WORLD OIL SPECIAL REPORT

Technology, environment drive service / supply’s future during weak 2002

Loren Carroll, President & CEO, M-I L.L.C., and Chairman, Petroleum Equipment Suppliers Association, Houston

As we enter 2002, the service and supply sector is at a crossroads. All indicators point to a depressed operating climate next year, with weakened prices, reduced drilling, and supplies of oil and gas outstripping demand. Accordingly, as with all down cycles, hard decisions appear to be on the horizon.

Today, service companies must sometimes make the tough adjustments necessary to cope in a down market. But they must not lose sight of the subsequent upturn and continue to invest in technologies necessary to capitalize on future opportunities. In its 2002 Drilling and Production Outlook released in September, Spears and Associates forecasts declines ranging from 21% to 40% within the service / supply market. The biggest drops are expected to hit such areas as tubulars, cement, logging and rig equipment, among others.

However, a handful of segments, such as subsea equipment, geophysical services and FPSOs, are predicted to see flat-to-moderate growth. Facing this declining market, which companies will out-perform their competition? For the immediate future, the best financial performers will be those that fully capitalized on the immediate period of robust activity to build and maintain a healthy balance sheet. These companies used increased revenue to pay down debt, optimized operating capital, streamlined inventories and strengthened their pricing mechanism, even at the risk of losing some market share.

With forecasts calling for drilling to slump more precipitously in North and South America than elsewhere, the companies that will yield the higher returns are those with strong positions in the Eastern Hemisphere. North American drilling is driven primarily by gas, and that market now confronts a supply overhang and reduced demand. Thus, some forecasters have predicted a drilling decline of as much as 31% in the U.S. and Canada. Eastern Hemisphere activity is also expected to decline, but with only single-digit reductions forecast.

"The service firms that weather an activity downturn are those that invested early to develop technologies that improve efficiency and maximize production. "   – Loren Carroll

A near-term bright spot continues to be deepwater areas, particularly the Gulf of Mexico, Brazil and West Africa. The fundamental economics of deepwater plays allow operators to exploit reserves at lower prices. This is a direct response to the size of the average deepwater field. Long lead times and contractual obligations push deepwater projects forward, even when their onshore and near-shore counterparts are delaying, or even canceling, drilling plans. Consequently, companies that supply products and services for deepwater operations will fare much better.

One factor that will mitigate a soft economy’s impact on a service company is field-proven, new-generation technology. The firms that successfully weather an activity downturn are those that made investments early on, to develop technologies that improve clients’ drilling efficiency and maximize production while also reducing costs.

To illustrate how new technology impacts an operator’s return on investment (ROI), consider the Norwegian North Sea. Last year, energy analysts Wood McKenzie reported that oil and gas production from that area was up four-fold from a decade earlier, approaching about 3.5 million boed. They said that average operating costs in those fields were 30% below 1991 levels and half of what they were in the previous 10 years. Much of that reduction can be attributed to new technologies that optimized production and drove down operating costs – in nominal terms – to a little more than $4/bbl.

The past 10 years have seen a service / supply technology explosion, centered on improving drilling efficiency, increasing production, reducing costs and enhancing environmental performance. Developments have been remarkable. Creation of time-lapse 3-D seismic has dramatically improved drilling success rates, resulting in more production with fewer dry holes. Advances in directional drilling, logging and measurement-while-drilling, and new-generation PDC and roller cone drill bits have brought record-breaking, horizontal and extended-reach wells.

Today, coiled tubing technology has evolved to an ideal alternative for re-entry and well-intervention services. More recently, a conductive oil-base drilling fluid was developed that delivers cost-effective performance of an invert emulsion system and produces logging quality previously possible only with water-base fluids. These are but a handful of new-generation technologies that become especially invaluable during periods of reduced activity.

Regardless of prices or drilling levels, one constant will always be the need to protect our environment. That mandate takes on more importance as operators move into more sensitive areas, such as rain forests and the Barents Sea. The environmental technologies developed by the service / supply sector have, in fact, allowed these areas to be drilled in the first place.

Today, companies with strong positions in the environmental area will see a measure of growth. For example, waste management is expected to become one of the fastest-growing sectors. Onshore environmental centers are now treating waste as a resource to be recovered and re-used for other purposes. The onus will be on service companies to not only treat waste, but to dramatically minimize the amount generated at the wellsite. Consequently, environmental issues should be considered an opportunity for growth.

In summary, while the near-term outlook for the oilfield service / supply sector is less than promising, companies must not lose sight of our industry’s reality. That is, weathering a downturn in activity should not come at the risk of losing the resources required to capitalize on the ensuing upturn.