Markets can be murky and messy, especially at times of potential turning points. Months later, the clouds may have lifted and signs become clear whether a trend has—or has not—been established. But management typically must make decisions with the best—albeit limited—data available at a given time.

The pressure pumping sector was the subject of increased attention recently, when Halliburton Co. announced it was shifting its strategy back to gaining market share at the expense of margins that, near term, would be affected by reactivation costs. Halliburton cited markedly improved pressure pumping margins for the move, which involves reactivating by midyear almost the entire capacity it previously planned to bring back onto the market through year-end.

This accelerated reactivation schedule comes alongside an influx of new capacity from other sources, including IPOs, in anticipation of a durable upward trend in demand in pressure pumping.

“Everyone knew there was a lot of excess equipment, but the industry has been saying for the last two years that the equipment is in such poor shape that it can’t come back,” said J.P. Morgan’s senior equity research analyst covering the oilfield service sector, Sean Meakim, CFA. “What people underappreciated was how willing the capital markets are to fund that equipment. People are realizing how many private pressure pumping companies are looking to go public.”

Upfront reactivation costs are obviously designed to generate a return in a tradeoff of short-term pain for long gain. The hit on Halliburton’s earnings estimates for 2017 was significant, but analysts in several cases held their 2018 estimates flat or nudged them higher. For Meakim, Halliburton remained a “top pick,” reflecting in part the company’s market-leading supply chain in the U.S.

However, for pressure pumpers with less robust supply chains, the “battle for utilization” is unlikely to get any easier, said Meakim, with supply chain scale and flexibility across basins remaining “essential in a fiercely competitive frack market.”

One analyst observed that companies “reactivating” faster than their peers are likely to be “rewarded near term as long as oil price sentiment recovers.” But what if a turn in oil sentiment is slow in coming?

On the Monday following the pre-market Friday announcement by Halliburton, some of the smaller pressure pumper stocks slumped as oil prices weakened. ProPetro Holding Corp., which made its debut as a public company in March (NYSE: PUMP), was down 7.6% on the day. Keane Group Inc., which went public in January (NYSE: FRAC), fell 6.8%. Both companies’ stocks, at $12.47/share and $14.18/share, respectively, were down markedly from their IPO prices of $14 and $19.

Halliburton was not spared, but held up somewhat better, down 3.3%.

Clearly, pressure pumping demand is on an upward swing, but what if the rush to reactivate equipment and add newbuild frack fleets leads to ample capacity and a more restrained recovery in margins?

Potential cost inflation from rising oilfield service costs, including pressure pumping, has been a topic of much discussion. A focus has been on the degree to which cost savings are structural (and likely retained by producers) and the degree to which they are cyclical (likely to revert to oilfield service companies). In turn, the topic guides E&Ps as to how much cost inflation should be baked into their capex budgets.

J. David Anderson, CFA, senior equity analyst covering the oilfield sector at Barclays, has been preliminarily estimating 5% to 10% of cost inflation in the first half of this year, rising to 10% to 15% or more in the second half of the year.

“I think more than half of the well cost savings are cyclical and will come back,” said Anderson. “To date, high-grading has meant E&Ps have had the best service companies, with the best crews and equipment, working on the best acreage. As we start to expand out and start to scale up, I think those efficiencies will start to turn to inefficiencies.”

But a surge of pressure pumping equipment may act as an overhang and help hold down costs for E&Ps.

“Big chunks of pressure pumping capacity that we previously thought were never coming back are all of a sudden appearing,” said Anderson. “It’s probably going to put a damper on pricing near term, or push out to the right the pricing inflection we were looking for. If the pressure pumping sector brings back too much capacity too quick, that’s how the 15%-plus expected for the second half of 2017 could go back down to the 5% to 10% range.”

Comments