A pledge for smarter profitability
Wall Street analyst leads movement to reform struggling oil field service sector
Onshore oracle. Offshore oracle. OFS quarterback. James West has several nicknames.
As a senior managing director for the Wall Street investment banking advisory firm Evercore, West is regarded as a leading analyst of the oil field service sector, known as OFS, keeping a close eye on companies that range from drilling rig operators to equipment manufacturers to hydraulic fracturing specialists. He is now one of the analysts and investors leading a movement to reform the sector, which made big promises during the so-called shale revolution, but delivered few returns to investors.
“Only two people ever made money on shale,” West said. “One was the landowner, who saw their acreage values increase substantially and they were able to sell the mineral rights at very high prices. And the other was consumers, who benefited from low energy prices. It was bad for the energy companies, good for the world and bad for investors.”
West’s answer is what has become known as “The Pledge,” a manifesto for oil field services firms with three simple tenets: control spending, improve profit margins and tie executive pay to financial performance. It’s a mantra that is being repeated by analysts, investors and executives across the oil and gas industry as it faces a crisis of confidence that has sent energy stock prices plunging and made the capital needed to fuel drilling projects increasingly hard to get.
The New York private equity firm and activist investor Kimmeridge Energy Management recently issued a white paper that criticized energy companies for high costs, poor incentives and expansions that are unsustainable. Houston investment banks Simmons Energy and Tudor, Pickering, Holt & Co. regularly call for changes to the expand-production-atall-costs business models as do consulting firms such as Deloitte and Accenture.
West’s pledge comes at a time when numerous companies in the industry are tightening their belts to deliver better returns to investors, regardless of the price of oil. Chevron recently pledged to funnel some $80 billion to investors in the form of dividends and share buybacks over the next five years — more than it did during the oil boom that ended in 2014.
Horizontal drilling and hydraulic fracturing unlocked massive reserves of crude oil and natural gas from shale formations from Texas and Oklahoma to North Dakota and Pennsylvania, transforming the United States into a net exporter of oil for the first time in decades. But it all came at the expense of investors, West said. The industry, he said, invested $1 trillion dollars of Wall Street’s money into shale over the the past decade and returned only $700 billion.
Targeting the oil field services sector, West’s pledge mirrors one issued by Evercore for exploration and production companies in 2016, during one of the lowest points of a crude oil downturn. Back then, West said,
“We want to have an advantage over customers. We invest in things where we have a capital advantage, where we can generate our return on our investment.” James West, senior managing director for the Wall Street investment banking advisory firm Evercore
companies weren’t keen on such advice. But now, in the midst of the industry’s second slump in fewer than five years, they’re much more receptive to the message.
Following the pledge, West said, means companies need to walk away from unprofitable work, focus on core areas of expertise, sell off unprofitable business units and increase market share to raise prices and increase profit margins. To that end, he urges companies to follow one of his favorite mottos: “Don’t wait, consolidate.”
One area ripe for consolidation, West says, is coiled tubing, which deploys crews to the field with flexible tubes that are unwound and used to send fluids or sensors into wells. In one analysis, West said, no single oil field services company had more than a 2 percent market share of the coiled tubing market. But if enough companies merge their tubing operations, they could raise their prices and profits.
“The way things are now, it’s absolutely great for customers, but that’s not what we’re in business for,” West said. “We want to have an advantage over customers. We invest in things where we have a capital advantage, where we can generate our return on our investment.”
West rolled out the pledge in Feb. 2019 when crude oil prices were stubbornly stuck in the $50 to $60 per barrel range. They plunged below $42 a barrel Friday as the global coronavirus outbreak undermines energy demand and OPEC and its allies failed to reach a deal to cut production further.
The resulting shale slump already has led to substantial cuts to drilling and fracking activity across the United States. It has also put oil field service companies under intense pressure to cut prices so everybody else can make money. The result has been billions of dollars in losses for service companies who have made deep cuts and written down the value of equipment removed from the field.
Schlumberger, the largest oil field service company in the world, closed 2019 with a $10.1 billion loss. Houstonbased Halliburton, the second largest oil field service company, ended the year with $1.1 billion loss. Wall Street has lost its patience and wants service companies to improve their margins and returns, West said.
“That business didn’t work,” West said about shale. “We gave them a decade. It didn’t work. Time to bring capital out.”
Duane Dickson, vice chairman for U.S. oil, gas and chemicals at the consulting firm Deloitte, has echoed West and Evercore. He wrote in a December white paper that statedthat on top of sticking to core products and areas of expertise, oil field service companies need to embrace digital technology that will improve efficiency and lower costs.
“This is not expected to be an easy lift,” Dickson wrote. “Many oil field service companies rely on the same business models that worked for $100 plus per barrel of oil, which are stifling innovation and efficiency today.”
West has found some loyal followers of the pledge. Warren Zemlak, CEO of the Tomball oil field service company BJ Services, said the privately held company has two business lines — hydraulic fracturing and pouring underground cement casings for oil wells — and he intends to stick to those core areas of expertise.
Like other competitors in the hydraulic fracturing business, BJ Services has pulled fracking crew and fleets of its high-pressure pumps that send mixtures of water, sand and chemicals into wells from the field. The idea is that those remaining can command higher prices.
“We were a pledge company before there was a pledge,” Zemlak said.
Active in shale basins across Texas and the United States, BJ Services is also testing new turbines that can power hydraulic fracturing pumps with cost-saving and pollution-reducing natural gas that is produced at well sites. The company, Zemlak said, will deploy the technology gradually as it retires and replaces fracking fleets.
“We’re happy to be a 25-fleet operation,” Zemlak said. “We’re not going outside those boundaries unless there’s a meaningful shift in the market. We’re very much disciplined.”