Rob Black's First Quarter Oil Market Recap

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Includes: BHGE, GSF, HAL, NOV, RIG, SLB, WFT
by: Rob Black

With the first quarter earnings reports mostly behind us, it is a good time to assess the current state of the oil service and drilling industry and, more importantly, where it is headed. The earnings season just ended was characterized by record-setting growth in revenues, profit margins, new orders, and backlog.

There is virtually no historical precedent for the ongoing surge in demand for oilfield services and equipment. Virtually every product and service line in every geographic market is sold out, as the growing number of “job turndowns” amply demonstrates. Oil service and drilling companies keep track of these job turndowns, which are simply work opportunities that they cannot accept due to a lack of equipment and/or personnel. The job turndowns added up to hundreds of millions of dollars in the first quarter of 2006. The global shortage of oil service capacity, and extreme supply chain congestion, are issues that are being urgently addressed but which defy quick or easy solutions.

What was most evident in the strong first quarter earnings reports is that the oil service and drilling companies continue to raise their prices aggressively, staying well ahead of the upward creep in their costs of doing business. Oil service companies justify their price increases by citing a broad upturn in the costs of labor, raw materials, subcontractor services, and insurance. The oil service and drilling companies are anticipating general cost inflation of 8%-12% in 2006, and perhaps more in 2007.

When it comes to price increases, the oil services industry is seeking, and generally achieving, substantially more than mere cost recovery. Margins continue to expand sequentially and year-on-year, a testimony to pricing power in what has become a sellers market for oilfield equipment and services.

The national oil companies [NOCs] are a relatively new and increasingly powerful force in shaping the global balance of supply and demand for oilfield services. The NOCs of Saudi Arabia, India, Mexico, Russia, and China (among others) are accelerating their drilling programs and are seeking the best drilling technologies available from the world’s top oil service companies. They are directly competing with the world’s “supermajor” oil companies and the mid-tier oil and gas companies for the finite human and technological resources of the oil service and drilling industries.

The NOCs generally seek long-term contracts for rigs and oilfield services. Their buying power is formidable and they have become favored customers for the largest oil service and drilling companies. A significant cause of the current global shortage of oilfield equipment and services capacity is the rapid growth in the power and influence of the NOCs. In discussing first quarter earnings and the outlook for further expansion, several oil service companies commented on the lucrative markets that are emerging in the Middle East and elsewhere with the NOCs.

Another theme that permeated first quarter earnings reports was that while the North American oilfield services market remains strong and profitable, it is clear that the long-term growth opportunities in the Eastern Hemisphere are superior to those of any other geographic market. It is simply a fact that most of the world’s undiscovered oil and gas reserves are in the Eastern Hemisphere: the Middle East, the Russia/Caspian region, and the deep waters offshore the Asian Continent and West Africa.

The best performing oil service and offshore drilling companies are those that have established a strong presence in the major Eastern Hemisphere markets. These would include Schlumberger (NYSE:SLB), Halliburton (NYSE:HAL), Baker Hughes (BHI), Weatherford (NYSE:WFT), Transocean (NYSE:RIG), GlobalSantaFe (NYSE:GSF), and National Oilwell Varco (NYSE:NOV). The strong and sustainable demand for oilfield services in the Eastern Hemisphere will, inevitably lead to premium valuations for the companies that have captured the largest market shares in this part of the world.

Related: 1Q06 Earnings Conference Call transcripts from ExxonMobil, ConocoPhilips and Halliburton.