- The outlook for the Eastern Hemisphere has improved dramatically over the past three months and pricing power is returning.
- Weatherford’s (WFT) strength in artificial lift will be a tailwind for the stock.
- North Africa remains a short-term obstacle, but management noted that activity has increased in Algeria.
Weatherford International reported strong second-quarter results--welcome news after several embarrassing fumbles. Although the stock has lagged its peers thus far in 2011, investor sentiment toward the name remains overly negative given the cyclical recovery under way in the international demand for oil services.
Management’s missteps over the past year have undermined its credibility, but investors shouldn’t forget that the stock outperformed in the last big oil services up-cycle. CEO Bernard Duroc-Danner and his team have delivered value over the long term and have years of experience.
Meanwhile, strengthening demand for its core services and growing confidence in the firm’s ability to execute should be enough to prompt a dramatic re-rating of the stock over the coming year.
During Weatherford International’s conference call to discuss second-quarter results, management echoed Schlumberger’s comments about improving volumes and pricing in the Eastern Hemisphere. The firm also noted that pricing in North America is beginning to improve in businesses other than pressure pumping.
Weatherford International has earned a reputation for its expertise in producing oil and gas from mature fields. To this end, management and analysts focused on the prospects for the company’s artificial-lift business during the July 26 conference call. .
Artificial lift encompasses a number of different services that enhance output as an oil or natural-gas field matures. In the early stages of a field’s life cycle, geological pressures push oil from the reservoir rock, into a well and to the surface. Depending on the type of field being drilled and the quality and pressure characteristics of a reservoir, primary production can continue for years or just for a few months. Once output slows, operators can use a handful of methods to bolster production.
One example of artificial-lift technology is the horse-head pumps that dot the landscape in mature oil-producing regions such as Southern California.
Source: Weatherford International
The electric submersible pump--which is installed at the bottom of a well and pumps oil to the surface--also falls into this category.
Artificial lift is an attractive business to be in from a long-term perspective because most of the world’s largest and most-prolific oil fields are in decline. Producers continue to deploy artificial-lift techniques as a way of reducing output declines from these fields. Duroc-Danner explained his bullish outlook for artificial lift in North America during the company’s recent conference call:
Analyst: [B]ack to your comment, Bernard, with regard to the North American outlook and I think justifiably talking about a series of product lines which have yet to really inflect and should be coming down the road, especially lift. One thing that I'm sort of curious about is revenue per well opportunity on this backlog of new generation wells that are building, costing call it $5 million to $10 million per well to drill and complete versus what used to be a million dollar well to drill and complete. Have you thought about the revenue per well differential, if you will, on this new generation well that's being drilled today versus what used to be the case?
Bernard J. Duroc-Danner: Yes, I--well, I have. It's a complicated question because of the--it depends, as in everything else in our business, depends on the well, depends on the reservoir, depends on location. But maybe what follows will be helpful. Roughly 25% of what North America sells, top line, is artificial lift for us.
What we--so you can derive the numbers. What we are noticing is that on--not only on the wet shales but also what we call tight oil and also tired oil being developed with different approaches are using the lessons learnt from the experience from shales. We're noticing that the billings and the equipment specification for artificial lift is more than two times what it normally is.
Duroc-Danner’s comment suggests that a recovery in the artificial-lift business -- which tends to pick up a few quarters after services related to primary drilling -- provides an opportunity to grow North American profit margins. That’s because operators often wait a few months for a well’s initial production to decline before pursuing artificial-lift technologies.
According to Weatherford International’s CEO, wells drilled in oil and NGL-rich shale plays and longer horizontal wells in mature fields such as the Permian Basin generate twice the artificial-lift sales as traditional North American wells. Expect robust drilling activity in these unconventional plays to support fast-rising demand for artificial lift.
As I noted in my InvestingDaily.com article, "Oil Services: Second-Quarter Results Signal Further Upside," Weatherford has also managed to push through two rounds of price increases on its artificial-lift services. But the full benefits of these price hikes won’t be apparent until the company works through its lower-margin backlog. Over time, expect profitability in the firm’s artificial-lift segment to improve dramatically.
Weatherford International’s exposure to North Africa has also weighed on the company in recent quarters because of disruptions in Algeria, Libya, and Egypt.
Although the firm’s Libyan operations will remain on ice until the country’s internecine civil war ends and political stability returns, activity in Algeria’s oil and gas sector has ramped up and management expects a number of delayed projects to materialize in late 2011 or early 2012.
These developments prompted management to boost its guidance for 2011, though these estimates still appear conservative. Provided it can continue to execute and the macroeconomic situation doesn’t deteriorate, Weatherford International’s stock should be able outperform its peers over the balance of the year.
Disclosure: I am long WFT.