NEW YORK (
on Wednesday released 2012 guidance that implied
the driller had gained the upper hand against oil service companies in the pricing battle.
But there are at least seven factors that could keep the pricing erosion in the oil service market from being a worst-case scenario for stocks.
1. The pricing trend is already lower and that's not going to surprise anyone, and it already has led to multiple compression in stocks in the sector.
Look at Halliburton, considered among the better insulated of the oil service companies, both for its global reach and it "tier 1" status among land drillers. After a slide to end 2011, Halliburton shares have been priced at a level that harkens back to the financial crash and oil heading down to $40.
"I wouldn't say Halliburton loses its pricing advantage," said Stifel E&P analyst Dan Guffey.
Pricing erosion is coming for oil service companies, but they may be better equipped today to handle pricing shocks.
"Halliburton is somewhat better insulated, but no one is immune," added Stephens oil service analyst Michael Marino. During the last down cycle of 2008-2009, Halliburton's margins went down a lot, but still held up better than many peers. As companies relent on pricing, utilization becomes more important, and Halliburton has the advantage over many smaller peers by this metric.
2. The Goodrich outlook is based on the economics of the Eagle Ford where the pricing pressure started earlier than other drilling regions.
Many of the service providers have migrated to the Eagle Ford from the Haynesville drilling play in Texas as the natural gas-heavy Haynesville has become uneconomic for most drillers -- paying more to take natural gas out of the ground than they can get for it in the spot market doesn't make sense.
"I think the biggest cost reduction is for the lower end of the pressure pumping services, all the guys coming in to the Eagle Ford to frack wells and getting lot lower bids with rigs moving from the Haynesville," Guffey said.
Yet Marino cautioned that just because the migration from Haynesville to Eagle Ford has been going on for over a year now, there was a backlog of activity that kept frac equipment in the Haynesville and the migration trend may have picked up. "Equipment chases returns just like the money. The Haynesville is the most dramatic example and it's less pronounced in more oily basins, but over time, all the wheels will chase return," Marino added.
3. There's an important distinction to be made between long-term contracts and spot pricing.
Halliburton bulls make the case that the long-term nature of a majority of the company's contracts insulate it from the fears of a rollover in the pressure pumping market. Yet even though the difference between long-term and spot is key, there are still oil service companies with long-term contracts that take a fair share of spot work each month. "A pressure pumper could have 20 days a month of long-term contract work and 10 days a month of spot work, and that's still a lot of work outside the contract," Marino said.
4. Pricing on contracts could go down more than expected but utilization rise as E&P companies add stages to the drilling for each well.
It's a trade-off between pricing and volume.
5. Previous periods of the pressure pumping market may no longer reflect the current volatility level in the North American drilling market.
The North American market is moving away from natural gas and to more liquids-based "oily" plays and with crude pricing where it is today -- above $100 -- even a pullback in crude would not lead to a slowdown in drilling activity. Even if crude pulls back to $85 it would still be economical to a driller -- analysts say crude pricing would have to fall to $70 or below before the wells would stop working. North America is more of an oil market now than it has been in 30 years and that should bring less volatility -- even though oil is a volatile commodity -- because it is a global commodity.
6. The market may be more sustainable than it used to be.
Margins have been hit across the oil service sector and may take further damage, but unlike previous periods activity won't go away completely as more integrated oil majors and companies with strong balance sheets buy out the highly levered small independent E&Ps.
last year and
. This week,
two of the latest deals between U.S. E&P's and foreign, big balance sheet buyers.
"There will be oversupply in certain product lines and pricing coming off in pressure pumping but I don't think the investor community understands or fully believes the potential for sustainable drilling in North America because it has been hyper cyclical," said Marino.
"Stocks are going to see margin compression because of the pricing coming in but the flip side is maybe investors pay more on a multiple basis for more sustainable earnings stream because of the nature of the drilling plays and bigger players in there who don't turn wells on and off. The historical natural gas cycles are over," the analyst said. And that's the real issue which will play out in stock multiples.
7. As the historical hyper-cyclicality of the North American market ends, investors still don't have a clear idea of how the current supply/demand balance in the equipment markets plays out.
It's how much more equipment and how much more efficient that equipment is that is still being worked out and reflected in the commentary from Goodrich. In the least, it's something to monitor as more E&P 2012 guidance is released, for both opportunity in E&Ps gaining higher production on lower cost and potential trouble in oil service stocks whose multiples may not be discounted enough.
-- Written by Eric Rosenbaum from New York.
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