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Oil services feel the squeeze as majors rein in spending

Scotland On Sunday

Published Date: 03 May 2009

Neither is likely to struggle even at today’s price of a barrel – a third of its $147 peak last summer – but the sharpness of the fall and the likely maintenance of the price in the $40 to $50 range for at least a year has focused minds on costs, investment and the companies’ ability to maintain dividend payments.

Over the past five years Shell’s chief executive Jeroen van der Veer has brought calm and consistency to a company that was scandalised by the misreporting of its oil and gas reserves and was subject to takeover speculation. His successor, the current chief financial officer, takes over a much stronger company but one that will require fewer people if he is to meet his investment goals.

Likewise, Tony Hayward, who was appointed chief executive at BP two years ago just as the price of a barrel was about to begin its record rise, is now assessing the results of a substantial cut in head count, a focus on simplifying the business and a downward drive on costs. 

Both companies are squeezing suppliers, renegotiating terms and prices in an attempt to maintain growth, but both have let their employees and shareholders know they are in for a tough period.

Some analysts question how they’ll meet their promised targets. Peter Hitchens at Panmure Gordon says in a newly published note that a combination of weak global demand for oil and rising inventories will keep the price to about $45 a barrel this year. While he is positive on the long-term outlook, he warns that the oil services sector is facing a less certain future. There are, he says, “growing concerns over the viability of many companies. The oil services companies will be hurt by the reduced capital expenditure from the oil companies. This will lead to lower revenues and a squeeze on margins, which will lead to a major reduction in profits.” In a generally downbeat recommendation, he says investors should sell Amec, Petrofac and Wood Group.

Hitchens has produced startling cap-ex figures showing how the current commitments will be tested by weakening balance sheets. The international integrated companies remain strong enough to increase capital spending from $124.2bn to $128.3bn, a rise of 3%. But the smaller companies will make some sharp reversals, including a 37% reduction by ConocoPhilips, 39% by Apache and 33% by Hess, producing an overall fall in this group from $108.1bn to $73.6bn, or 32%.

BP is alone among the big international integrated companies in that it is expected to cut cap-ex and has done so twice since publishing its year end results. “It needs oil at $60 a barrel to pay its dividend and invest in the business,” says Hitchens. Consistent with this group, Shell says it will slightly increase capital spending though Voser will be faced with cash flow from operating activities down from $16.9bn a year ago to $7.6bn.

Hayward has committed BP to at least maintaining the dividend but the expectation is that debt levels at all the majors will have to rise to maintain that same commitment to investment. As a result, gearing – net debt as a proportion of capital employed – will rise from 21% to 29%. Tony Shepard, analyst at Charles Stanley, expects Shell’s gearing to rise from 7% to at least 20%.

Optimists in the industry are awaiting a bounce in the price but it shows little sign of coming. Margins will be under pressure and there is an expectation that cuts in investment will be inevitable, leading to less work for the oil services companies.

One big problem for the North Sea in particular is that the oil majors are directing exploration investment to the Norwegian waters, where they qualify for a 78% subsidy. It removes a lot of the risk. Only where the oil is ready to come out of the ground is it fiscally advantageous to take the UK option.

The oil services companies are said, to some extent, to be still in denial about the prospect of a fall in investment. Most will adjust and are robust enough to do so. Hitchens says he does not expect large-scale layoffs as firms find it hard to recruit skilled staff again when the good times return. Nor does he see much scope for consolidation in this sector of the industry. “There will not be a wave of mergers as there was in the 1990s. Each company is a different proposition so there are few efficiencies to be gained.”

But he warns: “Next year could be painful if the oil price doesn’t recover.”

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