Over the past two decades, the definition of what it means to be an “oil company” has changed dramatically. There’s a common perception that oil companies—such as ExxonMobil, Saudi Aramco, or other national and international oil companies—are entities that manage the process of extracting oil. A new report from KPMG explores how this has become less and less true over time: Oil companies are now more in the role of managing portfolios and risk, while oilfield service companies are in charge of drilling and innovation.
Oilfield service companies have established themselves as the heavy lifters of the oil and gas industry.
“Oilfield service companies have established themselves as the heavy lifters of the oil and gas industry (or, as the Economist puts it, “Unsung workhorses” or “Masters” of the oil industry) by leading both the delivery of operations and the innovation space,” argues the report, which is based on interviews with oil industry leaders from around the world. In particular, the shifting role of oilfield service companies is helping national oil companies (NOCs) tackle new and challenging geologies, without relying as heavily on the oil majors or international oil companies (IOCs) for the necessary technology. Schlumberger in particular is described as the most integrated service company, offering the most competitive suite of services in a “one-stop shop.”
Who does what in the oil patch
In the 1960s, oil majors took charge of everything in-house, which included drilling, reservoir engineering, procurement, construction, laying pipe, and ongoing maintenance. In the 1980s, the industry began outsourcing these tasks, and now the technical expertise has fallen to the oilfield service companies.
Oil companies still call the shots, however. They make decisions about where to drill and how, they book reserves and production, and probably most importantly, they manage risk. Service companies are not responsible for accepting huge uncertainties and exposing their shareholders to such risk. Service companies provide value to oil companies by providing technical expertise and accepting performance incentives in return. For example, in the wake of the Deepwater Horizon oil spill, BP largely accepted responsibility for the incident in spite of the fact that Transocean operated the drilling rig and Halliburton provided the cement for the well casing which ultimately failed.
Oil companies still call the shots.
To meet the needs of oil companies, the oilfield service sector is an increasingly diverse one. On one hand, companies such as Schlumberger and Halliburton provide virtually every service required to explore, develop, and produce a reservoir. Demand for “integrated” oilfield services has increased dramatically, from 5 percent of service company sales in 2010 to an expected 25 percent at the end of the decade. There are also many smaller companies which provide a high level of specialization. For example, Geolog specializes in surface data logging. Smaller companies like this are highly focused on particular technologies, enabling economies of scale to be achieved from repeated application and helping to drive innovation that benefits the entire industry.
Sometimes, these smaller specialists are acquired by the larger oilfield service companies, as they seek to provide a broader suite of services. This is highly beneficial to national oil companies, who prefer to contract with a single oilfield service provider—and the industry as a whole is pushing toward integrated project management offered by service companies. However, the mergers and acquisitions process can also hamper innovation in the long run.
The increasing sophistication of frontier oil geologies is also increasing the role for oilfield service providers, and the reliance of oil majors on these providers. In general, projects are growing more complex and costly, and the likelihood that an individual oil company has the necessary technical expertise to tap the resource is smaller. Service companies achieve scale by tapping similar geologies for multiple oil companies.
Low oil prices challenge the sector
The market for oilfield services has taken a severe hit thanks to the low oil price environment. According to Spears and Associates, the market was $454 billion in 2015, but fell to $332 billion in 2015, and will fall further to $294 billion in 2016—a decline of 35 percent. There’s also the fact that, according to Wood Mackenzie, $1.5 trillion of oil industry capital expenditures do not break even at $50 per barrel.
In response to the lack of business, oilfield service companies have stripped research and development budgets, and they have been forced to lay off tens of thousands of skilled employees. This is likely to lead to consolidation in the industry in coming years, and the companies that survive the downturn will be the ones who find a way to maintain their workforces and research budgets. They will also likely acquire weaker companies that have developed promising technologies.
KPMG finds that in order to avoid future consequences of the current price crunch, oil companies should seek to partner with oilfield service companies rather than keep them at “arm’s length” as contractors.
Additionally, KPMG finds that in order to avoid future consequences of the current price crunch, oil companies should seek to partner with oilfield service companies rather than keep them at “arm’s length” as contractors. A different approach, which includes sharing risks and rewards, greater information transfer and planning between oil companies and service providers, could lead to more thoughtful application of technology, improving conditions for a the industry as a whole.
The structure of the oilfield service sector varies widely on a global scale. Around the world, large multinationals that are global in scope complement smaller local players that have regional expertise. The United States is by far the largest market, with the highest number of companies and a strong culture of innovation. The low price environment and corresponding collapse in the rig count are likely to drive significant consolidation through the industry, as well-capitalized players fill gaps by acquiring smaller competitors.
In China, there is a well-developed oilfield service sector, with many companies that are subsidiaries of the large Chinese NOCs. China has some of the highest research and development funding around the world—but observers note there is little incentive for innovation because these subsidiaries are not incentivized to outperform their peers. In Russia, the oilfield service sector has grown because of increasing demand for more sophisticated drilling and well stimulation techniques. Sanctions have also created a void, once filled by international companies, that local players are striving to fill. Finally, in the Middle East, there has been a historic dependence on the established international players. However, new entrants from China, Korea, and Canada are gaining market share, and an indigenous set of local, private service companies are gaining ground.