Putting the cart before the horse is never good practice. Everyone knows that the horse comes before the cart. But what if the cart is broken? Then what? Clearly, not much work will get done.
The oilfield service business is a cart that is breaking down. Sixty-dollar oil prices are causing capital starvation across the industry. Oil companies have zipped up their wallets; drilling rigs and all sorts of peripheral field equipment are mostly un-contracted and lying idle. Any heavy iron that’s working now is being offered to customers at rental rates that barely pay the bills.
If field equipment is idle, then so are the workers that coax the oil out of the ground. Our table this week shows that layoffs are becoming pervasive. Note that the shrinking oilfield workforce is not exclusive to the ‘patch’ in Canada and the United States. Multinationals like Halliburton, Schlumberger, and Weatherford have shed tens of thousands of skilled workers that have centuries of combined experience. If history is our guide – and it’s a good guide – most of these people will find employment in other industries and never return, even when the text message, “When can u come back to work?” flashes on their mobiles.
But it’s not only skilled human capacity that’s contracting in the oilfields. The fleet of machinery is being culled too. None of the oilfield service companies are announcing “equipment layoffs,” but it’s happening. Auctioneers are going hoarse peddling yards full of big things on four wheels. And there is another destructive dynamic in play: because there is no money to buy spare parts, operators are cannibalizing good equipment in their yards to repair the equipment that is currently working in the field. In our horse-and-cart analogy, a broken wheel on Cart 1 is being replaced with the good wheel taken off of Cart 2.
Sometime over the next year, the price of oil will again rise to levels when producers will call on drilling, fracking and well servicing companies for more of their services. It will be like the owners of a herd of horses looking for cowboys and carts. Yet what will happen if one hundred horses can only be offered sixty of each? It doesn’t take a ranching economist to figure out that those sixty cowboys and carts will be priced at a premium again. And so too for an oilfield service industry that is being progressively gutted for each month that low prices and near zero profitability persists. The 20% to 30% cost reduction that oil producers are gloating about today is unlikely to last.
A lame oilfield service industry also implies amplified oil price volatility in future. The prevailing wisdom is that when oil prices rise, North American tight oil producers will immediately contract rigs and equipment, ramp up their drilling of new wells, and quickly bring on new oil production. But oil companies in their forty-story office towers don’t bring on new production – the service companies they hire in the field do that. The ability for oil companies to respond to higher prices is diminishing with each field worker that is laid off and each piece of equipment that is auctioned or cannibalized for parts. Weakening field capacity over time means that a production response is going to lag further and further behind upward price movement, which is only a formula for higher price.
After a recent price run to $60/B (WTI), oil prices look set to seesaw back down again – a sign that more damage to oilfield service capacity is nigh. For some oilfield service companies, bankruptcy is just past the summer months. To be sure, workforce and equipment can be built up again in the future, but it will take time and money. What wounded service company is likely to invest in new parts and hire back people unless they are convinced that activity is going to be sustained?
Thinking that higher oil prices are going to lead to a quick rise in production might be putting the cart before the horse.