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The Oil Crash Is Making The Strong Stronger

Via Business Insider : Pride of place in this week’s Houston Auto Show goes to “Texas Edition” trucks: hulking vehicles, selling for $50,000 and upwards, specially designed for the Lone Star state’s expansive tastes. Allout Offroad customises them further, lifting the chassis to fit outsize wheels and tyres. They are selling “like crazy”, says the firm’s boss, Chance Kamp. “People can afford to put gas in them now.”

Houston, America’s fourth-largest city, is poised between the joys of cheap fuel and the pain of the industry which produces it. Dave Lesar, chief executive of Halliburton, which provides drilling and pumping services, says its customers are cutting spending by 25-30%. On January 21st BHP Billiton, a giant miner and oil producer, said it would cut the number of its onshore oil rigs in America by 40%. A so-far modest fall in the total number of active rigs (see first chart) is set to accelerate.

A survey of 225 companies by Barclays, a bank, forecasts that if crude settles in a range of $50-60 a barrel (it was below $50 in the middle of this week) the industry worldwide will cut its capital spending by 9% this year, to around $620 billion.

Consolidation has been under way for months. Last year, before the oil price’s latest tumble, Halliburton, which is the world’s second-biggest oil-services firm, agreed a merger with the third-biggest, Baker Hughes. The intention is to save $2 billion a year in costs. Both firms announced strong profits on January 20th, while warning of hard times ahead. Baker Hughes said it would cut 7,000 jobs and a fifth of its capital spending; Halliburton has already cut 1,000 outside America, and says it will shed more labour at home in the weeks ahead. Total, an integrated oil giant from France, this week said it would speed up a cost-cutting programme.

No one doubts that a crunch is coming. The question is who crunches whom. The crunchers will be companies with strong balance-sheets, diversified businesses and the foresight to have hedged their production (selling this year’s production at last year’s prices). The crunched will be debt-laden firms with a narrow base, high costs and a risky business model–such as some natural-gas frackers, whose output is now selling for less than the cost of production. As weaker firms have their credit ratings downgraded and lose access to finance, the prospects for those businesses’ lenders, as well as their shareholders, is the subject of much gossip in Houston.

oil price drop news

Oilmen are used to such ups and downs. In the skyscrapers of Houston, few would deny the scope for savings. “There’s plenty of fluff in the system,” says Scott Nyquist of McKinsey, a consulting firm. When prices were high, costs mattered less than keeping output up. Suppliers asked, and got, top dollar. The Katy school district near Houston struggled to find drivers for its buses: there was better-paid work on offer in oil-related firms.

For those who can afford to, now is a good time to buy. Schlumberger, Halliburton’s largest rival, has cut 9,000 jobs and announced $1.8 billion in write-downs, but it has also just bought nearly half of Russia’s biggest onshore driller, Eurasia Drilling, for $1.7 billion. The Russian company’s share price had crashed as a result of the oil-price fall and Western sanctions. To signal its confidence, Schlumberger also raised its dividend by a quarter and said it would continue a share buy-back scheme.

Technology is continuing to change the industry’s economics. Halliburton is pushing ahead with upgrades to the equipment and techniques it uses at drilling sites, including improvements to pumps and storage systems. All this, the company says, can cut a typical well’s capital spending by a quarter, maintenance by half, labour by a third, and development time by more than half, compared with the previous approach. So far 30% of its North American operations have been upgraded. The aim is to reach 50% by the end of the year.

Such new techniques, and falling costs for everything from rigs and pumps to steel and labour, are helping the drillers who are still in business. “We used to think everything worked at $80-85 per barrel. Now it’s $70-75,” says R.T. Dukes of Wood Mackenzie, an energy-consulting firm. Looked at another way, he says, two-thirds of the shale drillers needed oil at $70 to break even. Productivity gains and lower costs have now pushed that down to $60 (though that is still uncomfortably higher than this week’s crude price).

Share prices are sliding (see second chart) but gloom is surprisingly scant in Houston. Oilmen expect supply to tighten by the end of this year: output may decline in mature fields; American shale-oil production may slip back; and there is always a risk of turmoil in some foreign oil province. “Excess supply is just 3-4% of global production,” notes Mr Nyquist. Not much has to happen for prices to recover, when fortune will reward those who spent money wisely during the downturn–or so they hope. So when the going gets tough, the tough go shopping.

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