BP to Halliburton in ‘Barroom Brawl’ as Drillers Slash Costs

Alex Nussbaum  David Wethe Javier Blas  

August 17, 2016  Updated on August 18, 2016 — 8:16 AM CDT bloomberg.com

  • Oil industry cost cuts for 2015 to 2020 total $1 trillion
  • Service providers that reduced rates say discounts to end

Mad Dog, BP Plc’s drilling project deep in the Gulf of Mexico, could be Exhibit A in the oil industry’s war on cost.

When the British oil giant announced the project’s second phase in 2011, it put the price at $20 billion. Last month, after simplifying plans and benefiting from a sharp drop in everything from steel to drilling services, Chief Executive Officer Bob Dudley said he could do the job for $9 billion.

Across the industry, companies have taken a chainsaw to expenses, slashing spending for the 2015-to-2020 period by $1 trillion through cutting staff, delaying projects, changing drilling techniques and squeezing outside contractors, according to consulting firm Wood Mackenzie Ltd. That’s cushioned businesses as oil prices plunged 60 percent since 2014. Now producers seek to show they can make the savings stick, while service providers try to reverse their losses.

Industry costs “may be the defining issue of the next six to 12 months," said J. David Anderson, a Barclays analyst in New York. “As you start ramping up, the fact is you’re going to need more services and they’re going to have to come in at a higher price."

London-based BP expects 75 percent of its reductions to hold even if oil rebounds, Dudley told investors in July. In earnings reports over the past month, U.S. shale drillers said at least half of their savings are permanent improvements in efficiency. But service providers such as Schlumberger Ltd. and Halliburton Co., which perform much of the drilling and hydraulic fracturing around the globe, tell a different tale: They may have cut rates to keep business during the oil rout, but those discounts were temporary.

“Price negotiations have been a barroom brawl," Jeff Miller, president of Houston-based Halliburton, said on a July 20 conference call. “But we believe prices will recover."

Who’s right could have big implications for the oil industry and the broader economy.

U.S. benchmark oil has climbed almost 20 percent since closing below $40 a barrel and slipping into a bear market earlier this month. The grade traded at $47.23 as of 9:15 a.m. New York time on Thursday.

“A lot of the actions that we’ve taken are what we would call self-help type of things, changing the way we work,” said Stephen Riney, chief financial officer of Houston-based Apache Corp., an oil explorer. “These are things that are not dependent upon the pricing from third parties.”

While the industry has gotten more efficient, it’s likely to give back most of the gains, said Pritesh Patel, upstream director at research firm IHS Markit Ltd. About half the decline came as a strong U.S. dollar reduced the relative price of materials and labor, Patel said. Contractor discounts accounted for much of the rest, he said.

Sustaining Cuts

Producers will be lucky to sustain a third of the cost reductions, Patel predicted.

One example of a cut that may soon be lost is in the Eagle Ford Shale in south Texas, where the price to lease a drilling rig with a crew tumbled by almost a quarter in the two-year downturn to $18,208 a day, according to a Bloomberg Intelligence estimate.

Service providers say they’re getting to a point where they may no longer be able to offer such a discount. Schlumberger, Halliburton and Baker Hughes Inc., the top service companies, all reported losses in North America in the first three months of 2016.

“A large wave of cost inflation from every part of the supplier industry is now building," Schlumberger CEO Paal Kibsgaard said on a July 22 call. Profit margins, he said, are “deeply negative."

Permanent Changes

Oil explorers insist they’ve made lasting changes. In the North Sea, producers such as BP are standardizing everything from drilling equipment to the light bulbs and paint used on offshore rigs. In the U.S., companies have built out infrastructure in shale plays, installing pipelines to transport crude and wastewater rather than paying to truck it away.

In the Permian Basin in west Texas, Devon Energy Corp. has extended electricity to its well sites, allowing it to eliminate 300 rented generators, Chief Operating Officer Tony Vaughn said on an Aug. 3 call. Occidental Petroleum Corp. CEO Vicki Hollub said her company has improved well designs and can drill more quickly, accounting for about 80 percent of cost reductions.

Apache has renegotiated power, water and chemical-handling contracts and cut lease-operating expenses, a measure of drilling efficiency, by 17 percent, CEO John Christmann told analysts on Aug. 4.

Producers such as Apache and Devon are going to have to accept “the reality” of the service companies’ situation, Halliburton CEO Dave Lesar said last month.

“Some of the efficiency gains we have made with customers are in fact sustainable and will continue, but others including deep uneconomic pricing cuts are unsustainable and will have to be reversed,” he said.

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Maintaining some significant portion of the cost savings is critical to the future of higher cost basins such as the TMS.  Many of the improvements in well design are associated with higher costs such as longer laterals, more water, more sand, etc.  If those cost increases can not be offset with some meaningful long term savings the only other path to improved well economics is higher commodity prices.  And that does not look to be in the cards for some time to come.

The more efficient they become...the lower prices will go...
More production = lower prices

Supply greater than demand depresses prices.  However a lower cost of production per unit increases profit but does not necessarily lead to greater production volume.  Two factors served to wreck the supply/demand balance in the early days of the established economic unconventional basins.  The requirement to drill wells to HBP leases and the requirement to maintain cash flow to service debt.  The first basically no longer exists and the second is in the process of being mitigated by M&A and bankruptcies.  The industry will be better in the future at balancing the equation it just has to get over the lingering effects of the over-production price decline and the massive debt load many companies took on during the shale land rush.

Do you think US drillers would restrict production to maintain higher prices?

I can see right now costs are an issue...but assuming it wasn't an issue.

Isn't that what they'd like to see OPEC do?

I think there is an opportunity to take advantage of the production characteristics of unconventional reservoirs (high initial production, long decline tail) to maintain a more balanced supply/demand equation.  Every energy company has its own Internal Rate of Return (IRR) targets and that is actually a more important metric than total production volume.  As established basins are supported by adequate infrastructure particularly the connection to transportation options, the tendency to boom and bust cycles should fade.  I think "manage" is a better descriptive term than "restrict".

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