Oil Price Crash Won’t Doom the Supply Chain : “It’s Better Than You May Think!” Says Exploration CEO

Industry contributes approximately $1.2 trillion to U.S. GDP and over 9.3 million permanent jobs.

The oil industry is a major producer of jobs and wealth for the U.S. It contributes approximately $1.2 trillion to U.S. GDP and over 9.3 million permanent jobs, so any serious drop in the price of crude oil could spell disaster for related industries. But according to Shawn Bartholomae, CEO of Prodigy Exploration Inc., the sudden sharp drop in crude prices may sting the industry at first, but it won’t last long. In the very near future drilling will become more cost-effective, resulting in higher profit margins over time.

Bartholomae’s take is that low crude pricing will force the exploration community to renegotiate every aspect of their cost structure throughout the supply chain, forcing drilling companies to cut workforce wages and perks for skilled workers. And that supply chain is larger than is generally believed, engineering everything from drill bits to drilling mud in a highly technical, productivity driven industry.

But what if oil prices stay low? He believes that demand for oil remains strong, which will provide a “floor”.  That floor will prevent prices from going so low that profit margins can’t return to a profitable state. In fact, he says, production costs in the industry have risen in lock step with crude prices:

“Drilling for oil in the last several years has become easier and more efficient but production costs have gone through the roof. Why? There are a few reasons for this but the primary reason is high oil prices. When oil service firms like Halliburton and Schlumberger negotiate contracts with developers they take the oil price and demand into consideration. The higher the oil price, the higher the demand, the higher cost for their services which equates to higher costs for everything associated with the industry, such as labor, pipe, equipment, administrative costs, engineers, geologists, and drilling costs.

Furthermore, when prices drop, development costs do as well which brings the “break-even” price down with it as I mentioned previously. The larger developers know how to accomplish this task.  They simply don’t engage new drilling contracts unless it is economical which has a rippling effect on other oil field services. What happens next is simple.  Drilling companies drop their rates to keep their rigs active. As this occurs the drop in drilling costs becomes highly competitive dropping rates even further and profit margins come back into focus even if the price of oil falls to an unimaginable $30 a barrel.”

Still profitable at $30 a barrel

Bartholomae believes that the new, leaner industry will support reasonable margins for exploration activities even if oil remains at $30 a barrel for a protracted period of time. In the short term however, drilling rig counts have dropped sharply.  The latest Baker Hughes rig count reflected that the total number of US rigs in operation (including both oil and gas) fell again last week to 1,750 as of Jan 9th 2015, down another 61 rigs from 1,811, which is down from 1,842 the previous week. This is down from 1,920 for the week ending December 5.

Oil rigs in use fell by 37 the week before last, while gas rigs increased by two. For the week ending December 12, the number of oil rigs in use fell by 27, which at that time was the single largest weekly decline in two years. The following week, the number of rigs in use fell by 18. While rig counts make headlines, they don’t immediately equate to falling production, the key factor in pricing. With major new resources in the US coming on stream, such as the Bakken formation in North Dakota, many producers have set $60 a barrel as the breakeven point.

Bartholomae notes however that large developers with shale holdings in South Texas can remain profitable at $45 a barrel by strategically driving the price of oil service contracts down. There is tremendous inertia in the system. Renegotiating or terminating oil service contracts and shutting down an existing drilling operation is much more costly than delaying new exploration, so it is no surprise that supply chain price cuts trail the decline in oil prices as contracts run out.

The same inertial forces work in the other direction. New contracts signed at lower pricing mean enhanced profit margins if and when crude pricing returns to historical averages. Over time this may move the margin squeeze down from exploration companies and producers into the service and supply chain who in turn will increase efficiency and cut costs. Whether the supply chain can restore lost margins when oil activity improves is uncertain. The likely outcome is an increasing disconnect between supply and service pricing and operating costs in the supply chain. Efficiencies once gained, aren’t lost regardless of how supply and demand effects pricing.

Prices will rise, says CEO

“The drop in oil rigs is already lowering the cost of development!” declares Batholemae, adding, “the price of West Texas Intermediate touched down as low as $48 a barrel for the first time since June 2004.  But this is no reason to panic. Back in December 2001, WTI crude was priced around $25 a barrel and steadily climbed to $82 per barrel by 2006.  Shortly thereafter prices dropped to $68 a barrel before skyrocketing to an all-time high of $143 a barrel in July of 2008, just two years later.  Then, within six months it spiraled to $43 a barrel in 2009, even lower than it is now!

And then what happened? By April of 2011, prices steadily increased to $115 a barrel, again just two years later. The cycle is starting again and we know that the best time to invest in oil and gas is when development costs are down and profit margins have re-inflated as they always do thereby allowing for maximum gain during the next ‘bull run’.”

This could be the talk of an enthusiastic wildcatter, or Bartholomae may win his bet and make a fortune for his shareholders. The Republican-controlled Legislature in Washington as well as the destabilizing effect of conflict in the Middle East are factors in crude pricing, but the new and unprecedented supply driven collapse in crude pricing is driven by Saudi Arabia’s commitment to higher output.

If Bartholomae is correct, oil prices will rise again? But with the Saudi’s recently announcing that $100 barrel oil won’t return, rising demand is the only certain price driver.  With a slow global economic recovery, tight margins may be the norm for the rest of the decade. For the supply chain supporting exploration activity, maintaining profitability will require an even greater emphasis on cost control, with  more, flexible automation and tight controls on production scheduling and inventories.

Written by

James Anderton

Jim Anderton is the Director of Content for ENGINEERING.com. Mr. Anderton was formerly editor of Canadian Metalworking Magazine and has contributed to a wide range of print and on-line publications, including Design Engineering, Canadian Plastics, Service Station and Garage Management, Autovision, and the National Post. He also brings prior industry experience in quality and part design for a Tier One automotive supplier.