2017 was a weird year for oil services companyHalliburton (NYSE: HAL) . Even though drilling activity in North American shale roared back, the company's return to profitability took longer than expected because of some longer-term moves that management made.
However, with 2018 in full swing, the executive team at Halliburton thinks that the very moves that hurt the business last year will lead to a much, much better 2018. Here are a few of management's comments from the company's most recent earnings conference call that highlight how Halliburton expects 2018 to play out.
Bet paid off
Back in late 2016 and early 2017, Halliburton's management made a somewhat audacious move. With oil prices and drilling activity on the rise, it elected to bring a lot of its idle equipment back into service. In doing so, it incurred higher-than-usual costs, which management noted would significantly dent margins . But these actions were predicated on the idea that drilling activity would continue to grow and that the company could capture market share early, then gain back margin from a larger base later on.
It appears that move was well played as the company posted great results this past quarter compared to its peers. So, as you might expect, CEO Jeff Miller took a bit of a victory lap in his opening remarks about how this bet paid out nicely:
We recognized the changing market before anyone else, moved more quickly to reactivate equipment, maintained historically high market share, raised prices, and captured key customers before others could, a pretty tough task to pull off, and we did it.
Cost pressure increasing quickly
Drilling activity is still strong in North America thanks to oil prices above $60 and producers finding more ways to lower their per-barrel breakeven cost. This has been a boon for oil services companies as they deploy more equipment and put crews to work. For all this good news, though, such rapid growth is not without its downsides, like higher costs. According to Miller, though, that's a trade-off the company is still willing to make in today's market:
The frack calendar remained full due to the tightness in the overall market, but it came at a higher cost due to the increased idle time and mobilization required between jobs. I would rather serve our customers and capture revenue with temporarily lower margins than I would like as opposed to losing the revenue entirely.
One of the largest sources of cost inflation has been fracking sand. Producers and service companies alike have found that much higher amounts of sand in their fracking fluids improve well performance. As a result, sand use today is higher than in 2014, when there were more than double the number of rigs in the field. High sand costs have been a priority for management, and Miller believes Halliburton has some ways to mitigate those costs:
[W]e also saw cost inflation in sand and trucking. The price of sand escalated over the last few months of 2017, but I believe the increasing sand capacity, particularly from localized mines, combined with our supply chain strategy, will reduce the cost throughout 2018. Trucking is tight across North America and is particularly tight in areas like the Permian, where activity is strong and locations are remote.We believe our increasing use of containerized sand will help mitigate trucking inflation by reducing the required trucks per well site and demurrage. Now, these headwinds were anticipated, are transitory, and are not a surprise at this point in the cycle.
Still room to run
All of the things mentioned above sound good, but when there is talk of things like capacity constraints, it suggests a company could be at its peak. According to Miller, though, that isn't the case. While the company may not be as generous with adding new capacity to the market, there is still some room to increase revenue with excess capacity.
We have a set criteria, it's return-driven, and we follow that criteria. That criteria was met in the fourth quarter, and we delivered a handful of spreads to the market. This additional equipment, along with our existing equipment, maintained market share, improved our margins, and generated industry-leading returns. But let's get some perspective.We still have less equipment in the field than we did at our peak in 2014. You know I'm committed to leading returns. We build our own equipment. We manufacture faster, cheaper, and with less lead time.
Increased activity might not mean better returns outside the U.S.
Over the past few months, we have finally started to see drilling activity across the world start to pick up. Certain pockets of the market have been better than others (the Middle East and the North Sea, for example). While that sounds like great news for Halliburton and others, Miller noted that investors should temper their expectations for now:
When I described green shoots [in the international market], I'm talking about activity, but that activity is spread thinly. The -- a lot of capital available in the marketplace. And because this activity is spread thinly, it doesn't create the type of tightness for a price inflection. And then the concessions given were significant, and in some ways, continuing into 2018.Some of those haven't even been implemented. So look, trust me. My tone has changed, and I see price inflection, but I don't think it's until later '18. And certainly, it -- we'll see it in '19.
The things that Miller is saying here make the international market sound a lot like the North American market 18 months ago. While there is interest in adding capacity, there isn't enough to sustain all players in the market. This leaves Halliburton with a choice. It can elect to pursue the same path it did in shale and shun margins for market share, or it can take a more measured approach and focus on generating some form of pricing power.
The difference between North America and the rest of the world is that Halliburton doesn't have as many embedded advantages internationally as it has stateside. As large as Halliburton is, Schlumberger dwarfs it in the international market and has many more inherent advantages there. That's not to say that Halliburton can't pull it off, but it will be harder to do so.
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