Why Is Schlumberger’s Stock Plunging Despite A Rebound In Oil Prices?

by Trefis Team
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The year 2017 began on a great note for the oil and gas industry, as commodity prices showed signs of recovery on the back of 1.8 million barrels per day (bpd) of production cuts implemented by the Organization of Petroleum Exporting Countries (OPEC) and some of the Non-OPEC members. While this led to a strong rise in the drilling and exploration activity worldwide, the world’s largest oilfield services company, Schlumberger has not fared that well year-to-date.

Despite showing improvement in its quarterly results, the company’s stock has dropped more than 25% since the beginning of the year, under-performing the 10% rise in crude oil prices during this period. The major reason behind this under-performance has been the company’s weak outlook for the drilling markets in the coming quarters. Below we discuss the rationale behind Schlumberger’s outlook for the drilling markets, particularly the North American markets, and its impact on the company’s valuation.

See Our Complete Analysis For Schlumberger Here

US Oil Production To Grow, While Capital Investments To Decline

The announcement of OPEC supply cuts in November 2016 caused the oil prices to surge, with WTI prices trading in the $50-$55 per barrel range for the early part of 2017. Consequently, the US oil and gas producers, who found it uneconomical to produce oil at sub-$50 per barrel levels, began to expand their operations to leverage the rising commodity prices. This led to a sudden rise in the demand for drilling and exploration activities, resulting in a steep improvement in the US rig count, both oil as well as gas, in the first half of the year. As a result, oilfield services companies, such as Schlumberger, witnessed a boost in their profitability in the first six months of the year.

However, as the year progressed, the company realized that the growth in the US drilling demand in the first half was not sustainable in the long term. This is because while the profitability of US oil and gas companies improved over the last couple of quarters, their cash flows have remained under pressure. Hence, they are now more focused on generating higher financial returns and operating within their available cash flows, rather than chasing production growth. In other words, the appetite to invest in exploration and drilling activities is expected to be low in the coming quarters.

Source: 7th Annual Energy & Natural Resources Conference (Cowen & Company), 4th December 2017

Accordingly, Schlumberger expects the North American drilling markets to continue to expand going forward, but at a slower rate compared to the previous quarters of this year. However, despite the company acknowledging the dim outlook of the drilling markets, the investors have penalized the company’s stock over- severely over the last few months.

Focus On Cost Efficient Technology

Apart from tight capital investment budgets, US oil producers are now focusing on producing more with their existing wells, rather than exploring for new wells. This implies that these companies are looking to bring down their break-even price and boost their profitability and returns. Due to this, the drilling industry has seen a sharp rise in the pad drilling and the use of longer lateral lengths to improve the operational efficiency and the output of the existing wells.

Being the market leader in the oilfield services industry, Schlumberger has consistently worked on improving its current product offerings as well as developing new and advanced products that would not only enhance the efficiency of the existing wells, but also reduce the cost of operations for the clients. While the company has made significant progress in enhancing its products to fulfill the needs of its customers, it has continued to witness pricing pressure in several markets. Further, the company has also seen a drop in the demand for oilfield services and equipment, evident from the decline in the US rig count in the last three months. Again, since Schlumberger had highlighted this trend in its earnings release, its stock has seen a slide in the last few months.

Going Forward

With the recent extension of the OPEC production cuts until the end of 2018, we expect the oil prices to improve in the coming quarters. This would, in turn, cause the US oil production to surge further, resulting in a higher demand for drilling equipment and services. While the resultant demand may not be high enough to match the growth witnessed in the early half of 2017, it could be higher than what Schlumberger had anticipated a quarter ago. Hence, if the company can reassess the impact of the OPEC deal on the drilling demand, and reflect a positive view on the outlook in its fourth quarter earnings release, its stock could regain some of its lost value over time. However, on the flip side, if the company continues to hold a pessimistic outlook for the drilling markets in the coming months, its stock could face another downfall soon.

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