Service firms are trying to stay positive by focusing on improved technology to lower costs instead of the tough 3Q that left pressure pumpers laying down equipment.

Several large diversified, multi-national service firms are breaking with historical precedent and are actively idling pressure pumping equipment and letting crews go rather than fight for market share.

The same firms are also deflecting attention from a pricing environment which is expected to stay soft into 2013 by touting new technology that will help customers lower costs—even though the majority of that technology won’t reach critical mass in the market until 2014.

And, as usual, the big diversified firms are blaming smaller regional firms for cuts in well stimulation pricing, though that line of argument flies in the face of how the market-dominating big firms acted in previous downturns when they, in fact, were the ones who aggressively cut prices to gain incremental market share and drive smaller firms out of the market.

The charge this time is that regional firms are operating below breakeven costs while chasing utilization in a brutally competitive market. Although, there is evidence that regional firms sport a lower cost structure than top heavy multi-national companies thanks to more judicious decisions on supply chain purchases such as guar coupled with a business ethic emphasizing strong customer service orientation.

Regardless, it has been a tough quarter for pressure pumpers of all stripes with falling US land rig count, price reductions on contract renewals, hurricane-related disruptions in the Gulf of Mexico, and a stunted seasonal recovery in Canada. The challenges have been compounded because large public independents front-loaded capex in the first half of the year and have now spent through budgets and are subsequently reducing field activity as 2012 closes out.

To date, the pressure pumpers, on balance, have been less than optimal in predictive capabilities. None of the well stimulation firms, for example, had the foresight to halt massive capital spending programs to add capacity in 2012. To the contrary, none expected the market to reach equipment overcapacity until the first half of 2013. They were right on the part about the first half; unfortunately, they misgauged the year. A downturn in natural gas prices at the end of 2011 resulted in an oversupplied pressure pumping market as equipment rotated out of dry gas basins into oil or liquids rich plays in the first half of 2012 instead of 2013, knocking the bottom out of pricing.

New Technology On The Horizon

During 3Q earnings calls, management at Halliburton and Schlumberger Ltd. outlined programs to improve well stimulation efficiency in the future. For Halliburton, the future rests on improving three areas: creating a more efficient pumping fleet; better fracture designs to create more productive wells by only fracturing the most productive zones; and developing fluid systems to improve reservoir response.

The company once again touted its new Frac of the Future footprint, or a fleet that incorporates a proprietary equipment design that reduces the demand for hydraulic horsepower (HHP) by 25% while operating longer (with less downtime) before the need for scheduled maintenance. Halliburton previously announced the development of its Knoesis advanced reservoir modeling software to help customers make better decisions on fracturing formations.

In other words, the company is promoting finesse over brute force when it comes to well stimulation.

That argument echoes the theme Schlumberger has promoted over the last 18 months. Schlumberger sees efficiency originating from placing the horizontal lateral in the right part of the formation, using rock evaluation to allow an operator to identify the best parts of the horizontal lateral that are likely to flow, and focusing stimulation efforts only on those zones.

Both models assume that frac processes today are largely inefficient and require greater HHP on site as well as larger volumes of proppants and water, much of which is wasted on non-performing parts of the well. Schlumberger management continued to promote their HiWAY frac technology during their third quarter earnings call, claiming that studies of state production data show significant improvements in average flow rates versus wells that did not use the technology.

Implementation of the technique has expanded beyond the Eagle Ford shale to the Bakken shale in the US and Canada while the number of stages fraced with the system nearly doubled to 2,100 during the quarter.

“I would say that we have a very clear view on where the waste is in the current process, and we have technologies and workflows that can help our customers address these,” Schlumberger CEO Paal Kibsgaard told listeners on the company’s 3Q earnings call.

The big service firms are arguing that the drive for greater efficiency among customers favor the types of integrated packages that the big firms provide. The reality is those new technologies won’t reach critical mass in the market until 2014.

Furthermore, the reality is that troubles in the 2012 market have not originated from technological shortcomings. Rather, it has been the ability to manage costs for inputs like guar or to manage supply chain issues involving water and proppants.

While well stimulation firms touted technology as the key driver in the business in 2011, the financial story for the group in 2012 centered on issues such as guar beans and sand, the least high-tech elements in the business. The firms’ predictive abilities failed to anticipate the harvest shortfall in the guar bean crop in India that sent prices soaring during the first half of 2012 and which will continue to negatively impact margins for at least one of the big diversified well stimulation firms into 2013.

Guar Issue Subsiding

The crystal ball for guar remains a little hazy as well. Prices have come down from the peak in May 2012. The harvest season in India begins in November, and management at Halliburton estimated the 2012 crop will be 25% to 50% larger than the 2011 crop. That variance in expectation would make investors feel more comfortable if they were betting on horseshoes rather than oil services. For Halliburton, pushing the high-priced guar pig from mid-2012 through the corporate supply chain python gets company margins back above 20% in the first half of 2013.

Meanwhile, Halliburton plans to have four frac spreads retired by year-end.

Schlumberger is focusing on minimum effective margins, which is a combination of bid price multiplied by utilization. Once the effective margin drops below a certain level, the company lays down crews and Schlumberger has been releasing crews over the last two quarters to protect margin.

Schlumberger’s Kibsgaard described the North American well stimulation market as a commodity business, noting margins have fallen from 30% at peak to the low single digits currently. Normalized margins, according to Kibsgaard, are somewhere in the middle, or sub-20%.

The pressure pumpers remain resolute that the well stimulation business is at or near its trough phase. Improvement in 2013 operator spending, coupled with an expected rebound in natural gas, means a bright future in the second half of 2013. In the meantime, the big boys are going to do something that seems impossible at first glance, and that is shore up their margins by idling equipment and crews, something that has not previously worked in the domestic oil services market — just ask the large publicly held land drillers.

But idle equipment they will as they wait for what many view as a temporary situation to pass. As Jim Landers, vice president of corporate finance at RPC Inc. told investors on the company’s third quarter earnings call, no one intends to work at a loss.

“If it came down to pricing at below sort of operational EBITDA, we wouldn’t do it, we will not do it. We would idle equipment before we would work at below EBITDA margins at the operational level.”

Adapting To A Lower-priced Environment

The well stimulation companies that have reported so far expect conditions won’t change much in the fourth quarter thanks to the way the 2012 holiday season falls.

“At this point, we believe the downside pressure to the fourth quarter outweighs the upside, and we will take the necessary steps to adjust our operations,” David Lesar, CEO for Halliburton, told analysts during the company’s 3Q earnings call.

That said, the publicly held well stimulation firms have gazed deeply into their respective corporate crystal balls and are telling investors that 2013 will be better, particularly when it comes to operating margins. Investors are waiting to see.
So how are the well stimulation companies responding to a soft market? The larger integrated service firms are yielding on pressure pumping price when contracts renew while seeking to pull through additional product lines where margins have not eroded.

Secondly, larger well stimulation firms are increasing their percentage of 24-hour frac crews in order to sustain utilization.

Those are admirable goals, but the reality is that pressure pumping firms will have to lower internal costs going forward as the well stimulation industry evolves from the high demand for proprietary stimulation services that is characteristic early in an unconventional play’s evolution toward demand for commodity well stimulation services as an unconventional play enters the resource harvest phase of the cycle.

Contact the author, Richard Mason, at rmason@hartenergy.com.