Ladies and gentlemen, good evening.
My thanks to Bill Herbert and Simmons and Company for the invitation to return to Scotland.
Two years ago at this conference we spoke about the market turmoil and short-term uncertainty that the industry was about to face. This evening I would like to look at the future by discussing the markets for oilfield services and how we have been positioning Schlumberger to benefit from those markets.
I plan to spend about 15 minutes on prepared remarks before opening up a question-and-answer discussion. Scott Rowe, president of the Cameron Group at Schlumberger, will join me and we hope that this format will allow us to spend more time on what you'd like to know.
First, some legal information. Some of the statements I will be making today are forward looking. These statements are subject to risks and uncertainties that could cause our results to materially differ from those projected in these statements. Therefore, I refer you to our latest 10-K and other SEC filings.
The current downturn, which is now nearing the end of its second year is the most severe in 30 years. Competing sources of supply from and within OPEC, combined with North American unconventional production led to a market low of $27 per barrel for WTI last January.
Prices have now recovered to levels close to $50 per barrel for both WTI and Brent. And while supply disruptions in Canada, West Africa, and Iraq undoubtedly contributed to increasing prices these effects have now moderated. On the downside, however, increasing stock levels and concerns about demand continue to exert pressure on oil prices.
A number of key producing countries lie at the center of the supply-demand balance. As Iran seeks to further increase production, Saudi Arabia continues to boost its own production in defense of market share. Russia continues to produce at high levels, which is in contrast to a number of producers including China, Venezuela, and Mexico who are suffering from the falling investment due to low commodity prices. Declines in these and other countries are in addition to the dramatic 600,000 barrel year-on-year drop in shale oil production in the United States.
Most sources of supply growth remain in the Middle East and, despite new capacity being brought on line, OPEC spare capacity has now declined to some of the lowest levels we have seen for eight years. This puts worldwide supply at increasing risk of disruption from geopolitical or other events.
Taken overall, we believe that the macro view of supply continuing to tighten remains valid. With demand holding steady, markets are moving closer to balance by the end of 2016 supporting what we have called a medium-for longer oil price environment. This is further supported by the continuing but slowing increase in crude oil and product stocks that will temper near-term increases in oil price.
As a result, it is too early for any improvement in price to affect E&P investment levels as operator confidence and balance sheets must first be repaired. This leaves the service industry in critical condition with billion-dollar write-downs and a number of companies in financial distress if activity does not pick-up rapidly.
With the medium-for-longer oil price outlook we have made our case for the industry to change the way it works. There have been positive developments in well design and costs that are improving drilling and completion efficiency. Some of these cost reductions are structural and therefore sustainable, while others are not. Let's take a closer look at these.
On land in the US for example, it has been estimated that the cost of the average well for unconventional resources has fallen by 40% since 2014. The reasons for this are a combination of changes made by the operators and the pressure that has been brought to bear on the service industry.
The effect on production has been boosted by increased well design complexity from, for instance, drilling longer laterals with more hydraulic fracturing stages and from executing larger fracturing jobs by using more sand. Changes such as pad drilling with easily movable “walking” rigs, choosing the best acreage to drill, and using the most efficient rigs with the best crews have all lowered overall cost.
The service industry has also lowered its cost base. Using the most modern fleets, operating 24/7, consolidating infrastructure, and employing multiskilled crews have all helped. But one of the largest contributions has come from the service industry's acceptance of lower pricing. This has now come to a point that parts of the business are financially unviable.
With the price of oil having nearly doubled since the start of this year, the service industry must now seek to increase price to restore the financial viability it requires to develop and deploy technology, maintain its geographical footprint, and preserve its technical expertise. At Schlumberger, we have already shifted our focus from managing our performance in the downturn to recovering temporary pricing concessions and renegotiating contracts that have become financially unviable.
However, with oil prices likely to recover to lower levels than before, well costs cannot return to previous levels. Recovery of service pricing must therefore be accompanied by transformation to lower total cost.
We maintain that greater integration of process and workflow between operators and the largest service companies backed by new collaborative business models can provide the necessary framework. New levels of commercial alignment will more than offset the price recovery that the service industry requires and will lead to further potential savings in land well costs.
Contrary to land well construction, deepwater operations are characterized by bespoke solutions. Every project is different and there has been little early supplier engagement nor much standardization, simplification or industrialization in the approach to designing and building the complex infrastructure required. This has escalated cost over the years rather than removed it, and the level of regulatory change that has been layered on top has led to further increases.
However, some costs have been reduced both by efforts on the part of the operators and by lower service industry pricing, while the largest contribution has come from significantly lower deepwater rig rates as well as from commodity prices such as steel. While all three of these actions work together to reduce costs it’s important to remember that they do not do so in a uniform way across countries, plays, or projects.
At the same time, service pricing has come under pressure but the complexity of deepwater and the need for high technology have meant that prices have fallen less than for land operations. In spite of this, the service industry must still seek to reverse those concessions granted during the depth of the downturn in order to preserve the ability of the industry to produce the vital deepwater supplies in the future.
With some deepwater operators now beginning to seek supplier-led solutions, earlier supplier engagement, and increased levels of integration and collaboration, an approach to lowering deepwater well costs to more sustainable levels is perhaps beginning.
US land and deepwater represent just two examples of how well costs may be lowered. They are not exclusive and each resource will be required if the industry is to meet future demand although deepwater activity will take longer to fully recover. While they differ in how their savings may be achieved, they both depend on greater integration and collaboration.
Greater integration and collaboration are particularly key to the success of offshore operations. Within this area, increasing the integration of technology from surface to subsurface is essential. This was very much part of our rationale for acquiring Cameron and we are well on track toward integrating Schlumberger reservoir and well technology with Cameron wellhead and surface equipment, flow control, and processing technology.
As Scott Rowe is with us today I will leave the more detailed discussion to him in the question-and-answer session. However, I would like to run through some of the key achievements we have made since the acquisition closed in April this year.
We realized $52 million in synergies in the second quarter of this year. We also booked $125 million of new orders, which is the direct result of integration synergies. This keeps us firmly on track to achieve the $300 million in synergies that we announced for year one, and the $600 million for year two.
The operational, engineering and manufacturing footprints of Cameron and Schlumberger have enabled us to co-locate more than 85 facilities across the world so far. This will drive further synergies as well as the development of our integrated surface and subsurface technologies in both drilling and production systems.
The early benefits of this can be found in the research and engineering projects that have already been sanctioned. These are wide-ranging, covering development of products and services for drilling and production applications in both conventional and unconventional resource developments.
Our proforma financial statements show the progress we have made. Cameron's pretax operating margin is near its all-time high despite the market, and their corporate and interest expenses have been lowered. Revenue synergies and associated operating income will become visible in late 2017 as new orders are delivered and new services introduced.
I would now like to turn to the outlook for our business in the third quarter.
By geography, many of the trends of the second quarter continue to affect our activity.
In North America, service pricing in most basins for a number of services remains at unsustainable levels. While an increase in the price of WTI has led to more operator confidence and a continuing increase in land rig count, this has yet to have a meaningful effect on pricing.
In Latin America, activity in Venezuela continues in line with collections while activity in Mexico remains low, with increasing seismic acquisition activity as a result of the new licensing rounds unable to offset lower rig operations.
In the Europe/CIS/Africa Area, projects continue to be delayed in Sub-Saharan Africa while activity in Russia has remained seasonally high during the summer.
Activity in the Middle East & Asia Area remains more or less flat, as robust activity for all product lines in the Gulf GeoMarkets largely offsets budget and project cuts in Asia.
Looking now at the third quarter by Group, we expect Reservoir Characterization to be almost flat sequentially despite increased activity and multiclient sales for WesternGeco in Mexico & Central America, land seismic surveys in Saudi Arabia, and the ramping up of Early Production Facilities in Kuwait for Testing Services.
For the Drilling Group, we see slightly lower results as further declines in deepwater activity in West Africa, Brazil, and Asia affect the Drilling & Measurements and M-I SWACO product lines. This weakness will only be partially offset by increasing Integrated Drilling Services activity.
Production Group will be flattish because lower stimulation vessel activity in Mexico and end of season fracturing campaigns in Alaska will be offset by an increase in USL activity.
As mentioned during last month's earnings call, the Cameron Group contributed revenue of $1.5 billion while generating pretax operating margin of 15.8% in the second quarter. However, with decreasing OneSubsea and Drilling equipment backlogs, revenues and margins will be lower in Q3.
Looking further ahead, I would like to take a minute or two to describe how we currently think the market recovery will look.
As in the past, this will not be a uniform process, neither by geography nor by group. In fact, we expect recovery to be by resource type driven by the sustainability of the price of oil. In adopting this approach, we will be able to focus on the investment needed in each business unit in terms of capex and human resources.
Drilling and completion activity has already begun to recover on land in the US. Next, we expect to see a return to conventional land drilling internationally, followed by a recovery in shallow offshore waters, deeper offshore areas close to existing infrastructure, and finally a more complete deepwater recovery that involves new projects reaching FID and a return to exploration activity.
Translating this into recovering activity for each of our groups, the Production and Drilling Groups will both respond in line with increasing rig count although the Production Group will also benefit from rigless activity and from increasing SPM activity worldwide.
The Cameron Group will be impacted by the declining backlog for OneSubsea and drilling products with fewer orders expected for the next 18 months. At some point, this will be offset by the short cycle businesses of Valves & Measurement and Surface that will be positively impacted by activity increases in North America.
The last to recover will be the Reservoir Characterization Group which has been impacted by the absence of exploration activity.
Ladies and gentlemen, let me now summarize the main points that I have made this evening.
The overall supply and demand balance for oil continues to tighten. While demand remains robust, production continues to decline in many non-OPEC areas. Middle Eastern OPEC producers are pumping at record levels, but spare capacity continues to fall to lower levels.
The land rig count in the US has been slowly rising over the past three months in response to higher oil prices. This has translated to increasing service company activity but there has yet to be any material change in pricing.
International activity is not yet recovering, creating a headwind for the third quarter, although work in the Middle East and Russia has been increasing. We have, however, started to focus on recovery of the temporary pricing concessions made during the depth of the downturn.
Five months after the acquisition of Cameron, integration is firmly on track and the level of the expected synergy gains has been confirmed. I would also like to say that the position of Cameron inside Schlumberger has been positively received by the customers and employees of both companies.
Finally, after two years of the severest downturn in a generation, the financial strength of Schlumberger remains intact. We have continued to invest through the cycle, adding not only the Cameron product lines but also a series of smaller technologies. We have expanded our production management business with new projects and with a growing opportunity pipeline. And we have protected our operational infrastructure and technical expertise.
The moves that we have made, together with our unequalled geographical footprint and broad technology portfolio, position us very well to outperform the inevitable market recovery.