In the midst of global concerns for future energy, the abundance of shale oil and gas reserves has been a revelation. The U.S. has been at the fore of this energy transformation.
According to a latest report by U.S. Energy Information Administration, technically recoverable shale oil and shale gas resources across the U.S. account for an increase in crude oil and natural gas reserves of 35% and 38%, respectively. Currently, shale gas contributes as much as 30% of U.S natural gas production and this is expected to touch 60% by 2035. This opens long term avenues for the oil-field services companies like Halliburton which has the expertise, technology and strong positioning in North America.
Halliburton (HAL) is one of the largest oil field services companies in the world. It derives about 57% of its revenues from its operations in North America. With 40% of its revenue generated through hydraulic fracturing and pressure pumping services. It should be noted that it is highly exposed to natural gas.
Halliburton’s second quarter results highlighted slowdown in North American operations as revenue fell 8.2% to $3.8 billion. This is on the account of low gas prices of $3.80 per thousand cubic feet and fall in active rig count from 726 to around 464 over the year. In the short term, there is respite from lowering of the guar gum prices, which skyrocketed last year due to supply constraints.
To further elevate its margins, Halliburton is focusing on measures such as transitioning "fracking" fleet from diesel fuel to natural gas, adoption of multi-pad drilling and 24 hour operations to improve service intensity. This is expected to have an upside on its Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA), particularly in the regions where such measures are implemented.
According to GBI research, the U.S. oil and gas field services sector is estimated to have annual revenue of $99 billion, which forms a staggering 61.8% of the global revenue. Halliburton has a market share of 15.5%. Roughly 40% to 50% of this is dedicated to natural gas services via pressure pumping.
U.S. natural gas production is expected to grow by roughly 20% in the next five years. As per World Bank projections, the long-term price for natural gas is expected to be $5.1 per thousand cubic feet by 2018. This offers an upside of 34.2% on annual revenue generated after five years.
Rig Count Upside
As the current environment is not conducive for marginal players, Halliburton should be able to raise its market share over a period of five years. A 3% to 4% gain in market share would translate into 2.5% upside on according to a Trefis price estimate.
Considering the growth rates in crude oil and natural gas production, it is expected that the rig count will reach 2797 in the year 2018, against Trefis projections which estimates rig count will not reach the 2800 mark until 2020. This gives an upside of 3% over the Trefis price estimate and 14.7% above its market price.
The most optimistic but certainly possible scenario is the parallel occurrence of above-mentioned developments which will lead to an upside of 5.5% over Trefis price estimate.
Revenue Per Rig
As per Trefis estimates, Halliburton should achieve 7% to 8% annual growth in its revenue per rig during this decade. This is predominantly due to deployment of superior technology, streamlining of operations and an expectation of recovery in gas prices.
The Trefis estimate is based gas prices rising to $7 per thousand cubic feet from its current price of around $4. In case the gas price trend follows World Bank estimate of $5.60 per thousand cubic feet by 2020, there is a downside risk of 3.1% to Trefis' price estimate of $49.76. There can be further downside to this in terms of a correlated decrease in rig count.
Comparative Analysis: Halliburton, Schlumberger, Baker Hughes
Over the past five-year period, Halliburton has outperformed its competitors with a 6.91% increase in stock price, while Schlumberger and Baker Hughes have experienced a slump of 8.49% and 31.11%, respectively.
Halliburton, with more than 50% revenues, has the greatest exposure to the North American market. Schlumberger, on the other hand, is well diversified internationally with 70% of revenue from overseas markets. In the current scenario of low gas prices and flat rig count in North America, Schlumberger is better positioned to offset local slowdown with strong international growth. Baker Hughes, of the three, is the most affected by the North American slump. Unlike Schlumberger, it lacks strong international exposure to beat the decline in demand.
Halliburton, although positioned fairly similarly to Baker Hughes, leads with a year-on-year growth rate differential of 3% to 4% in revenue per rig and 1% to 2% in rig count. In the longer run both Halliburton and Baker Hughes are great prospects with Shale exploration booming.
Natural gas prices in the U.S. have slumped drastically primarily due to oversupply of capacity. This hurts the oilfield industry, and as expected its revenue levels are not lucrative.
In contrast, the price of natural gas in global markets is three to four times higher. Going forward, export facilities for LNG are the most viable way to transport natural gas to Asian and European markets, and will be extremely crucial to the sector's growth. This will not only improve exports but will propel local gas prices and drive exploration and production activities. Nevertheless, the road to growth is expected to be undulating due to internal lobbying from chemical and other forward industries that are contesting for low gas price.
Considering the initiatives taken by Halliburton such as transitioning "fracking" fleet from diesel fuel to natural gas, successful implementation of multi-pad drilling and 24-hour operations to improve service intensity are expected to elevate its profitability in the coming future.
The second quarter witnessed a slowdown predominantly due to low gas prices; however, projections made by Trefis and World Bank suggest that gas prices will go through an escalation in the coming future. Therefore, I suggest investors hold on to Halliburton's stock.