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Andrew Gould Speaks at 2009 CERAWEEK Conference
Managing the Service Industry in Today's Oil Market
Ladies and gentlemen, good morning, let me thank CERA for their invitation to be part of this oil plenary.
Those pundits who talked of a paradigm shift in commodity prices for oil and many other commodities have been proved wrong again. Today's lower prices for commodities generally, and for oil and gas in particular, are the result of shrinking demand. Exploration and production remains a cyclical industry with downturns that arise from a variety of factors that include oversupply, regional trends, and falling demand. It is important however to understand that while oil and gas are different, both require sufficient long-term investment.
The oil market is currently characterized by a number of factors that include declining OECD demand—which has been falling for three consecutive years; growing non-OECD demand—albeit at much slower rates than in recent years although growth will resume; limited growth in non-OPEC production, which in the current environment is likely to decline rapidly; and increased OPEC production capacity in a limited number of countries.
Natural gas markets are also characterized by a variety of factors. In North America, demand is currently weaker due to reduced industrial demand, but also because technology has boosted the capacity to produce shale gas cost effectively—compare the production from an original Barnett shale well to a horizontal well in the Haynesville today. North American production is also increasingly unconventional. In the rest of the world, natural gas demand is growing through the need for power generation in both developing economies and producing countries and I would point out that the "unconventionality" of the North American natural gas reservoirs today will be everybody's "unconventionality" in a decade or so.
Recent downturns in exploration and production activity have been characterized by increasing sharpness—faster declines followed by more rapid recoveries. The reasons include overall larger absolute demand—with small percentage changes meaning larger underlying numbers. Overall oil supply also suffers from an ageing production base, accelerating decline rates, as well as inconsistent and insufficient investment. The question that preoccupies us all now is not what will happen to supply but what will happen to demand. Stabilization in demand will be the precursor to a recovery in exploration and production activity and that depends on the state of the general economy. This is not 1985. There is no 15 million-barrel per day overhang of production, yet like the early 1980s the current collapse in commodity prices is being driven by a drop in demand.
In this climate, industry players will be affected differently. All operators will have to retest project economics. The spate of announcements around heavy oil projects are testimony to this. Major IOCs have the financial muscle to continue long-term development of complex, difficult fields. Resource-rich NOCs will continue life-of-field management of national assets. Resource-poor NOCs will seek to maintain exploration and development nationally and internationally as much as possible, independents will have more difficulty without strong financial reserves. Yet for all this, the most noticeable difference so far in this downturn is the speed of reaction among our customers to reduce activity. Here, the turmoil in financial markets is serving as an accelerator on activity cuts.
But I am really here to talk about managing the service industry in today's oil market.
The period 2004-2008 has been one of strong growth and Schlumberger has seen a compound annual growth rate of more than 20%. This means that we have had to manage a doubling in size with the creation of 35,000 jobs. The supply chain organization, capex expenditure program, investment in research and engineering and investment in recruiting and development have all raised significant challenges. Our customers scrambled to lock in equipment and trained people we simply did not have. As a result, the system created a great deal of its own inflation and inefficiencies not only, dare I say it, in the service industry but also in our customers' projects as witnessed by some of the extraordinary project overruns we have seen. The dilemma that we now face however is how to maintain a service industry that will support new increases in activity when demand returns and at the same time meet an acceptable level of shareholder return.
Our customers quite naturally want to reduce cost to reflect lower commodity prices and keep projects profitable and alive. They are all more or less brutal in the way they approach this and they will obtain lower costs. But although the total E&P investment has now reached somewhere between $350 and $450 billion, the inflation that I just mentioned has consumed much of that with little change in the underlying amount that has flowed into building hydrocarbon supply.
In measuring inflation, the CERA IHS cost index is the tool of choice for our customers' procurement departments. No index is perfect, and unfortunately for us they do not choose to take into account that it is not just a cost index but also an efficiency index as it reflects the quality of project execution and inefficiencies. While our prices have increased they have not done so to the extent the index indicates. I would also point out that Schlumberger no longer owns any offshore rigs—one of the cost elements that drives the index. A little more rigor in the index's description would be therefore welcome.
So how do we manage all of this? Well, if we are to have a chance of responding efficiently to the recovery when it comes, the service companies need to bear a number of matters in mind while managing the downturn.
First, the supply chain organization has had to become very savvy, very quickly in the past period of growth. We use a lot of complex parts and sub-assemblies in oilfield service equipment that must be sourced, qualified, manufactured, and deployed. Subcontractors are important, and it's essential to us that we help them manage the downturn almost as much as we help ourselves, otherwise the equipment needed in the future may not be available. We are therefore already actively monitoring the finances of some of our key suppliers of components and sub-assemblies.
Second, capital expenditure. The majority of service company capex is focused on new equipment for field deployment. Some of this is for replacement of existing equipment, some is in support of new products and services. Consolidation at the time of a down-cycle provides the opportunity to review the fleet and prepare for the next period of growth. At the same time, we can afford to be more economical in our use of capital because we are not rushing to bring a large amount of equipment to market to meet growth. Furthermore, inflation will be much less of an issue although this will take time to work itself out of the system. Finally, engineering and manufacturing can concentrate on reducing the cost of new equipment through design.
Third, research and engineering. Today's research and engineering provides the fuel for the technology of tomorrow. Nobody disputes that the age of easy oil is gone, and careful management of research and engineering investment is essential. This must be done globally, drawing on the expertise and talent of every culture. It must be done in partnership with operating companies and academia and we should not be frightened of maintaining a strong commitment. Schlumberger has traditionally not cut research and engineering expense during downturns, and we will not do so this time. This allows us to emerge from each downturn with a refreshed and stronger portfolio of products and services.
Fourth, industry consolidation. There will undoubtedly be further consolidation in the service industry as the down-cycle progresses. As margins thin the value of synergies increases and many small companies that were formed during the last five years will find refinancing difficult. Opportunities to acquire equipment at below asset value will arise, and interesting niche technology will become available at reasonable prices. We are already seeing considerable numbers of these types of transactions being proposed. It was a founding principle of the Schlumberger brothers to maintain financial independence through a strong balance sheet and it is at times like this that that principle pays off.
Finally, people. I mentioned that we have created 35,000 jobs. Let me be more specific. In the last five years we have recruited 11,613 engineers in 140 countries from 200 different universities. We have also recruited 8,574 field specialists. These are skilled workers performing complex well site tasks be they in stimulation, well testing, completions or other activities. In the same five-year period we have invested in two new state-of-the-art training centers with a capital cost in excess of $200 million and we have conducted over 1.3 million training days.
The cuts that we have recently announced therefore come after a period of tremendous growth, and it is natural to remove some of the excess on the basis of the quality of performance. At the same time however, we will need to continue some recruiting. We have all learnt the lesson of the 1980s when the lack of attention paid to hiring new talent left us with a missing generation of managers and experienced professionals, not to mention an exceedingly poor reputation on campus.
We also know that retiring North Sea or Alaska baby-boomers still have to depart in large numbers. Managing their retirement, while not cutting too deeply into the numbers of recent recruits, will be essential to having a qualified workforce when activity returns. If the investment in recruiting and training has been substantial since 2004, then the investment in retention must be just as substantial right now.
I have just a few more comments to amplify my earlier remarks. It is very easy to focus solely on demand. There are more than enough stories around—both factual and anecdotal—that crystallize demand weakness as a function of decaying economic performance. But I would say that focusing on supply is going to be just as important. We saw for the first time last November from the IEA the first comprehensive field-by-field study of decline in production of the world's ageing oil production base. Any significant and prolonged lack of investment in maintaining production, particularly in non-OPEC areas, will likely intensify that decline. In addition, new exploration, which will undoubtedly be curtailed in the short term, must continue if the industry expects to meet production expectations by the middle of the next decade.
In summary, I believe that we have all seen the effects of uneven management in past downturns—and this personally is my fourth—on the quality of services when growth returns. To be a service company with the necessary technology, equipment and above all people, requires a lot of hard work and some tough decisions while activity is declining.
Thank you very much.
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