In 2012, when Ohio became an “oil and gas state,” we all knew that the business was cyclical. Prices go up and down, and with it, so go the fortunes of those who depend upon the business for their livelihood.
But I certainly did not expect that the down cycle would come this quickly. Within two years, oil prices went from over $100 per barrel (bbl) to under $50, and natural gas prices at the wellhead went from over $3.00 per thousand cubic feet to under $1.50. Predictably, oil and gas producers are reigning in spending. Most of this is being accomplished through projects deferrals, but some through the renegotiation of service contacts. This of course has led to difficult times for service companies.
Lawyers are part of the service industry as well. I have personally felt the downturn this summer. I had two oil and gas contracts courses scheduled; one was cancelled and the other deferred. Even the National Oil Companies are feeling the pinch of budget cuts.
So what can those of us do who work in the oil and gas service industry do to stay afloat?
You should expect operators to come to you with new contracts that impose severe conditions. Producers will push hard to reduce rates and to transfer risk to the service companies.
The first is inevitable. By now, most service companies have had to slash rates. One creative idea I like was to tie day rates to a natural gas price index. Should prices come back up, so, too, would day rates. This idea should have appeal to the producer as fair. Unfortunately, it is not standard practice for operators, who like to have predictability when they send out authorities for expenditure to their working interest investors. So operators my resist this idea at first.
The second – reallocation of risk – will likely be more appealing to service companies than rate cuts. Service companies who make $10,000 on a small job may be asked to take on $100 million or more in risk. It will be tempting to accept such risk just to get the job. Likewise, underfinanced turnkey service companies will begin pop up, offering to guarantee performance at ordinary day rates. Operators should beware this practice – if things go bad, many turnkey companies just go out of business, leaving unpaid subcontractors who will place a lien on the well.
It was during a similar down cycle that Texas and Louisiana legislators passed oilfield anti-indemnity statutes to curtail operators from using their leverage to force service companies to take on extraordinary risk. Ohio does not have an oilfield anti-indemnity statute, although arguably there are construction anti-indemnity laws that may apply. The best practice is to have your counsel or your insurer look at the contract to be sure you are not taking on undue risk.
Of course, the best solution for service companies that have the wherewithal to do so is to diversify your client list. This is what lawyers do. This means you should not only have as many oil and gas clients as possible, but you should also have non-oil and gas clients. When I worked for a big New Orleans law firm, our rule was to never have more than 5% of our firm receivables from any one client.
For small firms, client diversity is a headache – it requires a great deal of time and effort maintaining multiple clients. But it may be an economic necessity to get through these difficult times in the oil and gas service industry.