West: Oil Service Industry 2024: A Tale of Two Markets

As the industry turns the calendar to 2024, several themes are clear: The U.S. land market will experience a decline in activity; International land growth is poised to continue—especially in the Middle East and in certain pockets of Latin America and Asia; and offshore momentum will be on full display.

As investors, we maintain our view that those companies leveraged for growth in offshore—where assets are in short supply, technology is dominated by a select few and consolidation has already unfolded—are best positioned to significantly grow earnings, cash flow, margins and maximize shareholder returns.

North American activity growth began to slow considerably as 2023 unfolded with companies maintaining capital discipline. Natural gas activity softened with high inventories and low prices. M&A activity grew within the E&P industry.

Consolidation in the E&P space is a net negative for oil service providers as capital budgets following transactions tend to be optimized, resulting in lower oilfield service (OFS) equipment utilization and sometimes pricing declines. The M&A announcements last year and in the beginning of 2024 have been very large. The loss of market power for OFS will likely be felt as industry activity declines this year. The oil service industry needs to refocus on consolidation.

The benefits of a consolidated market are clear in subsectors such as land drilling, pressure pumping and offshore drilling, where major changes to market structure have led to better economics and returns across the board. When your customers consolidate faster than you, you are deconsolidating and may not realize it.

The international land markets remain strong, particularly in the Middle East where the desire to restore productive capacity, produce more natural gas for internal consumption and raise production capacity are driving all-time highs in E&P spending and rig counts in many countries. Despite many OPEC+ countries producing below their maximum stated capacity, this has not prevented prominent members of the group such as Iraq, the United Arab Emirates (UAE), Kuwait, Iran and even Saudi Arabia from increasing investments to potentially expand their oil production capacity. Saudi Arabia, Iraq and the UAE are targeting a total 4 MMbbl/d of new oil production capacity by 2027. That represents an average 47% increase from current stated capacity. Kuwait is similarly targeting to invest in 1.9 MMbbl/d of new capacity by 2040 — 68% of its current maximum.

The global offshore oil and gas markets have rebounded and will be the largest drivers of E&P spending growth in 2024 after a very tough decade. The push into U.S. oil shale from 2010 to today kept offshore spending at bay for most of that period, which led to a painful downturn. The downturn was exacerbated by a massive expansion of offshore assets, especially in deepwater starting in the early 2000s.

The industry found itself extremely over-leveraged, deconsolidated and in need of a serious restructuring. Almost every publicly traded offshore asset-heavy company went through a bankruptcy and debt restructuring. What emerged in late 2020 and 2021 was an industry with fewer assets and reduced debt leverage.

The industry is quickly running out of available modern offshore rigs, vessels and aviation assets to support the surge in activity. As a result, asset values are surging and day rates have jumped considerably. A scramble for assets is underway, which is playing into asset owners’ hands. Many of the negotiations for assets are happening directly, reflecting the desire of the oil industry to quickly and quietly secure assets for many offshore drilling programs.

Major oil companies, national oil companies (NOC), international independent operators and some U.S. independents are all getting in on the offshore action. The majors and NOCs recognize the need to replenish baseload, low-decline rate oil production while international independents are attacking prospects divested by the majors in prior years. There is also a shift towards increasingly targeting natural gas in the Middle East to replace oil in electricity generation and in many other regions to supply the major LNG facilities currently under construction. Energy security concerns are a driver of this trend, as well as the desire for lower carbon fuels.

For the year, we anticipate solid free cash flow generation across our coverage universe and more capital to be returned to shareholders through buybacks and dividends as the cycle continues. Most companies have announced shareholder return frameworks. The industry is also in an enviable position to help drive the energy evolution and the de-carbonization of oil and gas.

James West is senior managing director at Evercore ISI.