickering Energy Partners

James Crandell - Barclays Capital

Kurt Hallead - RBC Capital Markets Corporation

Robin Shoemaker - Citigroup Inc

Michael LaMotte - Guggenheim Securities, LLC

Angie Sedita - UBS Investment Bank

Daniel Boyd - Goldman Sachs Group Inc.

Ole Slorer - Morgan Stanley

Operator

Ladies and gentlemen, thank you for standing by, and welcome to Schlumberger earnings conference call. [Operator Instructions] I would now like to turn the conference over to our host, Mr. Malcolm Theobald, Vice President of Investor Relations. Please go ahead.

Malcolm Theobald

Thank you, Julie. Good morning, and welcome to the Schlumberger Limited Second Quarter 2010 Results Conference Call. Today's call is being hosted from Paris, where the Schlumberger Limited Board meeting took place yesterday. Joining me for today's call are Andrew Gould, Chairman and Chief Executive Officer; and Simon Ayat, Chief Financial Officer. Prior to Andrew's overview of the results and his comments on the outlook, Simon will first review the quarter's financial results. After the prepared statements, we will welcome your questions.

However, before we begin with the opening remarks, I'd like to remind the participants that some of the information in today's call may include forward-looking statements, as well as non-GAAP financial measures. A detailed disclaimer and other important information are included in the FAQ document, which is available on our website or upon request. And now I will turn the call over to Simon.

Simon Ayat

Thank you, Malcolm. Ladies and gentlemen, thank you for participating in this conference call. Second quarter income was $0.68 per share. Excluding the charges in prior periods, this is an increase of $0.06 sequentially and flat as compared to the same quarter of last year. During the quarter, we began to see the early effects of the deepwater drilling moratorium in the U.S. Gulf of Mexico. The impact of the moratorium on Oilfield Services resulted in a reduction of Schlumberger's Q2 earnings of approximately $0.02 per share. We anticipate the moratorium earnings impact for the second half of 2010 to be approximately $0.08 to $0.12 per share.

Turning to the business segments. Oilfield Services second quarter revenue increased 7% sequentially, while WesternGeco revenue increased 1%. The growth in Oilfield Services revenue was largely attributable to a surge in activity and increased pricing in U.S. Land, the post-winter seasonal rebound in Russia and increased activity in Mexico/Central America and the North Sea. The acquisition of Geoservices during the quarter also added to revenue. These increases were partially offset by the impact of the spring breakup in Canada, the previously mentioned early effects of the deepwater drilling moratorium in the Gulf of Mexico and reduced activity in the North Africa GeoMarket.

Oilfield Services pretax operating income of $1.07 billion increased 11% compared to the prior quarter, while pretax operating margin increased 75 basis points to 19.8%. The increase in margin was primarily driven by a strong performance in North America. International margins increased slightly to 22.4%.

By area, Oilfield Services sequential pretax operating margin highlights were as follows: In North America, pretax operating margin improved 237 basis points to 10.4%. Within North America, U.S. Land margin improved significantly by 15 percentage points as a result of higher activity and pricing for Well Services technologies. However, this increase was tempered by lower margin in the U.S. Gulf of Mexico from the early effects of the deepwater drilling moratorium and reduced margins in the Canada due to spring breakup.

Latin America margin increased 35 basis points to 17.9%, primarily due to the increased activity in the Mexico/Central America and Argentina/Bolivia/Chile GeoMarkets. However, as noted in the press release, we anticipate a slowdown of activity in Mexico, and we will subsequently have an associated charge in Q3. Europe/CIS/Africa margin increased 29 basis points to 18.4%, as the positive impact of the seasonal rebound in activity in Russia and a more favorable revenue mix in the North Sea offset the impact of reduced revenue in the Western South Africa and North Africa GeoMarkets. Middle East/Asia margin remains strong at 31.1%.

Sequentially, WesternGeco pretax operating income decreased 31% to $47 million, and pretax operating margins slipped 447 basis points to 9.8%, primarily due to a decrease in monthly client sales and lower revenue combined with the startup costs for Land. These decreases were partially offset by improved productivity in Marine.

Now turning to Schlumberger as a whole. The effective tax rate was 17.8%. This was lower than last quarter, primarily due to a more favorable geographic earnings mix in WesternGeco. As you are aware, the ETR is very sensitive to the geographic earnings mix and as such, we do experience some volatility on a quarterly basis.

Net debt was $766 million at the end of the quarter as compared to $75 million at the end of the first quarter. We ended the quarter with $3.7 billion of cash and investments on hand and short-term debt of only $719 million. Significant liquidity events during the quarter included $1 billion relating to the acquisition of Geoservices, $634 million of CapEx, $535 million of stock repurchases and the conversion of $297 million of outstanding debentures into 7.4 million shares of common stock. During the quarter, we repurchased 8.4 million shares at an average price of $63.33. We repurchased the maximum number of shares we could under the SEC Safe Harbor provisions in light of the pending merger with Smith. Oilfield Services CapEx is still expected to reach approximately $2.8 billion for 2010, while WesternGeco CapEx is expected to be approximately $335 million.

And now, I turn the conference over to Andrew.

Andrew Gould

Thank you, Simon. Good morning, everybody. Schlumberger's second quarter revenue of $5.94 billion or 6% higher sequentially and 7% higher year-on-year. The sequential revenue increases recorded in all Oilfield Service areas, led by strong performances in both North and Latin America. Among the technologies, sequential revenue growth was strongest in Well Services, primarily due to stronger U.S. Land activity in pricing, increased product sales in the Middle East and a seasonal rebound in Russia.

In North America, surging activity and improved pricing in the U.S. Land GeoMarket more than offset the combined effects of the Canadian spring breakup and the start of the drilling moratorium in the U.S. Gulf of Mexico that began late in the quarter. In Latin America, Mexico grew on higher activity and stronger Integrated Project Management activity, while Brazil continued to see a buildup in offshore exploration activity.

In Europe/CIS/Africa, the effects of a strong post-winter rebound in Russia and improve activity in the North Sea drove revenue growth, although these effects were partially offset by lower activity in North Africa and lower exploration services in West Africa. In Middle East/Asia, most GeoMarkets saw higher activity with strong demand for Wireline Services boosted by higher sales of Well Services product and Artificial Lift equipment.

In the Middle East, Integrated Project Management services diversified further, as our presence increased in Iraq and preparations began to pud the first well in the Rumaila field with the first of the three rigs planned. The second and third rigs will follow, we see continuing increases in Iraq activity throughout the rest of the year.

The WesternGeco revenue is sequentially flat with strong increases in Marine and data processing were insufficient to overcome the effect of reduced multi-client activity mainly in North America, following the traditionally strong first quarter sales and in Land, following the completion of a contract in the Middle East. New technologies continue to contribute to the overall performance particularly in Well Services, while a number of new contract awards underpinned future progress.

In particular, I would mention the award by Petrobras of two new stimulation vessels, would represent the return of Schlumberger to the Brazilian vessel stimulation marketplace after a long absence. In a similar move in Mexico, an award of a vessel from PEMEX will give us a strong presence in the country's offshore stimulation market. Looking forward to the remainder of the year, we see a continued slow build of activity in the second half in most parts of the world.

U.S. Land, Brazil, the North Sea, Russia and the Middle East and Asia will be areas of continued strength. This will be partially offset by reductions in IPM [Integrated Project Management] activity in Mexico, in both Chicontepec and Burgos. In the deepwater Gulf of Mexico, we are not planning for any resumption of drilling activity this year. In deepwater activity elsewhere, we have not seen nor do we expect to see any significant delays or program reductions as a result of the U.S. Gulf of Mexico drilling moratorium. Internationally, operators, contractors and regulatory bodies have stepped up maintenance and verification of key well control equipment and procedures, but have not restricted actual drilling activity. The outlook for WesternGeco will be governed by the evolution of the multi-client market in the Gulf of Mexico, which remains uncertain at this time.

At Schlumberger, we began a program three years ago called Excellence in Execution. This program was designed to create a step change in the service quality and efficiency we provide. And in deepwater, we aim at enabling our customers to reduce the risk and cost of their deepwater operations. The program, in addition to equipment and procedure improvements, provides the competency certification of all our personnel involved in deepwater operations. We are encouraged by the results, as well as our customers' acceptance of this multiyear initiative.

We believe that the contribution of deepwater discoveries has been and will remain very significant to future hydrocarbon production. We therefore welcome the current efforts to better understand and control the risks associated with these types of operations. While additional control and oversight will undoubtedly add costs, we expect this will be offset in the long run by improvements in operating procedures and technology.

The recovery in world demand for oil had been reasonably robust, and current forecast for the coming year remain consistent with slowly increasing levels of exploration and production activity. Natural gas economics remain more challenging, the supply of both LNG and unconventional gas in the U.S. would appear to continue to outstrip the demand recovery. Overall, therefore, we see the current trend of a slow but sure recovery in activity, as likely to continue without a change until we have a clearer view of the sustainability of the recovery in the world economy.

Finally, as an update on our proposed merger with Smith International, our view has not changed that the merger will close in the third quarter of this year. The closing remains subject to clearance by the U.S. Department of Justice, clearance by the European Commission, approval by Smith International stockholders and the satisfaction or waiver of other closing conditions. I would only add that the annual meeting of the Smith International stockholders has been announced for August 24.

And I will now turn the call back to Julie.

Question-and-Answer Session

Operator

[Operator Instructions] With that, we'll go to the line of Kurt Hallead with RBC Capital Markets.

Kurt Hallead - RBC Capital Markets Corporation

My initial question here is given the recent changes and the moratorium in the Gulf of Mexico and a lot of the regulation and other types of concerns, does this at all alter your -- it doesn't sound like it, but I'd like to hear it again, does this alter your viewpoint of the deepwater growth prospects? Does it alter your strategy on how you're going to try and attack that market?

Andrew Gould

So I think the first thing to say is, in the last three years, somewhere between 40% and 50% of the new field discoveries have been in deepwater. Deepwater production has been scheduled to become 10 million barrels a day by 2015, so that's approaching 10% of world supply. And it's a bigger supply than almost any country apart from three. So I think it's highly unlikely that apart from some delays caused by proper caution and control, that there is any significant reduction in deepwater activity anywhere. And I find it extremely interesting that both Norway and the U.K. have permitted some of the deepest water wells they've ever drilled since the Gulf of Mexico moratorium was put on. So I don't think this is going to significantly slow deepwater in the medium to long term. I do think that the issue of spill response is something the industry has to address, I was pleased to see what the majors put out yesterday. And in terms of ourselves, I feel extremely comfortable because as I pointed out in the press release, we've made a huge effort to understand the risks of what we do in deepwater and to specifically train our people to be aware of those risks and to react to them. So after a brief pause in the Gulf of Mexico, I don't see any reason to change our strategy in deepwater, Kurt.

Kurt Hallead - RBC Capital Markets Corporation

Along the lines of the Smith, it sounds like things there are clearly progressing very well, maybe even ahead of your initial expectations, so I don't want to put words in your mouth. It doesn't appear to me like the Street is really giving you any credit or paying much attention to what Smith may bring to the overall organization. I was wondering if you share that view and if so, what do you think we're all missing?

Andrew Gould

Well, I don't know whether the Street understand or appreciate what it will bring to Schlumberger or not. But, I mean, I like to do things sometimes by anecdotal example. So we presented the Smith strategy to our Board of Directors on Tuesday, and they all came out very excited. And on Wednesday morning, I got an e-mail from the manager of one of the countries in the Middle East, where under the current new rig assignments, six rigs have been taken away from our competitors and given to us on the basis that we drill faster, and that was without Smith. So I'm extremely bullish on what Smith is going to do for us, once we start to integrate the different drilling services they have with the drilling services that we have.

Kurt Hallead - RBC Capital Markets Corporation

Would you like to offer up what country that was?

Andrew Gould

No. I'm afraid I wouldn't, Kurt.

Operator

Our next question comes from Ole Slorer with Morgan Stanley.

Ole Slorer - Morgan Stanley

Andrew, you highlight strong performance in North America, and then we look at your margins and compare them with other companies that have reported so far and there's clearly a big gap. And I mean, that's just, of course, due a bit some way on mix. But you seem to put in place in the organization, can you just outline the road map to getting your North American business to kind of close the gap at some way over at your peers?

Andrew Gould

I think that perhaps the thing to say is that the improvement in our U.S. Land margins in Q2 was purely through activity and pricing and without any effects of the reorganization, though a lot of the reorganization work was taking place. And therefore, I would remind everybody that we said we would take a restructuring charge associated with North America in Q3, and that is still the intention, but it won't be very large. But the effects of the restructuring will only start to flow through to the margins in the third and fourth quarters. And therefore, we continue to expect to see outside the constraints of activity and pricing improvements in our cost structure and efficiency in North America through the balance of the year.

Ole Slorer - Morgan Stanley

Historically, or not historically, but you've previously alluded to the fact that there must be smarter way of doing shale and unconventional than brute horsepower. Could you update us to your latest thoughts there, and whether any new technology has any way of playing into your strategy in North America?

Andrew Gould

So I think we are much closer, I'm not going to announce what we'll be doing over the sound waves, Ole. But I think we're much closer to understanding the technology set that we think is appropriate to improving our capacity to predict the productivity of shale from measurements. And if we do that, this is not going to happen this year, it's going to take a little time. If we can do that, then eventually, it will start to change the technology set that is used to produce shale. But it's not this year, Ole. But I think, we are much closer to defining what we think that technology set will be.

Ole Slorer - Morgan Stanley

So we shouldn't expect you to put as reason, go and massively increase your capacity or horsepower for example?

Andrew Gould

No.

Ole Slorer - Morgan Stanley

Second question would be on Middle East, impressive margins. You're building up in Iraq. Could you -- as Iraq gets going and you get beyond the startup costs, will Iraq be accretive or dilutive or neutral to your Middle East margins?

Andrew Gould

It's going to be negative to our Middle East margins overall in 2010, and I think it will balance out in 2011.

Ole Slorer - Morgan Stanley

Are you already taking substantial startup costs there?

Andrew Gould

We're taking startup costs, I wouldn't call them huge. We haven't identified them but they are in the margin in Q2.

Operator

Our next question comes from the line of Jim Crandell with Barclays Capital.

James Crandell - Barclays Capital

Andrew, my first question is about your Seismic business. Can you talk about, first, the outlook for the Multi-Client business over the rest of the year?

Andrew Gould

I can only give you the known, unknown, Jim. So the first question is, is the moratorium extended beyond six months? I don't think so, but we don't know yet. We haven't been granted a seismic permit since the moratorium came on to keep the boat working. The big question is going to be whether the March 2011 Eastern Gulf or Central Gulf lease sale takes place or gets postponed, and I could see a very good case for the new BOE [Bureau of Ocean Energy] actually postponing it. There are two next year. The other one being in August. If it's just a postponement, then it will be a postponement of revenue rather than a cancellation. We honestly don't know whether or not the moratorium in the traditional ramp up of Multi-Client sales at the end of the year is going to have a positive or negative effect. If the future of exploration drilling in the Gulf is still very uncertain in November, it's going to have a negative effect. If the rules will become clearer, then maybe some of our customers will be tempted to buy some data with some of the budget they haven't used for other things. But today, it's almost impossible to say, which way that will go. We have not seen any signs or we don't have any indication that third-party Marine inactivity in the Gulf is going to be any different. But on Multi-Client, until the situation on the future exploration drilling becomes clearer, it's extremely difficult to predict what's going to happen, Jim.

James Crandell - Barclays Capital

And if we saw the negative outcome in the Gulf of Mexico persistent to 2011, would you be markedly more cautious on your outlook for better pricing in the Vessel business for 2011 that I think you articulated last quarter?

Andrew Gould

So the good news in the Vessel business is despite the Gulf of Mexico, the capacity is still being absorbed. And you're quite right to point out that the question will be, once the capacity is absorbed, if there's no big shooting market, acquisition market in the Gulf of Mexico, will pricing move ahead in 2011? And I have to say, if that is the case, I doubt there would be much pricing leverage.

James Crandell - Barclays Capital

Andrew, has your view on whether divestitures will be required as a result of the Smith acquisition change since you announced the acquisition?

Andrew Gould

I can't comment on that, Jim.

James Crandell - Barclays Capital

And lastly, do you see yourself having a presence in the Gulf of Mexico Stimulation business in the intermediate to longer term?

Andrew Gould

It's not high on our priorities.

Operator

Next question is from Daniel Boyd with Goldman Sachs & Co. (sic) [Goldman Sachs].

Daniel Boyd - Goldman Sachs Group Inc.

Just a question on the margins in Europe/CIS/Africa. It sounds like from your comments that mix played a part in pretty, almost flattish margins sequentially. How should we think about margins over the next couple of quarters? Always tough to predict mix, but should we see a nice step up there, as sort of mix normalizes, so to speak?

Andrew Gould

There are some issues in the mix that we can predict and some that we can't. So the one we can predict, for example, is that in Q2 a lot of the rigs, the offshore rigs were on completion and not drilling. And when this happens, the revenue swings in favor of our competitors rather than us and when they're on drilling, it swings in our favor. So logically, they should swing back to drilling in Q3, which will help. And the exploration success, a lot of the prospects that were being drilled in the second quarter were fairly marginal, quite deliberately fairly marginal on the part of our customers. And the question is, if they swing back to more really perspective exploration in Q3, will that improve the mix or not? But that one is extremely difficult to predict. And North Africa, I think we will probably not see much improvement.

Daniel Boyd - Goldman Sachs Group Inc.

And then just one follow-up on North America and U.S. Land, it's come up quite a bit in terms of long-term contracts, I guess, especially for stimulation equipment. Are you seeing those? And what are you thoughts on Schlumberger participating in signing long-term contracts?

Andrew Gould

Well, yes, we're seeing customers making inquiries. But as my peers pointed out, long-term contracts don't really mean very much in North America, so we're not in a hurry to sign over at this point.

Daniel Boyd - Goldman Sachs Group Inc.

And similar to that, are you also of the thought process that you don't want those margins or returns to get too attractive in North America to prevent potential overcapacity building again?

Andrew Gould

I think that the argument that we all have to be conscious of is the argument that what is the correct return on the capital for pressure pumping, and not to let pricing go to the point where the return on capital is so high that it's going to attract a lot of competition, yes, I agree.

Operator

The next questions from Bill Herbert with Simmons & Company.

William Herbert - Simmons

Andrew, with regards your international growth prospects or international prospects in general, you mentioned sort of a steady improvement from this point forward with most regions partially offset by what's going on in Mexico. Relative to your perspective of the Q1 or on the Q1 call, which regions internationally are likely to show a more restrained rate of growth relative to what you thought was a case a quarter ago other than Mexico?

Andrew Gould

I think that we would say that Latin America, and the rest of Latin America is fine, sorry. So ECA, [Europe/CIS/Africa] I would say that we think the offshore market has slipped by one quarter. So the improvement that we thought we would have in Q2 will come in Q3, et cetera, et cetera, which means that overall, my view of ECA for the year probably hasn't changed very much. If it has, it's a slight negative bias, basically because of North Africa not West Africa. On the other hand, if I had to change my bias for MEA, for Middle East/Asia, it would be slightly more positive than it was at the end of Q1, but skewed towards the end of the year.

William Herbert - Simmons

So really net-net, other than Mexico on balance, no real change from what you thought was the case in Q1?

Andrew Gould

Not really, no. A little bit of a shift away from Africa towards Asia but apart from that, not really. And of course, Mexico is worse than we thought at the end of Q1 but apart from that, no.

William Herbert - Simmons

You mentioned economic uncertainty with regard to perhaps tempering customer appetites a bit. We know it's early, but as you look into 2011, do you hazard a guess with providing us with a framework for international growth?

Andrew Gould

I still think that the international growth for oil stems very much off GDP. So if you look at the latest forecast, they're talking about a 4.3% instead of 4.7% in 2011. If that turns out to be the case, I think the oil price will be very healthy and international oil will be good in 2011. If the GDP growth rate slips back then it will affect it consequentially.

William Herbert - Simmons

Next subject here is Gulf of Mexico and I know that this is a tough question to ask, but just a conceptual one. We had a 30-rig floater market before the spill, likely growing to 40 to 45 rigs. Now we had the spill, and the likely results are going to be increased costs, increased regulation and generally speaking at a given commodity price, probably lower rates of return for the industry in general E&P industry in deepwater Gulf of Mexico midsize and large independents getting marginalized, and really probably becoming the exclusive province of the super major. You went from a 30-rig market, which was the second largest market in the world likely going to, I don't know, something smaller going forward based upon the return profile getting impaired. I don't know what that number is, 15, 20

rigs, but looking more like Norway as opposed to the Gulf of Mexico. You've conveyed a sense of no real change in strategy, but I'm just curious as to your Gulf of Mexico footprint and cost structure. As you look out over the next couple of years, what should we expect to see?

Andrew Gould

Actually, I think that the issue you're raising is not the issue of the additional cost. I think the issue that you're raising, which is the very real issue that our customers will have a great deal of difficulty coming to terms with is what is the ultimate viability going to be; people who own leases in the Gulf of Mexico because that's the thing that will limit the number of operators, not the cost. And so we actually have transferred out something like 200 people to U.S. Land and to other places, and we have loaned 250-odd very skilled engineers, operators, maintenance technicians to other deepwater theaters around the world. So we have actually retained the potential to come back as and when we are asked to come back. And some of this has been in close cooperation with our customers who don't want that potential destroyed. I agree with you that the market is not going to be the 45 rigs that people were talking about as little as four or five months ago. I don't know that it's going to be 15 to 20 because I don't think you're going to be able to define that until you actually know how the liability is going to be defined. There is a risk that you quite rightly point out that this becomes limited to the super majors and perhaps people with national government backing, but I think it's a little too early to assume that. So for the moment, we're doing our best to get the Gulf of Mexico to break even by lending out people and equipment. That's going to be very tough in Q3, and then after that, we'll look and see how it looks afterwards. Now in the longer term, I think that people will adapt their deepwater programs to other theaters where, perhaps, they feel they have a more clement regulatory climate in which to drill. And I don't know whether you looked at the Financial Times yesterday, but there was a very good summary of all the reactions so far around the world in different regulatory bodies to this. And there isn't one yet that has taken and, obviously, they don't have the emotional problem that the U.S. does, has taken such a firm stand against deepwater, and I very much doubt they will.

William Herbert - Simmons

Simon, could you share with us what the margin improvement was in U.S. Land quarter-on-quarter in the second quarter?

Simon Ayat

From the first quarter to the second quarter was 15 percentage points.

William Herbert - Simmons

U.S. Land?

Simon Ayat

U.S. Land improved by 15 percentage points.

Operator

Our next question comes from the line of Dan Pickering with Tudor, Pickering, Holt.

Daniel Pickering - Pickering Energy Partners

Andrew, with a lot of moving parts in North America, I heard you talk about taking charge of reorganization, et cetera. I guess I'm just curious, Gulf of Mexico is going to have a full quarter of impact. I assume that means third quarter margins will be down as well as the second. And I'm thinking about how we bounce back from that given cost cuts, et cetera, earned, do you think you'll exit the year -- in other words, Q4 margins are kind of in line with this Q2 level or even better? Or is it going to be tough to get back to these levels by the year end?

Andrew Gould

So I mean, the moving parts that we have, Dan, I mean, I have very little -- I have no doubt that U.S. Land margins will continue to improve provided the rig count holds up. Canada will undoubtedly improve from now on because Canada Q2 is there is spring breakup. So the unknown is at what stage can we get the Gulf of Mexico to the point where it's not diluted to the overall U.S. margin. And in Q3, it will be diluted, there's no doubt about it. We haven't had enough time to do all the transfers, the loans, moving of equipment that is necessary to get the Gulf of Mexico to close to break even. So I think you can assume that in Q3, there is a possibility that the effect of the Gulf of Mexico on the other moving parts is to slightly dilute the margin compared to Q2, slightly. But in Q4, I've no doubt that it will rebound, and I think that it will be -- unless something dramatic happens in the Gulf, and that it will be above the levels -- we'll exit the year above the levels we've shown so far this year.

Daniel Pickering - Pickering Energy Partners

And then as we think about the Seismic business, can you remind us again of how much the Gulf of Mexico represents of Multiclient sales and if we think about Q3 and given what's going on in the Gulf of Mexico, is that going to be a break-even business overall Seismic in the third quarter or should it be better than that?

Andrew Gould

I think it'll be slightly better than breakeven, Dan, but below Q2 partly because of transits and partly because, as you point out, of lower Multiclient.

Daniel Pickering - Pickering Energy Partners

And overall margins for Schlumberger, your thought has been in the Q1 call that Schlumberger margins were going to make a fairly steady upward progression through the year. I mean, given all the moving parts again, Andrew, you see them better than we do obviously, do we manage to continue that? Do you reiterate that [indiscernible] (54:17) level of margins in the second half?

Andrew Gould

Can we leave Seismic out of that as we just discussed that? So x seismic, the two things that have changed since I made the statement in Q1 is number one, Gulf of Mexico and number two, the fairly dramatic reduction that's being announced in activity in Mexico. If you extract those two things, I don't change my statements in Q1.

Operator

The next question comes from David Anderson with JPMorgan.

David Anderson - Palo Alto Investors

Just want to ask you a question about Russia. Russian activities ticked up pretty good this year, even beyond the seasonal recovery. In light of your very good position over there, I just want to get your sense of the sustainability of this market in the next 12 months? And how concerned are you about the new taxes that are being put in place there? Q3 focused entirely on natural gas, so I guess a sense of your oil gas mix over there will be very helpful.

Andrew Gould

Well, we don't have a big gas presence in Russia, except in the very high end. So I don't think that, that'll have a dramatic effect. You're quite right that the seasonal rebound in Russia was very strong, and we think that, that will continue through the balance of the summer, and the question always becomes what is the seasonal effect of the winter going to be like next year. And as to the situation for oil with tax, I think you would just need to watch what happens to the overall level of Russian production, and that will very much govern what happens next year.

David Anderson - Palo Alto Investors

On a different subject, going on to Brazil. Last quarter's call, you had talked about that giant sucking sound [ph] (56:07) came out of the Middle East last cycle that drove earnings growth and you were sure that's going to come from this time. In your release today, you highlighted a couple of new stimulation vessels you're putting in there and it just would seem to me that over the next five years, with the deepwater activity down in Brazil that, that could very well be where that sucking sound [ph] comes from this cycle. Do you view it that way? How long do you think that takes to play out or kind of the competitive dynamics different here that makes this a different market for the Middle East in terms of Schlumberger...

Andrew Gould

No, I don't think the competitive dynamics is different. What is different is the speed with the ramp up. In other words, in Middle East, the Saudi ramp up took place over an incredibly short period of time. I mean, they basically ramped up three huge projects in the space of three years. There's no way that in an offshore development like Brazil that they can possibly ramp up at the same speed. And therefore, while you're quite right that the markets are going to go on increasing and growing very fast, it will never create, I don't need to create the sucking effect that Saudi Arabia created when they went into their big development projects.

David Anderson - Palo Alto Investors

On WesternGeco, I think you guys were projecting somewhere around 50 3D vessels to be in the global market by the end of the year and maybe a dozen or so on the sidelines. How any of those were you projecting to be in the Gulf of Mexico? And how should we be thinking about if we don't get another lease sale in the next 12 months, which who knows, but if you get three or four or five vessels leaving the market, won't that throw the whole global seismic market into disarray?

Andrew Gould

I don't know the answer to your question. As to the precise number of the new vessels we projected going to the Gulf -- talked to [ph] (57:54) WesternGeco this morning, certainly on the basis of the vessel count, they know between now and the end of the year, they are not concerned about utilization.

David Anderson - Palo Alto Investors

But 2011, wild card?

Andrew Gould

2011, it's just impossible to know until we have clarity on future exploration activity in the Gulf of Mexico.

Operator

Our next question comes from the line of Alan Laws of BMO Capital Markets.

Alan Laws - BMO Capital Markets U.S.

I'm going to ask you about the North American market here. Maybe I'm reading into this, but your tone on the U.S. Land seems less pessimistic than it has maybe in the past. Is that a function of your restructuring or changes in your view of the fundamentals and/or maybe demand dynamics? And are you seeing any evidence of investment being swung onshore from the Gulf at this point?

Andrew Gould

I mean, the answer to that is no. I haven't seen any major move in investment onshore though they well may be some, particularly with the independents. My view of the fundamentals of gas, I'm sorry, is I'm still puzzled because gas supply is still outstripping the recovery in demand. And the question is I hear all these reasons why people are drilling, but the question is how long is that going to last? And the only assumption I've made, Alan, is it's going to last for the rest of this year. Beyond that, I'm not making any predictions.

Alan Laws - BMO Capital Markets U.S.

So essentially, you're going to take the high-level activity and pocket that and then see what happens?

Andrew Gould

Exactly. We're not going to just leave it.

Alan Laws - BMO Capital Markets U.S.

The other thing, last quarter, you'd mentioned decline in deepwater rig rates as a potential catalyst for exploration spending. With kind of recent events, it seems that this may accelerate. Is it too early to expect to see any signs of increased demand for Seismic beyond 2010? And comment maybe, I guess, on how do you think the cycle for Seismic might unfold over the next 18 months?

Andrew Gould

I don't think that lower rig rates will affect Seismic because most of our customers, particularly the big ones overseas, have portfolios that will allow them to generate exploration drilling prospects without shooting additional seismic. I think the question is at what stage will they be tempted by lower rig rates to increase exploration programs, and I don't think you'll see much of that in 2010. But if the oil price is decent and the rig rates are low, you may well see something of that in 2011.

Alan Laws - BMO Capital Markets U.S.

What's the level of oil price to incite the incremental Seismic? Does that need to be 80 or 70 and up?

Andrew Gould

Well, I think it's bouncing towards 80 instead of bouncing all the time toward 70, Alan.

Operator

And our next question comes from Michael LaMotte with Guggenheim.

Michael LaMotte - Guggenheim Securities, LLC

Quick question on the Middle East. It's been interesting to watch the rig count come down and counting [ph] (1:01:36) come back as you pointed out they were a big driver for growth in that region in the previous cycle. What are we seeing in terms of mix shift that's allowing your revenues and margins to hold up?

Andrew Gould

Exploration and deep and toxic gas development.

Michael LaMotte - Guggenheim Securities, LLC

In Saudi and UAE?

Andrew Gould

Saudi, UAE, Kuwait, to a lesser extent in Oman, it's tight. It's not particularly toxic. And then actually, exploration's been good in the far -- it was very good in the Far East in Q1, slightly weaker in Q2, but we expect to rebound in the second half of the year.

Michael LaMotte - Guggenheim Securities, LLC

The reason for the question, I think, is we talked about gas in the global markets, obviously, LNG creating looseness in the international market and we know it's gone on in the U.S. There are pockets where you have countries that are short gas and short power in particular as you pointed out Saudi being...

Andrew Gould

And when they produced domestic gas, it's normally to substitute oil so it releases oil for export, not in Saudi, obviously, but in other countries.

Michael LaMotte - Guggenheim Securities, LLC

If I think about India, there's another market that's very short power and looking to develop gas. It's just the country has not been talked about much in the last couple of quarters. I'm just wondering if you could speak to what's going on in that market.

Andrew Gould

I think there's a fairly steady long exploration process that's taking place offshore, and actually there is some interesting work going on on onshore, in gas, particularly even some work in shale gas. So yes, the interest of India in gas is rising, Michael. But apart from the offshore development, I don't think there's anything major yet that they're putting into development.

Michael LaMotte - Guggenheim Securities, LLC

Is it something that maybe we could see a step up in the next 12 months or is it further out, do you think?

Andrew Gould

I think it's probably -- I think there's a lot of work to be done before they know exactly what they want to do.

Michael LaMotte - Guggenheim Securities, LLC

Switching to U.S. Land, you've mentioned I think on the Smith conference call that we would be moving towards drilling geologically as opposed to geometrically. I heard anecdotes...

Andrew Gould

Drilling and completing.

Michael LaMotte - Guggenheim Securities, LLC

Drilling and completing. I've heard anecdotes that some of these bigger fracs and close proximity wells is that you're getting fluid invasion from one or the other and sort of problems with just sort of getting bigger and louder, so to speak, with the frac. I'm wondering if that kind of trend is actually going to be an accelerant to exactly what you're talking about, drilling geologically.

Andrew Gould

I can't speak to fluid invasion. I don't know. I'll find out, but I don't know. What I can speak to is in these large fracs, the percentage of perforation that actually produce is quite low, and obviously, the more percs [ph] (1:05:01) you frac, the more water you use. And therefore, if you can devise a method on it which you only complete with perforations, we're pretty sure we're going to produce, you're going to use less water, and hopefully, you'll have a more productive well. But I think I would re-emphasize that this is a goal. I don't think we're there yet.

Operator

Next question is from Angie Sedita with UBS.

Angie Sedita - UBS Investment Bank

Andrew, given your comments that certainly this recovery is driven by oil activity versus oil and gas, do you believe it's going to be more difficult or take longer before we can push for pricing as it simply will become longer before capacity becomes tight?

Andrew Gould

You're talking of CIS [ph] (1:05:55)?

Angie Sedita - UBS Investment Bank

International, right.

Andrew Gould

Yes, it's obviously the slower the rig count climbs, the longer it's going to take. But it's going to be, I think, more selective by service rather than the general sort of shortage that occurred in 2005, 2006. So it's going to depend very much on the nature of activity. Is it exploration, is development, et cetera?

Angie Sedita - UBS Investment Bank

And thus, when you think to the product lines or specific regions, where do you believe we could potentially see pricing gains first?

Andrew Gould

Well, I still think that the first signs of shortage, or not shortage, but the first signs of our ability to look at pricing because tighter capacity is going to be in drilling tools, probably. But I mean, it's still early days. It's too early to start really knowing. That's more my feeling than any tangible evidence.

Angie Sedita - UBS Investment Bank

In certain regions over others?

Andrew Gould

Well, I think it will occur offshore before it occurs on land, put it that way.

Angie Sedita - UBS Investment Bank

And then when you think about international margins, 2008 you were 29%. Today, we're at 22%. If you think about 2011, is it fair to assume a slow and steady recovery that we would be in the mid-20s or is higher or lower possible?

Andrew Gould

Like I said in answer to an earlier question, there's an $80 oil price that would stimulate considerable activity for oil in 2011. And if that's the case, then I don't think, and I said this before, I don't think we'll get back to the 2008 margins if only because of the mix and the speed with which activity is climbing. But certainly, we will have another margin improvement.

Angie Sedita - UBS Investment Bank

Then finally, when you think about international growth in 2011, as far as year-over-year growth, what are your thoughts there as far as percentage or range?

Andrew Gould

I'm not going to start giving numbers on 2011, international growth in July 2010. Way too early.

Angie Sedita - UBS Investment Bank

First of all, it's not that good.

Andrew Gould

No.

Operator

Next question is from Geoff Kieburtz with Weeden & Co.

Geoff Kieburtz - Weeden & Co. Research

Andrew, in responding to earlier question, you seem sort of -- I think I took the message that your view about the kind of multi-period outlook has not really changed since the first quarter with the exception of Gulf of Mexico and Mexico. On the CapEx side, it seems like you're, through the first half, spending considerably below the run rate that your full year outlook would suggest. What's going on there? Why is that?

Andrew Gould

We always do, Geoff. [indiscernible] (1:09:16) stronger. It's nothing new. It's pretty much par for what happens every year because the field wants their CapEx earlier and manufacturing does their best, but they can't necessarily deliver it. So CapEx is always higher in the second half than the first half.

Geoff Kieburtz - Weeden & Co. Research

Is there any sense that supply chain is starting to become constrained?

Andrew Gould

Generally, no. There are one or two specific bottlenecks that occur because they're very specialized, but they're not really very [indiscernible] (1:09:52). They're not something that stops its progressing.

Geoff Kieburtz - Weeden & Co. Research

And you've bumped up your WesternGeco CapEx a little bit. It seems a little bit inconsistent with the tone that you've been talking about in the business.

Andrew Gould

It's marginal, I think. I don't know where...

Geoff Kieburtz - Weeden & Co. Research

The equity earnings dropped sequentially in the quarter. Why shouldn't we think that's an indication of what's happening at M-I?

Simon Ayat

Well, Geoff, you know the equity line in Schlumberger, it's a mix of several items. There is a bit of impact coming from the deepwater moratorium, I think, on some of our investments, not necessarily on the M-I, but it's a mix. You will always see a bit of a fluctuation.

Geoff Kieburtz - Weeden & Co. Research

And, Simon, could you give us any guidance? You mentioned in the release that Geoservice did impact revenues somewhat in the quarter? Can you give us any idea of magnitude and/or regions that were impacted?

Simon Ayat

So, Geoff, it's one month as a matter fact. In the month of June, we account for Geoservices on a one-month lag, so it's a one month only that was reported in the second quarter. It's very marginal, and it is spread over most of the areas outside North America, more outside North America than inside North America. And it's a very marginal, really. It's one month only.

Operator

Next question's from Bill Sanchez with Howard Weil.

William Sanchez - Howard Weil

Andrew, you talked a lot about your expectations in the deepwater as it relates to the Gulf of Mexico incident and the impact on activity internationally. I'm just curious if you could talk a little bit about with people and equipment now making those moves internationally, in some cases, if they're not going to U.S. Land. Can you just talk about the pricing environment whether or not that's got more competitive even if activity stays similar, in your mind, but activity or pricing gets more competitive?

Andrew Gould

So in deepwater, we have not seen, and I do not expect to see on existing contracts any request to revive that pricing because more service capacities become available. I think that people are going to stick with their contracts and worry more about service quality and risk than they do about pricing. As to new bids, we haven't actually submitted very many since this happened, Bill, so I can't give you an intelligent answer. Yes, obviously, pricing will, on new bids, probably suffer a bit. I would reiterate that I think anyone drilling in deepwater these days is not going to want to take risks.

William Sanchez - Howard Weil

Do you expect the length of the contracts, the service contracts, you'll bid in deepwater offshore markets to be similar, Andrew, as a result of this? Or do you think guys will look for shorter as they want to see what the impacts of maybe additional capacity could mean longer term to the market?

Andrew Gould

I think that, in this year, if there is any rebidding or programs that are bid, they're likely to be short term. And we'll only see return to the longer-term commitments next year.

William Sanchez - Howard Weil

As far as the name [ph] (1:13:41) restructuring is concerned, do you think we're done by the end of the third quarter on that? And I guess it was a comment made earlier, but you didn't see any benefit in your 2Q margins from the restructuring. I'm just curious if you can give us an idea, structurally going forward, what kind of basis point margin improvement do you think you can get in your U.S. onshore or your North American as a whole as a result of this restructuring? Is that something you could quantify for us?

Andrew Gould

We think that will be highly competitive with our competitors by the time that we finish as equal mix.

William Sanchez - Howard Weil

Is third quarter pretty much a conclusion of this? Do you think you're done by that point, Andrew?

Andrew Gould

I think a lot will have been achieved by the end of the third quarter, but I think as I originally said, it's 2011.

Operator

We have time for another question and that comes from the line of Robin Shoemaker with Citigroup.

Robin Shoemaker - Citigroup Inc

Andrew, I wanted to just get your thoughts about the IPM business. Presumably, when Mexico rebounds, that market, as it definitely will, that will play an important role. But is there any change to your thinking about the IPM business model internationally? In terms of the very strong outlook you had and today?

Andrew Gould

No, I think that the only change in the outlook we have for IPM is that it's twofold, actually. First is that the portfolio is becoming much more balanced between Latin America and the rest of the world because it was originally fairly highly concentrated in Latin America; and secondly, there are two types of well construction contracts evolving partly because of Iraq, one of which is the Mexico one, which is, as you know, is very much lump-sum performance-based, not necessarily the most attractive; and the ones in Iraq, which I think will be much more disciplined and more the execution contracts rather than risk contracts.

Robin Shoemaker - Citigroup Inc

Are there any -- as some national oil companies become increasingly more technologically capable and sophisticated, do you see IPM becoming less important in those countries or more?

Andrew Gould

The long-term objective of IPM from the very beginning was not to drill wells. It was to assist in the management of mature production and the business case for assisting the management in mature production for an oil company, national or otherwise, is that they don't have enough internal capacity to do everything they want to do. And we are seeing encouraging signs that, that shift is beginning to take place. So over the long term, while well construction, I think, will always remain a part of it, packaged well construction, we think that the long-term future is in the management or assisting in the management in mature production.

Malcolm Theobald

On behalf of the Schlumberger management team, I would like to thank you for participating in today's call. Julie will now closing comments.

Operator

Thank you. Ladies and gentlemen, this conference will be available for replay after 10:30 a.m. today through midnight, August 23, 2010. You may access the AT&T teleconference replay at any time by dialing 1-800-475-6701 and entering the access code of 157440. International participants dial 1-320-365-3844. That does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.

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Source: Schlumberger Limited Q2 2010 Earnings Call Transcript
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