Musings: A Retrospective View of A Restructured Energy Industry

In 2015, GE made the strategic corporate move to exit its financial services businesses, which had propelled the company’s outstanding stock market performance under legendary leader Jack Welch in the late 1990s and early 2000s. That business became an albatross around the neck of GE when the 2008 financial crisis emerged. GE’s strategic move drove the company to emphasize oil and gas equipment that it continued growing through a series of acquisitions. With that new focus, GE felt compelled to acquire businesses in order to broaden its well completion and subsea equipment portfolio, and subsea service provider Oceaneering became its latest acquisition target. The deal was brutal and expensive as the new Halliburton Company battled GE to the end. The two other large oilfield service companies, National Oilwell Varco and Weatherford International, both built by serial acquisitive managements, battled over the Halliburton-Baker Hughes assets that they were forced to sell to complete their merger. As always in the oilfield service industry, the big boys are continually wrestle with the buy/grow decision, especially over unique product lines.

In the new normal world of the petroleum industry, despite moderate  and consistent demand growth, oil prices continue to lag where they had been trading before the last collapse in 2014-2015. That price collapse forced oil and gas operators to cut their exploration and production spending and begin aggressively axing staff and overhead in order to lower E&P costs. The oilfield technologies that were critical for opening shale basins around the world proved capable of enabling operators to increasingly increase their production by extracting a greater percentage of hydrocarbons from shale reservoirs than initially. So, while many observers had expected a “V-shaped” recovery in 2015, much like what occurred in 2009, that didn’t happen. As the resiliency of shale output coupled with healthy volume growth from low-cost conventional reservoirs around the world battled low oil demand growth due to the continuation of the era of historically low economic growth, oil prices failed to rebound quickly.

At the start of the oil price collapse, the debate within the industry was whether companies were looking at a “V-shaped,” “U-shaped” or “L-shaped” recovery. Having quickly dismissed the first choice, the debate then shifted to the remaining options. The problem was that the length of the bottom of the “U” can easily transition into an “L,” and in this case it did, much like what happened in the late 1980s and 1990s. One could say that it was the lack of any oil price improvement for an extended period of time that contributed to the petroleum industry’s merger wave at the end of the 1990s and early 2000s. Based on history, no one was surprised that the petroleum industry would go through another consolidation phase - the surprise was the speed and magnitude once the effort began.

One of the outcomes from the petroleum industry restructuring was the rationalization of E&P activity. Lower oil prices forced the newly combined E&P companies to re-prioritize their exploration prospects and, importantly, their development activity. Managers seemed less troubled with cutting back exploration due to the emergence of shale production as they were able to rapidly respond to changes in supply and demand dynamics by quickly adjusting capital spending. When you needed to boost production you went out and drilled a few more wells. If supply exceeded demand, you just stopped drilling and waited for production to fall-off. Companies with substantial shale operations were blessed with the flexibility to grow their reserves and potentially their production despite the rapid production decline of shale wells. This flexibility was rewarded with investors clamoring to own their shares. The problem was that there weren’t many of these companies.

For those companies that operated primarily in the offshore arena, they found that its cost structure proved to be higher than the breakeven point for most of the shale basins, meaning that offshore, and especially the very high cost deepwater and ultra-deepwater production was a victim of economics. To respond to the growing uneconomic arena producers reacted by embracing standardization of field development. Offshore exploration wasn’t something that allowed standardized actions, but development presented many opportunities to standardize, especially well production equipment and even platforms and floating production facilities. Rejecting the not-invented-here phenomenon was difficult but changing the culture of how to develop offshore fields was critical for the success of their owners.

Re-ordering development work proved more difficult to achieve than anticipated. Many development projects, especially those offshore, were already underway when the oil downturn arrived at the end of 2014. Management teams historically have been reluctant to delay or shut down already approved development projects. But, as one of the petroleum industry’s leading consultants pointed out in mid-2015, the industry at that point had already delayed $200 billion of development projects, which represented about 30% of annual industry spending during the good times. The price for these producers delaying projects was the realization that there would be a delay in a substantial volume of future oil and gas production. For companies worried about their cash flow and profits, enduring these cutbacks was a tough decision.

The industry’s consolidation effort has led to reduced overhead at the oil companies enabling them to lower their well breakeven costs, especially with their onshore properties. At the same time, the consolidation within the oilfield service sector has contributed to improved efficiencies across the range of products and services that are needed to develop new hydrocarbon reserves. The increased efficiencies within the service sector translated into lower service and equipment costs that further helped lower the oil companies’ production break-even costs. But the efficiencies also meant that not as many drilling rigs and other oilfield services were needed to achieve the same level of oil and gas output. That reduced activity became a meaningful hurdle for the service industry to overcome in order to restore the sector’s profitability.