“We expect the market to remain close to being balanced in the coming quarters”

Schlumberger (ticker: SLB) kicked off another oil and gas earnings season today, reporting net income of $530 million, or $0.38 per share.

Schlumberger reported revenue of $7.8 billion in Q1 2018, down 4% sequentially but up 14% year over year. This trend occurs throughout Schlumberger’s earnings this quarter, with results up since early 2017 but down since Q4, generally on seasonal effects.

SLB strongest revenue growth is in North America

The company reported its strongest revenue growth in North America, where it generated $2.8 billion in Q1 2018. This is 52% greater than revenue from this time last year, and is 1% higher than Q4 revenue, the only region to show sequential growth. This was primarily due to growth in land activity, as seasonal declines in offshore sales weighed on results. Canadian and U.S. activity ramped up during the quarter, with U.S. customers drilling longer laterals with increasing utilization of rotary steerable systems.

Schlumberger reported similar problems to those hinted at by Halliburton, with “widespread disruptions in rail deliveries of sand.”

While these developments are unsurprising, and were expected by most industry watchers, Schlumberger also discussed something that wasn’t anticipated.

New information: frac fleet pricing softening

The company continues to bring hydraulic fracturing fleets back online, but it reactivated less capacity than planned this quarter. Schlumberger reports that market overcapacity has led to lower utilization, inefficiencies and softer pricing. This appears to be directly contrary to the situation in the pressure pumping business during 2017, when service companies could not bring frac fleets online fast enough for operators.

As recently as November, for example, Permian producer Jagged Peak Energy (ticker: JAG) reported it could not get enough reliable and experienced frac crews, and was unwilling to pay the nearly $1 million more per well that a spot crew charges. While supply constraints are generally worse in the Permian, this situation is indicative of a very tight market for fracturing fleets. If the market is now oversupplied, this would be a very quick transition.

Schlumberger, however, reported today that many service companies have added significant new capacity, and will continue to do so throughout the year. Schlumberger itself is bringing one of the largest fleets online, and plans to add a combined one million horsepower in 2018. This new capacity, according to Chairman and CEO Paal Kibsgaard, will have an effect through the year. Kibsgaard said, “we expect the market to remain close to being balanced in the coming quarters from an equipment capacity standpoint. This means that frac pricing will arguably be range bound and driven by short-term or local supply demand variations, and that any upwards pricing movement will likely be limited to passing on people and supply chain cost inflation.”

Russia, Middle East and North Sea show strong growth

Kibsgaard also discussed international trends, with a moderately positive outlook. “In terms of geographical trends,” he said, “our outlook for Russia, the Middle East and the North Sea remains solid and in-line with our expectations for the year, while the emerging upside we are seeing in Asia will likely be offset by a somewhat slower growth trajectory in Africa and Latin America where the start of the activity recovery now seems to be pushed out to the second half of 2018.”

“In the international markets, tendering activity remains high and continues to be very competitive and with a clear move towards performance-based contracts from many of our customers. In terms of pricing for basic stand-alone products and services, we have yet to see an inflection point, and there is still sufficient capacity in the market. However, as the early signs of improving rig rates for land rigs, shallow water jackups and selected ultra-deepwater rigs continues to evolve over the coming quarters, the value proposition of our high-end products and services become increasingly attractive compared to the basic performance offered by our competitors, and this is where we first expect to see pricing traction in the international market.”

Q&A from SLB conference call

Q: You mentioned during the first quarter you’ve had some challenges around the industry bringing in some new capacity, and that led to some softer pricing. And then I heard Patrick talk about things kind of picking up as you go into the end of the first quarter. And then some positive dynamics for the second quarter yet couched around the prospect for incremental capacity still kind of creep into the system.

Where do we stand? Is demand still exceeding available supply in the frac business? Or are we now at a point where we’re kind of going to be stuck in neutral and companies are going to continue to put capacity into the market and crimp the pricing power as we get into the last three-quarters of the year?

So just, again, if you can give a little more color around that, that would be helpful.

SLB: What we have said is from a supply and demand standpoint of frac equipment in Q1, I think it’s pretty clear that we had overcapacity as an industry based on the available stages during the first quarter. So we are more or less at capacity today. I think the market going forward when it comes to frac equipment I think is going oscillate around being in balance. I think you will probably have local variations in certain basins. You might have a temporary oversupply, undersupply based on where companies introduce new capacity.

But I think the fact that we are now more or less at capacity and we need to accept that we will be in that situation for the duration of this year I think is pretty clear. And given the fact that the market has been growing steadily now for the second year in a row, and also given the fact that we have a very agile service industry and manufacturing industry to support the service industry, it’s not a huge surprise that in a fully commoditized market that supply is going to match demand at some stage, and I think we’re basically there.

I think from a pricing standpoint, we don’t expect any significant tailwinds of kind of net effective pricing. We do expect to continue to be able to pass on additional costs associated with people and supply chain inflation, but beyond that, I think operating margins and profitability is going to have to be driven by how you execute.

Q: One of my first questions is on pressure pumping. You’re planning to put a million horsepower out. How much did you actually deploy in Q1?

SLB: Well, I’m not going to go into the details of exactly how much we deployed. We continue to deploy. We said that we deployed less than what we planned to mainly because the overall softness that we experienced in the market.

I think the overall stage count growth market-wise was a bit lower than expected, and in addition to that, a number of other companies added fairly significant capacity to the market, and this had an impact on softening pricing and also it impacted utilization. So we introduced somewhat lower – a lower number of fleet in the first quarter, and it was more back-end loaded. But we are back on our planned rate of introduction now as we enter Q2 and our plan is still to deploy the full 1 million horsepower that we acquired during the course of 2018.

Q: Okay. And then stepping to a big-picture question, you’re very optimistic about the outlook. It makes a lot of sense, given what we’re seeing in inventories. Are you concerned with the Wall Street estimates on timing of the recovery—because it seems like international is going to remain slow; North America up 20%. I think some estimates are a little bit higher than that.

But it just doesn’t seem like people are moving to raise their CapEx budgets very quickly. So I think the trend is very positive, but do you have any concerns about the timing of the growth in activity?

SLB: Well, from an operational planning and execution front from the Schlumberger side, international is unfolding this year as we were expecting. The rate of increasing investment levels is, as you know, significantly lower than what we see in North America, which was expected. But even with the 5% or plus/minus 5% increase in investments, we can generate, I think, quite reasonable earnings growth out of that mainly because we have a much higher market share internationally.

Our margins are generally higher and our ability to generate incremental is also much higher internationally than in North America. So even though there is a 4:1 ratio in investment’s growth levels, the softness in our ability to generate earnings, based on that I’m quite positive on what we can make out of this growth rate even in 2018. But if you ask me if the investment levels in the international market is sufficient, I would say no, it isn’t.

So from a supply ability, I would be concerned whether the international market and the producers there are going to be able to produce sufficiently to meet the growth in demand, but there’s little I can do about that. But I would just say that international for us is unfolding as expected, and I think there is only upside beyond where we are today and going forward.

Q: A couple years ago we were talking a great deal about the transformational effort that Schlumberger was going through and on a staged basis, and I know the downturn kind of interrupted some of the plans. Can you tell us is the transformational effort that was started a couple years ago, is that done yet? Are we getting close? Or what phase are we in at this point?

SLB: I would say that the downturn the past few years has had an impact on the – what the transformation has brought to our bottom line. And it’s mainly because it is very difficult to monetize efficiency in an environment where your business continues to shrink quarter-after-quarter. What we have done during this period of time is that we have ring-fenced the investment in the transformation program and we have continued to evolve it. We have continued to deploy it. We are in the middle of significant deployment as we speak around how we change our workflows, how we introduce new back office systems, and how we basically conduct all our internal business processes.

So this is all progressing. And I would say that going forward, the transformation is going to be a critical factor in our ability to generate the incremental margins that we have promised, and I think as soon as you see us now, it’s starting to generate a little bit of growth in the international market and we are finished with the pricing concession. That’s when I think the impact of the transformation is going to start to become very visible again. We are maintaining, for instance, our CapEx investment levels for field equipment around $2 billion this year, which is as low as it’s been throughout the entire downturn, and we’re doing this because a significant part of the increased activity we are actually going to absorb through increased asset utilization.

But it is one way that we are demonstrating what a transformation can bring. So I would still say that we are in the mid-innings of what the impact of the transformation can bring. But we have continued to advance forward the investments and the deployment of this, so that we are very optimistic of what this is going to bring as we go forward into 2018 and 2019.

NOTE: Schlumberger talks about its transformation on its investor relations website:

“The Schlumberger transformation program has four main themes—technology, reliability, efficiency, and integration. Further developing these themes enterprise-wide is inherently complex due to our large footprint: more than 95,000 people, approximately 85 countries, 150,000 mobile assets, and 2,250 facilities. However, leveraging the transformation across the enterprise will enable us to fully capitalize on our size so that we will continue to outperform the market in the long term.”


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