As the price of oil remains at the lowest levels since the 2008 recession, oilfield services (OFS) companies are faced with difficult decisions regarding the reduction of expenses to offset the decreased revenues being generated. OFS companies have been in the news recently for their broad stroke strategies to cost savings through personnel reduction via across the board layoffs. According to a recent Houston Chronicle article, OFS job reductions have climbed above 40K, with five of the ten largest OFS companies (Top 10) accounting for 32K, an average of 10% per company.
These types of reactionary measures have become commonplace in an industry that assumes a cyclical business staffing cycle. In 2008, when oil prices dropped over 75% in five months, the Top 10 OFS companies responded by drastically reducing headcount by 25.3K positions, averaging 6% per company. When oil fell to $33.73/bbl in December, 2008, the Top 10 saw their stock price decrease by an average of 67%, compared to a 30% S&P 500 decrease during the same period. The post-2008 recovery actions of these companies can give us insight on what to expect in 2015 and beyond, when companies must again reclaim share value.
The need to increase capacity and the distressed market compelled the Top 10 to engage in over 91 M&A deals, in the next few years, totaling over $32 billion. These transactions rely on proper integration to capitalize on expected synergies to realize their full value. Sometimes, however, the integration may prove to be superficial in nature, with management focusing its attention mainly on the increased revenue generated from the newly acquired assets. This can result in long-term decreased operational efficiencies as lost synergies lead to increased expenses, missed revenue opportunities, and reduced margin.Following the crash of 2008, the Top 10 began to experience a period of hyper-growth, increasing collective revenues generated by $60B from 2008 to 2013. Industry growth was mainly driven by a steady increase in demand world-wide for petroleum products, increasing oil prices, and the proliferation of shale oil and gas drilling in the United States. These factors contributed to a spike in new drilling projects and increased active oil wells, enabling the Top 10 to flourish.
Utilizing an Operational Efficiency Ratio (OER), the company’s financial efficiency may be measured. OER divides a company’s expenses by its revenues, essentially answering: “how much does each dollar of revenue cost?” We use this ratio to get a high-level picture of a company’s productivity. For example, while the Top 10 increased collective revenues by 55% from 2008 to 2013, their expenses increased 70%. Further, during this time, there was a 42% correlation between the average price of oil and the average OER levels of the Top 10. This implies that as the price of oil increases, inefficiencies are also likely to grow due to increased expenses incurred via rapid hiring and acquisitions. The inverse is also true. When the price of oil falls, companies are likely to implement drastic cost-cutting measures, often resorting to large-scale layoffs, as we are seeing again in 2015.
A viable alternative to aggressive adjustments of headcounts is for companies to evaluate their OER and focus on strategically improving efficiency. Taking a structured, detailed, top-down financial and operational look at the organization to find key performance areas ensures sustainable operational effectiveness. Next, a bottom-up approach identifies the detailed processes within each key impact area, streamlining operations wherever possible. This method creates sustainable cost-cutting measures that can position OFS companies to gain competitive advantage during the high and low cycles. The lower volatility in staffing levels creates a positive and confident image both internally and externally. Within the company, morale remains higher with perceived job security thereby increasing productivity. Externally, the negative press associated with layoffs is avoided, and the company can often see positive impacts to financial coverage from analysts thereby increasing a company’s reputation with its shareholders and the public. As shown below, companies going into the oil downturn with favorable OERs were able to retain an average of 8% more value in their share price than those with above average OERs.
Top 10 Efficiency and Performance Results (2014)
To find out more about OER, please visit North Highland’s Operational Efficiency Ratio website.