Necessity is the mother of invention and in the year ended December 31, 2015, adapting to a rapidly shrinking market was absolutely necessary for oilfield service (OFS) companies to survive. When OFS players fold or disappear, for whatever reason it always makes the news.
What is discussed less often is who survived the continuously contracting OFS market of 2015 and how they did it. Because no matter how bad business looks at the present time or the near future, it is useful to at least occasionally notice the glass is half full.
It is in this spirit of determined survival we examine the financial performance of 25 diversified Canadian OFS companies last year. There are numerous different businesses supporting multiple sectors of the upstream oil and gas industry. These companies had revenues ranging from $60 million to $1.8 billion, from comparatively small businesses to huge. Most had some sort of presence in markets outside of Canada, while five had meaningful revenue diversification outside of the oilpatch.
The financial performance of publicly traded OFS operators is analyzed continuously. The data is sliced and diced and presented in many ways. But most analysts focus on how much money these companies make, a key driver of value.
At MNP, we take a different approach, which is to focus on how OFS companies make money. Where the rubber hits the road for OFS is the margin between what companies can charge the client versus the direct expenses, or cost of goods sold (COGS). This is the primary measure of pricing power or pricing pressure and the company’s ability to operate effectively, control costs or adapt to changing market conditions.
The following chart ranks success by each company’s ability to grow, maintain or slow the decline of the gross margin on revenue — sales less direct expenses or COGS. These are the direct variable and direct fixed costs incurred to generate revenue. This most often includes field labor, fuel, expendables, repairs, subsistence, cash cost of product sold, maintaining field service locations, field administration and transportation (including field vehicles). Related: Why the Saudis Want a Deal in Doha
Some companies include depreciation and amortization in direct expenses and disclose it elsewhere, while others report it as a separate line item on the financial statements. Therefore, to normalize the comparative gross margins for companies that include it in direct expenses, depreciation and amortization have been deducted, thus increasing gross margin from what the companies publicly reported.
Gross margin does not include corporate fixed costs commonly called SG&A or sales, general and administrative expenses. SG&A is the fixed cost a company spends to run the organization, whether there is any revenue or not. Nor does gross margin including other expenses such as financing costs, foreign exchange or asset value restatements.
(Click to enlarge)
(Click to enlarge)
Source: Company reports SEDAR
Abbreviations: Mfg, Manufacturing; Svc, Services; Prod, Production; Enviro, Environmental
1 – Company reports depreciation and amortization in cost of goods sold so this has been deducted from direct expenses for accurate comparison with companies who report depreciation and amortization as a line item elsewhere on their financial statements.
2 – Company reports material business and operations outside of Canada.
3 – Company reports revenue diversification into non-petroleum business sectors.
Color coding reflects margin maintenance success: green for increasing or holding year over year margin loss below 2%; yellow for holding margin loss below 6%, red for margin loss 7% or more Related: Oil Slips While All Eyes Are On Doha
Analysis
• Total revenue for the 25 companies in 2015 was $16.096 billion, 32.2 percent lower than $23.747 billion reported in 2014. Two companies reported year-over-year revenue declines exceeding 50 percent, eight companies reported over 40 percent, seven companies over 30 percent, five companies over 20 percent and only three companies enjoyed revenue declines of less than 20 percent. No companies grew revenue last year. Tough 12 months, by any measure.
• Pricing was a big factor in the contraction but it was difficult to calculate. Many exploration and production (E&P) companies have reported a 20 percent to 30 percent decline in their direct field expenses such as drilling, completion and tie-in costs. In their financial reports, OFS operators do not disclose whether the average 32.2 percent year-over-year revenue decline is because of reduced prices, less business or, most likely, a combination of both. It is certain E&P companies reduced their total well drilling and completion costs significantly through lower prices (many brag about this in their public disclosures). But operational efficiency and effectiveness has proven historically to be as or more important than individual input prices (do the job once, do it right, and have minimal to no standby time on location). E&P companies rarely admit their project management and logistical coordination capabilities are anything but outstanding. However, because neither E&P nor OFS companies report exactly why their costs or revenue declined, it is impossible to allocate the elements of reported lower E&P capital costs between price reduction and operational efficiency gains.
• Considering an average year-over-year revenue decline of 32.2 percent for these 25 companies, that the average gross margin decline was only 4 percent is a testament to the agility of OFS operators to slash costs when they must. Fuel prices were certainly lower and field wages were cut significantly. These are two major direct cost inputs. OFS operators also put pressure on their own supply chain for lower input costs. Doing less work allows higher utilization of the most skilled and experienced employees, the people OFS managers will try the hardest to retain. This means there is likely less downtime, unbilled hours or price adjustments based on operational mistakes. All these increase gross margin, even at lower prices. Related:The Great Glut: Why LNG Markets Might Not Balance Before 2025
• Of the 10 companies reporting gross margin increases year-over-year or decreases under 2 percent, half of them operated drilling and service rigs. Rig operators have a collapsible field labour force such that when the rig is not operating, variable direct labour charges fall to zero. Other OFS operators like pressure pumpers have been moving from a salary / bonus compensation model, where they pay field personnel something whether they are generating revenue or not, to a pay-when-you-work model more like rigs. Unfortunately, not everyone in OFS can be in the drilling and service rig business.
• The companies which endured the greatest reduction in gross margin were the three operating in the pressure pumping and hydraulic fracturing business; Canyon, Calfrac and Trican. Three companies in this essential but clearly overbuilt sector have gone into court bankruptcy protection in Canada in the past 15 months (GasFrac Energy Services Inc., Sanjel Corporation and Millennium Stimulation Services Ltd.). Having sold its U.S. and Eurasian operations, Trican is reported above as essentially serving only the Canadian market, though some smaller divisions may still operate outside of Canada.
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• Of the 25 companies reviewed, only five reported a profit in the 2015 fiscal year: Shawcor Ltd., Mullen Group, Enerflex Ltd., Total Energy Services Inc. and Canadian Energy Services & Technology Corp. Shawcor actually reported higher profits in 2015 than 2014, despite a slight drop in revenue. Of the five, Shawcor and Mullen have revenue from clients and industries from outside of upstream oil and gas. Shawcor, Enerflex and Canadian Energy Services do significant business outside of Canada. Shawcor and Enerflex serve clients all over the world while Canadian Energy Services does its international business in the U.S. Only Total and Mullen reported no material business outside of Canada in their year-end 2015 financial disclosures.
Unfortunately, 2016 has started off even worse than last year. Due to continued low commodity prices and the expiration of higher priced commodity hedges (which sustained cash flow), E&P companies are continuing to reduce capital spending in 2016. While crude oil is showing some signs of potential recovery, natural gas prices in Canada are severely depressed because of high storage levels and competition from U.S. sources like the Marcellus shale in historic markets such as eastern Canada. With spring break-up underway, there is no indication OFS business will improve in the short term. A meaningful oil price increase could change the outlook in the second half of the year.
However, the above figures certainly demonstrate OFS operators will do what they must when they must to sustain their businesses and the viability of operations. As awful as it looks, the ability of these companies to hold their average gross margin loss to only 4 percent, when as nearly one-third of their business disappeared, due to lower capital spending and severe client pricing pressure is a testament to the skill and determination of these companies, their executives and their management teams.
That doesn’t mean the operational adjustments made in 2015 are sustainable. Margins were held because workers with no options took pay cuts; repairs and maintenance investments were delayed on equipment that was parked, and vendors in the supply chain were ground down to rates that won’t stand the test of time.
If and when E&P companies want to go back to work, they will have to pay more. That said, the foregoing data indicates at least there will be somebody there to answer the phone when they call.
By David Yager for Oilprice.com
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