THINK ACT A New Age Dawns For Oilfield Services
Beyond Mainstream A new age dawns for oilfield services Halliburton-Baker Hughes and the oil price downturn february 2015
think act A new age dawns for oilfield services THE BIG 3 1 mod els There are four oilfield services participation models defined by breadth of offering and geographic coverage p. 3 2 e vents Two events – the Halliburton-Baker Hughes merger announcement and the oil price downturn – have the potential to significantly shuffle the competitive landscape p. 5 3 strat e gies The current environment provides unique opportunities for companies which adopt focused strategies by offering or basin/geography to grow and sustainably compete against Schlumberger and Halliburton p. 7 Key issues to keep on your radar p. 10 2 Rol and Berger Strategy Consultants
think act A new age dawns for oilfield services Agile oilfield services players will take advantage of the highly dynamic oilfield services environment to emerge as new industry leaders alongside Schlumberger and Halliburton. Through our extensive work in oilfield equipment and services, we have observed that companies typically adopt one of four participation models in the industry. Two recent back-to-back structural events – the possible end of the protracted oil price super-cycle and the Halliburton-Baker Hughes merger announcement – will change the rules for winning for each one of these participation models. Oilfield services players will need to adapt to a lower oil price environment due to anticipated changes in the oil & gas industry landscape and operator buying behaviors. Divestitures and share capture opportunities stemming from the Halliburton-Baker Hughes merger will present oilfield services players with considerable growth opportunities. The most agile players will take advantage of a highly dynamic oilfield services environment over the next few months to evolve and emerge as new industry leaders in select categories, with the ability to compete against the giants, Schlumberger and Halliburton. 1 Four participation models in oilfield services with significantly different historical performance levels In our analysis of the oilfield services industry over the last 10 years, we have defined four participation models based on breadth of participation across service categories and geographies: Focused players, Category Kill- ers, Regional Diversified players, and Global Integrated players A . These four models have different value propositions and customer segment focus: Focused players and Regional Diversified players tend to serve independent oil & gas operators with a relatively commoditized technology and product offering but with a high customer service emphasis. Regional Diversified players typically offer a range of ancillary services (such as basic equipment rentals, site preparation, etc.) to enhance convenience for their customers. Category Killers and Global Integrated players serve all types of operators with differentiated technology and service capabilities sold at a premium. They capture the lion share of the business of oil majors and national oil companies (NOCs). In this article we consider Baker Hughes and Weatherford as Global Integrated players, albeit more from an aspirational perspective, given their geographic and portfolio gaps, as well as their lower degree of exposure to NOCs. We have found that in general, any participation model can win in oilfield services. For example, TGS (Focused), FMC Technologies (Category Killer), RPC (Regional Diversified), and Schlumberger (Global Integrated) have all delivered top quartile shareholder returns over the last 10 years. However, on an aggregate basis, Category Killers and Global Integrated have performed better. In fact, Category Killers have performed so well that they have Rol and Berger Strategy Consultants 3
think act A new age dawns for oilfield services A Oilfield services participation models1) Service category breadth Single basin Single service category Comprehensive service offering Focused Regional diversified Revenues driven by one service category in select oil & gas basins Revenues driven by a broad range of service categories in one or select oil & gas basins Patterson-UTI Basic Energy Services FTS RPC C&J Energy Services Geographic breadth Trican TGS Nopec Superior Energy Services Newpark Category killer Revenues driven by one or multiple service categories across major global oil & gas basins, with a comprehensive technology and product portfolio in each category Helmerich & Payne Weatherford Revenues driven by a comprehensive service category offering across major global oil & gas basins, with the ability to provide integrated services Baker Hughes All global basins Transocean FMC Technologies Nalco Champion Halliburton NOV 1) Based on 100 publicly traded service companies analyzed over 2004-2013 Source: Roland Berger 4 Global integrated Rol and Berger Strategy Consultants Schlumberger
think act A new age dawns for oilfield services regularly been targeted for acquisition by larger players, as evidenced by Schlumberger's acquisition of Smith International in 2009 and Baker Hughes' acquisitions of BJ Services in 2010 – to the point where few Category Killers exist today. Focused, Regional Diversified, and aspiring Global Integrated players have been clear laggards B . Focused and Regional Diversified players' performance has historically been negatively impacted by the volatility in the activity levels of their customers, the independent oil & gas producers. The focus of these producers on developing relatively small size and short-term projects (e.g., shale resources), has rendered them highly vulnerable to swings in oil and gas prices. Additionally, Regional Diversified players have faced pressures to enter new basins to meet their customer needs or investor expectations for growth. They have struggled to profitably replicate their value proposition given the different technology and knowledge requirements from one basin to another. Aspiring Global Integrated Weatherford and Baker Hughes have also failed to broaden their portfolios from successful "Category Killer-like" business lines to provide truly comprehensive, integrated offerings valued by customers. With its "One Baker" strategy, Baker Hughes has recently been attempting to deploy an integrated model to better compete with Halliburton and Schlumberger. The merger with Halliburton can be construed as Baker Hughes' admission that it would not be successful on its own within a timeframe acceptable to investors. 2 Global Integrated players and Category Killers have performed significantly better than Focused and Regional Diversified players over the past 10 years, including the recent downturn. Low oil prices to drive oilfield services industry consolidation and specialization The collapse in oil prices will create considerable challenges for operators. We expect to see oil & gas operator consolidation, especially onshore where the competitive landscape is highly fragmented. Lower financial valuations will facilitate mergers and acquisitions activity across the oil & gas value chain: many small independent operators are already in financial distress, creating an apt medium for consolidation or attractive Rol and Berger Strategy Consultants 5
think act A new age dawns for oilfield services b Total growth in shareholder value1) across oilfield services models 2) Value of USD 100 invested Oil prices start declining Economic downturn 450 400 350 300 250 200 150 100 50 0 2005 Total growth [%] 2006 2007 2008 2009 2010 2011 2012 2014 12/200406/2014 303% 87% 210% 173% 157% 06/201412/2014 -30% -34% -40% -40% -42% Category Killer Focused Global Integrated Aspiring Global Integrated 1) Dividend-adjusted stock prices, normalized to 100 2) Based on 76 oilfield equipment and services companies headquarter in North America and Europe Source: Capital IQ, Roland Berger 6 2013 Rol and Berger Strategy Consultants Regional Diversified 2015
think act A new age dawns for oilfield services targets for financial investors. Larger, more sophisticated operators are also likely to purchase services differently in order to reduce costs and drive efficiency. While we see a recovery in oil prices over the next twelve to eighteen months, we believe the downturn will be long enough to drive lasting structural changes in the oil & gas operator landscape and behaviors, with implications for the oilfield services industry. First, we believe operators will seek to achieve scale basin by basin to enable durable cost reductions via leverage of technology and knowledge over similar sets of projects. For this reason, operators will look to increasingly source services from "basin specialists", such as Cudd Pressure Pumping (RPC) in the Permian basin. This will drive consolidation in oilfield services as well. In their focus geographies, Focused players and Category Killers will be well positioned to become the suppliers of choice to operators, alongside the inevitable Schlumberger and Halliburton. Regional Diversified players will face greater challenges towards achieving scale within a basin. Doing so organically will be difficult given the need to extend their customer base beyond historical relationships and adapting their convenience offering to the different needs of new customers. Doing so via acquisitions will also be difficult given the low probability of finding look-alike targets amongst a small set of diversified players or finding sellers willing to carve out specific businesses. C&J Energy Services' acquisition of Nabors' Completion and Production business announced in June 2014 stands out as an exception. With the transaction, C&J will become one of the largest pressure pumpers in the Bakken, Eagle Ford, and Permian oil basins. Second, operators will likely seek to disaggregate bundled service offerings that provide convenience to shift emphasis onto efficiency, cost reduction, and quality. This acceleration of the secular unbundling trend which we described in our 2013 article will, in particular, pressure Regional Diversified players as well as aspiring Global Integrated players such as Weatherford, who have not succeeded in providing truly integrated and comprehensive service offerings. Halliburton–Baker Hughes merger to drive share redistribution The Halliburton–Baker Hughes merger also shakes up the industry. It presents oilfield services players with a rare opportunity to buy large properties. Halliburton has announced its willingness to divest up to USD 7.5 billion in assets to allay antitrust concerns C . The exact service categories that will be impacted will likely require scrutiny to the basin level in the US and internationally in countries like Brazil. For example, we expect that the deal will leave operators with only two service providers (Schlumberger and Halliburton) in a range of offshore drilling services. Such duopolies will be incompatible with the oil & gas industry's traditional "three bids and a buy" sourcing approach. This creates opportunities for oilfield services players to enter these market segments and gain share by breaking up traditionally integrated oilfield services contracts. We expect Focused players and Category Killers to be better positioned to take advantage from the merger fallout. Acquiring the divested assets in their service category of focus will enable them to improve their scale, breadth and depth of product and technology offering, and address key geographic strategic gaps. We expect them to pursue these assets aggressively and have the advantage at the negotiation table, as the divested properties will strategically and synergistically fit their existing focused portfolios. We also believe Focused players and Category Killers will be in the best position to capture share organically in market segments where operators are left with two suppliers. Indeed, companies such as Trican in hydraulic fracturing or Newpark in drilling fluids have achieved strong reputations with operators in recent years, and will likely be invited to bid to provide continued expertise and technology. Aspiring entrants, however, will need to pre-invest in assets and capabilities that clearly position themselves as credible third-supplier alternatives to operators, and manage the risk of being treated as a mere "stalking horse" in bids versus Schlumberger and Halliburton. In contrast, it will be more challenging for Re- Rol and Berger Strategy Consultants 7 3
think act A new age dawns for oilfield services C 2013 global market share by key service category 47% Logging-while-drilling 28% Cementing 35% 37% Drilling and completion fluids 29% Drill bits Likely increasing regulatory scrutiny 20% 22% Coiled tubing services 7% 13% 10% 30% 30% 8% 27% 4% Geophysical equipment/services 15% 1% 14% 13% 12% 10% 3% 6% Production testing 16% 15% 33% Solids control and waste management HAL 24% 27% 30% Surface data logging SLB 18% 45% Hydraulic fracturing 45% 45% 42% 39% 32% 30% BHI Source: Spears, Roland Berger 8 10% 25% 25% Wireline Artificial lift 24% 15% 13% Completion equipment/services 16% 16% 31% Directional drilling services Specialty chemicals 29% Roland Berger Strategy Consultants 65% 62% 61% 60% 57% 72% 71% 16% 78% 92%
think act A new age dawns for oilfield services gional Diversified and aspiring Global Integrated players to benefit from the merger. Regional Diversified players are less likely to find divested properties they are interested in or opportunities to capture share, as they tend to focus on the North American onshore market which has a fragmented supplier base and is therefore less likely to draw antitrust scrutiny. Regional Diversified players, who have developed clear long-term strategies to refocus their respective portfolios and migrate towards the Focused and/or Category Killer models, can benefit from acquiring the divested properties to accelerate the pathway towards their ambition. However, they will likely need to pay steep acquisition premiums relative to the near-term synergies they can extract, and face tremendous execution risk. For Weatherford, the merger could mark the end of its aspiration to compete with Schlumberger and Halliburton on a global scale. Both companies would be more than three times its size from a revenue standpoint. While Weatherford could be in the best position to take Baker Hughes' place as the third player in the industry by growing in size and broadening its portfolio, we believe its high degree of leverage and recently challenged financial performance will prevent it from doing so. With its divestiture of drilling fluids and production chemicals to Lubrizol in December, it may be already embarking on a different direction: smaller and more focused. To summarize, the different oilfield service participation models are likely to experience a range of fortunes in the current challenging environment. Focused players and Category Killers will have significant opportunities to achieve or consolidate leadership positions. Going forward, they can play a vital role with oil & gas operators to provide a balance and an alternative to Schlumberger and Halliburton. They can also be the drivers of innovation in their categories of focus, enabling operators to achieve better performance and withstand a low oil price regime. Regional Diversified players and Global Integrated aspirants are likely to be increasingly challenged within the parameters of their traditional participation model and will be better served by re-inventing themselves – evolving their long-term value proposition and re-aligning their portfolios against it. Companies with focused strategies are more likely to win in the future oilfield services environment. Rol and Berger Strategy Consultants 9
think act A new age dawns for oilfield services Let's think:act! Key issues to keep on your radar. Oilfield services model Key issues Focused/Category Killers Which gaps do I need to address to achieve/ strengthen Category Killer status? Do potential Halliburton–Baker Hughes divestitures enable me to achieve/strengthen Category Killer status via M&A? Can I achieve the technology, cost, and service levels required to capture share in market segments where Schlumberger and Halliburton are the major or only two suppliers going forward? How can I drive the restructuring of traditional integrated service contracts in these market segments? How can I mitigate the risk of being the operators' "stalking horse"? What room do I have in my balance sheet to fund organic growth and capitalize on acquisition opportunities in the current environment of depressed valuations? 10 Regional diversified What is the long-term value proposition of my portfolio? Which service "bundles" do I provide and do they create value to customers or will they be unbundled? Are there potential offerings or geographic gaps in my portfolio? Are there M&A targets which align with them, including potential Halliburton–Baker Hughes divestitures? Are there service lines or basins which I should exit? What is the right timing and value? Aspiring Global Integrated Are there market segments where I can deliver an integrated service offering that is competitive with Schlumberger and Halliburton going forward? Do potential Halliburton–Baker Hughes divestitures enable me to do so? Should I refocus my portfolio on my set of leadership positions to become a portfolio of select Category Killer positions? Rol and Berger Strategy Consultants
think act A new age dawns for oilfield services About us Roland Berger Strategy Consultants Roland Berger Strategy Consultants, founded in 1967, is the only leading global consultancy of German heritage and European origin. With 2,400 employees working from 36 countries, we have successful operations in all major international markets. Our 50 offices are located in the key global business hubs. The consultancy is www.rolandberger.com an independent partnership owned exclusively by 220 Partners. Further reading Links & likes Order and Download www.think-act.com Stay tuned www.twitter.com/RolandBerger Like and share www.facebook.com/Roland BergerStrategyConsultants The shale gas phenomenon North American Oil and Gas Value Chain Reconfiguration Roland Berger experts highlight the relevance of this resource to the US energy landscape – by 2050, shale gas could make up 50% of total gas produced in the US. Specialists believe its potential can revive production and manufacturing in the US through four competitive advantages. After 5 years of unbridled growth between 2006-2011, industry expansion has slowed down, with falling gas prices, oil prices stuck in a narrow band, and logistical constraints in the Bakken driving low tight oil pricing at the wellhead. In parallel, industry participants have increased their understanding of where value is created and captured along the chain, and are adapting their participation models and behaviors accordingly. This value chain reconfiguration is creating significant opportunities and threats for incumbent players as well as new entrants from North America or other countries seeking to capture a slice of the shale boom pie. www.think - act.com Tablet version Download our think act App To read our latest editions on your tablet, search for "Roland Berger" in the iTunes App Store or at Google Play. Download the Think Act App for free. 11
think act A new age dawns for oilfield services Publisher Roland Berger Strategy Consultants LLC Two International Place 25th Floor Boston, Massachusetts 02110 USA www.rolandberger.us Marketing and Public Relations Linda Saliba linda.saliba@rolandberger.com The authors welcome your questions, comments and suggestions Frederic Choumert Principal 1 617 869-8771 frederic.choumert@rolandberger.com Shashin Shah Principal 1 857 204-2511 shashin.shah@rolandberger.com Design: Stephanie Tortomasi Printed on FSC -certified recycled paper. This certificate supports responsible forest practices, meeting the standards of the Forest Stewardship Council (FSC ). This publication has been prepared for general guidance only. The reader should not act according to any information provided in this publication without receiving specific professional advice. Roland Berger Strategy Consultants LLC shall not be liable for any damages resulting from any use of the information contained in the publication. 2015 Roland Berger Strategy Consultants LLC. All rights reserved.
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