M&A outlook for the global Oilfield Services (OFS) sector
In the film comedy ‘Groundhog Day’, the actor Bill Murray is forced to wake up and relive the same day multiple times. At first he is bewildered by the element of repetition. He then capitalises on it to indulge his own gratification. And finally, he uses it to change and make himself a better man. Whereupon the curse is lifted and he is able to wake up to the following day. There is an element of this déjà vu with the global oilfield services (OFS) sector. For decades the supply chain has navigated business upturns and downturns with a certitude of what the cycle brings. Upturns would see profits grow for the service companies as margins charged to operators rose. Downturns would see operators negotiate aggressive discounts from the service providers. In turn OFS would innovate and develop more agile business models to respond to these market changes. And so the supply chain would weather the storm in the knowledge that when the upturn came, margins would recover as quickly as oil prices rose. Moreover, during previous major downturns when there was a feeling we had reached the trough, we would see increased deal activity levels across oil services, as players acquired competitors to gain scale and deliver synergies. In a sense, a little like the lead character in ‘Groundhog Day’, you knew what would happen next.
However, this time round – things are different. The world OFS companies now operate in has changed. Operators have shifted their focus, meaning OFS companies will need to tailor their service offering in response. Also a high oil price upturn (such as US$70/bbl+) can no longer be an assumption underpinning business plans. Furthermore, and perhaps more saliently, while we are witnessing a wave of asset deals sweep across the upstream oil and gas segment in recent months, this time round - global OFS M&A waters have been somewhat calmer. Despite the occasional headline grabbing transactions at the top of the services pyramid (GE Oil and Gas merging with Baker Hughes for example), significant deal activity across the whole value chain has yet to be realised. Why is that? Either way, if OFS companies are to survive and prosper in a low oil price world that is different to previous decades, they will need to reset their businesses, innovate and demonstrate a level of agility like never before.
Before we consider how the M&A landscape might evolve across OFS, it is important we briefly reference the macro trends shaping the sector, as they will ultimately determine how deal activity may develop. In many ways, the world in which OFS companies operate has changed since the oil price decline which started in June 2014. It is clear we are now in a lower oil price world. Unlike in the past where the supply chain could assume a recession would be followed by the cyclical steep oil price recovery to rescue margins – this is no longer the case. Facing the risk that prices remain low (underpinned by an over supplied world with weaker demand), senior OFS executives will need to reset the operating model to reflect a US$40-50-60/bbl world in order to succeed.
Equally the supply chain’s clients, the operators, have changed many of their areas of focus. As illustrated in Exhibit 1, IOCs are shifting the operational focus from exploration to production and are under pressure to deliver a return on investment more quickly for example. Moreover, given how much oil prices have plummeted, existing operators (and for that matter new operators) are heavily focused on cost reduction and this is likely to continue for the foreseeable future, which suggests OFS margins will remain under pressure going forward in non-core regions. As the Halliburton CEO, Dave Lesar, stated recently, “The headwinds we faced in the international markets in 2016 still persist, and we do not expect to see a turn until the latter part of the year. As a result, we will continue to control our costs.” Similarly in a recent trading update, the Wood Group stated, “The oil & gas market has continued to present challenges and as expected, year to date performance is down on 2016…overall we are seeing lower activity and the impact of competitive pricing on contracts renewed over the last 18 months.” In short, as the focus of operators is changing, so OFS will need to tailor its service offering, adapting to the needs of operators, rather than riding the cycle in the hope of a stronger oil price recovery.
Halliburton CEO Dave Lesar, Q4 2016 Results – earnings transcript
 Wood Group trading update10th May 2017
As already described in one of our earlier publications, overall activity levels in oil and gas M&A transactions remain high. The total volume of ‘Pending’ deals (announced deals but not yet completed) and ‘Completed’ remained robust in Q1 2017 reaching some US$126bn (see Exhibit 2).
 See our publication Upstream Oil and Gas M&A – a Window of Opportunity…and Risk
In the upstream sector the bulk of these deals are asset based (recent examples include Shell’s North Sea divestments to Chrysaor and Engie’s assets to be divested to Neptune). Aside from Shell’s acquisition of BG Group, there have been hardly any major corporate plays. That said, in global OFS there have been some corporate transactions but these have been at the rarefied top end of the OFS universe. Some of the larger OFS companies (as shown in Exhibit 3) have pursued M&A strategies targeting specific capabilities, such as industrialising digital innovation (GE Oil & Gas and Baker Hughes), or focusing on subsea capabilities (the FMC Technip combination) and in the case of Wood Group merging with Amec Foster Wheeler to deliver a geographic and service line diversification and achieve cost synergies.
Nevertheless, the reality is the majority of the OFS sector, which is made up of a very diverse group of players from mid-tier to smaller companies, has seen limited deal activity. A number of factors have hampered M&A including the fragmented nature of the sector and the lag effect of the downturn which continues to impact OFS segments at differing rates. So for example, onshore drillers focused on unconventionals in North America are currently well placed to meet strong demand. In contrast seismic companies remain in a state of siege as they face reduced exploration spend across operators and some offshore drillers are forced to bid for loss making work to keep rigs active.
So looking ahead how do we see the OFS landscape evolving in terms of activity levels?
Firstly, in contrast to upstream oil and gas where we already see the green shoots of a broader business recovery, we do not envisage significant recovery momentum for OFS until the end of 2017 or early 2018. Overall upstream capex is forecast to recover gradually in 2018 (see Exhibit 4) with some regions benefiting from increased spend such as North America and the Middle East. The OFS recovery is likely to mirror this capex upturn, with different regions moving at different rates, with the North Sea for example remaining challenged in the short to medium term.
Secondly, as we described in a previous paper, the upturn will be lumpy and uneven for OFS, with some segments being early beneficiaries of the upturn and conversely other segments taking longer to see the recovery. The fragmented nature of OFS will further hamper a recovery.
As for future drivers of M&A, it will be less driven by a recovery in market fundamentals. In previous downturns deal activity in OFS was underpinned by big balance sheets riding the cycle, grabbing M&A from weaker rivals. Now OFS companies need to develop a new service offering and once this portfolio is ready, this in turn will drive M&A.
We believe moreover, a key driver for M&A will be specialty plays around technology, geography and innovative service offerings. In other words companies that offer a differentiating capability in one or several of these areas will be well placed to acquire or merge with other companies.
As for Private Equity, always a useful barometer for investment appetite, they are likely to play an active role in OFS M&A. However, while PE will be looking into potential deals, they are unlikely to be as active as in upstream until there is a clear line of sight on a recovery in specific OFS segments. Furthermore, PE is likely to have a very narrow focus, targeting OFS companies with technological differentiation, strong project pipelines and quality assets. In short, PE is likely to be more cautious with potential investments, until there is more traction in the market. Moreover, PE and other investors will need to avoid the temptation of rushing into this sector as the upturn builds momentum. Given we are unlikely to see the kind of oil prices that delivered the healthy margins of the past, investors should be wary of over paying for assets, however attractive they may seem.
 See our publication A Sea Change: Emerging from a Downturn
But it is difficult for companies to position their businesses for increased deal activity, while the sector is still buffeted by the headwinds of financial distress. So what should OFS players do? The answer is simple. They need to review their operational, financial and strategic imperatives to ensure their business model is fit for purpose.
As part of this exercise the supply chain needs to address some core questions:
The net result of all of the above is OFS companies will need to look outside their traditional business areas and innovate. For some companies this degree of business transformation will not come easily to them. Let’s take a hypothetical example to illustrate the point. OFS companies may need to help upstream operators modularise project delivery. In the past, OFS companies may have been required to deliver massive projects, with significant upfront capex spend, designed to deliver cash flow in the longer term with high returns. Now OFS will need to help operators deliver projects in smaller modular stages, where the kit is standardised, cash flows are delivered earlier in exchange for lower returns. In short, OFS companies will need to adopt new thinking, explore risk sharing models and pursue greater industry collaboration.
So with a prolonged period of depressed activity levels ahead of us, underpinned by an unpredictable and lower oil price, OFS companies have a window of opportunity to get their house in order. Now is the time to reshape the business and rethink operational, financial and strategic imperatives to reflect a different operating environment. Those companies that can transform their business to deal with the challenges of the new world will be ideally placed to benefit from consolidation when it comes. Much like the Bill Murray character, they will change for the better and rise to embrace a new world of opportunity. In contrast those players counting on a cyclical oil price recovery to rescue them will be doomed to repeat the errors of their way and likely not remain in business for very long.
Adrian Del Maestro
Director of Research, Strategy&, PwC United Kingdom
Tel: +44 7900 163558