IHS Markit

Major oilfield service company earnings driver shifting away from North America, says IHS

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Source: IHS Markit

Higher costs squeeze North American margins for sector, but counterbalanced by increased profits outside US, where rig counts projected to climb eight percent in 2012

After riding high in 2010 and 2011 on drilling demand created by the North American shale boom and some recovery in the U.S. Gulf of Mexico following the Macondo incident, the major oilfield service companies saw their mid-year margins in North America shrink in 2012, while their costs rose. However, margins from activity occurring outside the U.S. are growing for companies in this sector, and rig counts outside North America are projected to be up eight percent in 2012, according to a recent report from IHS (NYSE: IHS), the leading global source of information and analytics. The four companies covered in the report are Baker Hughes, Halliburton, Schlumberger and Weatherford.

According to John Parry, author of theIHS Herold Oilfield Service Company Peer Group Analysis, these companies saw their margins decrease because they had significantly higher costs for guar gum (a component used in fracturing fluids), they faced pricing pressures for their hydraulic fracturing services, and at the same time, had to adjust to the costs and impacts associated with the ongoing relocations of equipment and personnel from gas to liquids-rich basins.

“Aside from cost pressures, these companies are continuing to adjust to the U.S. shift to oil shale from gas plays, with the most pressure being felt in the hydraulic pumping sector, which is the result of building excess pumping capacity,” said Parry. “The good news for these companies is that, while margins in North America are being squeezed, profit margins outside of North America are showing sequential improvement, which are benefitting from improved activity in several regions aided by earlier targeted investments.”

For these companies, a look at aggregate operating margins for the first six months of 2012, as compared to the same period in 2011, tells the tale of eroding margins in North America while improving outside of North America. Although six-month results for these four companies showed $24 billion in North American revenue, a 24 percent year-over-year jump, operating income failed to keep pace, rising just 8.3 percent to about $4.8 billion.

Outside of North America, aggregate revenue rose 18 percent to $28.3 billion, but operating income rose a more impressive 42 percent, reaching $4.6 billion. Measuring operating income as a percent of revenue further demonstrated the shift, as aggregate North American margins eroded to 19.9 percent for the 2012 six-month period, which was down from 22.8 percent in the same 2011 period.

At the same time, operating margins outside of North America for the 2012 period advanced to 16.3 percent of revenue from 13.5 percent one year earlier. The squeeze on the North America contribution is further evidenced by its reduction to 50.8 percent of total operating income in the first half of 2012, down from 57.6 percent in 2011.

Added Parry: “While we expect these companies to face tight margins in their North American operations for the remainder of the year, we also anticipate higher margins in other parts of the world to buttress those results and buffer the impact. In addition, these companies are highly innovative—they are not just sitting on their hands. Baker Hughes and Halliburton are developing replacements for guar gum, for example, and Schlumberger is preparing to market its advanced reservoir simulation software.”

Also contributing to North American margin pressure is the fact that the U.S. natural gas rig count declined 18 percent in the second quarter, and is down 43 percent from its high in October 2011.

Looking at company specifics, in the second quarter, about two-thirds of Halliburton’s North American margin compression from 28.9 percent to 20.7 percent was due to the impact of guar gum costs, which rose about 75 percent since the first quarter. An additional 25 percent cost increase is expected in the third quarter for guar gum. However, by 2013, Halliburton expects it will have worked the higher priced guar from its inventory and replaced it with more normally priced product. In the Gulf of Mexico, the company continues to see activity recover and second-quarter margins were reported at near pre-moratorium levels. Halliburton’s outlook for international markets has not changed. While slow, it is expected to grow steadily and to translate into long-term pricing improvement.

Baker Hughes also felt the pricing squeeze from guar gum, and saw its costs continue to rise, while due to competitive pressures for pressure pumping, was unable to pass those costs on to customers. Internationally, Baker Hughes noted that its Europe, Africa, Russian, Caspian segment delivered strong results for the second consecutive quarter, but its North American pressure pumping market struggled with overcapacity issues.

In the second quarter, Schlumberger saw its North American hydraulic fracturing margins decline further as a result of lower pricing and higher product costs. In the Gulf of Mexico, deepwater activity grew in line with the company’s outlook for the year and its operational performance remained strong. Schlumberger reported that, “in the international markets, overall second quarter revenue grew nine percent sequentially, while margins expanded by 161 basis points.” The company’s Latin America revenue grew by five percent, helped by strong growth in Mexico. In the Middle East and Asia, revenue grew by seven percent sequentially, while margins were essentially flat. Europe, CIS and Africa grew 14 percent sequentially, while margins were up 356 basis points.

Despite the pricing and cost pressures facing the sector, Weatherford reported second-quarter revenues of $3.8 billion, the highest in company history. Revenues were five percent higher sequentially and 24 percent higher than the comparable quarter in 2011. While North America revenue was down four percent sequentially and up 25 percent versus the comparable quarter in 2011, international revenues were up 14 percent sequentially and grew 23 percent as compared to to the same quarter in 2011. A higher level of activity in Russia during the second quarter 2012, led to a whopping 100 percent, or $60 million, increase in revenue above the prior quarter for Weatherford, while reported operating income was $120 million, an increase of 35 percent year-over-year. Latin America was another strong performing region for Weatherford, which said its second quarter operating income for the region was $104 million, an increase of $54 million year-over-year, and a 20 percent improvement from the prior quarter.

Added Parry, “Due to the uncertain global economic outlook and its impact on oil and gas commodity prices, particularly in North America, we expect the sharp shift in geographic operating income contribution will continue for the remainder of the year for these companies; a fact now borne out by subsequent guidance from some of these companies. Offshore activity will prove to be a partial buffer for these companies, as well as anticipated relief from the spikes in guar gum pricing.”

The IHS Herold Oilfield Service Company Peer Group Analysis is available by subscription to the IHS Herold advisory services.For more information about this report please contact John.cannon@ihs.com. To speak with John Parry, please contact melissa.manning@ihs.com.

IHS will host its 21th Annual IHS Herold Pacesetters Energy Conference, “Winning Strategies in a World of New Opportunities,” Nov.13 -14, 2012, at the Washington Hilton Hotel in Washington, D.C. This year, the Pacesetters Energy Conference is being held as part of the IHS Forum, a new event that allows for expanded programming and networking amongst the various client groups, the opportunity to hear additional keynotes from senior executives and thought leaders, as well as access to a wide range of IHS experts. For the complete agenda and registration information, please visit the Pacesetters website at: http://www.ihs.com/events/ihs/pacesetters-2012.aspx

About IHS (www.ihs.com)
IHS (NYSE: IHS) is the leading source of information, insight and analytics in critical areas that shape today’s business landscape. Businesses and governments in more than 165 countries around the globe rely on the comprehensive content, expert independent analysis and flexible delivery methods of IHS to make high-impact decisions and develop strategies with speed and confidence. IHS has been in business since 1959 and became a publicly traded company on the New York Stock Exchange in 2005. Headquartered in Englewood, Colorado, USA, IHS employs more than 6,000 people in more than 30 countries around the world.

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