I got a call last week from an oil and gas training company in Singapore that asked me to teach a short course there on how regional oil and gas service companies can survive the drilling downturn that has resulted from the crash in oil prices.
I felt a bit like the bankruptcy lawyer who makes money off other people’s misery. But if you have been through a bankruptcy, either as a creditor or a debtor, you can appreciate the value such lawyers bring.
I am not really sure yet how much value I can bring to the service companies that will be taking my class. But as with most of the material I use in my oil and gas contract short courses, I look first to personal experience. If this is going to be a course about how to negotiate from a position of weakness, I got lesson number one when they offered me half my regular rate for teaching overseas.
But, like about everyone else in the oil and gas service industry these days, I did not turn it down.
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 to under $50. Natural gas wellhead prices went from over $3 per thousand cubic (mcf) feet to under $1.50, and even lower in our region. Oil and gas producers are, as they must, reigning in spending. Most of this is being accomplished through projects deferrals. However a good deal of cost cutting is through the renegotiation of service contacts. This in turn has led to difficult times for oil and gas service companies.
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 is 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 investors. So operators my resist this idea at first.
The second — reallocation of risk — likely will 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.
It was during a similar down cycle in the hydrocarbon pricing 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.
The best solution for service companies that have the wherewithal to do so is to diversify the company’s 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. Later, when I worked with a small oil and gas specialty firm, rarely did oil and gas make up more than half my work.
For small firms, client diversity is a headache, since it requires a great deal of time and effort maintaining and managing multiple clients. No service company can resist the call of the one great client that generates ample work and timely pays. However, small service companies are extremely vulnerable to this model. If that client changes its business strategy, is bought or even changes management, the small service company can go under quickly. Diversification of clients may be an economic necessity to get through these difficult times in the oil and gas service industry.
Now I am developing a course to take overseas on how service companies can survive the downturn. I need ideas. So I guess I am bit like the bankruptcy lawyer; it turns out I am in the right place. Ohio is currently proving to be fertile ground for developing survival strategies for oil and gas service companies.
This was original published in Crain’s Cleveland in October 2015.