How Different Oil Price Scenarios Could Impact Halliburton’s Stock

Crude oil prices are down by close to 40% from their mid-2014 highs, owing to slowing global demand growth, strong tight oil supplies from North America, and the OPEC’s decision to not cut back on production rates as it looks gain market share at the expense of weaker pricing. While the current turmoil has had repercussions across the energy industry and the broader economy, the oilfield services sector has been particularly badly hit, as upstream players scaled back on their exploration and production plans amid weaker cash flows. Halliburton (NYSE:HAL), the second largest oilfield services company, has been particularly badly impacted, since its business is heavily levered towards the high-marginal cost North American market. North American upstream E&P spending is expected to fall by as much as 30% in 2015, and the U.S. oil rig count is already down by over 50% since the beginning of the year, leading to a broad-based decline in drilling and completions activity. In this note, we take a look at different oil price scenarios and how they are likely to impact Halliburton’s valuation. We will be focusing our analysis on the North American rig services business, since it accounts for 50% of our $42 billion valuation for the company and is likely to be the largest source of variability under different commodity price scenarios.

Trefis has a $50 price estimate for Halliburton, which is slightly ahead of the current market price.

See Our Full Analysis For Oilfield Service Companies Halliburton| Schlumberger |Baker Hughes

Factors Driving Our Price Estimate For Halliburton

Brent crude prices are currently around $65 per barrel, recovering by about 40% over the last few months, owing to large cutbacks in exploration and production by most major oil companies and a moderation in supply growth from North America. We currently expect Brent crude prices to average around $70 per barrel for this year, below the marginal cost of production for most North American shale players. We expect prices to increase gradually to about $80 per barrel over the next two years as supply becomes tighter due to the recent cutbacks in capital spending by oil companies, and also as growth in demand picks up to more normalized levels. Under the current situation, oilfield services directed towards unconventional wells could face the most significant near-term impact. Shale wells have higher production costs, on average, compared to conventional wells, making their output less viable as prices fall. Planning cycles are also typically shorter, allowing operators to respond more quickly to the commodity cycle. Halliburton’s business is heavily exposed to unconventional plays, with close to a third of its revenues coming from the pressure pumping product line alone. Deepwater projects, which are mostly located in the U.S.Gulf of Mexico, could also see a cutback. These projects typically have long cash conversion cycles and higher risk, and oil and gas companies are likely to be more circumspect about committing to new projects in the current environment. Our $50 price estimate for Halliburton assumes that the average North American rig count will decline by about 37.5% in 2015, falling to about 1400 rigs, with North American revenues declining by about 34% to $12 billion. We expect EBITDA margins to shrink to about 17.5% this year, from about 24% in 2014. We expect revenues to rise to about $21 billion by 2021 (the end of our review period) with EBITDA margins rising to about 28%. We expect the average rig count to rise to about 2000 units by 2021.

Impact of A V-Shaped Recovery In Oil Prices (+15%)

There is a possibility of a much sharper, V-shaped recovery in global oil prices if the growth in demand for oil products picks up significantly on the back of lower oil prices or increased economic activity in China. Oil production could also decline because of a sharp and sustained slowdown in drilling activity. The U.S. EIA reports that oil production from the seven major U.S. shale plays is expected to fall by a total of 86,000 barrels a day in June, with production from the prolific Eagle Ford and Bakken shales taking the largest cuts. ^[1] If the cuts continue going forward, it could help to bolster oil prices. Additionally, if the OPEC, which accounts for about a third of global crude oil output, decides to change its current stance and reduces its production, this would also have a very positive impact on oil prices, providing significant tailwinds for oilfield services stocks. If oil prices see a V-shaped recovery, rising to levels of close to $90 per barrel by next year, this would incentivize oil companies to bolster their exploration and production spends and undertake more expensive and challenging plays. This would effectively translate into higher revenues and earnings for oilfield services players. If Halliburton’s North American revenues recover to about $16 billion next year, rising to about $24 billion by 2021, with margins rising to approximately 31% by 2021, this could result in an upside of close to 15% to current price estimate.

Impact If Oil Prices Remain At Currently Depressed Levels (-20%)

On the other hand, OPEC could maintain its current stance and demand for crude oil could remain suppressed because of a continued slowdown in economic activity in China, the world’s second largest oil market, or the increased use of alternative fuels. If this were to occur, the recent decline in oil prices could sustain for a much longer period. Additionally, upstream service cost deflation for oil companies could help to reduce the overall cost structure of the oil industry, leading to more robust non-OPEC supply growth despite the slump in oil prices. If this results in oil prices remaining at levels of $60 to $70 per barrel over the next several years, it could result in significant headwinds for the oilfield services industry. Under this situation, if Halliburton’s North American revenues remain depressed over the next three years at levels of around $13 billion, while gradually rising to about $18 billion by 2021, with margins improving to just about 22% in the same time frame, this could reduce our price estimate by about 20% to about $40 per share.

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1. Drilling Productivity Report, U.S. EIA [↩]