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Oil Well Drilling Equipment Manufacturing Challenges Still Await

By James Crompton Analyst, IBISWorld

Recent declines in oil prices have dramatically impacted industries of many types, and oil drilling equipment manufacturers must be particularly attentive to recent market conditions. As oil companies curtail spending on production, demand for oil drilling equipment is anticipated to undergo a period of weakness. Revenue in the Oil Drilling Equipment Manufacturing industry is projected to decline by 14% in 2015, and this decline can be attributed to the steep decline in oil prices in late 2014. However, market conditions will likely improve over the next five years as upstream companies shift their spending from new production projects to focus on cost management objectives. Consequently, high levels of oil supply are anticipated to ease, which will likely bolster oil prices in the years to 2020.

Fayeteville_Shale small.jpg
A drill rig on a pad in the Fayetteville Shale gas play. The rig is used to drill the vertical and directional wells prior to the hydraulic fracturing process.

A Cautious Environment

Oil production has continued to be strong since oil prices began to erode in 2014. A variety of factors pressured oil prices in the second half of 2014, including weakening demand from Asia and Europe, high production levels in the United States, and the Organization of Petroleum Exporting Countries’ (OPEC) decision in November 2014 to maintain production levels. In light of the current challenges oil producers face, operators in the Oil Drilling Equipment Manufacturing industry will likely focus on cost management and acquisition opportunities in the near term. IBISWorld anticipates that employment in the industry will decline by 4.8% in 2015, and the number of industry operators is projected to decline by 1.8% during the year.

One of the most high-profile industry events to have occurred in the past five years is Halliburton’s $34.6 billion acquisition of competitor Baker Hughes in November 2014. Though still awaiting approval, this acquisition will solidly cement the combined company atop the industry if approved. Acquisitions are commonplace in the industry, as large companies must continuously seek high-value assets and technology to remain competitive on a national scale. However, as market conditions improve over the next five years, IBISWorld anticipates that market entry will outpace the rate of acquisitions in the industry. Over the five years to 2020, IBISWorld estimates that the number of industry operators will expand at an annualized rate of 1.5% to 647. The majority of industry entrants will likely be regional and specialized product and service providers.

In 2015, most major companies in the industry expect a slowdown in new orders. National Oilwell Varco, for example, expects that its revenue from backlogs will exceed revenue from new orders. Halliburton also expects that 2015 will provide a challenging business environment for its industry relevant segments. As upstream oil and gas companies scale back operations and reposition existing assets rather than purchase new equipment, companies in the Oil Drilling Equipment Manufacturing industry will have to emphasize providing high-value services to customers.

A Shifting Landscape

Though challenges will persist in the short term, the overall outlook for oil drilling equipment manufacturers is bright. Low oil prices are anticipated to reverse in the five years to 2020, and in the process, the industry’s customers will likely increase investment budgets for equipment. As oil wells become more complex to drill and resources diminish, upstream oil and gas companies must rely on more efficient and technologically advanced equipment. Consequently, oil drilling equipment manufacturers will be well positioned to provide solutions and products to customers.

Since 2010, the number of horizontally drilled wells has drastically increased. According to Baker Hughes’ rig counts, in April 2010 horizontal wells accounted for 50.2% of active rigs, and this percentage has risen to 77.7% in April 2015. Likewise, the split of oil and gas rigs has drastically shifted over the period. In April 2010, oil rigs accounted for 34.3% of active rigs, while in 2015 oil rigs account for 78.0%. Over the next five years, IBISWorld anticipates the overall share of oil rigs and horizontal drilling will persist at current levels. These overall shifts also played a role in the overall success of the Oil Drilling Equipment Manufacturing industry in the five years to 2015.

Rig counts have declined drastically since the price of oil began its slide. As of April 2, 2015, the number of rigs in North America was 1128, compared to 2053 a year prior. In fact, over the same period, every major basin in North America registered declines in the number of active rigs over the year. Uncertainty in oil markets will undoubtedly persist over the next five years, as there has yet to be a concrete floor on oil prices. Furthermore, the potential for exogenous shocks remains constant, and as a result, industry operators will continue to focus on internal restructuring and acquisition opportunities to weather the current price environment.

Hydraulic_Fracturing_Drill_Site_Marcellus_768x432.jpg
In 2012 when this photo of a hydraulic fracturing drill site was taken, the Marcellus Shale play in southwestern Pennsylvania was a hotbed of activity.

Uncertainties Loom

The United States is expected to maintain its focus on developing a more self-sufficient energy production model, and industry operators will likely benefit from this trend. The shift towards the nation being an energy producer rather than solely a consumer has already altered energy markets in the United States. High levels of natural gas production, largely influenced by shale gas deposit extraction using this industry’s technology, have led to an oversupply of the commodity and a shortage of transportation infrastructure to handle it. While the outcome of the Keystone XL pipeline project is still being determined, the project has the potential to seriously impact energy markets in North America. Furthermore, export restrictions on crude oil also have constrained price growth for domestically produced oil and gas. These regulations, which were implemented decades ago to protect the supply of oil in the United States, have recently been up for debate as demand for energy products in the developing world, especially in Asia, could positively impact the prices of crude oil and natural gas. Although there is much uncertainty surrounding regulatory actions during the next five years, the industry could experience a boost in demand if regulations are relaxed, which would bolster domestic production.

Despite this uncertainty, hydraulic fracturing and horizontal drilling are anticipated to maintain their significant role in shale resource production. As investment in this sector continues to increase, technology is likely to improve during the next five years. The environmental focus on the oil and gas sector ensures that the industry’s downstream customers will continue to demand the highest-quality, most environmentally friendly products. Furthermore, the importance of new technological development is expected to boost demand for highly skilled workers, a trend that will drive up wages an annualized 1.1% to $3.1 billion during the five years to 2020. Despite higher industry wages, average industry profit margins are anticipated to slightly increase during the next five years. The lack of substitutes for industry products and the resulting inelastic nature of demand for the industry will help industry operators boost their performance during the five-year period.

Oil drilling equipment manufacturers are also anticipated to continue seeking trade partners overseas to bolster revenue. In the five years to 2020, exports are anticipated to increase at an annualized rate of 1.5% to total $8.5 billion. This represents nearly half of industry revenue in 2020. However, like the United States, international markets are exposed to a wide range of risks, including currency fluctuations, regulatory changes and geopolitical events. The ability of industry operators to supply global markets with oil drilling equipment will be important for industry operators to develop and maintain.

Summary

Overall, this year is poised to be challenging for the oil drilling equipment manufacturers. Continuing uncertainty over oil prices, regulations and infrastructure expansions will encourage companies to focus on internal operations and rely on order backlogs to generate the bulk of their revenue. The largest companies in the industry, including Halliburton, National Oilwell Varco and Cameron International, will continue to pursue acquisitions and cost management strategies to navigate the low price environment. However, the cyclical nature of the oil industry is well understood by industry operators, and as a result, IBISWorld anticipates the industry to perform strongly once oil prices recover and existing oil drilling equipment is decommissioned. Industry operators will continue to emphasize efficient drilling equipment and technology, as more efficient machinery typically coincides with higher cost effectiveness and safety standards.

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