A New, More Transparent Schlumberger?

Abstract: Schlumberger has seen its stock price tumble after the acquisition of a high-tech IT company during the height of the telecom bubble. The company's new CEO says it is in oilfield services to stay.

Analysis: One could forgive attendees at this month's Howard Weil Energy Conference for rubbing their eyes when the event kicked off sharply at 7:45 a.m. on a Monday morning.

And no, it wasn't the blaring rendition of George C. Scott's Patton soliloquy. Howard Weil morning sessions always start with bang whether it is a Marine Corps band, or a local gospel choir. After all, 7:45 comes around early a couple blocks south of Bourbon Street.

But this year, analysts were not rubbing last night's fun out of their eyes; rather they were trying to convince themselves that what they were seeing was in fact what they were seeing. And yes, it really was Schlumberger CEO Andrew Gould at the podium.

Frankly, it had been awhile since anyone attending energy conferences had heard from Schlumberger. The company avoided investor conferences and restricted access to management under former CEO Euan Baird.

But things have changed. The company had been the class act in the large multinational oilfield service large capitalization category for decades. Schlumberger was typically awash in cash and represented a highly liquid investment and world-class technology. It was the General Electric of oilfield service stocks. One could almost forgive a little management aloofness when it came time to spin the company story.

Then in February 2001, the company uncharacteristically stepped outside the oil and gas business during the height of the telecom bubble and purchased Sema, a European information technology and communications company. The transaction included more than $4 billion in goodwill.

One can hardly blame investors for wondering what management was thinking. They exited the stock. More than $6 billion in market capitalization evaporated from Schlumberger in 2001.

Certainly one of the more fascinating transformations in the oilpatch involves the reversal in fortune on Wall Street for the large multinational oil service firms. The Big Three--Baker Hughes, Halliburton, and Schlumberger--used to be the pillars of oil service investing. But that was back then. If one uses stock price as a benchmark, and most investors do, this sector has not been a great place to park money over the last half-decade. Halliburton had asbestos problems; Baker Hughes went through the management shake up. Schlumberger had Sema.

All three stocks were worth less in 2003 than they were in, say, 1998 or 1999 when oil fell to $10.

So there was Schlumberger CEO Andrew Gould at the podium on a fine New Orleans morning, hat in hand, explaining to institutional investors and fund managers that Schlumberger really was first and foremost an oil service company rather than a high-tech conglomerate--and intended to stay that way.

So what is the state of the industry according to Schlumberger? According to Mr. Gould, digital technology could expand oil reserves by 125 billion barrels globally, much of which is currently left behind in existing reservoirs. This is more than the proven reserves in Iraq.

It is an important concept because the challenge facing the industry over the next few years is how to reconcile global energy demand, which is rising 1.7 percent annually, with depletion. Rising demand will add 11 mmbbls/d of consumption by 2010, while a five percent decline rate in existing fields will destroy 33 mmbbls/d of production. In other words, the oil and gas industry must invest up to a trillion dollars over the next seven years to generate 44 mmbbls/d in production in order to balance the supply/demand equation.

And this will take place in a changing oilpatch. Fifteen of the 20 largest E&P companies in terms of production and reserves are state-owned, or located in Russia. It creates a new kind of customer.

"These customers have to be convinced that the price they pay for our technical services produces better results than their domestic service industry, which charge a fraction of what we do," Mr. Gould says.

One way to justify this is through integrated project management services, which includes premium technology and technically competent personnel and management to help the large state-owned entities achieve lower finding and development costs through greater reservoir recovery.

Schlumberger anticipates $4.8 billion in revenues between 2001 and 2006 from integrated project management (IPM) involving field development, field rehabilitation, or strategic, remote projects. Last year, the company drilled 1,500 wells worldwide as part of its IPM initiative. IPM employed 2,000 professional staff members and 80 active rigs in 47 programs stretching across 40 countries.

Schlumberger envisions three main technology trends evolving in today's oilpatch. The first involves the economics of deepwater exploration which are price sensitive to error and require improved reservoir definition, typically through high-resolution seismic, advanced logging, and improved monitoring and control.

The second trend is associated with improving production in both old and new fields. The last trend is for technologies that will expand non-conventional hydrocarbon exploitation such as coalbed methane or heavy oil.

Mr. Gould argues the key to all three trends is technological innovation and estimated that 30 percent of oil industry expenditures currently are associated with technology.

He also addressed candidly the company's problems with WesternGeco and SchlumbergerSema, which were responsible for $3 billion in writedowns at the end of 2002. For the seismic business, the mistake has been treating the sector like a commodity and assuming the added value, which was the interpretation of seismic data, was a proprietary function of E&P companies. Furthermore, the multi-client data business model was non-sustainable now that more than $2.2 billion had been added to the balance sheets of the four largest seismic companies while demand languished.

"The party is over," Mr. Gould says.

Schlumberger was responding by improving technology to produce higher quality seismic images that it can sell at premium pricing. These images produce better well placement, help avoid drilling hazards, and can be used to monitor reservoir characteristics over the life of the field. Mr. Gould sees a successful seismic operation as an integral part of the company's reservoir management services. The challenge is convincing customers that they are getting added value for higher price.

As for SchlumbergerSema, the segment's information technology functions were something Schlumberger could not develop internally. Sema had network infrastructure and security expertise, an ability to integrate technical systems and business applications, and the capacity to handle complex projects. This expertise will help Schlumberger develop real-time reservoir management and services integration for its global client base.

In December, Schlumberger announced Sema was being reorganized with an emphasis on energy and those regional non-energy markets where it can compete at an acceptable economic level. Non-core aspects will be divested as the market permits.

According to Mr. Gould, the company intends to return its balance sheet to pre-Sema levels, reduce debt below $3 billion by the end of 2003, partially through asset sales and downsizing, and increase profit margin after tax in the oilfield service segment from 10 percent last year to 13 to 15 percent.

Mr. Gould says he expects Schlumberger's return on capital to recover from the single-digit level to double digits over the next two years, and reach 15 percent in the long term.

And he left no doubt about the reason Schlumberger is in business.

"We remain an oilfield services company," he said.