Drilling activity dropped at an unprecedented rate over the past two months, with horizontal rig counts falling over 50% and fracturing fleets plunging more than 75% so far. Work for many oilfield service (OFS) companies isn’t there anymore. Unlike operators who generate some cash from existing production despite cutting activity (albeit at a low commodity price), cash flow largely stops for OFS providers. This raises the question whether the sector can survive a halt in activity.
We have seen swift and deep cuts throughout the industry in an effort to curb operating costs and survive. Calfrac announced reducing staff by ~70%, FTS International is down to four manned fleets from 17 in 1Q20, Halliburton is using rotating furloughs for 3,500 North Houston employees and the trend continues across OFS companies. Additionally, OFS has been defined by margin compression since 2016 and has not benefited from high profits in recent years.
We believe that rig activity will drop ~70% from 1Q20, yielding a ~50% year-over-year reduction in L48 well completions and a corresponding revenue decline for OFS companies. During the 2014-16 downturn, cost of goods sold (COGS) and sales, general and administrative expenses (SG&A) followed the decline in revenue, with COGS trailing by 5% on average and SG&A by 25%. Figure 1 applies these reductions to 2019 earnings for a flat pricing scenario, resulting in slim EBITDA margins across the board with land drillers on the high side and tools on the low. Some producers are pressing for additional pricing concessions of ~25%; incorporating this demand into our model results in negative EBITDA margins. A 10% price reduction results in negative EBITDA for all OFS companies except land drillers.
Since E&P companies must pare costs to survive low oil prices, OFS firms will experience significant revenue reductions and embark on their own cost-cutting programs. Reduced activity levels at lower prices mean many OFS companies with negative EBITDA margins will be driven out of business. With a moderate recovery in activity later this year, we think the surviving OFS companies will place a premium on creditworthy clients who can guarantee an activity level – those with access to the best resource.
FIGURE 1 | Sensitivity to Price Reductions on EBITDA Margin