In some ways the numbers don’t look that bad. For a group of 25 diversified, publicly traded Canadian oilfield service (OFS) companies, combined revenue of nearly $9 billion in the first six months of 2015 was only 22.1% lower than $11.53 billion for the same period in 2014. With oil prices down 50 percent for the first half of 2015, a revenue decline of 22.1% looks misleadingly attractive.
The problem is that at the field level, OFS is nowhere near as profitable as producing oil or gas. When producers fetch $100 for a barrel of oil, direct field lifting and operating costs can be as little as $10, particularly if the production is within a royalty holiday period. Most oil wells that produce without steam or EOR (enhanced oil recovery) only cost $20 or $30 a barrel to operate. Even after paying Crown royalties, it is usually $40 or less. Oilsands operations have cash operating costs of $50 or less per barrel.
Field margins for OFS have never been as high as 90 percent or even 50 percent except for a few select companies. If it does happen, margins that high don’t last long, either because of a down cycle or because high profits attract competition. Any loss of field margin clobbers the bottom line. As a group, OFS gross margins shrank significantly in the first half of 2015.
And that was back before July, when oil prices were high compared to current levels. WTI (West Texas Intermediate) averaged US$53.19 a barrel in the first six months of 2015. At the time it looked awful. Now with oil trading near US$39 or nearly 30% below that average first half number, it is clear for OFS things could get worse before they get better.
The financial performance figures analyzed in the following chart are:
• The ranking order based upon gross margin gain (loss) in 2015 vs. 2014 for the six-month period ended June 30, with the order starting at the highest in descending order.
• 2015 six-month revenue to June 30 and the percentage increase (decrease) versus the same period in 2014.
• Gross margin in 2015 for the period as a percentage of revenue. Gross margin is revenue minus direct expenses related to generating that revenue. They include labor, fuel, cost-of-goods sold for products, expendables used to generate the revenue, transportation to and from location, field service locations, support vehicles, direct repairs and maintenance, and field operations personnel. They do not include fixed costs for sales and administration, interest expenses, depreciation or amortization.
• The increase (loss) in gross margin for 2015 vs. 2014.
• OFS subsector classification using MNP’s proprietary coding system.
• Companies are color coded in order of year-over-year gross margin performance in three categories: those with gross margin gains greater than 1 percent in 2015 compared to 2014 (green); neutral classified as a gross margin fluctuation of less than 1.1% in either direction (yellow), and a gross margin decline greater than 1.1% in 2015 compared to 2014 (red).
• Data is from company financial statements for the period ended June 30, 2015 filed on SEDAR.
The highlights of the foregoing are:
• The growth or shrinkage of gross margin is a key indicator of product or service pricing and the ability to pass on to clients rising costs as they occur. Fuel expense was lower in the first half of 2015 but all other costs were more or less the same. Extraordinary income (often with no direct expenses) would contribute to gross margin. The fact that only 10 of 25 companies were able to hold or increase their gross margin despite some costs like fuel being lower is representative of the intense pricing pressure the OFS sector faced in 2015’s collapsed oil price environment.
• Of the 11 companies able to raise margins or hold them to within 98.3% of last year’s levels, seven of them operated drilling rigs, well servicing rigs or both. This is indicative of how quickly rigs can collapse their field labor structure, something most other OFS companies cannot do. When the rig isn’t working the crews come off the payroll. Drilling contractors are often protected with long-term contracts for newer equipment. The four companies that were able to materially raise their gross margin this year can all thank their rigs.
• Of the five companies that endured the greatest gross margin reduction, three (Canyon, Calfrac and Trican) are in the pressure pumping or hydraulic fracturing business. The other two operate in drilling instrumentation rentals (Pason) and directional drilling (PHX). Companies in these businesses require highly trained field service personnel who often receive a base salary even when not generating revenue. While Pason’s revenue and margin reduction is based mainly on the decline in the number of operating drilling rigs, the other four companies were subjected to both volume and pricing pressure.
• Three companies had direct expenses exceeding revenue. All three are primarily pressure pumpers. The speed at which companies are able to reduce direct expenses in line with revenue depends on the type of business, the responsiveness of management and the company’s views on the depth and length of the downturn. Frackers, in particular, are loath to release their key field operations personnel because they take so long to hire and train. Obviously, having every dollar of revenue cost more than 100 cents in direct expenses is unsustainable and must be addressed. Combined with additional fixed costs for sales, general and administrative expenses (not included above), it is impossible to be profitable under this structure.
• Only three of 25 companies raised revenue: Enerflex, Horizon North and Canyon Services Group. Enerflex has an international footprint and is oriented to production with gas compression; Horizon North has camps under longer term contracts, and Canyon closed two acquisitions last year that substantially grew the business but had no material impact on the financial results in the first half of 2014.
While the Canadian rig count has been fairly steady at about 200 since the end of spring break-up, it is half of what it was in 2014 and 2013 and weakening with oil prices. This will put further pressure on revenue and margins for OFS. It is likely performance in the second half of the year will be similar to the first half on a year-over-year basis, possibly worse if oil prices don’t improve.