Lower Rig Count Reflects Tough Short Term Outlook For Oilfield Services Companies

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Drilling activity continues to trend lower on the back of a challenging crude oil pricing environment. Benchmark Brent crude is currently trading at levels of around $58 per barrel, down by close to 50% since June 2014, and most oil and gas companies have scaled back on their capital budgets for this year in order to conserve cash as they see their revenues decline. According to Baker Hughes (NYSE:BHI), the rotary rig count, which is one of the most closely watched metrics of activity in the oil field services industry, was down by roughly 4% sequentially to 1,258 rigs in January for international markets. The total U.S. rig count has declined by around 20% since the beginning of the year to 1,456 rigs while the U.S. oil rig count has fallen by over 23% to 1,140, marking the lowest level since December 2011.

Trefis has a $70 price estimate for Baker Hughes, which is about 10% ahead of the current market price.

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Oilfield services companies will see weaker revenues over the next few quarters, as spending cuts take effect and also as customers push for better pricing and terms on contract negotiations and renewals. That said, we do not expect the revenue declines to be as sharp as the decline in the rig count. The rig count is only a direct indicator of drilling and development related activity, which just represents a subset of the suite of services that oilfield services companies provide. Demand for production-focused services is likely to hold up better, as oil companies may choose to cut down on the number of new wells that they drill, but still extract maximum production from their existing wells. Spending on services such as pressure pumping, artificial lift, and enhanced oil recovery are likely to hold up better compared to services such as drilling, wireline and cementing. This production-focused spending could provide some cushion for companies such as Baker Hughes and Halliburton (NYSE:HAL), both of whom derive roughly 60% of annual revenues from production and completion services.

While the fact that operators are rapidly laying down rigs and curtailing capex is certainly a near-term dampener for oilfield services firms, it should prove positive for the broader oil markets. The weaker drilling and capital spending could suggest that there will be tighter supply of oil in the future, helping to bolster prices.

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