Looking toward 2019, as WTI enters bearish territory in a similar fashion to late 2014, we assess the current state of the oilfield service (“OFS”) market and offer ways to position your company for what’s ahead.
While it’s impossible to predict future commodity prices and the corresponding impact on energy industry activity, it’s worth noting the similarities in commodity prices of the past few months to those at the beginning of the downturn in 2014. Will the delayed drop in rig count of early 2015 play out in 2019? Despite the similarities in the early stages of these cycles, there are differences in the current environment that are worth noting and some of which are addressed below.
Company Performance: Trailing earnings performance for many segments of the oilfield service industry is favorable, yet given the capital intensity, free cash flow remains elusive. Further, capital deployed prior to the downturn hasn’t achieved a sufficient return, thus thwarting the ability for even performing players to attract new capital for growth.
Public Equity Markets: WTI and oil and gas share prices across the value chain, specifically the oilfield service sector, have meaningfully decoupled since 2014, further illustrating institutional investors' skepticism of OFS opportunities.
Private Equity (“PE”) Markets: Generalist investors who previously ventured into OFS have largely avoided new investments. As a result, the universe of OFS PE investors is limited and focused on specific segments.
Debt Markets: The debt markets for oilfield service companies, specifically in the middle market, continue to be thin or nonexistent, which has inhibited growth capital expenditures and capped transaction multiples.
M&A: The current OFS M&A market is active, but a bid-ask spread persists. There is a large backlog of sell-side participants in the OFS market vying for buyer attention, while M&A transactions with high quality companies continue to be completed.
Bankruptcies: While bankruptcies in the oilfield service space have returned to normal levels, companies with capital structure issues are often pushed into sale or merger processes by debt providers seeking to return capital, many times flushing equity in the process.
Capital Discipline: E&Ps are hyper-focused on investor driven capital discipline and cash flow generation, instead of production growth.
Standard Hedging Requirements: Investors and debt providers across the capital structure are seeking to mitigate risk by locking in cash flow through required hedging programs.
OPEC Production: OPEC+’s recent meeting in Vienna ended with an agreement for a 1.2mm bbl/d production cut to remove excess supply in the market, however, individual country positions remain in flux. Questions persist if cuts will be enough to offset increasing shale supply. So far, the market isn’t convinced, as prices remain depressed.
Industria Views
As commodity prices fall further and / or stay lower for longer, options, flexibility and control become increasingly scarce - early acknowledgment and action are critical to sustainability and positioning for the next upcycle. Below we highlight a number of proactive strategies to enhance company positioning and flexibility that can apply at any point in the cycle.
Debt Renegotiations (Capital Advisory | Restructuring): Companies with positive trailing performance have a finite window to negotiate with debt providers to reassess credit limits or push out maturity dates to alleviate potential leverage issues and provide additional liquidity and flexibility.
Recapitalizations (M&A | Capital Advisory): Despite inferior values to recent highs, top quartile-type companies with tangible growth opportunities, either organic or inorganic, continue to have access to capital to consolidate during market weakness.
Divestitures / Closures (M&A | Restructuring): Non-core asset divestitures or unprofitable division closures provide a pathway to concentrate resources, capital and management focus on higher growth, higher margin core service offerings.
Cashless Combinations (M&A): Scarce external capital does not preclude companies from exploring strategic mergers that favorably combine geographies, services, and / or customers to gain scale and operating leverage.
Irrespective of market direction, these strategic considerations have merit in fortifying companies to withstand uncertain conditions and position them for the next upcycle. Our best advice is to get prepared and take action – waiting and hoping for a peak to do so is risky and costly.
We hope you find this piece insightful – please feel free to contact anyone on the Industria team – we would welcome the opportunity to discuss our viewpoint.
About the Firm
Industria Partners provides focused strategic advisory services to energy companies at every point across the business cycle. Through industry connectivity, transaction experience, and expert execution, Industria delivers superior outcomes to its clients.
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