If you invested $1.00 in the stock market 10 years ago, you would have $2.60 in your pocket today. However, if you invested that $1.00 in the Oilfield Services (OFS) sector, you would have $0.15 in your pocket today. I started my career in oil and gas, following my dad who spent his career in the industry. My dad started when oil was discovered on the North Slope, and his career marked the pinnacle of our industry. Where we are now is at the opposite end of the spectrum. I am deeply troubled that the industry I have dedicated my career to hasn’t created shareholder value. Despite my occasional tirades about the industry screw-ups that in part led us here, I am thoroughly committed to this industry.
It’s not easy fixing an industry that has its cards stacked against it. However, there are some key positives. Every day globally, over 1.4 billion cars are on the road, of which 99% consume gasoline, and most electric vehicles have their energy derived from natural gas. Nearly 4 trillion cubic meters of natural gas are consumed globally, and demand growth has been higher than global GDP. We need an Energy Industry for the United States to be energy secure and for the world to prosper. While there is increasing scrutiny to be cleaner, the good news is that there are technologies to help the industry get there and be the beacon for environmental sustainability. The energy sector is needed and can play a leadership role in the clean energy transition. Like any other industry, the Energy Industry needs the OFS sector, relying on a supply chain of equipment, services, and technologies.
However, no fancy analysis is needed to prove that the industry hasn’t yielded shareholder returns anywhere close to the S&P index over both the short and long-term. Yes, the global activity level in aggregate has dropped, driven by an oversupply of oil and gas, but this situation is nothing new. With any commodity, there are cycles whose length is defined by the capital intensity of the industry. The industry has mostly failed to see that we went through a dramatic structural shift in energy fundamentals in late 2014. Until then, supplies were short, sanctions were placed on certain producers, and OPEC largely remained unresponsive as their market share eroded. These dynamics visibly flipped on a dime. The structural shift finally manifested itself into price reality when OPEC decided to stem the decline in market share just when the global markets were becoming oversupplied. Since then, the industry has been in turmoil with mirages of recovery, and with each mirage, individual players made their moves. These moves often included adding capacity, extending offerings through M&A, and organizational expansion.
I experienced the thrill of working with and for OFS companies that were once growing beyond all expectations. I interviewed candidates who were eager to enter this industry because it was global, technology-driven, and growing to meet insatiable global demand. It is easy to forget when we are suffering through the turmoil that is upon us that this is a great industry that serves an essential purpose. I am convinced this sector can thrive again, but to get from where we are now to where we need to be requires a dramatic shift in thinking.
The typical response of binge spending followed by anorexic cost cuts is a certain recipe for continued disaster. This becomes the race to the bottom, where competition erodes margins to the point there are no profits. While cost-cutting is paramount to near-term survival, it is no longer sufficient to be successful. For one thing, talent is leaving the industry in droves. Once the industry gains some level of traction, who will want to come back into it?
So, what does the industry need? I don’t have all the answers, but I am urging leadership teams to think differently this time to end this cycle of self-destruction. Here are my observations to catalyze discussions on what would help make this industry thrive again.
Consolidation to Achieve Rationalization Will Make Your Company Healthy
The industry needs to shift from adding capacity and capabilities during an uptick in demand only to have to shed these additions when there is a downturn. These “buy high, sell low” actions have contributed to poor shareholder returns, incredible churn, and painful restructurings. Further, M&A has been primarily driven by expanding offerings to integrate several products and services, which many call horizontal integrations. These horizontal mergers were done with the argument that the customer would value a more end-to-end offering. While horizontal integration can add value to customers, several issues arise, especially in an oversupplied market. Expanded offerings often require a significant shift in purchasing habits. However, the customer’s preferred line of defense is to lower costs by unbundling the value chain to take advantage of excess capacity. Horizontal integration may lead to differentiation in the long-term, but it does not solve the ills of overcapacity in the short-term. Horizontal integrations can also mask the poor performance of individual products or services underpinning the integrated offer, and also takes the focus away from improving the competitive positioning of the individual pieces. Finally, synergies in horizontal mergers are more challenging to obtain. The capability overlap is limited, and processes are varied, so scale economies are difficult to achieve.
Most likely, a series of vertical combinations, where capacity can be better rationalized and competitive dynamics improved, would be helpful. We might be witnessing a shift to this idea as evidenced by the SLB-Liberty frack business merger, and the Baker Hughes-Pelican surface wellhead transaction. Capacity has to exit the industry, and consolidation is required to improve industry competitive dynamics.
Sustainable Differentiation Will Help Your Company Thrive
A significant issue with the OFS sector is the lack of differentiation between players. For the most part, most customers have several choices and any one of these choices can serve their needs. Very few stand out as different. This differentiation is required to set an OFS player apart but needs to be achieved expediently and demonstrably.
Differentiation needs to occur in at least one of the following ways. Want to really kick ass? Deliver on all three:
New Technology: The technology landscape is a bit confusing in our industry. Technology is what enabled development into deeper waters and shale. However, it is paradoxical that the industry doesn’t embrace new technology too quickly. In order for a new technology to be effective it needs to be clearly different, robust, deliver high demonstrable value, straightforward to adopt, and connect to the customer’s holistic economics. Often, we witness technologies that claim to save time, or costs, or well productivity, but it is hard to differentiate the myriads of technology bits that come at us. The benefits seem piecemeal. Customers are not staffed up or motivated to do pilots unless economics are defensible, and the application is straightforward without risk.
Structurally Achieve Lowest Cost: An OFS company can create a moat around its business by achieving a structural cost advantage that is not able to be replicated. For example, structural cost advantages can arise from economies of scale through vertical integration, design for manufacturability, integrated supply chains, and digitalization. Many cost reduction efforts are not differentiated and can be replicated. The key is to integrate several advantages so that they work together to achieve lowest cost and are impossible to replicate.
Defensible Value to the Customer: Recently we analyzed several OFS company products and services from their websites and brochures. The brand names, product and service descriptions, and the marketing messages did not have a clear connection to customer economics in most cases. Positioning the economic differentiation clearly in the marketplace is paramount. Understanding customer dynamics including new buyers and influencers in re-structured companies, their agenda for their transformations, and how the OFS products and services enable their agenda is critical to develop and market.
Oilfield Service companies are necessary and needed, but a willingness to face the deep underlying issues and addressing challenges in new ways will be required. Bringing together a synergy of disciplines, including strategy, marketing, technology, operations, and digital will help catalyze practical new thinking to tackle challenges head on. Oilfield Service companies can thrive again.
Evolve Collective is transforming the consulting experience by investing in our clients, building long term partnerships, and putting skin in the game. We are an Energy Industry management consulting firm with an experienced team that offers unique and tailored services to our clients. We serve startups, established companies, and private equity/venture capital firms by providing a flexible and efficient consulting approach to help with projects and complex problems. Our mission, to help people and companies thrive, is at the heart of all we do.