istorically, there has been a correlation between rig counts and oil prices driving capital spending in the upstream sector of the energy industry. Likewise, this has typically been an indicator for the performance of the oilfield services (OFS) sector as well.

The onset of 2020 began with an active rig count of 796, down from the peak of 1,075 in January 2019. Post-COVID-19, the rig count declined to 247 and has since rebounded slightly to 269. Pre-COVID-19, the disconnect between rig counts and oil prices was evidenced by the change from 2019 to 2020. Post-COVID-19, the lowest WTI closing price was $16.94/bbl; however, the WTI crude price has since rebounded from historic lows to hover at approximately $40/bbl.

Is this a long-term trend or will the correlation return as we consider the current $40 to $45/bbl crude oil pricing environment? What impact will the above have on the OFS sector?

Navigating volatility

Assuming oil prices trend upward and the supply side of the oil equation moves toward equilibrium, there is an expectation that capital spending will eventually increase, and rig counts will rebound as a result. Nevertheless, there are three questions that will need to be addressed in the industry:

• Will shareholders continue to demand return of capital and deleveraging of balance sheets?
• Will borrowing base redeterminations and other credit-related issues decline, increase or remain static?
• Will OPEC+ control its supply to meet demand without negatively impacting oil prices?

In terms of shareholders, it is very likely that there will be a continued demand to increase shareholder value in the E&P sector. The significant decline in market value of publicly traded companies will lead to continued stress from shareholders and will require upstream oil companies in particular to effectively balance their production, restrain capital spending, lower debt loads, right-size their back office and create added value for shareholders.

On the credit front, as has been evidenced from the recent borrowing base redeterminations for reserve-based loans earlier this year and expectations for the current round, banks are expected to reduce their exposure to the upstream industry in the near term. As banks are under pressure to reduce their exposure, certain producers will have to find alternative sources of capital—most likely at higher rates.

For companies primarily focused on oil production, the expectation is their borrowing bases will at best remain unchanged and/or be decreased. The consequences of reduced borrowing bases will limit an oil producer’s availability to capital, thereby reducing capital deployed in the sector in 2021. Many oil producers will focus on maintaining production rather than increasing production because of limited capital. Consequently, these factors will continue to place stress on the OFS sector.

Cloudy with a chance of survival

What does this mean for the OFS sector? The next 12 to 18 months will continue to be challenging due to the factors mentioned above. Recent revenue forecasts for the OFS industry indicate 2021 will be a year of nominal to no growth, with 2022 being the year of upward trajectory.

Additionally, private-equity-backed OFS portfolio companies may be more receptive to the idea of portfolio company/investment combinations, or smashcos. In this environment, both sponsors and portfolio companies are looking for cost savings wherever they can find them and, as such, they may be looking for ways to promote cross marketing and other synergies among portfolio companies.

As we head into 2021, it is imperative that OFS companies preserve capital and ride out the storm before they can reasonably expect to see an uptick in activity.

About the authors: Dean Price is an Opportune LLP partner responsible for the Oilfield Services sector and the Valuation Advisory and Tax Advisory service lines. Kevin Cannon is a director in Opportune LLP’s Valuation practice.