Historical Industry Synopsis -1972-2012 – A 40 Year Review

Aestimo’s services are primarily provided to the oil and gas industry and as such Aestimo follows the market closely. The following overview on the oil and gas industry was prepared by Aestimo to assist those better understand the changes that have occurred in the industry over the past 25-years and how these factors have impacted the oilfield service industry and equipment values.

After years of relative stability in the oil industry, in 1972 Arab nations withheld approximately 5-million barrels per day (mm/bpd) of oil from the market (Arab embargo against countries supporting Israel during the Yom Kipper war). This resulted in oil prices quadrupling form the $3 to $12-per barrel range by the end of 1974. Prices remained in this range until the Iranian revolution in 1978/79 and the Iran/Iraq war in 1980, approximately 5.8-mmbpd (million-barrels-per-day) of oil was taken out the market during this period. The combination of these two events resulted in crude prices more than doubling from $14 in 1978 to $35 per barrel in 1981. This led to three years of aggressive growth in Canada with over 166-drilling rigs built during this period. The growth was significantly more aggressive in the U.S with the drilling rig fleet more than doubling to over 4500-rigs. Canada with over 166-drilling rigs built during this period. The growth was significantly more aggressive in the U.S with the drilling rig fleet more than doubling to over 4500-rigs.

In October 1980 the federal government unilaterally imposed the National Energy Program (NEP). The NEP took away a large share of production revenues through new taxes and paid frontier exploration incentives according to a company’s level of Canadian ownership. Compounding the impact of the NEP, during 1981 & 1982, the Canadian economy weathered a severe recession with a rate of inflation that exceeded 10-percent and interest rates that neared 20-percent.

This combination led to several years of general industry decline, during this period OPEC attempted to set production quotas low enough to stabilize prices. These attempts met with repeated failure as various members of OPEC would produce beyond their quotas. During most of this period Saudi Arabia acted as the swing producer cutting its production to stem the free falling prices. In August of 1985, the Saudis tired of this role and tied their oil prices to the spot market for crude and by early 1986 increased production by some 3-mmbpd. Markets were flooded and crude oil prices plummeted below $10 per barrel by mid year.

Oil Prices quickly dropped from the $26.00 to $28.00 U.S. level to a low of around $10.00 U.S. with some low gravity crudes selling in the $6.00 to $8.00 U.S. range. As 1986 unfolded, industry experts were predicting a slight decline in world crude oil prices; however, no one could foresee the precipitous drop that was to occur.

The Canadian and American oil and gas industry was wrenched with unprecedented layoffs. Employment in the oilfield service sector in Canada dropped from 30,000 to 15,000 representing a 50% loss of employment in a one-year period, January 1986 to December 1986. Exploration companies were forced to take write-downs on reserves. The virtual collapse of exploration precipitated severe price cutting by contractors and manufacturers as the number of wells drilled in Canada was nearly cut in half from the previous year (see history of wells drilled on the following page).

Deregulation of oil and gas prices which occurred in 1985 exposed the Canadian industry to the volatility of international oil markets. In 1986 oil and gas prices fell approximately 43-percent and 23-percent respectively against 1985 prices. Between 1986 and 1992, relatively high interest rates and continued weak oil and gas prices created a heavy burden for companies with large amounts of debt. Many companies laid off more staff, sold assets or merged with stronger firms.

This period also saw rig and service industry equipment values take a beating as drilling contractors and other owners of equipment were often forced to liquidate their assets at depressed prices. At the bottom of the cycle around mid 1992, rig and equipment packages were selling at 10 to 20% of 1980’s value.

By the beginning of 1990 the economy in the US was strong and the Asian Pacific region was booming. From 1990 to 1997 world oil consumption increased 6.2-mmbpd. Asian consumption accounted for all but 300,000-barrels per day of that gain and contributed to the price recovery that extended into 1997.

By the beginning of the fourth quarter of 1992, the industry in Canada was showing some signs of improvement, this momentum carried over into 1993 and in 1994 a record number of wells were drilled in Western Canada. The pace tapered off slightly in 1995 and came back strong in 1996, as once again there were a record number of wells drilled. By the first quarter of 1997, the Canadian oil and gas industry was operating at effective capacity, as there was more work then there were men and equipment capable of doing the work. This resulted in another record year for the Canadian Industry.

However, the oil price increases came to a rapid end when the impact of the economic crisis in Asia hit the markets. In December, 1997 OPEC increased its quota 2.5-mmbpd to 27.5-mmbpd effective January 1, 1998. The rapid growth in Asian economies had come to a halt and in 1998 Asian Pacific oil consumption declined for the first time since 1982. The combination of lower consumption and higher OPEC production sent prices into a downward spiral. In response OPEC cut quotas by 1.25-mmbpd in April and 1.335-mmbpd in July. Prices continued down through December 1998, however, prices began to recover in early 1999 as OPEC reduced production by another 1.72- mmbpd in April 1999.

The deep cuts made by OPEC and an improving economy in 2000 once again put upward pressure on oil & gas prices with oil jumping to over $30 per barrel & gas nearly doubling in price to just under $5 per MCF Cdn. These strong prices carried over into 2001 spurring record oilfield service activity levels in Western Canada.

In the wake of the 911 attack, crude oil prices plummeted. Spot prices for the U.S. benchmark West Texas Intermediate were down 35 percent by the middle of November. Under normal circumstances a drop in price of this magnitude would have resulted in another round of quota reductions. Given the political climate OPEC delayed additional cuts until January 2002. It then reduced its quota by 1.5 million barrels per day and was joined by several non-OPEC producers including Russia which promised combined production cuts of an additional 462,500 barrels. This had the desired effect with oil prices moving into the $25 range by March 2002. By midyear the non-OPEC members were restoring their production cuts but prices continued to rise as U.S. inventories reached a 20-year low later in the year.

By year end oversupply was not a problem. Problems in Venezuela led to a strike at PDVSA causing Venezuelan production to plummet. In the wake of the strike Venezuela was never able to restore capacity to its previous level and is still about 900,000 barrels per day below its peak capacity of 3.5 million barrels per day. OPEC increased quotas by 2.8 million barrels per day in January and February 2003.

On March 19, 2003, just as some Venezuelan production was beginning to return, military action commenced in Iraq. Meanwhile, inventories remained low in the U.S. and other OECD countries. With an improving economy U.S. demand was increasing and Asian demand for crude oil was growing at a rapid pace.

The loss of production capacity in Iraq and Venezuela combined with increased OPEC production to meet growing international demand led to the erosion of excess oil production capacity. In mid 2002, there were more than six million barrels per day of excess production capacity and by mid-2003 the excess was below two million. During much of 2004 and 2005 the spare capacity to produce oil was less than a million barrels per day. A million barrels per day is not enough spare capacity to cover an interruption of supply from most OPEC producers.

In a world that consumes more than 80 million barrels per day of petroleum products that added a significant risk premium to crude oil price and was largely responsible for prices in excess of $40-$50/bbl.

Other major factors contributing to higher prices included a weak dollar and the rapid growth in Asian economies and their petroleum consumption. The 2005 hurricanes and U.S. refinery problems associated with the conversion from MTBE to ethanol as a gasoline additive also contributed to higher prices.

One of the most important factors determining price is the level of petroleum inventories in the U.S. and other consuming countries. Until spare capacity became an issue inventory levels provided an excellent tool for short-term price forecasts. Although not well publicized OPEC has for several years depended on a policy that amounts to world inventory management. Its primary reason for cutting back on production in November 2006 and again in February 2007 was concern about growing OECD inventories. Their focus is on total petroleum inventories including crude oil and petroleum products, which is a better indicator of prices that oil inventories alone.

In 2008, after the beginning of the longest U.S. recession since the Great Depression the oil price continued to soar. Spare capacity dipped below a million barrels per day and speculation in the crude oil futures market was exceptionally strong. Trading on NYMEX closed at a record $145.29 on July 3, 2008. In the face of recession and falling petroleum demand the price fell throughout the remainder of the year to the below $40 in December

Following an OPEC cut of 4.2 million b/d in January 2009 prices rose steadily in the supported by rising demand in Asia. In late February 2011, prices jumped as a consequence of the loss of Libyan exports in the face of the Libyan civil war. Concern about additional interruptions from unrest in other Middle East and North African producers continues to support the price while as of Mid-October 400,000 barrels per day of Libyan production was restored.

  • During the boom of 1979 to 1982 the industry rapidly overbuilt putting combined over 5500 rigs into the field in the US and Canada.
  • When the industry started its decline in the latter part of 1982 (1981 in Canada) this caused many start-up and established companies to fail. Those that managed to hang on struggled to survive and many did not when the industry collapsed in 1986 and generally continued in a downward spiral until the industry finally bottomed in 1992.
  • During this period rig utilization dropped through the floor and often there were as many as 3- auctions per week of drilling equipment. Equipment values dropped precipitously with equipment and rig packages at times selling for 10 to 20-percent of 1980’s values.
  • Contractors that survived the fallout for the most part came out as lean and much more efficient companies. Many of these companies went on a rapid growth expansion through the nineties through mergers, company acquisitions and upgrading their fleets with the huge amount of surplus equipment that was still available in the marketplace.
  • By 1997, the face of the industry had changed significantly with the emergence of a number of large public drilling companies. Some of the larger companies included Nabors, Patterson UTI, Grey Wolf, Precision and Ensign.
  • Through this period equipment values were increasing significantly and by 1997 the availability of good used equipment was limited and the deals of late eighties and early nineties were long gone.
  • Although the industry dipped again in 1998 through 99, this generally had a neutral effect on equipment values as the large multinational public companies generally used this period to consolidate and in some cases continue to expand their operations through mergers and acquisitions.
  • With the turnaround of the industry in 2000 and the record year in 2001, contractors had to go back to the manufacturing shops for the supply of major rig components. Rig and equipment values were at a premium.
  • Although the industry experienced a soft year in relative terms in 2002, it was still the fourth best year in rig utilization in Western Canada since 1983. Good quality equipment maintained its value although it was for the most part a neutral year with limited transactions of major packages.
  • Although 2003 was a record year in terms of wells drilled, the increase in activity did not translate into a significant increase in equipment values from those established during the 2001 era with the exception of some spot shortages in certain items such as drill pipe. For the most part contractors were well positioned to handle the increased demand and the increasing value of the Canadian dollar tended to help offset increases in equipment costs.
  • Rig costs went up by approximately 5-percent per annum from 2004 through 2008 coinciding with drilling demand, depleted quality used inventory, overbooked fabrication shops, increased labor, insurance and material costs, especially steel.
  • The notable decrease in demand in late 2007 through mid 2010 was primarily expressed in the discriminating utilization patterns i.e. newer more efficient equipment were still in demand however the lesser units were parked and dramatically reduced in value.
  • There was little change in 2011 through 2014, with continued utilization patterns favouring newer, more technology advanced equipment bolstered with crude prices hovering around $100-bbl.
  • In the second half of 2014, the oil market experienced a powerful downward price adjustment which was sustained throughout 2015.

The following shows the number of wells drilled in Western Canada since 1983.