Who’s Better Positioned in Oil Services?

By Peter Pham - October 3, 2012 | Tickers: HAL, RDS-B, RDS-A, SLB | 0 Comments

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The world’s leading oil services firm Schlumberger Limited (NYSE: SLB) opened the Schlumberger China Petroleum Institute (SCPI) in Beijing on the 21^st of September. The institute will provide services to local as well as foreign firms operating in China. It will also provide services to Chinese oil companies operating outside of China besides working with national oil companies and universities on various R&D projects.

China is due to hold the second round of Shale gas auctions on the 25^th of October, which has already attracted foreign firms such as Shell (NYSE: RDS-A)  and ConocoPhillips. The former has announced an enormous $1 billion per year shale gas investment plan in the country. Schlumberger is also one of the leading service firms in the shale gas sector. The main problem associated with Shale gas extraction is the massive use of clean water that it requires, a resource already in short supply. Earlier this week, Schlumberger revealed that it has developed a technique called channel fracturing that can reduce water consumption by half.

Schlumberger has been active in China for about three decades, now it will be looking to reap profits from China’s infant shale gas industry.  Chinese government officials have admitted that they neither have the skills nor the technology to develop the shale gas sector and this is where firms such as Schlumberger and Halliburton (NYSE: HAL) come into the equation. The Chinese government has traditionally supported those foreign companies that invest in the regional infrastructure and bring FDI, instead of just considering it as a source of cheap labor.

Schlumberger is doing just that, by signing a joint venture agreement with China’s Anton Oil Field Services in which Schlumberger will have a 60% stake. This comes after Schlumberger purchased 20.1% stake in Anton Oil Field Services about two months ago for $82 million. Anton’s management revealed shale gas exploration was the primary motivation behind the deal.

This is all part of China’s multi-pronged plan to address its future energy needs while it fights a cold war with the U.S. over securing overland oil and gas reserves west of the Himalayas and Strait of Malacca.

While Schlumberger was announcing its Chinese expansion plans, Halliburton announced that it has lost a 7-inch radioactive rod that was used in hydraulic fracturing somewhere in West Texas in a 130 square mile radius. The tube is highly dangerous and the members of the public are advised to stay at least 25 feet away from it, if they happen to locate it. FBI officials have questioned some Halliburton staff and cleared them of any misconduct.

In the long-run, the outlook for both Halliburton and Schlumberger remains strong. Although US, Europe and China are recording slowing economic growth now the non-OECD countries remain robust with demand rising.  Unfortunately, most of the operations of both Halliburton and Schlumberger is in North America. So, the short term outlook is mixed.  Halliburton has lowered its third quarter estimates due to decline in North American drilling activity. Although gas prices have started rising but they are still 25% lower than last year. Furthermore, the guar gum shortage is still hurting both companies as they work towards bringing their substitutes online. Halliburton is trying to convince its clients to adopt PermStim instead, which it introduced in the second quarter. Although the company claims some success but so far, its impact has been negligible (taking up 5% of the Guar demand).

Schlumberger is also the market leader in innovative shale gas drilling techniques and its cost reduction processes will ensure that it maintains this position in the future. According to Pacwest Consulting, the demand for fracking is set to rise by 41% in 2012-16, with most of the increase coming from outside North America. Both companies have recognized this. While Schlumberger is tapping into China, Halliburton is looking towards Argentina, Australia and Poland is primarily focused on North America, where its political ties are very strong. Until last year, Halliburton earned more than 75% of its income from North America in general and from the Bakken field in particular.

Analysts had earlier predicted that Halliburton would suffer in 2012 because it has built most of its infrastructure in North America which is evident in the drop in profit guidance for the third quarter.  But, the oil and gas glut in the Midwest will eventually be alleviated once the political landscape for the next four years is settled.  Expect the Keystone XL pipeline to be approved after the election regardless of who wins.  A lame duck Obama or a 1^st term Romney will be bullish for oil and gas infrastructure projects badly needed to match U.S. output with domestic demand.

For the second quarter of 2012, Schlumberger posted total revenues of $10.4 billion out of which $3.34 billion were from North America and $7.1 billion from outside. Halliburton in its second quarter posted revenues of $7.2 billion, $4.1 billion from North America and $3.1 billion from outside. Furthermore, Halliburton has not announced any significant plans for expansion, particularly in China and the shale gas sector. It has completed an evaluation of shale gas reserves and has recognized Centrally Planned Asia & China, Pacific, and MENA as three biggest markets outside North America. 

However, Halliburton has consistently improved its ROA and ROE which by the end of fiscal year 2011 were 12% and 21.5% respectively. Schlumberger returns were slightly lower with 9% ROA and 16% ROE in 2011. Schlumberger’s diversity is turning out to be its strength which could make it more profitable in the coming years.

Since January, Schlumberger has been up 9.8% and Halliburton by 3.8%. Schlumberger has proven less vulnerable to the price of Brent Crude.  The US Brent Oil Fund has trailed it by 8% year to date.  So, while oil will benefit from both structural shifts in production towards higher recovery costs and a world flooded with liquidity, Schlumberger’s diversity both geographically and better operating costs structure make it an excellent derivative play.  Halliburton’s focus on N. America will take longer to pay off as the price of natural gas recovers which is why it is trading at a much lower multiple PER 10x versus Schlumberger PER 18x. 

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