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Anti-Trust Compliance Everyone will remain muted. During Q&A: If you have questions/comments, please unmute yourself. Please do not place the call on hold to avoid music disrupting the call. PESA will share a post-event summary.
May 20th, 2020
James West
+1 212 653-9047 james.west@evercoreisi.com
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Already felt like the industry had been in a downturn since the middle of 2014 before going into this latest unprecedented decline driven by a decline in oil prices and enhanced by Covid-19 logistical issues.
Oilfield Services companies were facing challenging fundamentals, overleveraged balance sheets, and increasing investor apathy.
Many companies had started restructuring efforts, pulling costs out, making changes to strategy and compensation since
Narrative has shifted towards survival and protecting liquidity.
Unprecedented Downturn
Key Timeline Since Start of 2020
Source: Bloomberg, FactSet, Evercore ISI Research $0 $10 $20 $30 $40 $50 $60 $70 $80 $90 $15 $25 $35 $45 $55 $65 $75 OSX Oil Price Brent WTI OSX Oil Services begin reporting 4Q20 earnings Oil price peaked OPEC+ collapse, Saudi declare war China alerts WHO of several pneumonia cases China reports first death; disease spreads
China WHO declares outbreak a global health emergency; first death outside of China; Trump restrict travel from China WHO names COVID-19; first death in Europe Disease spreads to MidEast and LatAm; Italy begins lockdown; Trump asks for $1.25B emergency fund First US death; Trump issues additional travel warnings Trump declares national emergency OPEC+ Emergency Meeting agrees to 9-10MMbpd cut Texas RRC meets with NAM E&Ps E&P companies begin slashing capex budgets Crude contracts go negative
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Supply will exceed demand and inventories will rise to record levels in Q2 2020. But the Tide is Turning - demand will exceed supply and inventories to draw by mid-year 2020 and fall further thru 2021.
Stronger demand and reductions in supply have flattened the curve for global oil inventories. We maintain our Brent forecast of $40 and $50/bbl at YE 2020 and 2021. Brent could move into backwardation during Q3.
Our forecast calls for 2020 global oil demand to decline by -8.7mmbpd while global oil supply will fall by -6.8mmbpd.
Record global inventories near 75 days are likely approaching a peak. Will fall to 55 days by year end 2020 and 45 days by YE 2021
US production growth has declined in 9 of the past 12 months. Declines will gain momentum in the coming months. NAM production exit rate at year end will likely exceed 2.0 mmbpd.
Global Oil Supply to Exceed Demand, But Tide is Turning
Oil Supply Will Exceed Demand in 2020 US Shale Production Declining
Source: IEA, OPEC, EIA, Evercore ISI Research Source: EIA, Evercore ISI Research
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Investors have fled the energy sector in pursuit of higher returns driven by other sectors of the economy. Oilfield services equities have decoupled from crude prices for the past several years.
Capex never recovered to the 2014 peak and is now plummeting again. 2020 will likely be almost 55% below the 2014 peak.
We forecast a 40% drop in North American E&P spending in 2020.
Industry change is imperative. There is still too many companies (320 OFS firms at the end of 2019), too much debt (industry at ~$280B but nearly 85% held by E&Ps), too many assets, and too many management teams!
Sector Headwinds Will Continue Past Covid-19 Unless Behavior Changes
Price Performance of S&P 500 vs S&P 500 Energy Stocks E&P Capital Expenditures Will Fall Sharply in 2020
Source: Bloomberg, Evercore ISI Research Source: Evercore ISI Research 600 1,200 1,800 2,400 3,000 3,600 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 S&P 500 Index S&P 500 Energy
Our Playbook for Value Creation (And Higher Stock Prices)
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The Path to Value Creation is Not Easy
The Original “Pledge” The Pledge: Part Two
Espouse disciplined spending and consider returning surplus capital to shareholders. Employ returns-based performance goals at the C-suite that will likely increase intrinsic value in the equity market (ROIC).
sense of urgency for companies to consider consolidation. Value creation for OFS is a “nice-to-have” at this point and given some of the perils facing a number of upstream companies at current commodity price levels, service providers catering to E&P customers need to consider greater scale in order to avoid significant value destruction.
in key markets, declining product differentiation and rising buyer sophistication nullifies assertive pricing strategies across the sector.
market.
Hydraulic Fracturing Offshore Drilling Offshore Construction Land Drilling Subsea Equipment Artificial Lift Cementing Completion Equip. Geophysical Equip. Rig Equipment Rental & Fishing Supply Vessels Downhole Drilling Tools Unit Manufacturing Well Servicing Casing & Tubing Logging While Drilling Inspection & Coating 500 1,000 1,500 2,000 2,500 3,000 3,500
0% 4% 8% 12%
Concentrated Moderately Fragmented Fragmented
HHI Score 10 Year Revenue Growth
It’s Simple: The Four Too’s
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Time Is Of The Essence
the market. We’re not against a competitive marketplace but this kind of behavior has been counter-productive to the sector.
to its peak of nearly 500 in 2016. Despite the massive amount of stress placed on the OFS industry these past four years, today there is only 3.4% less of those companies operating within the industry. More work needs to be done.
a 15-20% market share in their product line. The benefits of scale and a more concentrated operating environment should hopefully raise the barriers to entry and inhibit adverse pricing behavior and unfavorable supply/demand scenarios.
386 397 411 422 439 470 484 491 496 488 480 479 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Land Contract Drilling Wireline Services Rental & Fishing Services Coiled Tubing Services Offshore Drilling Pressure Pumping Directional Drilling Completion Equipment Cementing Well Servicing Offshore Construction Geophysical Equip 8 16 24 32 40 48
# of Firms With <5% Share in Each Product Line OFS Companies With <5% Share In All Product Lines
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US land rig count was relatively resilient in Q1, declining by 4.2% sequentially. This compares to the prior three quarters of - 11%, -7.5%, -5.5% respectively.
Thus far in Q2, the US land rig count has declined by 39% from Q1 levels. It fell below the 400 level in early May for the first time since June 2016.
We now expect the US land rig count to decline by 55% in 2020. Most of the rig count decline will occur in Q2.
E&Ps have been quick to revise lower capex budgets, with North American changes being more acute than International (where we expect capex to fall a more modest ~15%).
US Land Rig Count Pulled Back Sharply in April and May
Source: Baker Hughes Rig Count, Evercore ISI Research
Evercore ISI US Land Rig Count Forecast Negative Revisions to Capex Budgets by Region
Source: Baker Hughes Rig Count, Evercore ISI Research
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Several pressure pumpers deployed spreads early in Q1 as completion activity picked up and utilization improved.
Then the industry quickly cutback on completion activity in March. The active completion crew count fell below 100 in April and then below 50 in May. It could be in the 30s today.
We expect pressure pumping utilization will now fall quickly from the low-to-mid 50% range in Q1 into the 25% range in Q2 before improving briefly in Q3. We think utilization falls below 2016 levels.
Pressure pumpers are responding by stacking spreads, laying off workers, and lowering costs. Quick change in direction from adding spreads to stacking in less than 2 months time.
Frac Holiday – Not Much Completion Activity Happening Right Now
Source: IHS Pacwest, Evercore ISI Research
Evercore ISI Pressure Pumping Forecast Pressure Pumping Demand Collapsed Quickly
Source: IHS Pacwest, Evercore ISI Research
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Brent moves into backwardation from contango in Q3.
Drilling permits likely near a bottom as April levels were the lowest permit count since 2006. On a YTD basis, permits are down 61% YoY with privates driving most of that decline (-98% YoY).
Weekly rig count declines are starting to shallow out. Last two weeks have averaged a decline of 33 rigs dropped versus 50 since the downturn has started.
Recovery likely looks like a ‘W’ in US land – Q2 activity down sharply, Q3 rebounds slightly, budgets get fully exhausted early in Q4 which then causes another decline in activity levels into year-end.
Bottoming Process Starting?
Drilling Permits Bottoming Declines Shallowing Out
Source: Evercore ISI Research Source: Baker Hughes Rig Count, Evercore ISI Research
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Offshore activity is typically more resilient to oil price shock due to longer rig contracts, a high mix of development activity, lease commitments, customers taking longer term views, and a host of other reasons.
But offshore has been less resilient this time around than in pass cycles.
Both the floater and jackup rig count are falling at an unprecedented rate due to early contract terminations or as contracts are completed and options are lapsed.
Offshore Falling At An Unprecedented Rate
Global Floating Rig Count Global Jackup Rig Count
Source: IHS-Petrodata, Evercore ISI Research Source: IHS-Petrodata, Evercore ISI Research
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Contracting activity tracked steadily lower for five straight months as oil prices declined, but new contracting activity appears to be stabilizing at a floor run rate of 2-to-3 signings per week.
Operators announced several contract force majeures, rig tender cancellations and project deferrals in March and April but the pace of these announcements have also eased.
Contractors announced several rig retirements, cold stacking, impairments, write-offs and restructurings during 1Q earnings, confirming a day of reckoning has arrived.
But The Fallout Looks To Be Bottoming As Well
Monthly New Offshore Rig Contracts
Source: IHS-Petrodata, Evercore ISI Research
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Companies going through restructuring will emerge stronger and unencumbered to kick off a much needed consolidation wave in the fragmented offshore drilling industry.
The reacceleration of rig retirements will result in a dramatically smaller global fleet, floater supply down 32% from the 2014 peak to 220 vs. the long term demand estimate of 180-220 rigs.
The shallow water replacement cycle is entering a second phase and the global fleet has significantly high graded.
Pricing power may finally shift back in the hand of contractors when demand improves.
Set-up Is Encouraging For The Long Awaited Multi-Year Upcycle
Global Floater Supply Global Jackup Supply
Source: IHS-Petrodata, Evercore ISI Research Source: IHS-Petrodata, Evercore ISI Research 200 220 240 260 280 300 320 340 YE '13 YE '14 YE '15 YE '16 YE '17 YE '18 YE '19 2020 Newbuilds Retirements 400 420 440 460 480 500 520 540 560 580 YE '13 YE '14 YE '15 YE '16 YE '17 YE '18 YE '19 2020 Newbuilds Retirements
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Peak US production had already been reached with growth limited by geology, technology, technique and capital.
Shutting in 5+ mmbpd in 2Q20 does further irreparable harm to the reservoirs.
Fewer oilfield services suppliers are needed in the new normal, but more technology is needed rather than brute force.
Re-sizing The US For A 10 mmbpd Supply Chain
Reimaging the US Upstream
Alaska 0.5 mmbpd Permian 3.6 mmbpd 180 rigs $25 Bn capex GoM 1.75 mmbpd Williston 1.2 mmbpd 25 rigs $6 Bn capex Eagle Ford 0.95 mmbpd 25 rigs $5 Bn capex Mid-Cont 0.4 mmbpd 15 rigs $2 Bn capex Niobrara 0.5 mmbpd 10 rigs $1.8 Bn capex Other L48 1.0 mmbpd
Source: EIA, RigData, Evercore ISI Research
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We are making a call for technology to disrupt the Oil Patch. In our view, the combo of learning to survive in a $35/bbl world and an industry largely still in the “intermediate stage” of technology adoption makes this a ripe opportunity.
Our proprietary survey of 160 Energy executives paints the “Digital Road Ahead”. Expect for AI / Machine Learning, Mobile Operations, and the Industrial Internet of Things (IIoT) to play a pivotal role across the oil and gas value chain.
Hopefully new commercial models distribute the value capture accordingly. It remains to be seen whether or not Oilfield Service providers can earn adequate returns on technology investments that have largely benefited the customer.
The Digital Road Ahead
Source: Evercore ISI Research Source: Evercore ISI Research
Where would you consider your company in terms of its digital journey?
3% 17% 46% 27% 7% Not started / n/a Novice / beginner Intermediate Advanced Elite / Fully integrated
What role do you believe technology and especially digitalization and / or AI and automation will play within the Oil Patch?
8% 1% 8% 46% 38% Non-issue Not importantSlightly important Important Critical
79% 109% 117% 66% 67% 40% 55% 70% 85% 100% 115% 130% 3/10 3/17 3/24 3/31 4/07 4/14 4/21 4/28 5/05 5/12 5/19 Group 1 Group 2 Group 3 Group 4 Group 5
Balance Sheets Will Drive Near-Term Stock Performance
We recently updated our bi-annual liquidity analysis for our entire coverage universe and believe that the “Haves” and “Have Nots” that we identified will see their equities predominantly driven by perceived liquidity sufficiency or shortfalls.
The companies in the lower half of the bottom-left chart were identified as those with potential liquidity challenges across the near-term. Our liquidity-driven investing framework has identified a half-dozen firms that have entered restructurings or cut their capital distributions.
The average stock price performance of all Group 1-3 companies indexed to March 9th, 2020 have significantly outperformed their peers in Group 4-5 companies. Forget the fundamentals and ESG considerations, liquidity will become the key indicator to focus on as the sector works through this downturn.
Group 1: Strong survivors Group 2: Solid but cuts will be made Group 3: Fine, with less breathing room Group 4: OK but keep an eye on it Group 5: Critical challenges ahead
The Results of Our Liquidity Analysis Price Performance of Stocks by Group Indexed to 3/9/2020
Liquidity Trade
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DNOW DRLCO.dk DRQ ERA NESR BKR NOV TS FTI MRC HAL PD.ca HP SLB LBRT SOI APY EXTN NR RES ASPN BASX OII SLCA CLB FI OIS SND ERII ICD PUMP THR GTLS NEX QES PTEN CFW.ca TDW DO RIG HCR RNGR NBR SHLF.osl TCW.ca BDRILL.osl IO VAL CVIA PACD ESI.ca SMHI FET SPN FTSI TTI
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Each month Evercore ISI surveys institutional equity managers and asks them if they are overweight of underweight the 11 S&P sectors.
Energy clearly remains underweight and well below historical holdings.
S&P Energy underperformed the S&P 500 for the 7th time in 8 years in 2019. Significant capital discipline, corporate governance and pay for performance issues plague the sector.
Return on capital employed for S&P 500 Energy stocks declined from 19% to 8% during the past decade and valuation declined.
Institutional Equity Sector Allocation Survey
Source: Evercore ISI Research
Energy Remains Well Below Historical Holdings Portfolio Managers Remain Underweight Energy
Source: IHS Pacwest, Evercore ISI Research
Analyst Bio:
James West is a Senior Managing Director responsible for the research coverage of the Oil Services, Equipment and Drilling industry consisting of detailed fundamental research on over 70 companies. Prior to joining Evercore ISI, Mr. West was a Managing Director and Senior Research Analyst at Barclays and Lehman Brothers for a combined 15 years.
Since assuming lead coverage in 2011, Mr. West has been top ranked in Institutional Investor, including number three in 2011, number two in 2012 and number one from 2013 to today. Prior to joining Lehman Brothers, Mr. West worked at Donaldson, Lufkin & Jenrette. Mr. West received his B.A. in Economics and a minor in History from the University of North Carolina at Chapel Hill.
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James West Oil Services, Equipment & Drilling Evercore ISI