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September 30, 2009

Oilfield services: have 24 months been wasted?

Oil & Gas Vertical magazine
Pavel Makhov

By now, the oilfield services market has shrunk by 38-46%. Its stabilisation will commence in 2010, while its recovery is due to arrive as early as in 2011-2012. Overall workload is down by 25-40%, whereas prospecting drilling has dropped two-fold. Operational oilfield services provided at producing oilfields are down by 5%, their price rates are down by 10 to 15%, whereas the same services provided at new oilfields are down by 15 to 30% in terms of workload and by 20% in terms of price rates. In particular segments, our service rates are down by 15-20% on average. Our price rates remain the same in unique segments, while the cost of our services goes up. 

Meanwhile, overall operational headway performed by vertically integrated oil companies was rising in the course of the first six months of the current year, although its accrual is symbolic at 0.6% as compared to the last-year figures. However, the rise is heterogeneous: Surgutneftegas rose by 12% whereas Bashneft plummeted by 37%. Nonetheless, the fact that multiple market players speak of a 50% reduction in this market sector means redistribution of projects between major contractors that feel reasonably well. It is likely that these market players will do their best to strengthen their positions by acquiring the assets that are on the verge of bankruptcy. The same pattern may apply to international companies. The most vivid example is the acquisition by Weatherford of TNK-BP’s oilfield service providers, the transaction which has just been closed.

The current state of the Russian oilfield services market is assessed by the experts as ‘pre-stability’: no losses suffered by the key players are no longer life-threatening, although the majority of minor market participants are already subjected to a post mortem examination. The market was wheeled into the third quarter in a wheelchair, unable to move without any helping hand.

According to projections made by several experts for 2009, the oilfield services market, including its machine building sector, will shrink by 38 to 46%, or by US$15.5 billion. Stabilisation is coming in 2010, recovery will not arrive before 2011-2012, on condition that oil prices remain at US$60-80 per barrel. If all of the above is in place, in the longer term, namely by 2014, the market will rise to US$20.8 billion.

Production is up while prospecting is down

Operational headway performed by major vertically integrated oil companies went up by 0.6% in January through June 2009, if compared to the same period of 2008. (See Overview of Operational Headway of Major Vertically Integrated Oil Companies Performed in January – July of 2008 and 2009.) In January – July 2009, Surgutneftegas raised its operational headway by 12% against 2008 figures. Tatneft as another leader raised its operational headway by 1.5%, having drilled 257.1 thousand metres against 246.9 thousand metres a year before.

Here comes the end of the story. ‘Successes’ of other market players make us truly unhappy. In January – July 2009, LUKoil reduced its operational drilling by 20%, Rosneft by 13%, TNK-BP by 4%, Gazprom Neft by 10%. Bashneft is the champion, as its operational headway plummeted by 37%.

Things are a lot worse in the prospecting drilling sector. The headway is down by 48.1% in January – July 2009, if compared to 2008. Surgutneftegas and Tatneft are standing alone, as they have increased their prospecting drilling by 20% and 13%, respectively. All major oil companies have curtailed their operations: TNK-BP is down by 78.1%, Gazprom Neft by 75.8%, LUKoil by 44.2%, Rosneft by 18%, and Bashneft by 26%.

The drilling market is not likely to recover in the short term. According to the reports issued by the analysts of Bank of Moscow, both operational and prospecting drilling will be down by 11% as of the end of 2009. In the long term, drilling operations will go up to 3,500 metres per one extracted ton of crude oil. On the whole, given the projections of crude oil recovery growth to 536 million tons by 2014, the headway may reach 17 million tons.

Market experts believe that in the short term major drilling operations will concentrate in Eastern Siberia: according to varied estimates, 30% of the market of drilling and repairs will concentrate there, as compared to 10% in 2006. Therefore, the estimated growth of drilling workload will accrue about 20% in the coming 5 years. Thus, by 2014, the value of the drilling market may have gone up to US$7.5 billion (See Overview of the Drilling Market: 2007 – 2014).
Average drilling price rates will go down to US$362 per one metre in 2009. Nonetheless, in the long term, the price rates are likely to go up, and by 2014 they may have reached US$459 per metre.

Good luck in the new year of 2014!

Projected development scenarios covering other major oilfield services sectors are more or less the same: the market curtails to recover in 2010 – 2011. Thus, according to the estimates provided by Denis Borisov, a researcher employed with Solid Investment and Financial Company, the market of seismic and geological prospecting will have shrunk by 20 – 40% by the end of 2009. The analysts of Bank of Moscow are even more pessimistic: they project a 46.6% reduction to the 2008 level. Next year, the market may go up by 4.3%, and in 2011 is may go up by 9.9% against the 2009 figures, and its value may reach US$1.34 and US$1.473 billion, respectively. In the long term, by 2014, the seismic prospecting market may have reached US$1.889 billion (See Overview of the Market of Geological Prospecting: 2007 – 2014”).
Market experts believe that due to projected shrinkage of the workover market, the market of technological services (directional drilling, workover and maintenance, side tracking, etc.) will grow slower than the drilling market, though it will grow faster than the workover market. In 2009, the market will go down by 34.5% (to US$531.6 million). The market value will reach US$548.5 million in 2010 and US$589.9 million in 2011. The market growth rate will be fixed at 3.2% and 7.4% compared to 2009. By 2014, the value of the market of technological services may reach US$709.5 million (See Overview of the Market of Technological Services: 2007 – 2014).

In 2009, the workover and maintenance market will be down by 20% from US$478.9 million to US$383.1 million, however, it will go up to US$432 million by 2014, although it will fail to reach the figures of 2008 (See Overview of the Market of Workover Services: 2007 – 2014).

Whose life is not good enough in Russia?

Market experts believe that subsidiaries of oil and gas producers will find themselves in the best position in the short term. “Currently, affiliation to an oil or a gas company is a guarantee of viability,” Yevgeny Demidov, Director of Finance Management Consulting at CIG Business Consulting, notes. He believes that “On top of that, vertically integrated oil companies may expect some government support, and this support may produce an indirect impact on the state of the market of services. Therefore, the market share of subsidiaries is likely to grow in the short term. Major oil and gas companies will employ their subsidiaries.”

Mid-sized and small independent Russian oilfield service providers will face major problems. Their current market share is assessed at approx. 10%. The worst is the position of those companies that were incorporated ‘from scratch’, including those that had to purchase new items of equipment.

“Mid-sized companies could have generated a healthy competitive environment and become attractive acquisition ‘targets’, however, reduction of the number of contracts decelerates this process. Partners ready to fund these companies are hard to find. The loss of basic capacities and competencies is likely to occur. Small companies face workload shrinkage, although they keep their price rates low and they try to maintain their quality on the average level. They cannot replace their production facilities. Small companies are likely to leave the market,” Mr Demidov says.
Foreign companies are likely to keep their hands on the hi-tech intensive segment, 90% of which is already under their control. Moreover, the market share of foreign players may go up in the market segment of the independent service providers where their share is currently equal to 20%, through the acquisition of small and mid-sized local companies.
Consolidator: let Integra arrive!

The sector of major independent Russian oilfield service companies including Siberia Service Company, BKE, Integra, Rimera, Tomskburneftegas and some others, keeps aloof. Its short and mid-term development patterns are different. Mr Demidov does not exclude a possibility of further alliances designated to ‘consolidate positions’. Besides, it is likely that in the mid-run their market share will go up to 20-22%, as mid-sized and small market players may have to leave the market. Nonetheless, mass acquisitions and restructurings are unlikely due to the lack of financial resources.

The opinion of the analysts of Bank of Moscow is more or less the same, although, they try to avoid the word ‘alliance’ in their projections. They believe that major Russian companies are strong enough to act as consolidators of this sector while small players have to leave the market, and the share of the in-house oilfield services market is to shrink. 
In particular, Eurasia Drilling Company (EDC) is in a fair way to convert into the consolidator of the market sector in view of its control over BKE and BKE Shelf. EDC will increase its drilling market share, given its stable financial position. 
Therefore, its drilling workload will be slightly above the average market level, and reach US$4.29 million on average (per annum).

According to the market experts, its EBITDA will be down to 13.6% in 2009 following the market trend, thereafter, it will go up to 18.6%. As of 2010 when the long-term LUKoil contract expires, its EBITDA and financials will be boosted by higher price rates. 

“Pursuant to the plans of the management team, EDC will purchase about 10-12 new drilling rigs in the coming 3 to 5 years”, the report of Bank of Moscow says. The analysts believe that “To our opinion, given the market conditions, these plans are overoptimistic. The company may not find the purchase of new drilling rigs expedient enough in the short term due to slow market growth. High depreciation rate of its drilling rigs is also noteworthy. According to our estimates, starting in 2010, EDC will lose 4 rigs per annum. We believe that the company will curtail its investment programme in order to replace its drilling rigs that are essential to perform its drilling contracts. EDC’s capital expenses will reach US$145 million per annum in 2008 – 2014.”

Integra Group may also turn into a potential consolidator for several market sectors.

In late 2008, its heavy short term debts made the main problem. However, this problem has been restructured through a long-term US$250 million loan issued by the EBRD. According to the experts’ projections, in 2009, Integra’s EBITDA will fall to 11.9%, although later it will go up to 13.7%.

As of January 2009, Integra’s portfolio of contracts was assessed at US$600 million, although the analysts are sure that the Group’s annual gross revenues will exceed US$866 million. Nevertheless, 2009 and 2010 will be unprofitable for the Group, and revenues will show up in 2011. Revenues will be brought by the projected demand growth since 2011 for new drilling rigs. Today, Integra’s share of the drilling rigs market exceeds 30%. It must be noted though that the tightening competition with Chinese manufacturers may slow down the market growth pace.
Same as BKE, Integra has no intention to purchase any new drilling rigs. “To our estimates, Integra’s capital expenditure will average at about US$67 million between 2009 and 2014, of which about US$48 million will flow into the maintenance of drilling rigs and equipment each year. Apparently, 2007 saw the company’s maximum investment ever at US$ 181 million,” the analysts of Bank of Moscow conclude.

In pursuit of the leaders

The prospects for other major Russian companies are not clear enough to any market experts. For instance, Siberia Service Company is not likely to obtain the honorable title of the ‘sector consolidator’ for the reason of a financial confusion that has driven the company to the verge of a default. According to the poll performed by Oil & Gas Vertical, the experts have awarded Siberia Service Company 3 points out of 10 for its financial stability. For the purposes of comparison, BKE scored 6.3 points, and Integra 4.6 points.

For its financial strategy and development strategy Siberia Service Company was awarded 4 points; its recovery program involving abandonment and suspension of projects obtained 5 points out of 10. Short term and mid-term prospects of Siberia Service Company are also ranked at 4 and 5 points, respectively.
The scores of BKE and Integra are substantially higher: 6/6, 6/7, 6/6 and 6/7 points, respectively.
As for its long term prospects, Siberia Service Company owned by Rafael Nuriev will catch up with the other two players, as its score is 8 points while BKE has 8.6 points and Integra has 8.3 points.

It looks like experts have no doubts that the long term prospects for major oilfield services providers are favorable. Is it just the time for strategic investments?
According to projections of market experts, the geological prospecting market may go up by 4.3% next year, and it may go up by 9.9% in 2011.
According to projections of market experts, in 2009, the oilfield services market (including machinery building) will shrink by 38-40% (to US$15.5 billion).
The story of recession
According to Yakutgazprom General Director Andrey Zagorsky, the market of services for oilfields in exploitation (including equipment designated for replacement, maintenance of the operating fleet, producible oil improvement, wells workover and maintenance) has undergone no substantial changes, unlike the market of new oilfields (drilling machinery, prospecting wells, geological information systems) which has shrunk substantially. According to the expert, this heterogeneity is driven by the determination of the market players to maintain their recovery and to give up their long-term investments. The average market workload has shrunk by 25 to 40%. The figures differ in varied market segments, for example, the drilling workload has shrunk by 50%. The producing oilfield services market has shrunk by 5% in terms of workload, and by 10-15% in terms of price rates. In the market sector of new oilfields, the workload has shrunk by 15-30% and the price rates have shrunk by 20%. The price rates have shrunk by 15-20% in competitive sectors. The price rates remain unchanged in unique sectors while respective costs of services have risen. 
“Today oilfield service providers are cutting their costs in the most aggressive manner, also by way of layoffs,” Mr Zagorsky adds.

He also explained, that “Mass layoffs date back to August of 2008, when white collars were fired. Companies lost up to 15-20% in personnel. Layoffs of drilling specialists were less hasty; the total number of drilling specialists fired did not exceed 20% through the end of 2009. Suspended payments have turned into another method of saving cash: oil companies suspended their payments due to oilfield service companies that had to suspend their payments in turn. In January through June, overall losses reached 5 – 25%, depending on the business diversification rate, the size of the company and the market sector. Net losses of ALNAS, an oil and gas machinery manufacturer within Rimera Group, reached RUR354 million in January through June, and this figure exceeds the one of the last year 30.5 times.” (Note by Oil & Gas Vertical: The loss of ALNAS generated in the second quarter of 2009 dropped 3.5-fold as compared to its loss generated in the first quarter and equaled RUR82.787 million.)