July 2022
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Drilling Advances: Fundamentals are great, but...

After years of operating on beer budgets, service and supply companies have every reason to uncork the champagne these days. However, the Dom Pérignon may have to remain on ice for now, as bright prospects run headlong into near-record inflation, supply chain bottlenecks, repercussions from the Ukrainian war and China’s Covid-induced lockdown.
Jim Redden

After years of operating on beer budgets, service and supply companies have every reason to uncork the champagne these days. However, the Dom Pérignon may have to remain on ice for now, as bright prospects run headlong into near-record inflation, supply chain bottlenecks, repercussions from the Ukrainian war and China’s Covid-induced lockdown. 

“While there are clear risks posed by inflation, increasing interest rates, supply chain bottlenecks, serious Covid-19 lockdowns and geopolitical conflict, we believe energy security and supply will remain a focused priority. As a result, we should see further momentum in the second half of 2022 and 2023, “ said Weatherford International President and CEO Girishchandra Saligram. 

Saligram echoed many of his contemporaries, who seemed to be reading from the same script during the latest earnings season while discussing operating forecasts for the remainder of this year and beyond. 

“As we look ahead to the rest of 2022, we see a favorable oil and gas price backdrop, as well as a dynamic operating environment, with perhaps the most challenging supply chain and inflationary environment we have seen in several decades,” says Baker Hughes CEO Lorenzo Simonelli. 

Addressing that further momentum also means coming to grips with nearly a decade of underinvestment, they say. “I think the key is at $100 oil, everything is busy, and people want to be busy. But, the question is, can they be busy? What we’ve seen is really seven years of underinvestment around the entire world, spending about half of what we used to spend,” says Halliburton President and CEO Jeff Miller. 

Cost, supply pressures. It’s hardly a revelation that it costs considerably more to construct a well these days, with everything from tubulars to mud additives caught in four-decade-high inflation rates. And that is even if you can get them. 

While NOV says expanding its supplier base and increasing pricing helped ease the inflationary pressures of certain raw materials like resin, the costs of other key components continued to rise over the first quarter. “A lot of components got worse during the quarter, most notably, steel forgings, polymers, fiberglass, electronics, stainless steel and switchgear,” says CEO Clay Williams. “Freight challenges also intensified in the Eastern Hemisphere, owing to the conflict in Ukraine and continued Covid impacts in the quarter.” 

Weatherford’s Saligram also pointed to ocean freight bottlenecks and China’s Covid lockdown as contributing to the supply chain crunch and further aggravating the “significant inflation challenge” across the industry. “It (inflation) has been on the radar now for at least nine months, and it has escalated. It has not yet really decelerated,” he said on April 28. 

What’s more, the years of underinvestment that Miller and others eluded to has put the service sector at a particular disadvantage in responding to the uptick. 

“The downturn saw companies cannibalize underutilized oilfield equipment for spare parts rather than spend precious cash needed to survive on properly maintaining fleets required for more normal levels of activity,” says Williams. “As industry activity ramps, oilfield service companies are swimming upstream against the congested supply chains, as they scramble to put incremental equipment back in shape to work.” 

Shorts in demand. All this comes amid a world in desperate need for additional supplies. For now, the onus is on the producers of short-cycle barrels, just as publicly traded independents largely heed investor commands for fiscal discipline. That leaves less-scrutinized private companies to pick up the slack, says Miller, noting they are operating more than 60% of the active U.S. rig fleet. 

Miller believes investor demands for higher returns; public environmental, social and governance (ESG) commitments; and regulatory pressures make it difficult for operators to commit to long-cycle investments. “The pursuit of increased investment flexibility leads operators to prioritize short-cycle projects, development over exploration, tie-backs versus new infrastructure, and shale rather than deepwater,” he said. 

Olivier Le Peuch, CEO of Schlumberger, agrees, but adds the focus on short-horizon production is not reserved for the U.S. “The industry is responding to this high commodity price environment with accelerated short-cycle investment in North America. Internationally, short-cycle investments are set to accelerate with the seasonal rebound in the second quarter and more strongly in the second half of the year, led by the Middle East and the key international offshore basins,” he said. 

Likewise, the offshore still has a prominent role in the supply mix, Le Peuch said, pointing to sequentially increasing global activity with “some secular growth” in both the shallow and deepwater environments. “The acceleration of infill drilling and tie-back developments will combine with the resurgence of exploration drilling during the summer and with an acceleration of long-cycle development projects ahead of 2023,” he said. 

Meanwhile, investor resistance also has filtered down to the service and supply sector, Miller says. “I believe that poor service industry returns over many years in North America ultimately resulted in a closed-loop capital system, because access to meaningful outside capital doesn’t exist today. Market participants must generate their own cash, in order to reinvest and grow their businesses.” he said. 

All in all, investors’ retreat, in tandem with persistent vitriol from the anti-oil crowd, is coming to bear just when the industry is needed the most. “The world now finds itself in critical need of an industry that it had written off as a sunset industry, and reconstructing this industry will not be easy,” Williams says.  

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