With Recovery Underway, Has Anything Changed in the E&P/OFS Relationship? Here We Go Again – David Yager – Yager Management
By David Yager, December 15, 2016
Oilfield Service Management Consulting – Oil & Gas Writer – Energy Policy Analyst
There’s has been a lot of talk about a new relationship between exploration and production (E&P) company clients and their oilfield services (OFS) vendors. As is often the case when the cash dries up, everyone has a lot of time to become introspective and realize how much capital was vaporized when everybody had lots of it. High wages. Cost overruns. Low productivity. Green people in key positions. Relentless capacity additions. Flying workers in from all over the country. Financial discipline out the window because getting the job done had become more important than if the investment actually serviced the capital deployed.
With the downturn well underway and clearly serious, many resolved to do things differently next time around. We all remember the bumper sticker. E&P moved from one-off wells all over the WCSB to multi-well projects that created economies of scale and operating efficiencies. Oil sands operators realized perhaps every piece of equipment did not need to be custom-engineered and fabricated. An existing design could suffice. Other jurisdictions like the North Sea were studied where squeezed economics demanded E&Ps adopt new business models. It revealed not every component of a production platform had to be specially-designed by the well-staffed engineering and procurement divisions of every oil company. Something off the shelf might actually work!
With recovery underway it’s clear nothing has changed. Except pricing. When oil tanked and overcapacity became clear, E&P took advantage of the marketplace and ground oilfield service companies down to cost or below. While there were more conversations about a new business model, mainly because people had more time to chat, it of course was entirely price sensitive. Prove to me you’ll work for nothing or less then you can have all my work. We’ll sort the details out later. Now that demand has risen beyond current capacity (mainly labor), prices are rising and the warm body scramble begins anew. If there’s something different please let me know.
Back when I had a real job (founder, director and president of Integrated Production Services Ltd. and predecessor OTATCO Inc., 1994- 2002) I figured the way to make more money for our clients and ourselves was integrated services. Hence the name of the company. Service bundling. We offered cased hole e-line, slickline and production testing. Give us all the services on the same completion and we would sharpen our pencil, cut costs, and share them with our client. Win-win deal.
For us, it provided reduced marketing, dispatch, logistics, administration and invoicing costs. Service bundling would generate real savings for the customer through efficiency, job execution and reduced back office invoice processing and payment expenses. Costs could be reduced further by doing more work for one customer on the same location instead of driving all over western Canada from job to job. Reduced safety risk, reduced mileage on the fleet, reduced driving time, reduced risk of an operational failure compensated by reduced invoices or eating rig time. As is always the case, the bulk of the savings are yours Mr. Customer. Just quit making us continuously turn over more rocks for the next job through selling and bidding then wait months to get paid for too many invoices issued to too many clients.
One of our board members, a successful oilfield services (OFS) entrepreneur who had spent many years as a wellsite completions supervisor for an E&P company said, “It will never work Dave. In the simplest terms, the customer can’t get as many baseball caps this way. They’ll never buy it”. And buy it they didn’t. Our sales guys didn’t like to cross-sell or upsell. The operations guys at the E&P companies much preferred to play God and reward their buddies. They really liked all the perks and attention that came from a large number of vendors with large expense accounts in the OFS sales community.
This is not to say that OFS sale reps are dishonest or the clients are on the take. Compared to 30 and 40 years ago, this business has never been more squeaky clean, particularly among the larger companies. Gone are the days of the late 70s when I used to drive from rig to rig in the middle of nowhere with a case of whisky in the trunk of my company car peddling the goodwill of my employer in every way possible and, too often, necessary. Today’s successful client/vendor relationships are for the most part built on good service and trust. Nothing wrong with that. That’s how most of us pick a tire store or auto mechanic.
However, there remains an enormous amount of purchasing authority vested in the drilling, completion and production departments of E&P companies, much of it not directly related to the primary objective of its existence. While the actual business is locating, extracting and selling hydrocarbons at a profit, along the way, one of the core skills of the bigger outfits has become purchasing and logistics. They have entire departments that do nothing else but decide who they want when they need it because, after all, they are very skilled and qualified at this process. The customer is always right.
Drilling for oil and gas and building oil sands extraction plants used to be black magic because everything was new. There was no greater pioneer in Canada to try new things than Imperial Oil (Canadian unit of Exxon-Mobil). Imperial forever came up with bright ideas of how much oil and gas they could extract if they just solved a few engineering and logistical access problems. Like the missing chunk of the Norman Wells oilfield that required ice-resistant islands in the middle of the massive and mighty Mackenzie River. Or horizontal drilling at Norman Wells to reach all of the field from the islands. Or injecting steam into the massive bitumen reservoirs at Cold Lake to help them yield commercial quantities of petroleum.
All of this was done 30 and 40 years ago with Imperial driving the bus because nobody in the service industry knew how to do it. The model of the integrated E&P company survived because as it found new sources of oil and gas it had to invent new and unique ways of getting it out.
A more recent example was George Mitchell and the Barnett Shale in Texas. Mitchell knew the gas was there but didn’t know how to get it out. He is widely credited with the concept of using multi-stage fracturing of extended reach horizontal wellbores to unlock shale gas and light tight oil in North America. Again, he was an E&P guy who had to invent things with the help of OFS because the equipment, procedures and technology to get the job done didn’t exist yet. All this happened in the last decade.
But is this still necessary in 2017? Aren’t at least some elements of drilling for oil and gas so simple and non-technical they could be outsourced entirely? As the industry ramps up for the winter and hopefully an extended period thereafter following a dreadful two-year and slump – and all the thoughtful conversations about new relationships between E&P and OFS – has anything changed? The question was asked repeatedly but never answered. What are oil companies good at, what are they not good at, and what should the oil company of the future look like?
The essential function of E&P is to find and produce oil and gas at a cost lower than the sale price. That’s it. This is the only definition of success for capital providers. Get hydrocarbons on stream and sell them for a profit. How is irrelevant. So how did procurement, logistics and dispatch become core skills?
In early 2014, MNP LLP did a labor study for the Petroleum Services Association of Canada (PSAC) which calculated the number of direct jobs to drill, complete and put on stream an extended reach, multi-stage fractured horizontal well in three major regions of the WCSB. To calculate the jobs the number of vendors from pre-drill lease survey to tie-in and fencing were counted. Most modern wells of this type require some 50 different vendors and that was only if all the rental equipment from matting to light towers to tanks all came from one company, which never happens.
What an oil company must own and control is the path of the horizontal drain hole through the geologically identified “sweet spot” of the reservoir and the method by which it is completed. All the technical specs including drilling fluid composition and deployment, hole size, casing/liner size, frac stages, multi-stage packer assemblies, frac fluid, frac density, frac stage volume, proppant size and volume, and post frac cleanup are the sole property of the mineral title holder. Whether or not the operator is good at this defines success which is reserves, production, recovery and return on investment.
But the reality is only a handful of the 50 vendors are involved in this key element of the process. The rest are all logistics and support vendors such as surveyors, construction companies, camps, wellsite trailers, rental equipment, cuttings disposals, frac fluid and tanks, lease cleanup and even fencing to the keep the cows out. So long as the client insists these are core functions that can only be successful managed internally, every vendor must have a sale rep chasing work in downtown Calgary or in the field and every operator must have somebody important on the payroll to listen to the pitch and decide who gets the work. Mountains of paperwork to follow.
The most illuminating aspect of the PSAC study was as much as 1/3 of the total labor commitment was trucking; hauling stuff to and from location. While transportation is essential, whether or not an oil company needs to dedicate its technical, procurement and administration departments to the non-science of hauling things around is one of the great unanswered questions of the last slump.
When multiple rigs are drilling in the same area for multiple clients, full trucks going in pass empty trucks going out on the same road all the time. Why? Regional cooperation using shared dispatch systems to find a lower cost back haul would benefit everybody. This a project an OFS vendor has been trying to develop and sell. But this would require the clients to a) realize and acknowledge there is a problem and b) cooperate with each other. The senior executives of E&Ps responsible for the overall return on investment too often don’t understand there is a problem, hence let operations do the job. OFS vendors trying to sell higher up the food chain in oil companies do so at their peril and risk punishment by the personnel they believe they need to circumvent to materially change the business model.
E&P companies have an obligation to recover the greatest amount of oil and gas at the lowest possible cost. For the past two years the lowest cost has been primarily ensuring OFS works for nothing or less. There has been no material change in the client/vendor relationship. What has not been sufficiently studied is changing the way oil companies do business by allowing OFS logistics experts do the simple stuff which is almost everything except the placement and characteristics of the producing wellbore. This is also a significant portion of the total cost.
What the conventional industry needs is dedicated expert third-party logistics consulting companies much like the Engineering, Procurement and Construction (EPC) outfits engaged for major oil sands and production facilities development. These outfits would operate on a regional basis ensuring optimal cooperation among customers and vendors on all the other stuff from rentals to wellsite to trucking. Customers would make more money by reducing total costs including staff. OFS would make more money by spending less time chasing sales, creating invoices and chasing down payments.
The upstream oil and gas business is elastic in the sense that the lower the cost of each well the more wells will be drilled. The amount of money available is finite and based on production, commodity prices and capital markets. The secret is to stretch the money further to get more production on stream, thus increasing the size of the total pie. If well costs were cut by half the number drilled would double. Production would grow accordingly yielding more cash flow for reinvestment. Both E&P and OFS would actually be better off.
Instead of grinding every single vendor and invoice down to the lowest possible price a new partnership between E&P and OFS would be beneficial to both parties. That will require oil companies to think and behave differently. Lots of talk but, tragically, very little action. Here we go again.
About David Yager – Yager Management Ltd.
Based in Calgary, Alberta, David Yager is a former oilfield services executive and the principle of Yager Management Ltd. Yager Management provides management consultancy services to the oilfield services industry in a number of areas including M&A, Strategic Planning, Restructuring and Marketing. He has been writing about the upstream oil and gas industry and energy policy and issues since 1979.