Why the Comptroller’s Report Spells Doom for Texas Oil Companies

Today, I read with interest this article on the Texas Tribune. Overall, the tone of the article is nothing if not upbeat. Unfortunately for Texas oil companies (and the economy of West Texas in general) it spells doom for many of them.

You see, one of the things that the Comptroller in Texas is in charge of is forecasting revenues. Part of those revenues come from tax revenues derived from oil production activities. The Texas Comptroller, then, must necessarily make a prediction about what the price of oil will do over the next two years (Texas operates on a biennial schedule).

Which brings us back to Aman Betheja’s excellent synopsis of the information in his article. While Betheja rightly focuses the first few paragraphs of that article on the fact that revenues will still beat the projected expenditures in Texas; for those of us in the oil business, the story buries the lede in which we would be more interested… In brief, Glenn Heger has forecast doom for the oil and gas industry. Most damningly, he has forecasted doom for the oil and gas services industry, which, as I have argued before, is the actual foundation for the West Texas economy.

Mr. Heger forecasts that the price of oil will be $44.53 for the first year of the biennial and $50.87 in the second year of the biennial. In the region people seem to be of the mind that the sky is not falling because the oil production companies have largely pressured oil and gas service companies to lower costs – thereby protecting profits in the interim of low commodity prices.

Unfortunately, however, this seems to mistake two rather obvious conclusions one can draw from this information. First, Pollyanna prognostications tend to miss the generally recognized concept that cost reductions will be felt somewhere along the chain: from management reductions, reduction in service levels or, most likely, reductions in personnel in the labor sector. Second, this notion that more cuts will lead to greater efficiencies seems to miss the point that there is, somewhere, a point at which the oilfield service companies cannot drop below… to do so would disrupt cash flow, debt service and/or minimum payroll.

Back in July, the Economist magazine had a great article on the state of the oil and gas industry. In those halcyon days (when prices were closer to the $60/bbl range), the magazine noted that service companies in the Midland-Odessa region had already let go 20-30 thousand temporary employees. This was not reflected in the employment figures of the region because those people promptly left the area.

That article noted that this labor reduction was accomplished because the major shale production companies had “brutally” squeezed the oilfield services companies to slash spending by 25%. The brutal nature of this pressure indicates the shale firms have probably extracted substantially all of the cuts they will be able to achieve from pressuring these organizations in the near term. Yet, even back in July, the shale firms that were interviewed for the story (and there were a LOT of them), confidently indicated that they could continue to return sufficient returns with oil at $60 per barrel…

A concomitant conclusion that could be drawn is that oilfield service providers will seek to do more work to make up for the lower prices they make on each given job. Since the first concept listed above tends to illustrate doing more work with less workers, that indicates a strong incentive to increase the productivity of the remaining laborers, without increasing costs (such as by paying tons of overtime). What follows, then, is a strong incentive to find ways to assist those workers with getting more done in less time – read, “automation”. What this means for labor in the long-term perspective is that the jobs that are bleeding out of the industry are likely gone for good… Why pay for a worker when you can make a single capex investment, which can do the same work and be depreciated over time?

Return for a moment to the Comptroller’s analysis… these firms are projected to run into a shortfall on proper earnings for at least the next two years! Add to that the estimation by the Economist that 29 of the 62 largest e&p firms were in distress and that almost half of all firms relied on hedges to beef up balance sheets, which will expire over the course of the next few months, and it is easy to see that the writing is on the wall.

Perhaps what we’re seeing today is the interlude to the reintroduction of the majors in the fields of West Texas. They left during the last bust, and my thought is that they have been chomping at the bit to get back here in large numbers ever since the fracking revolution took place.

About Sennoma Civitano

You can trust me. I'm a law-yuh. Oh, and I have a Master's in Public Affairs. I read books. About things.
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