Ladies and gentlemen good morning. My thanks to Marc Bianchi and Cowen & Company for the opportunity to be here again.
The price of oil is dominating the headlines in our industry, with a level of volatility that has brought increased uncertainty and decreased visibility.
As this conference falls between last weekend’s G20 meeting in Argentina, and this week’s OPEC meeting in Vienna, presenting any reliable outlook for our business is like walking a tightrope.
Nevertheless, I’m going to give you our view of the current market environment and highlight what this means for the oilfield services industry, and for Schlumberger in particular.
First, the 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. I therefore refer you to our latest 10-K and other SEC filings.
Since the peak at the beginning of October, the oil price has dropped by around 30%, driven by a surge of US production from the Gulf of Mexico and the Permian, record high production from the core part of OPEC, US dispensations to the Iran oil export sanctions, and the ongoing trade war dispute between the US and China.
These elements, together with the strong US dollar, the potential for another U.S. Federal Reserve rate hike, and general investor concerns with the stock market have all had a significantly negative impact on oil market sentiment, even though market fundamentals have not dramatically changed.
Looking closer at the supply situation, US production has surprised to the upside, partly in the Gulf of Mexico and partly from the US shale basins. There was a surge in hydraulic fracturing activity in the second quarter, especially in the Permian. This activity surge levelled off in the third quarter and is dropping in the fourth quarter, which will show up in the first half production numbers for 2019.
The record high production from the core part of OPEC and Russia is simply coming from activated spare capacity, aimed at dampening the accelerating upwards trajectory of the oil price in the third quarter and leaving the remaining OPEC spare capacity at a record low level. A normal OPEC reaction would be to scale back production levels and restore prices but geopolitical factors may rule otherwise, causing the current uncertainty.
At the same time, the US dispensations to the Iran oil export sanctions are likely to be temporary and last up to six months to allow the main importing countries in Asia to make alternative arrangements.
Finally, while the potential trade war positioning and negotiations continue between the US and China, we have yet to see a major impact on the demand outlook with 2019 demand growth still estimated at a healthy 1.2 to 1.4 million barrels per day.
So, in summary, we have seen over the past two months a combination of short-term factors that has had a significantly negative impact on oil market sentiment, while at the same time the underlying physical balances between global supply potential and oil demand remain largely unchanged, which is further confirmed by the global oil inventory data.
Translating these oil market dynamics to E&P investment levels, we expect US activity and investment to recover during the first half of 2019. However, depending on the financial markets, the recovery will likely be measured initially and more closely aligned with cash flow, with the activity surge we experienced in the first half of 2018 unlikely to repeat.
Investment and activity growth in Russia and the Middle East looks strong and firm for 2019, as these key oil-producing countries continue to manage the full-cycle of their resource base by implementing their long-term investment programs in both wells and infrastructure, somewhat independently of short-term oil market fluctuations.
And in the rest of the international markets, the need for higher investment after four years of record low activity is still there, simply to maintain production at current levels.
Still, the recent increase in oil price volatility and reduction in visibility will likely mean that our customers will take a more conservative approach to the start of 2019, and that the expected ramp-up of international investment could be somewhat muted in the first quarter, before accelerating in the second half of the year.
The current market environment reflects the change in market dynamics that has occurred over the past four years.
First, shale oil production in North America has added or removed production in the global mix with a quicker response to investment than conventional oil. The structure and technology offering of our OneStim℠ business position us favorably to respond to the changes in this market.
Second, the big four Middle Eastern OPEC countries provide the fastest and largest response to counter global supply-demand imbalances. For Schlumberger, ease of coordination, scale of production, and availability of equipment capacity provide a strong platform for growth.
Third, the Rest of the World, which makes up the largest share of global production, is geographically diverse—both on land and offshore. It is highly dependent on investment, given the maturity of the producing base, and offers the opportunity to deploy the broadest range of technology from our portfolio.
These markets present a very different backdrop compared to that existing prior to the downturn, and in an environment in which commodity prices are more volatile and lower than before, the service industry has had to change. For Schlumberger, this has meant a series of transformation initiatives that have modernized our operating platform, as well as the development of our tiered offering of integrated services and collaboration models.
The contribution to our revenue from integrated services increased from 20% in 2014 to 27% in 2017. One of the fastest growing integrated offerings is our Integrated Drilling Services (IDS) lump-sum turnkey model, or LSTK, where our interests are closely aligned with those of our customers. Our IDS business benefits from the current drilling-led phase of the market recovery, bringing cost and operational efficiencies through transformation benefits, organizational scale, and best-in-class technology. The result is continual performance improvement, with each well drilled more efficiently than the last. In delivering performance, we retain wide operational discretion while accepting a managed and capped level of risk.
Risk is managed in two ways. First, we seek only to operate in a known geological environment in which Schlumberger technology can be optimally deployed and in a geographical area in which Schlumberger has built a wide footprint, where the operating structure favors the IDS LSTK model. Second, we only accept risk for the events that are under our control. This means that any loss for equipment or technology failure remains with Schlumberger, while our customer takes responsibility for subsurface risk. IDS contracts therefore exclude unforeseen or unknown subsurface conditions that could prevent delivery of the well as specified. Should additional services then be requested, project daily rates apply.
The advantages of IDS include the ability to capture the value generated by operational efficiency and reliability—two pillars of our transformation program—as well as the value of well engineering and differentiated technology. As activity develops, IDS project efficiency accelerates and in recent Middle East contracts, footage per day has increased by 40% over a three-year period and non-productive time decreased by more than half over the same period. In addition, the improvements that we have made in equipment reliability through engineering transformation programs have enabled us to free assets from use as backup and deploy them as primary equipment.
Deployment of innovative technology is a second key IDS advantage. The customer is not ordering a specific service with IDS, but rather contracting a level of performance. The technology to deliver that performance lies within our operational discretion. This approach overcomes the traditional, conservative industry approach to new technology adoption.
A third IDS advantage lies in smaller crew sizes. This idea began a decade ago during a period of growth, when it became impossible to deploy experienced drilling engineering personnel on every complex drilling operation. This developed to become a transformation program initiative to make drilling experts available from a central location, supporting multiple operations with consistent service and wide technical oversight.
IDS LSTK work is based on a contract that sets a fixed price to drill and complete a well. The model is typically applied to development drilling activity on land, in areas where significant numbers of wells have already been drilled. This means that substantial data and records are available to define drilling programs, minimize risk, and extract value from the project learning curve.
The latest LSTK contracts signed in Saudi Arabia cover a total of 344 wells over a three-year term with the option of extensions. Rig mobilization is now complete with a total of 25 rigs operational. 70% of the rigs on the project are operated by the Arabian Drilling Company (ADC), jointly owned by Schlumberger and TAQA. As we gain experience with the project learning curve, asset efficiency and crew size are being optimized, while new technologies are being evaluated for the performance improvement they bring.
The IDS way of working has also been a key element in our SPM portfolio that demands the highest level of integrated services and performance-based partnering. Further, the model offers one path to help deliver our incremental margin goal—even in a volatile, lower-commodity-priced environment.
Ladies and gentlemen, before we take your questions, let me provide you with an operational update in the light of the recent volatility in the oil market.
In our October earnings call, we forecast a fourth-quarter sequential drop in earnings per share, driven by lower activity and softening service and product pricing for hydraulic fracturing in North America Land. In the international markets, we were expecting flat sequential revenue, as further IDS growth would be offset by the winter slowdown in the North Hemisphere with little to no year-end sales.
So far in the fourth quarter, international revenue, excluding Cameron, is more or less in line with expectations, except for signs of weakness in a few countries in Latin America.
In North America, revenue from our offshore business and our land drilling operations is trending to be flat sequentially. For hydraulic fracturing, we are seeing a significantly larger drop in activity than we expected, which is leading to a larger drop in pricing than we anticipated. This is resulting in a sequential reduction in our total North America revenue in the range of 15%. We continue to see the weakening of the hydraulic fracturing market as temporary, with the expectation of a gradual recovery taking place over the first half of 2019. Therefore, the fourth-quarter and potential first-quarter revenue declines will come with relatively high decremental margins.
Global Cameron revenue is expected to be slightly down due to the weakness in its short cycle businesses in North America land.
Looking forward to next year, the recent volatility in oil prices has introduced more uncertainty to the outlook for 2019 E&P spend. Faced with this, our customers will likely respond by taking a more conservative approach to the start of 2019, as they await the current market dynamics to play out and subsequently provide better forward visibility. We still expect to post solid revenue growth in the international markets next year, but the growth trajectory could potentially be more back-end loaded than previously thought. We will provide a further update on the 2019 outlook in our January earnings call, at which time we will have a clearer picture from further customer discussions, and we will also have the conclusions from the December OPEC meeting.
Ladies and gentlemen, thank you very much.