U

ntil oil prices began to drop in 2014, North America’s oilfield services and equipment companies enjoyed a relatively smooth ride.

Over the previous decade, upstream E&P operators outsourced much of the work across a growing industry, paying a premium for availability when activity surpassed capacity.

Prices for equipment and services soared, and Oil Field Services & Equipment (OFSE) returns, though cyclical, were above normal.

Despite this, many OFSE providers left themselves poorly positioned for a downturn by allowing costs to rise along with pricing, and by orienting themselves to higher-cost, technically challenging applications-profit pools that have all but disappeared in today’s low-price environment.

When prices fell, OFSE executives followed their downturn playbook, cutting capacity, reducing overhead, and delaying capital spending. Even so, their revenues fell significantly as E&P customers slashed activity and pressured suppliers to cut pricing.

As a result, the leading OFSE companies saw a collective 25 percent drop in revenue from second quarter, 2014 (Q214) to second quarter, 2015 (Q215) and the sector lost more than US$130 billion in market capitalization.

Now many OFSE executives are coming to grips with the fact that we may be at a once-in-a-generation strategic crossroads that demands conscious and careful decisions about the future.

The current downturn could rival that of the 1980s in duration, and oil prices are likely to remain low for some time.

The industry that emerges might look quite different from the one that entered it. Lower-cost volumes, particularly from the Middle East, will continue to flow, and North American tight oil, while challenged at current prices, will also remain a significant part of new production growth.
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We may be at a once-in-a-generation strategic crossroads that demands conscious and careful decisions about the future.

Deepwater developments, however, are being radically reworked for the new price environment. Frontier plays such as arctic and ultra-deepwater-viewed as the industry’s next wave of growth a few years ago-are unlikely to be economical for quite some time, if ever.

For OFSE providers, the imperative now shifts away from pushing technical boundaries to finding efficiencies for themselves and their customers, while positioning their companies for long-term survival. Specifically, we see three things they should be doing:

First, continue to rebase costs. Most oilfield service executives have already cut discretionary spending, and many are now exploring ways to simplify operations.

The goal should be to create a leaner organization that can thrive in a low-price environment for years and emerge into a recovery in a stronger position. Among the
options:

* Require zero-base budgets to ensure costs are aligned with the most critical and valuable activities.

* Radically simplify the operational footprint, supply chain, and logistics and ensure alignment with new activity outlook.

* Integrate acquisitions taken during the recent growth period.

* Create a core set of standardized and modularized products.

Second, reduce customer costs. OFSE providers should collaborate with customers on a range of moves that radically restructure the cost base of the industry by engineering out cost, developing more efficient products and processes, and seeking novel business models to better align with incentives. These tactics can include:

* developing integrated, just-in-time supply chains to reduce total cost of operations;

* exploring design-to-cost and value engineering approaches to engineer out costs;

* identifying areas where customers’ standards drive significant costs and constructively challenge them to find ways to achieve the same objectives at lower cost;

* looking for selective areas where technology can push costs down, as with condition-based maintenance;

* searching for ways to collaborate with customers and exploring novel business models that better align incentives with customers; and

* using advanced analytics to identify opportunities to optimize equipment maintenance spend while maintaining strict health, safety and environmental standards.

Third, evaluate the portfolio. Companies should look for opportunities to reduce exposure to price volatility, fill key gaps in offerings and create optionality so they can respond effectively as the sector eventually recovers.

They may choose to reorient their product and geographic portfolios toward the lower end of the cost curve, building on reduced costs of engineering and manufacturing.

Or they may proactively identify potential M&A targets to build scale and scope and move lower on the production cost curve. Some equipment manufacturers, those for whom oil and gas is only one market among many, may consider exiting the market.

All of these moves require bold thinking, strong, collaborative customer relationships, and impeccable execution.

As with any serious disruption, the winners will be the players who can spot opportunities and act quickly to capture them.
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Ethan Phillips is a partner in Bain & Company’s Houston office and Marco Cioffi is a principal in Jakarta. Both work with Bain’s Oil & Gas practice.