Dec. 1, 2001
Like oil and gas producers, service companies and contractors are searching for economies of scale to keep margins attractive to investors.

Service companies' dilemma

Like oil and gas producers, service companies and contractors are searching for economies of scale to keep margins attractive to investors. But this group hasn't found the level of equanimity experienced by producers. Once oil and gas storage volumes begin rising, contracts and service agreements from producers seem to fall off the table, leaving collapsed revenue streams in their wake.

Service companies and contractors don't have the benefit of downstream margins or ongoing cash flow from production, and it is difficult to offset contract risk. As contractors and service companies are asked to take on more well-site risk from producers, how can they acquire protection from a collapsing contract market? Here are two paths that could emerge:

  • Take equity positions in E&P projects: Some of this takes place now when producers' cash flow dwindles. Service companies want to keep their equipment and people active, and producers need rock-bottom costs.
  • Take equity positions in producing companies: Service companies have always shied away from such investments, because it threatens service company neutrality.

Many service companies use a third option - employing a third party to manage equity investments, allowing the appearance of service company neutrality. Service companies have a window into the lives of producing companies, and dividends from successful producers can provide cash flow in difficult times. Service companies have other unrealized assets:

  • Technology transfer: While producing companies have been shrinking their core of expertise, that knowledge has re-emerged among the service companies. Have producing companies done so unwittingly? Maybe. The result today is that a very narrow margin exists between deploying that expertise externally, or internally.
  • Vertical and horizontal growth: In the process of chasing economies of scale, some large service companies can now carry out cradle-to-grave operations at the well site or field.

So what has prevented service companies from chasing the producer's role? Tradition holds that producers assume much higher degrees of risk and levels of investment without immediate return - something service companies shy away from. Service companies also have been reluctant to give up very high levels of income when business conditions favor the service sector.

Could we see more project equity trading and producer equity investing by service companies in the future? It seems likely, if service companies have no way of offsetting contract risk and are forced to play the role of 'poorer relations' in the profits game.

New oil map

A new oil and gas exploration map is taking shape across the globe as new theaters are opened up or producing basins are expanded into unexplored regions. Some of the changes are in:

  • Central Asia: The Middle East reserves and production glamour is shifting northward to the Caspian Sea. Pipeline access in the northern and southern Caspian is developing rapidly, and large and small fields can be tied in.
  • Eastern Canada: Prospects for 10 billion bbl in reserves are just the beginning of what is known for this area. Some geologists consider Eastern Canada prospectivity a western mirror image of the North Sea-West of Shetlands region.
  • Eastern Indonesia: Interest in exploration has shifted eastward in the Indonesian archipelago to minimally explored regions east of Borneo, and in the Celebes and Western New Guinea areas. Makassar Strait exploration successes have ignited interest in Asia-Pacific deepwater.
  • Central Gulf of Mexico: The US, Mexico, and Cuba may share one of the most prospective areas on the globe. If drillers putting exploration wells down in 8,000 ft plus water depths can bring costs down, leases there may offer a payback in this decade.
  • Eastern Russia: Sakhalin development is just the tip of the iceberg for exploration potential in the Sea of Okhotsk. New exploration has been limited by the harsh winter environment and Russia's business requirements, but that situation may be changing.

Even when all other conditions are ideal, oil and gas producers don't explore in areas where extraction and transport costs are too high. At the same time, the earliest explorers often benefit from 'creaming,' the process of obtaining the most productive prospects before other explorers move in. It's still a high risk game.

Leonard Le Blanc