More powerful, productive, and cost efficient: Today’s oil rigs break with the past
April 19, 2018
As active investors in the energy sector, we have witnessed a change in the economics of energy exploration, and we have seen companies push the boundaries of technological innovation. The past decade provides a good framework for assessing some of the forces that have been in play on both fronts.
Oil supply has increased sharply
As recently as 10 years ago, US oil reserves were thought to be drying out. The picture has changed dramatically since then, and several data points help explain the degree to which exploration and extraction have expanded:
- US crude output is up by 20% since mid-2016 and by more than 100% since 2007.
- In November 2017, US production surpassed 10 million barrels per day for the first time in 50 years.
If such production trends continue, the United States could become the world’s top crude oil producer in two years, pulling ahead of Saudi Arabia and Russia.
Meanwhile, drilling methods have grown increasingly sophisticated
Drillers have also found ways to extract oil more efficiently, particularly as companies have invested in scientific research. This focus on innovation has yielded horizontal drilling and hydraulic fracturing techniques that allow drillers to not only produce more, but to bring down costs at the same time. In effect, such unconventional drillers have created an environment in which they can reliably “do more with less” — a state of affairs that any industry would envy. Rigs come online faster (some can be online in less than 24 hours), and production volumes can quickly be adjusted in response to oil prices (see chart).
Data: Baker Hughes, via FactSet
We think the energy sector, and oil industries in particular, offer opportunities for investing in companies that can accommodate the economic shifts that unfold when commodity prices change. This includes companies that engage in the transformation mentioned above: improving the operational efficiency of oil extraction while bringing costs down at the same time.
Large-caps might be front of mind for many analysts who cover the energy sector, but it’s worth keeping in mind that small- and mid-caps are playing important roles as well. Smaller companies often supply the machinery, equipment, parts, and services that go into large energy complexes and the infrastructure that supports them. What’s more, small- and mid-cap companies are no strangers to investing in continued innovation and performance excellence. The state-of-the-art engineering being practiced within smaller companies is resulting in real-world benefits to the oil services industry, not least of which is the improved efficiency mentioned above.
As part of our day-to-day research, we are following a company that we believe exemplifies how new drilling technologies have reshaped the industry. The firm operates a large fleet of land rigs in the US, and has embraced several new extraction technologies, including:
Multiwell pad operations. These rely on a type of rig that is designed to be movable; after drilling a well in a certain spot (called a lateral), this rig can move (or skid, in industry parlance) a short distance to drill a new lateral. This engineering leap allows a rig to drill several laterals without having to disassemble and relocate.
Super-spec rigs. These rigs use computer systems to handle complicated drilling tasks, and they operate in sharp contrast to older rigs that rely on a full crew of men. These crews often perform dangerous, physical work, frequently standing on the rig itself and manipulating mechanical systems by hand. Technicians on a super-spec rig, however, can make remote adjustments via computerized control panels.
Optimistic outlook, with a focus on research
Overall, we are constructive on small- and mid-cap companies in the energy sector, while acknowledging cyclicality and volatility. At the company level, we think investors should note that (1) there’s no single recipe that will insure success, and (2) complications can arise from the complexities involved in energy exploration and production. Having said that, a reliance on careful, company-by-company research can reveal firms that are taking diligent, well-planned approaches to this exciting and increasingly technologically driven sector.
The views expressed represent the Manager's assessment of the market environment as of April 2018, and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice and may not reflect the Manager's views.
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