Schlumberger’s $12bn deal to buy fellow oil services company Smith International, announced on Sunday night and discussed by Andrew Gould, Schlumberger’s CEO, on Monday, looks like a turning point.
From now on, the cost of oil services seems more likely to rise than fall.
One possible reason for that is that the deal will restrict competition. Anti-trust authorities will undoubtedly take an interest, especially in the US, where the two companies paid a $14.6m fine a decade ago for anti-trust violations. The deal will further extend Schlumberger’s dominance of the global oil services business, creating a group with more employees than ExxonMobil, BP or Royal Dutch Shell.
Raju Patel, a consultant who advises the big oil companies that are Schlumberger’s and Smith’s customers, says the increasing concentration in the oil services industry – as seen in Baker Hughes’ 2009 bid for BJ Services – is increasing its bargaining power. He argues:
Just when it seemed as though the oil and gas industry was regaining control of their supply chain costs, the supply chain has responded by announcing consolidations, thereby further reducing the already constrained supply options available to the upstream oil and gas industry.
This spells trouble for the upstream oil and gas industry because structural shifts on the supply side such as these mean that oil and gas chiefs can no longer expect to reap sustainable savings through shrewder management of the supply chain.
He reckons the oil and gas majors between them could easily end up paying an extra $2bn-$3bn a year for their services once supply-side mergers take effect.
Andrew Gould, Schlumberger’s chairman and CEO, responds to concerns about competition by arguing that there is little overlap between Schlumberger and Smith in terms of products and services.
Their offerings are complementary, he says. Schlumberger has pioneered techniques and equipment for “directional” drilling: extending oil and gas wells horizontally, sometimes for distances of several miles from the rig, to hit pockets of oil and gas, but it has lacked two products provided by Smith: drill bits, and the fluids that lubricate the drilling. It provides those fluids only as part of its joint venture with Smith, M-I Swaco.
Mr Gould argues that integrating all the key components of the drilling process will make it easier to deliver the technological breakthroughs needed to produce the more challenging resources that are increasingly important for international oil companies, such as shale gas and ultra-deep water oil. As he puts it:
Engineering them together, you have a much better chance of being successful… We could have developed it an organic way, which would have taken a long time, or done it inorganically, through this deal.
A Reuters story suggests a few possible problem areas:
One analyst anticipated a potential sale of Smith’s PathFinder business, which logs real-time data while drilling.
Analysts at Tudor, Pickering Holt expect many of the assets acquired by Smith when it bought W-H Energy in mid-2008 will have to be sold to satisfy antitrust regulators.
Overall, however, the assessment backs Mr Gould’s version:
“There is some overlap areas where they would get a close look, but in large part it’s a complementary deal,” said Bruce McDonald, a former Department of Justice (DOJ) deputy assistant attorney general who is now with law firm Jones Day.
Even if you don’t buy the argument about service companies’ increased market power, however, there is another reason to think that oil services prices are going to rise. By doing this deal, Schlumberger is calling the bottom of the market.
As Mr Gould put it to the FT:
It probably would not have been possible at the top of the cycle, because valuations would have been out of alignment.
Complaints from some analysts that he is overpaying for Smith seem wide of the mark. The downturn his Smith harder than Schlumberger, and before the bid was reveleaed its shares had recovered less from their low point, but it has great long-term potential in the key growth markets such as shale gas and deep water.
Oil services is always a cyclical business, and the bust of the early 2000s turned into a boom in the second half of the decade.
Snapping up a strategically important set of products now seems like a very smart bit of business for Mr Gould.
Meanwhile, another prediction of the oil services upturn came today from S&P Equity Research. It noted of the results from Petroleum Geo-Services, which carries out seismic and other work for oil explorers:
Q4 results were below our expectations, nonetheless establishing Q4 as the bottom in the current cycle, in our view. We see improving results from tightening capacity and prospects of rate increases, against a backdrop of lower costs.
That tightening capacity, driven by international oil companies’ moves into Iraq, among other things, is bound eventually to start pushing the price of oil services higher. Offsetting that, more advanced and technically sophisticated companies should be able to bring costs down. If Mr Gould succeeds in creating the “step change” in technology that he wants, then Schlumberger’s customers will benefit. Still, the oil majors would be right to be nervous that cost reductions will be harder to achieve this year than they were in 2009. The companies that locked in long-term contracts at lower rates might have cause to reflect on how smart they have been, too.