“The combined capabilities of the E&P operators and the leading service companies have the potential to realize the required performance upside for the industry. Still, this requires a willingness to modify the existing commercial model because the procurement-driven contracting model of the late 1990s is today the main obstacle to create the needed performance progress,” stated Schlumberger Chairman and CEO Paal Kibsgaard while addressing the Scotia Howard Weil 2016 Energy Conference held in New Orleans in March this year. Excerpts from the presentation in his own words:

I would like to cover three main subjects. First, I will discuss the current industry challenges, which are only partly driven by the massive drop in oil prices but also as a result of our industry’s failure to sufficiently improve performance over the past 15 years to tackle increasingly more complex hydrocarbon developments. Second, I will stress the urgency for the industry to accept that the current commercial and collaborative model between operators and service companies is suboptimal. I will outline how changes to this model can benefit our customers and what we at Schlumberger are doing to lead this process of change. Furthermore, I will show that the breadth of our technology portfolio, combined with our unique size advantage, makes us a significant partner and enabler as the industry enters a new era of collaboration and commercial alignment.

Third, I will share with you our latest market outlook and the short-term and medium-term implications this has for our activity levels. And I will also comment on how we are continuing to navigate the challenging commercial landscape and how we are creating one of the strongest technical and financial platforms in the industry, which makes us a very exciting investment proposition.

Today the E&P industry finds itself in the deepest financial crisis on record, with profitability and cash flow at unsustainable levels for most oil and gas operators which in turn has created an equally dramatic situation for the service industry. In spite of the unique structural nature of this downturn, oil and gas operators have once again activated the traditional playbook they have used to navigate every industry downturn since the 1970s. This dictates halting investments in exploration, aggressively curtailing development activity, and relentlessly squeezing service industry prices.

This ‘hold-your-breath and-hope-for better-times-soon’ playbook has in the past allowed the industry to live through shorter-term demand downturns while waiting for business to return to normal.  The major difference in the current industry situation is that we are unlikely to see oil prices returning to the $100 level because this downturn is not driven by lower demand or by external factors. It is instead an immediate result of OPEC’s decision to protect market share rather than oil price which clearly demonstrates that they still have a firm grip on the global E&P industry.

This shift is likely to have deep and long-term consequences for the industry similar to how limited access to reserves in the 1990s drove international and independent oil companies to pursue unconventional and deepwater resources. It is also similar to how high oil prices over the past decade created a surge in investment and production from these higher-cost resources even though the underlying progress in project performance was insufficient.

Going forward, the industry is likely facing a ’medium-for-longer’ oil price scenario, subject to periods of volatility, as the national oil companies within OPEC can still generate significant returns for their owners in such an environment due to the low cost base of their conventional resources.

The combination of a moderate price and higher market share could largely restore the oil revenues for many of the challenged oil-producing economies and is also likely to prevent uncontrolled production growth from higher-cost resources.

So what are the implications of a medium-for-longer oil price scenario?

Assuming a 1 per cent demand growth scenario, it first means that the ‘hold-your-breath’ approach of the oil and gas operators will be unable to deliver the required production growth. The apparent cost reductions seen by the operators over the past 18 months are not linked to a general improvement in efficiency in the service industry. They are simply a result of service-pricing concessions as activity levels have dropped by 40-50 per cent and most service companies are now fighting for survival with both negative earnings and cash flow. The unsustainable financial situation of the service industry together with the massive capacity reductions mean that the cost savings from lower service pricing should largely be reversed when activity levels start picking up.