The market for pressure pumping services in North America has faced several challenging quarters, owing to the decline in gas-directed drilling, which has resulted in an oversupply of pumping horsepower in the market. Oilfield service majors Baker Hughes (NYSE:BHI) and Halliburton (NYSE:HAL) have faced the brunt of the downturn given their large exposure to the pressure pumping product line, which accounts for roughly 25% and 40% of their annual revenues, respectively.  While both companies have seen some positive developments in the product line in recent quarters owing to internal efficiency improvements, external factors (particularly pricing) have been lackluster. In this note we take a look at some of the factors that are likely to drive the pressure pumping business of both companies in 2014 and going forward.
Overcapacity, Pricing Could Still Prove an Issue As Gas Drilling Remains Subdued
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Natural gas reservoirs require higher horsepower pumps for stimulation when compared to oil reservoirs. However, gas drilling has remained subdued over the last two years, with the number of gas-directed rigs as a percentage of overall rigs falling from about 50% in late 2011 to just about 20% currently. This has meant that fracking of gas directed wells has also declining significantly, leading to a an oversupply in the pumping market. As of Q3 2013, both Halliburton and Baker Hughes had indicated that the fracking market was oversupplied by around 20% and we believe that this could persist through this year as well given the outlook for gas directed activity. Pricing is also expected to remain challenging, with consulting firm PacWest indicating that the trend could persist into 2015.
Efficiency Improvements Will Help Margins
While both companies do not break down the financials of their pumping businesses, the product line is likely to have been dilutive to margins in recent quarters. However, we think that profitability should improve going forward, despite the sluggish pricing outlook, considering that both companies have been focusing on improving operational efficiencies of their fleets. Among other improvements, Baker Hughes has been converting some of its fracking trucks into bi-fuel, so that they can operate on both natural gas as well as diesel. Halliburton has embarked on its “Frac of the Future” initiative which aims to cut down on both capital and operational costs of fracking. Under this program, the company will fit its fracking fleet with new equipment such as gravity, and solar-powered sand pumps. The company has also been introducing new and more productive equipment in North America, while moving less efficient equipment overseas. Both companies have also been running more 24-hour fracking operations, which help to cut down on manpower and operation and maintenance costs.
The fracking market is quite fragmented, with midsized companies and private equity-backed startups accounting for more than 50% of the market at the end of 2013.  We believe that companies such as Halliburton and Baker Hughes are likely to have an edge over smaller players in cutting costs given their greater scale and technology.
Higher Service Intensities
A significant part of North American exploration and production spending is directed at shale plays, and higher service intensity in these plays could bode well for the revenues of the pressure pumping businesses. Production from shale oil wells typically starts off strong, after which there is a relatively rapid decline when compared to conventional oil wells.  This could translate to higher service intensity for drilling and pressure pumping services, as oil companies drill longer lateral wells while also increasing the number of fracking stages for wells in order to maintain their production output. For instance, during Q3 2013, Halliburton has indicated that it has seen the stage count per well rise by around 15% to 20% compared to the previous year in the Marcellus and Eagle ford shales.
Greater Horizontal Drilling Activity In The Permian Basin
The Permian basin in West Texas, which is one of the largest and oldest oil producing regions in the United States, is becoming one of the most important markets for unconventional exploration activity, as oil and gas companies are drilling an increasing number of wells with layers of horizontal branches. ((WSJ)) These horizontal wells typically require hydraulic fracturing in order to stimulate the flow of hydrocarbons, and we believe that this market could contribute to higher demand in the fracking industry over the near to medium-term.
Horizontal drilling, which is a precursor to fracking and potentially an indicator of future fracking demand, has been on the rise in the Permain. Halliburton estimates that about half of all rigs in the region will be horizontally directed by the end of 2014, up from around 35% in early 2013 and this could be a significant number since the basin holds more than a quarter of all the active drilling rigs in the United States. However there are some caveats to the bullish outlook for the Permian. Firstly, almost all the activity in the basin is directed towards oil, which requires lower pumping intensities compared to gas directed activity. Secondly, a lot of the unconventional reservoirs in the basin are more difficult to access, making them potentially more expensive for oil companies to develop unless oil prices remain stable or rise. ((WSJ))Notes: