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Paying the price for service sector

Oilfield service companies' demands for higher costs could hit industry recovery

For months, oilfield services contractors have warned that they would seek higher prices for their services and that operators should expect to see some of their dearly loved cost savings begin to erode.

However, at least at this point in the recovery cycle, it is the service companies that are having to adjust their own financial expectations due to higher costs, and how long that dynamic lasts could have a big impact on the oil price recovery.

Major hydraulic fracturing and drilling services contractors have begun to warn the market that their first quarter results may disappoint investors because of higher spending associated with reactivating equipment.

The admissions do not mean that leading edge prices in the most active US basins, such as the Permian in West Texas and New Mexico, are not increasing because, anecdotally, fracturing prices have increased anywhere from 10% to 25% for the best equipment in the busiest places.

However, operators have not been forced to make similar statements regarding their own investment plans and financial results.

While operators tout their more efficient operations as a shield against higher well costs, it may actually be service companies that provide the near-term buffer to higher prices by rushing their equipment back to the field instead of waiting for higher service prices.

New and newly activated fracturing equipment is flooding into the most active basins, such as the Permian and the Anadarko basin in Oklahoma, which is home to the red-hot Scoop and Stack tight oil plays.

A new joint venture confirmed this week between Schlumberger and Weatherford is resulting in the reactivation of Weatherford's fracturing fleet, with capacity of around 1 million horsepower.

Also this week, Halliburton acknowledged that it was currently absorbing the cost of reactivating twice as much of its own horsepower than it had planned earlier in the year.

This comes on top of already-announced incremental equipment additions from smaller players in the fracturing market like Patterson-UTI Drilling, FTS International, Keane Group, and ProPetro.

On the drilling side, in addition to efforts by Nabors to get more rigs into the field, onshore giant Helmerich & Payne warned investors that it was incurring higher reactivation costs as it tried to put more rigs to work in an effort to keep market share.

But any relief given to operators by the newfound capacity in the service market — and the corresponding financial pain of service providers — is likely to be only temporary.

Once service providers reach their reactivation targets, they will look to recoup some of the expenses they incurred to get there, which ultimately means higher prices for operators.

Schlumberger's chief executive Paal Kibsgaard warned his customers of “an impending cost inflation avalanche coming from the service industry,” saying this “inflation will ultimately end up in the financial results of the E&P operators”.

A day later, Jeff Miller, president of rival player Halliburton said he sees “the best demand outlook” for the company’s services in any recent cycle.

While it may seem paradoxical that service providers would be the first to have to bend their financial expectations to fit with increases in their cost, operators have likely bought precious-little time before they too will have to figure out how to accommodate higher costs within their capital spending plans.

Whether those operators cut back on drilling to keep within their budgets or once again throw financial discipline to the wind and overspend could have a significant impact on US production and the trajectory of global oil markets.