The U.S. shale boom is turning into a bust for companies that provide drilling services as the number of rigs seeking natural gas has fallen faster than any time in the last 24 years.
The overall U.S. onshore rig count has dropped 9 percent this year, seeing the most sustained declines since the recession-led plunge in 2009. Those declines, caused in part by the gas industry’s shift to oil production, are eating away demand for drilling services and worsening a shale-equipment glut that’s pushing down prices.
Four of the biggest service companies, including Halliburton Co. (HAL) and Schlumberger Ltd. (SLB), will see their collective third quarter operating profit drop by more than $1 billion in North America compared to a year earlier, according to estimates from Houston-based Tudor Pickering Holt & Co. Prices charged for fracking services are expected to drop 14 percent this year and another 8 percent next year, according to PacWest Consulting Partners LLC, a Houston-based industry adviser.
“It’s a battle ground out there,” Joe Hill, an analyst at Tudor Pickering, said in an interview. “With activity contracting, it’s a fairly toxic mix. The real question is how bad this actually gets.”
Once-surging profits from hydraulic fracturing, or fracking, are fading as oil and gas producers became more cautious about spending amid lower energy prices and global economic troubles that are damping demand.
As producers shift production to oil, the number of working gas rigs has fallen 48 percent this year to 422, the fastest decline rate since Baker Hughes Inc. began tracking the count in 1988. Even in oil drilling, where gains have helped counter losses in gas, the rig count has flattened, falling below 1400 this month for the first time since June.
At the same time, rising competition and oversupplies of gear have swamped the market. Halliburton and its peers ordered more than $10 billion in new fracking equipment to meet demand as drilling accelerated in U.S. shale fields over the last five years, according to PacWest estimates. Equipment now exceeds demand by 30 percent, measured by the amount of horsepower available to drive the fracturing process, with about 15.6 million horsepower competing to meet demand for 12 million, PacWest says.
The earnings declines for servicers in the U.S. may deepen through the end of the year, said John Keller, an analyst at Stephens Inc. in Houston. As the companies added more equipment and competition heated up, customers began demanding price concessions.
Oil and gas producers “are getting super emboldened right now,” Keller said. “They realize there’s blood in the water.”
Pricing for shale work is expected to tumble further as the contracts that were signed at higher rates begin to expire and new deals are signed at lower prices. For exploration and production companies that have seen profits strained by the higher costs, those prices can’t fall fast enough.
“We are seeing reduced costs over the next few years,” Torstein Hole, senior vice president in charge of U.S. onshore work at Statoil ASA (STL), said in an interview. “But it has perhaps been slower than I would have expected.”
High service costs have combined with lower gas prices to shrink cash flow for producers, leading some companies such as Chesapeake Energy Corp. (CHK) and Occidental Petroleum Corp. (OXY), to curtail drilling programs and contributing to the drop in demand.
Statoil, based in Stavanger, Norway, knows it “definitely” has more bargaining power and is talking with its service providers about scaling its operations up or down in the Bakken Shale of North Dakota based on the prices it’s being charged, Hole said.
“They know that we need to see the cost level come down in our activities,” he said. “We are having a constructive discussion.”
The shift to oil may be the biggest factor contributing to the slump in demand, Schlumberger Chief Executive Officer Paal Kibsgaard told analysts and investors on the company’s second- quarter earnings call July 20. To frack a well, servicers pump millions of gallons of water along with sand and chemicals underground to crack rock and unlock oil and gas. Fracking an oil well requires less horsepower than the more intense gas wells that have higher pressures.
“The number of horsepower needed on a liquids job is significantly lower than what you need on a dry gas job,” Kibsgaard said. “That’s really what’s driving the oversupply in the market.”
Schlumberger, the third-largest fracking-service provider in the U.S., is mothballing an undisclosed amount of pressure- pumping equipment because it’s not needed.
Halliburton, Baker Hughes (BHI) and Weatherford International Ltd. (WFT) are anchoring the bottom of the Philadelphia Oil Service Sector Index, which also includes rig operators that are benefiting from growth in offshore drilling. The index has risen 2.4 percent this year.
While most offshore rig operators are registering double- digit gains, Halliburton fell 2.1 percent, Baker Hughes fell 8 percent, and Weatherford dropped 17 percent so far this year. Schlumberger, which relies more on business outside North America for about two-thirds of its revenue, rose 5.7 percent.
All four companies are expected to report third quarter operating profit margins that range from 12 to 19 percent, compared to a range of 22 to 29 percent a year earlier, according to James West, an analyst at Barclays Plc.
Halliburton, the world’s largest fracking-service provider with more than half its total revenue generated in North America, is seen as leading the way down for third-quarter margins. The company expects a margin drop of as much as 5.1 percentage points in the region compared to the second quarter, Chief Financial Officer Mark McCollum told investors Sept. 5 at a conference.
Baker Hughes, the second-largest fracking-service provider in the U.S., has about half of its pressure-pumping fleet exposed to the lower-priced spot market, Charles Minervino, an analyst at Susquehanna International Group LLP, wrote Oct. 2 in a note to investors.
“Margins are unlikely to recover in the near future,” he wrote. Baker Hughes has about 1.7 million horsepower of fracking equipment in the U.S., according to PacWest.
Weatherford, whose U.S. fracking fleet is less than half the size of third-ranked Schlumberger, is expected to report the smallest drop in regional operating profit in the third quarter, with a margin of 16.5 percent, down from 21.7 percent a year earlier, according to Luke Lemoine, an analyst at Capital One Southcoast Inc.
Servicers won’t see the kind of profits they enjoyed during the height of the shale boom coming back any time soon, Jim Rebello, managing director in the Houston office at Duff & Phelps (DUF) LLP, said in a telephone interview. The current pain from falling prices is compounded by the amount of investment in equipment that’s now idled.
“They spent a lot of money on the equipment,” Rebello said. “I don’t get the sense that Q4 is going to be materially different than Q3. I wouldn’t expect any rebound in Q4.”