A Look At Schlumberger’s Reservoir Characterization Business

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Oilfield services major Schlumberger (NYSE:SLB) is the largest provider of reservoir characterization services. In this note, we take a look at the key products and services provided by the company’s reservoir characterization business segment, as well as some of the current developments that are impacting the oil and gas exploration space.

Trefis has a $94 price estimate for Schlumberger, which is slightly above the current market price.

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Oil and gas exploration companies require reservoir characterization services to locate and define hydrocarbon resources. Schlumberger’s reservoir characterization segment provides products and services such as seismic and geophysical services, wireline and testing services as well as tools to integrate and interpret various types of exploration and production data. Seismic surveys, which constitute one of the first operations in oil and gas exploration, are used to produce images of the rocks in the earth’s subsurface, allowing oil companies to locate and determine the size of  oil and gas reservoirs. Wireline services are used both in the exploration as well as production stages in order to evaluate the formation of rocks as well as to monitor and evaluate production from wells.

Schlumberger’s Most Lucrative Product Segment

The revenues and profitability of this product segment are largely influenced by the exploration spending of oil and gas companies. The reservoir characterization segment has remained a key driver of Schlumberger’s earnings, contributing close to 40% of the company’s pre-tax earnings, despite accounting for just about 27% of the company’s total revenues. During 2013, the division had pre-tax margins of around 29%, which is significantly higher than the company’s overall pre-tax margin of around 21%. [1] The segment saw revenues and margins grow last year, driven by market share gains, higher activity in the U.S. offshore market and in land markets overseas.

Sluggishness Likely In Exploration Space As Companies Seek Returns On Tied-Up Capital

While spending on exploration and seismic activity was strong over the last decade or so, companies have been scaling back of late. FY 2013 turned out to be a lackluster year on the new discovery front, considering several large and expensive exploration failures. According to estimates, only around 20 billion barrels of conventional oil equivalent  may have been discovered last year. [2] This is well below the annual world oil consumption of around 50 billion barrels. Additionally, not even a single discovery made last year contained upwards of one billion barrels.

In the near term, oil and gas companies are likely to spend less on seeking out new discoveries, instead focusing on improving the productivity of their existing wells in order to maximize their returns on already invested capital. This could mean that they will focus their budgets on areas such as the stimulation and reservoir optimization. Oil companies have also been allocating more capital to areas such as shale, where the exploration related risk is less and the time frame between the investment (in identifying and developing a well) to the cash flow generation (from production) is shorter. [3] According to Barclay’s Global 2014 E&P Spending Outlook report, a majority of oil companies have indicated that their exploration spending was likely to remain at current levels or even decrease slightly this year.

Schlumberger Has A Long Term Edge

Schlumberger for its part, still expects to see some exploration growth in 2014, although it has indicated that spending on seismic services, to which it has a large exposure, could flatten out. [4] In any case, we believe that Schlumberger is better poised to deal with a potential slowdown in exploration spending growth given its strong technology portfolio and also due to its ability to provide a complete suite of services, unlike its smaller and more specialized competitors. The company also benefits from greater economies of scale compared to some of its peers.

Over the longer term , the growth of the reservoir characterization segment should continue, as offshore activity moves into more deep and ultra-deepwater plays which would require a higher service intensity. On the land front, growth could be driven by a shift from exploration of conventional plays to unconventional plays, particularly in international markets such as China and Latin America.

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Notes:
  1. Schlumberger Form 10-K []
  2. The 10 Biggest Oil And Gas Discoveries Of 2013, Forbes, January 2014 []
  3. Oil firms seen cutting exploration spending, Reuters, February 2014 []
  4. Schorn Speaks at Cowen and Company, Schlumberger, December 2013 []