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Service Cost Inflation Hitting Producers

As part of BTU Analytics’ continuing effort to monitor the effects of service costs on producer actions, today we examine service company data for 3Q’17. Last quarter BTU posted an article about how oil service margins had begun to rise from their lows of 2016. The most recent reporting for Halliburton (NYSE: HAL) and Schlumberger (NYSE: SLB) showed operating margins have now increased to 13%. For Halliburton, this is another significant rise, placing them slightly above their 5-year average of ~12%. While Schlumberger’s operating margin has increased only 2 percentage points since this time last year (compared to Halliburton’s gain of 8 percentage points), there is still likely room to run given the company’s  5-year average of 17%. The operating margins in the chart below show global oilfield services (OFS) for Schlumberger and North American OFS for Halliburton. While the global margins for SLB are not a perfect representation for activity in North America, the overall trends should be similar.

It’s one thing to see service companies reporting higher margins, however from a production and activity standpoint, the timing of the cost pressure and reaction from producers is of key importance. Through the first half of 2017, producers were generally quiet on service cost inflation, although this is starting to change.

With 3rd quarter earnings season underway, we are starting to see the impacts of these service cost increases on producer capex. Laredo Petroleum (NYSE: LPI) announced a higher 2017 capital budget of $630 MM, up from $530 MM due in part to cost inflation.   As additional earnings results are released, BTU expects to see more producers factoring in higher well costs to their forward-looking plans.

While service costs are only one factor in determining future producer activity, higher well costs may force additional discussion on capital discipline going into 2018, which could be a good thing for the overall supply and demand balance.

The chart above shows BTU Analytics’ oil production and drilling forecast (additional detail available in our Upstream Outlook service). Over the next couple of years, production is set to continue rising although a plateauing of drilling activity is expected. A rise in well productivity has allowed for higher production volumes with fewer wells.  While many factors drive BTU’s forecast, all else equal, a rise in service costs directly impacts economics, and the desire to keep service cost inflation at a minimum may help encourage the restraint needed to balance the market.

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