FSESX moved down 7.14% (from $37.25 to $34.59) in one week.
I don't like that but I am keeping my FSESX for long term.
The following is from briefing.com StreetBeat, October 17th.
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(From Briefing.com)
StreetBeat
Updated 10/17/97
The purpose of StreetBeat is to provide you with additional
insights on the market from recognized financial experts on
(and off) Wall Street. It should be noted that the views and
opinions expressed by the panelists below are not necessarily
those of Briefing.com.
StreetBeat asked James Wicklund from Rauscher Pierce and
Thomas Bates from Wheatherford Enterra (WII), a diversified
international energy service and manufacturing company, to give
us their views on the oil services industry.
Panelists
* James K. Wicklund, Senior Vice President, Senior Oilfield
Service Analyst and head of Energy Research at Rauscher
Pierce Refsnes. Mr. Wicklund spent eleven years in the oil
and gas industry working in the areas of finance, geophysics,
and engineering. He has covered the industry as an analyst
for the past eleven years.
* Thomas R. Bates, JR., President and Chief Executive Officer
of Weatherford Enterra. Mr. Bates has twenty two years
experience in the oil and gas industry, holding various
positions with Schlumberger Limited and Shell Oil Co. He has
published a number of papers on drilling technology and
other subjects.
Q&A
Briefing: Oil service companies, particularly in the offshore
segment have recently seen extremely strong earnings growth. How
long do you anticipate this boom continuing? What obstacles might
curb this growth?
James Wicklund: The oilfield service industry went through more
than a decade of recession/depression following the oil crash of
1986, adding virtually no capacity or equipment and going through
a number of reorganizations to try and stay alive. There was a
brief but unsustained recovery in 1990-1991 but when it failed
to continue, again the industry went through a final round of
cost reductions, rationalization of obsolete equipment and
started to focus on computer-aided technologies that were
increasing productivity in other industries. In early 1994,
the effects of significantly lower drilling levels over several
years started to be felt, constraining supply of oil and gas,
and demand for these hydrocarbons, which had been moving up
steadily for years, accelerated with higher demand growth for
natural gas in North America and crude oil in developing
countries worldwide.
With no capacity added for years, continued attrition of
marginal equipment and increasing demand driving prices higher,
activity and utilization of the offshore drilling rig fleet
started to increase significantly. With a fixed operating cost
base, higher dayrates provided dramatic earnings leverage. If a
rig with a daily operating cost of $10,000 per day and a dayrate
of $17,000 had its dayrate move up, and today that rig gets a
dayrate of $60,000, operating income increased seven-fold. This
increase over only about 2-3 years has provided the dramatic
earnings growth seen. And with dayrates expected to move up to
$85,000-$95,000 per day before new capacity is added, this growth
should continue. About the only potential weakness we see is a
substantial drop in natural gas demand and pricing but with the
current reserve base in decline, continued switching to natural
gas as a clean fuel and the shut-down of nuclear capacity over
the next few years, the possibility is remote. An increase in
supply of rigs could shift the economics but with dayrates not
justifying new construction and lead times in excess of two
years, there is no near-term potential for over-supply.
Thomas Bates: Sustained growth will continue as long as the supply
and demand trend in the oil and gas sector stays healthy. The
underlying fundamentals are stronger today than they have been
at any time in the recent history of the oil industry. Crude oil
demand, for example, has increased by 11 million barrels per day
in the last ten years and it is forecasted to increase by another
16 million barrels per day over the next 20 years. So this demand
driven recovery could last 10 years, 15 years or even 20 years
powered by the growing economies in the Pacific Rim. I think
the biggest obstacle that we have to worry about is if the price
of oil drops outside of, say a range from $17-24/bbl, either on
the low side or on the high side. At $20/barrel for oil, energy
is very affordable, both in developing countries and in the
already developing nations.
Briefing: What role has technology played in the resurgence of the
oil service industry?
James Wicklund: Technology has played a very dramatic role and in
more ways than conventionally assumed. Three-dimensional (3-D)
seismic technology is the more heralded and discussed technology
of the oil and gas industry over the past several decades and
rightly so. 2-D seismic was the primary method of detecting
potential oil/gas reservoirs for many years but was similar to
the old adage of describing an elephant by feeling its tail. The
technology told us that a potential oil/gas bearing anomaly was
in the area but did not define its location. 3-D technology is
similar to throwing a sheet over the elephant. While you cannot
directly see the elephant, you do know its location and shape.
As a result, a great deal of unsuccessful drilling is now
avoided. The success rate of finding oil and gas has increased.
The cost to the oil company of finding oil and gas has dropped
significantly.
In a broader sense though, this is just a single example of
what is happening in the oilfield service industry. While the
oil/gas industry has always been very technical, desktop
computing capability to boost productivity did not come into
the industry until about 4-5 years ago because of the very
large processing requirements. While grocery stores and video
stores made use of computer and software technologies to improve
their businesses years ago, the oil/gas industry was still using
paper analog displays to locate oil and gas. With computing
costs dropping dramatically over the past few years, we have
seen all facets of the oil/gas service industry enter the
computer age, bringing the same efficiencies and improvements
seen in other industries. Inventory control/bar coding of
equipment, CAD/CAM design of equipment, simulation of well
treatments, the ability to steer the drillbit to the exact
location and increased predictability of production have all had
dramatic impacts on the efficiency and productivity of the
industry.
Thomas Bates: Technology really has been integral to the growth of
the industry over the last ten years. In the early to middle
1980s, there was demand for additional oil at moderate prices,
but oil companies couldn't produce oil economically for less
than about $30 or $35/bbl in some swing producing locations,
like the North Sea and the deepwater Gulf of Mexico. In the
interim, technologies have evolved, including 3D seismic,
horizontal drilling, subsea wellhead and subsea completion
technology, and extended reach drilling. Those developments have
made $20/bbl very profitable for our company clients.
Briefing: Oil service companies have been raising prices as the
strong demand for oil services and equipment outpaces supply.
How long do you think this imbalance will persist? Do you see
a point where supply is greater than demand and if so, who will
this effect growth?
James Wicklund: The fiscal discipline of the oil service company
managements is having the greatest impact on these concerns. In
previous cycles, oil service companies would use free cash flow
to build more of whatever equipment they offered because demand
was high and they could. Greater emphasis is now placed on
return on capital employed, return on shareholder equity and
other measurements that cause managements to examine potential
returns before new investment takes place. This has had the
effect of keeping supply/demand of equipment in much tighter
balance and for a longer period of time, pushing prices higher
so that when new investment is made, adequate returns are
generated. This means that there is no real imbalance just a
closer balance than we are used to seeing in the industry. If
the company management adhere to these types of fiscal
discipline, the potential of too much supply coming onto the
market is reduced. When the cycle does eventually roll over and
the industry has always been cyclical in nature, than there will
be some over supply of equipment but it will be minor in
comparison to the levels seen at the end of past cycles and the
recovery from that point should be sooner and less painful to
industry participants.
Thomas Bates: First of all, I don't believe that a strong imbalance
exists between supply and demand. The price movement that has
taken place merely reflects the returns that the service industry
requires to maintain its capital base. If there were an imbalance,
you would see speculative increases in capacity and that is not
happening. As a result, I don't see that supply will exceed
demand by any significant margin unless there is a collapse in
the oil market.
I think a more important issue is whether today's price increases
for rigs, equipment and services will result in underlying
inflation which forces the price of oil up. Technology is the key
to sustained moderation on the price of oil. As long as technology
improves production efficiency faster than prices rise, there will
be no impact on the cost of producing oil.
Briefing: To what level would the price of oil need to drop to pose
a threat to the oil service business? Is this group in a better
position now than it was in the 1980s to weather a slowdown in oil
production?
James Wicklund: The increased use of technology we have mentioned
has brought the finding and development costs of oil/gas down
dramatically meaning that the economic break-even point for oil
companies is much lower. As an example, all of the deepwater
Gulf of Mexico projects have economic thresholds at about $8-$9
per barrel. Subsea completions, multi-lateral completions,
directional drilling, marginal field development systems, 3-D
and 4-D seismic, all technologies offered by the service industry,
help boost the returns to oil companies in low commodity price
environments. The fact that most of the R&D effort is now done by
the service sector rather than the oil companies, putting the
technologies into the public domain much faster, also provides
protection against drops in activity from lower pricing.
All of these factors taken into consideration mean that oil
prices would have to drop to about the $13-$14 per barrel level
and stay there for some time before there is a real threat to
the service sector. If commodity prices two years ago had
dropped, and they did in 1992, oil companies would have shifted
or cut capital spending budgets in uncertainty over the future,
having a detrimental impact to the service sector. Today, oil
companies are convinced that based on their view of engineering
and physics, oil and gas supply/demand are in such a tight
continued balance that any near-term weakness in commodity
pricing would not justify changes in capital budgets.
These continuing improvements in technology combined with
memories of the mid-1980's and the focus on performance based-
results will keep the service sector lean, competitive and in
much better shape to weather future shifts in production and
pricing.
Thomas Bates: I think that if we saw a sustained price of less
than $16/bbl, it would create some damage to the prospects for
growth. That problem should be self-correcting because as the
price of oil gets lower, it creates an acceleration in demand
for energy. If we go back to the decade of the '80s, we can
clearly see the impact of extremes of price on demand. When
the price of oil went up in 1980, demand dropped by 15% in the
space of five years. Then, when the price of oil crashed in
1986, energy became more affordable and demand recovered very
quickly.
Is the group in a better position now than it was in the '80s
to weather a slowdown in oil production? The answer to that is
definitely yes. Let's look, for example, at the drilling rig
business. I think it is characteristic of the reticence to over
capitalize the industry. In December of 1981, there were roughly
500 rigs working in the offshore market, the dayrate for semi-
submersibles was $80,000-$100,000/day, and there were 239 new
offshore rigs under construction. Today, we have more or less
500 rigs working in the offshore market, the dayrates for semi-
submersibles are essentially at the same inflation-adjusted price
and today there are only 20 or so rigs under construction. So I
think there is certainly a great deal more restraint in the
industry. There is a whole industry full of executives who have
been tempered by the downturn that we saw in the 1980s. So
I think there's a reticence on the part of the management teams
to invest at overcapacity at this stage and that clearly puts us
in a better position to weather any slowdown that might occur.
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