Oil-Service Firms Feel the Pinch of Megamergers

Crude prices have finally bounced, but now mergers among big oil firms threaten service providers' health.
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Little has been going right for oil-service firms lately.

First, they suffered through months of depressed oil prices. Now, just as prices have finally begun climbing, big oil producers are merging, forming behemoths with the clout to demand pricing concessions from the oil-service providers.

Just last week,

Atlantic Richfield

(ARC) - Get Report

agreed to be acquired by

BP Amoco

(BPA)

for about $26 billion, creating a supermajor oil company. (BP and Amoco only recently closed their own merger.) The Arco deal comes on the heels of

Exxon's

(XON) - Get Report

agreement to buy

Mobil

(MOB)

, creating another goliath.

Driving the merger craze is big oil's need to slash production costs. Combined, the major oil firms figure they can reduce overhead, gain economies of scale and make bigger exploration bets. With size also comes the power to push down supplier prices. Giants in the new supermajor tier are sure to try to squeeze oil-service firms dry in an effort to polish their own earnings.

Big mergers "aren't good for us for a lot of reasons," says Steve Manz, director of investor relations at drilling contractor

Noble Drilling

(NE) - Get Report

, which provides drilling services for oil producers. The industry "won't see a lot of new drilling by the combined company, and that's not good for any service company," he said of BP Amoco's proposed linkup with Arco.

Even in the short term, the mergers depress activity in the oil-service sector. BP and Amoco have been concentrating on completing their merger rather than on examining new drilling opportunities, says Manz. And the oil-service industry can likely expect more of the same as Arco joins the London-based firm's fold. That means there won't be a lot of activity coming out of the new company -- and that's bad news for oil-service providers.

Some segments will be hit harder than others as big oil concerns consolidate. The drilling segment, for instance, is still fragmented and highly susceptible to price competition, making it easy for giant customers to play competitors off against one another. And big producers could win volume-based cost savings on supplies such as drilling bits and fluids.

To be sure, some oil-service providers are better positioned for this new era than others.

"The company that has the right technology can charge more," says one manager at a major oil-service firm who declined to be identified. For instance, a technologically advanced provider potentially can deliver more oil from a well even if it charges more, effectively making its services cheaper.

Schlumberger

(SLB) - Get Report

, for instance, is often hailed for its technology.

Globally oriented service companies also will be better situated after the mergers shake out, this manager says, if only for the simple reason that they offer one-stop, one-contact shopping. An Exxon-Mobil or BP Amoco-Arco may decide to consolidate several service providers to just one, or possibly two, as part of a re-evaluation process.

That's partially why 1998 brought merger fever to the service industry as well.

Western Atlas

merged with

Baker Hughes

(BHI)

and

Dresser Industries

merged with

Halliburton

(HAL) - Get Report

to compete around the world with Schlumberger.

"At the end of the day you can have a lot of companies trying to get paid, or one large company that offers a suite of services trying to get paid," says the oil-service manager.

Companies with niche positions also may fare better. For example, oilfield-equipment manufacturers, which have only a few product lines and operate on a smaller scale than the Schlumbergers and Halliburtons, may face less pricing pressure. Only three or four companies manufacture products that compete with those made by

Cooper Cameron

(CAM)

, down from six or eight just over a decade ago, says Scott Amman, Cooper's spokesman.

So if you're looking for a part for a pressure-control system to be installed in 5,000 feet of water, "you're probably going to Cooper, to

FMC

(FMC) - Get Report

or to

Vetco Gray

," a division of

Asea Brown Boveri

, the spokesman says. "It's not like we have to be bigger to get Mobil or Exxon to recognize us." What has hurt Cooper's business more than recent mergers is the decline in activity stemming from low commodity prices, he says.

Yes, the bad news is that the drillers and service companies have lost a customer in Atlantic Richfield, says Bill Provine, a spokesman for

Rowan

(RDC)

, but there is some good news. When BP Amoco and Arco merge, the combined company is expected to shed assets worth $3 billion -- a boon for independent oil companies looking to grow. These independents are likely to drill immediately, Provine says. In addition, the independents will have access to qualified, experienced industry workers when they lose their jobs, Provine says.

More problematic for the drilling industry would be if the newly merged companies consolidate or seek to cancel current drilling contracts.

For now, oil-service providers are just getting ready for this new age. At Noble Drilling, the marketing team is trying to come up with new and "more anticipatory" methods of positioning itself in the developing hierarchy of oil companies, says Manz, the spokesman. In an industry rife with change, other drilling and service firms would be wise to follow its lead.