In late December, with $55 WTI, temporary relief in tightness for oilfield services was in sight for operators along with the prospect of reduced oilfield service costs. But a focus on simply getting reduced prices from suppliers is a short-lived tack that may not result in better returns now or in the long term, said Mike Hales, a partner with international management consulting firm A.T. Kearney Inc.

“Don’t ‘waste the crisis,’” said Hales, a co-author of Supplier Relationship Management: How to Maximize Vendor Value and Opportunity. “Use the crisis to build trust and a working relationship with the suppliers that are going to make a difference in the long term.”

Chris Wright, an operator of an E&P as well as of an oilfield service company, was studying this with his management team in December. Wright founded frack diagnostics firm Pinnacle Technologies Inc., which is now a part of Halliburton, and currently operates Liberty Resources II LLC, focused on the Bakken, and frack pumping firm Liberty Oilfield Services LLC, focused in the Rockies.

How can an E&P take advantage of this new downcycle to nurture a good ongoing relationship with vendors that will position it for yet-better results when the upcycle—thus renewed tightness in services—returns?

Wright said, “E&P companies are akin to general contractors. The key to success is choosing the right suppliers and working with them cooperatively to maximize production economics.”

Areas in which these parties are naturally aligned are efficient operations to maximize throughput; intelligent design, such as of the frack job, to lower production costs; and thoughtful task assignment so that each player brings forward its strengths with little duplicative effort, he said.

Pricing is where they part, however.

“A partnership relationship involves transparent dialogue on this issue that drives unit pricing down with commodity pricing or during times of overcapacity,” he said.

But prices shouldn’t be driven so far down that it impairs quality and safe operations, he added. “The same is true during boom times: Prices should rise but not so far that the spirit of partnership is impaired. Purely transactional relationships have no such bounds on price swings either way. Partnership relationships do.”

Dropping rigs

Oil and gas securities analysts are estimating some 500 U.S. land rigs—about 25%—will be dropped in the current price cycle. In the Bakken, in particular, higher well costs, a lower differential due to transportation cost and high debt among many publicly held operators will result in up to 50% of rigs being laid down this year, added analysts with Tudor, Pickering, Holt & Co.

The estimate is based on the fact that half of the 190 rigs drilling for Bakken and Three Forks pay in early December were drilling non-Tier-1 acreage. As for pressure pumping, some 650 wells in the play were waiting on completion (WOC) on Oct. 31, according to a mid-December report by North Dakota’s Department of Mineral Resources director Lynn Helms.

According to various analyst reports, the growing WOC count in the state is due, in part, to new rules on flaring, requiring increasingly immediate hookup to gas takeaway infrastructure upon oil production. Operators in the area also are expected to be affected by a state rule adopted in December that requires, beginning April 1, that gas liquids be removed from oil produced from the Bakken petroleum system before being transported.

In the Permian Basin, meanwhile, equity analysts with Simmons & Co. International Inc. reported shortly after the OPEC meeting that a privately held operator expected the rig count there to fall 25% by this spring. Another expected to drop half of his rigs in that timeframe.

That operator also had two frack crews at work for it, the Simmons analysts reported, and asked one of the pressure pumpers to reduce its diesel surcharge based on the newly lower market price for diesel.

“The frack company said no, and the E&P will now be releasing that frack company’s crew,” the analysts added. “When asked if the E&P would keep the crew—had the frack provider lowered its price—they said ‘most likely,’ but the E&P would have then dropped the other crew as this company will begin deferring completions.”

The best crews

Brent Ross, a principal with A.T. Kearney, said, “The biggest thing operators can do here is to try to set up contract structures—operating approaches—that help everyone earn their returns throughout the cycle.”

In downcycles drillers are stacking rigs and cutting crews. “When the upturn comes, it’s hard to find the good crews,” Ross said. Operators that continue to work with service companies through the downturn are going to be more favorably positioned on the other side of the cycle. “Operators want to set up a structure that assures the service company earns enough to keep crews together,” he said.

It may be at a lower cost, nonetheless, he added, “but you don’t want them operating at a loss on every well they drill for you because it usually means they’ve lost their best personnel, and it usually shows up in performance. If it takes you six days to drill a well now instead of five, it could eat up any savings you would see from a lower day rate.”

A downcycle also presents the opportunity to increase value going forward such as the value attached to drilling faster. A rig operator that can drill faster “means less time to first oil, so that creates value to you, the owner of the asset,” Ross said.

The largest oil and gas companies tend to fare better in upcycles and downcycles in terms of supplier relationship as their capex budgets tend to be fairly consistent, he added.

“They have a long-term view on pricing and respond less to market fluctuations,” he said. “The service companies appreciate that when times get tough, and they remember that in the upcycle. These companies get better crews and better supply assurance. Service and material providers remember who kept them in business when things weren’t good.”

Is there much value in simply paying bills promptly, for example? Ross said, “Absolutely.”

A client who is a rig operator asked Ross and his colleagues this past year what could be done about one of his largest customers that hadn’t done a good job of paying its bills. Also, the customer had entered a partnership with the rig operator and backed out—after the rig operator had invested in physical assets to fulfill the agreement.

“Between that and not paying bills promptly, there was real frustration there,” Ross said. The customer wasn’t dropped, but “it’s a small industry. People talk about how companies treat each other. If it’s overly onerous to work with you, there’s no point in putting the best crews to work on your site. Performance suffers.”

Top 1%

What else can an operator do in this renewed “buyer’s market” that is a win for it both now and in the long term? Hales references A.T. Kearney’s semi-annual global survey of best practices in procurement. During the 2008-09 financial markets crisis, purchasing power reigned, for example. “If you had money to spend, people were prepared to do whatever it took to capture that demand,” Hales said.

Looking at that survey, there are lessons to be learned from how market performance leaders behaved. Buyers who have thrived are those that were able to use that crisis to build trust with select suppliers.

“They focused on reducing total operating cost and not just pricing,” Hales said. They looked at suppliers based on long-term potential for performance, “finding the 1% really worthy of collaboration.”

Focusing on these, buyers began involving them with field management and procurement personnel, doing an “end-to-end review of operating cost. Your goal in a crisis is to reduce total cost and not just reduce the margin on per-unit pricing,” he said.

In short, “find that 1% that can give you a competitive advantage, invest in them and go beyond paying your bills on time to finding how to collaborate with them toward a reduced overall operating cost.”

The other 99%, “you just want to treat with respect,” he said. “That’s paying your bills on time and other matters of good ‘hygiene.’ You don’t want to upset the majority of suppliers, but you don’t have enough resources to do something special with all of them other than having basic respect in how you treat them.”

Comments