State of the Sector: Oilfield Services' Struggle May Persist In 2017

Ebbing EBITDA

Alam pointed to heavyweight OFS provider National Oilwell Varco, which generated $4.5 billion in earnings before interest, taxes, depreciation and amortization (EBITDA) in 2014. But in 2016, that figure will be closer to $300 million.

“The extent of drop – even for an industry leader – has been so dramatic that even if NOV were to triple its EBITDA from 2016 levels, it’s still going to be about one-fifth what it was in 2014,” Alam said.

NOV managed to pay down some debt during the downturn, but for the majority of OFS companies, that hasn’t been an option. During the ‘lower for longer’ cycle, many feared spending their liquidity would make them especially vulnerable to default.

Debt And Default

Companies with high quality assets or those that the market views as survivors will be able to attract cash, Alam said. Those saddled with significant debt will continue to struggle to meet more debt maturities with less cash. A smaller company with a lower credit rating or negative EBITDA will need to renegotiate revolver credit that’s due during the next three years, a daunting challenge.

“It’ll be almost impossible for these [companies] to find someone to give them money,” Alam said. “The only hope for them is if the oil price recovers between now and their debt maturities.”

A lag between ordering OFS equipment and then putting it to work for profit exists for the sector. If volatile oil prices decline sharply, they are left with expensive, idled equipment and excess workforce. That time differential can be one year for onshore drilling and closer to two years for offshore projects, Alam said.

“Oil price drops in a heartbeat and E&P companies quickly shut down their spending. All of a sudden the demand is gone and you’re stuck with a lot of debt,” he said.

Speculation capital flooded oil and gas in the early shale days chasing returns and great expectations. Service companies suited up staff for the field and bought equipment using debt – and very little equity. As a result, their debt levels grew based on the expectation of more demand to come. When the price collapsed, the companies were left strapped for cash.

OFS valuations are based largely on future cash flow, and equipment lacks intrinsic value. And when oil prices idle the equipment, the prospect of cash dwindles. Today these companies – especially those offshore – are worth a fraction of what they could command in 2014.

“Now it’s almost impossible for some of the smaller companies to pay down that debt or do something with it,” he said. “We expect a lot of continued default and this sector will have the most defaults within the energy industry.”

But where some companies were killed off by the brutality of the downturn, those that remain have grown nimble and stronger.

“The downturn threatened to destroy the industry, and for some, it destroyed their business,” said Evercore’s West. “But destruction breeds creation and the oilfield service, equipment and drilling industry has ushered in a once-in-a-lifetime change in the way it conducts business, interacts with customers, drives innovation engages in (mergers and acquisitions), and morphs into new businesses better positioned for the always inevitable upcycle.”

The Sector Savior

The key, it would seem, to rescuing OFS from the ravages of the downturn, is oil price growth.

“When we talk to service companies, they say there are some things that are within their control and a lot of it is not within their control. They’re trying to do things that are within their control like cost management, rationalizing their operations and more efficiently managing the capital structure, but ultimately, it’s oil price that dictates the fate of these companies,” Alam said.