Oil Exploration And Production Companies Management Essay

Oil Exploration And Production Companies Management Essay The oilfield service industry is a sector which mainly provides services to the oil exploration and production companies. Schlumberger is the leading name in the oilfield servicing market which has lots of stake in the highly competitive market environment of the Middle East. This report is basically an in depth understanding about the behavior and performance of Schlumberger in the highly competitive environment. The initial analysis of the report would focus on the qualitative aspects of the oil field service industry. It would provide an overview of about the current trends prevailing in the industry which would help in getting a better understanding about the issues and the current matters taking place. It would provide an in-depth analysis of how the oil and gas prices are affected by the demand in industry. In order to run a successful business, every company should have a competitive advantage in the market. This aspect would be analyzed through Porters five force model, which will identify the sources of competitive forces Schlumberger would face in the market in the future. The later part of the analysis would focus on the strategic approach of Schlumberger and the positioning of the company in the market with regards to its competitors which are Halliburton, Baker Hughes and Weatherford. The strategic approach identification of each company and the market position would be done by utilizing Porters framework of competitive analysis and will help in analyzing the position of the companies through its competitors array. This report will provide insights into the speed with which the competitors in Middle East are able to acquire the market share and also analyze Schlumbergers value-creating strategy which would determine how long this competitive advantage will last. List of figures: Figure 1: Revenue of the Oilfield Service Industry in Billion $ Figure 2: Upstream Capital Expenditure from 2001 2013 Figure 3: Average rig Count according to Baker Hughes International Figure 4: Porters five force model Figure 5: Production of crude oil in the Middle East Figure 6: Production of natural gas in the Middle East Figure 7: Revenue of Schlumbergers competitors region-wise Figure 8: Estimated percentage of merger and acquisitions in next 2 years. List of Tables: Table 1: Baker Hughes International Rig Count displaying the active rigs. Table 2: Relation between WTI crude oil price, upstream CAPEX and avg Rig Count Table 3: Impact of each force on the oilfield service industry Table 4: Key success factors of the oilfield service industry Table 5: Global and Middle East revenues of Schlumbergers competitors in Middle East Table 6: Comparative analysis of Schlumberger and its competitors Table 7: Competitors array of Schlumberger Table 8: YTD revenue of Schlumbergers competitors Contents Introduction: The oil and gas industry seems to have recovered from the slump in 2008-09 due to the economic crisis as we can see that the oil and gas prices are rising for the past three years. The oilfield service industry which is an integral part of the petroleum industry was no exception to this phenomenon. The oilfield service industry which provides services to the exploration industries has witnessed increase in the profitable quarters over the past three years and it continues to grow despite the current Eurozone crisis and all the challenges faced by the service industry due to economic situations such as the BP Deepwater Horizon incident. Schlumberger, which is the leading oilfield service company all across the globe, enjoys a major market share over other companies and has been one of the most profitable companies amidst all these hardships. As of December 31, 2011, the company had more than 113,000 people of over 140 nationalities working in approximately 85 countries. The companys revenue touched $39.54 billion in 2011 crossing the highest revenue by any company in this sector. Schlumberger is located in various geographic areas such North America, Latin America, Middle East/Asia, Europe and Africa. In the Middle East/Asia region, Schlumberger does have a competitive advantage over others but no competitive advantage is permanent. Thus the company has to keep a constant check on its existing competitors and the new players to the oil field services industry. Given the industry context mentioned above, the main aim of this business report is to analyze the current trend in this industry and also to analyze Schlumbergers competitors in the Middle East to sustain its competitive advantage. The primary objective of this report is to ensure that Schlumberger is aware of the changes going on in the Middle East that is affecting its ongoing strategies and business plans and also to keep a close eye on its competitors new strategies and the advancements they are making. It is also to ensure that their current strategies are in line with the business environment and if not, what changes can be brought about in order to keep it at par with the other competitors within the industry. The main findings of the project will assist Schlumberger not only in maintaining their strong position within the industry, but will also help them in evaluating and forecasting about the changes in advance and develop their business plans accordingly. Chapter 1: Literature Review: Porter five forces Model: There are a number of management tools which analyze the industrys profitability despite the existing competitions and changes in the economy. This section will help us in getting an understanding about the appropriate strategies to gauge industry analysis. For getting an understanding about the proper strategic analysis of an industry, there are a few management tools and theories such as SCP Paradigm, Porter five forces model and Value Net model. The Structure Control Performance framework is derived from the Industrial Organization (IO) economics and it studies the market based on the three elements and also tries to draw a connection between them, (Fu, 2003). Mason (1939, 1949) and Bain (1951, 1956, 1959) as cited in (Goddard, Wilson and Lipcztynski, 2005, p6) had developed the SCP paradigm. It correlates the relationship between the market structure, company conduct and company performance (Ajlouni, 2010). According to this approach, the structure of a market influences the conduct of the firms operating in the market, which in turn influences the performance of those firms. (Goddard, Wilson and Lipczynski, 2005, p6). Thus the SCP paradigm analyses the industry in three steps. First, the structure analyses the basic framework of the market which is required by the company for conducting business. It involves the buyers and sellers, barriers to entry, product differentiations, vertical integration and diversifications. Second, the model analyses the behavior of the firms to get an in depth analysis about the business objectives, pricing policies, research and development, acquisitions and mergers. The third, performance describes the parameters required to measure the performance of the industry through profitability, growth and increase efficiency. The SCP Paradigm is based mainly on empirical research than on theoretical aspects and it was one of the dominant models till the early 1980s (Slade, 2003). Thus there were many criticisms about the model because of its dependence on the empirical researches and one of the main problems of the paradigm was to analyze many of the variables in each factor of the paradigm. The further growth on the Industrial Organization witnessed the introduction of Porters five forces model. One of the well-known and an important framework is Porter Five Forces Model. Porters five forces is heavily influenced by the SCP Paradigm as one the Structure of the paradigm is basically the Porter Five Forces model and the other Performance is outcome of Porters model which is the profitability (Goddard, Wilson and Lipcztynski, 2005, p16-18). Micheal E.Porter (1979) developed this model which attempts to handle the main forces which affect the industry structure. Porter five forces model tries to explain the industry structure and the competitive conditions by evaluating the following forces: the risk of new entry in the industry, the degree of rivalry among established competitors, the bargaining power of buyers and suppliers and the threat of substitute products. According to Porter, the presence of stronger forces of the model, make the business environment of the industry to be more challenging and is less attractive to the investors. On the contrary, if the forces are weak, then the companies seem to be in a more profitable condition as there would be less competition in the market. According to Kevin Coyne and Somu Subramanian (1996) as cited in The McKinsey Quarterly(2001), this model is built under three essential assumptions: Firstly, the buyers, suppliers, substitutes and competitors are not related and do not interact with each other in the industry. Secondly, more capital will be available to the companies that have a structural advantage over their competitors and potential entrants. Thirdly, there is much lower risk involvement which let the companies in the market to plan properly and prepare a strategy accordingly. According to Mintzberg (1994), Porter assumption that future of the industry can be predicted based on the present market conditions is being discarded by Mintzberg. He explains that a company cannot forecast future market conditions precisely owing to economic changes and also technological innovations. Every model has its limitations and criticisms and Porter Five forces model is no exception to it. The limitations are: Firstly, the model was based originally on the economic situation of the eighties when there was a strong competition and relatively stable market structures. Second, it does not focus on the different challenges that a company faces as it enters international arena. The challenges faced by them in other nations are extremely different in comparison to what it faces in its own nation. Third, Porter takes into consideration only the industrial factors, whereas it overlooks the company resources available to the industry without which the profitability of the industry cannot be determined. Finally, as and when the companies expand, they diversify themselves into various other markets and other regions and thus the model does not concentrate on role of expansions and various acquisitions (Parnell, 2004, p50-51). Brandenberger and Nalebuff (1985) as cited in Unknown (n.d.) too identified an important flaw in the Porter model. In the book, Coopetition (Competition + Co-operation), has been discussed but the model ignores the strategic alliance which exists between some industries and which in turn helps each other to bring out a finalized product. These are mainly known as complementors in business terminology. Thus Brandenberger and Nalebuff in addition to suppliers, consumers and competitors introduced a new force namely the complementors. This was known as Value Net. This is basically an extension of the Porters model and is known by the name of Value Net model. Porters five forces analyze what are the challenges in the face of their growth opportunities whereas Value Net model analyses threats and opportunities available to the industry (Unknown, n.d.). Porter admits that developing a strategy in a new emerging industry or in a business undergoing revolutionary technological change is a daunting proposition (Downes and Mui, 2000, p60). According to Downes and Mui, Porter explains that the new digitalized and high tech world comes with a lot of complexities and developing a full proof strategy is a daunting task and this does not mean that the old rules are invalid. But if we look around in todays work environment, we will find that every industry is heavily dependent on the new technology. Thus Downes and Mui introduced three new forces to the Porter five force model namely Digitalization, Globalization and Deregulation (Downes and Mui, 2000, p64-67). These are the driving forces which steers the modern business houses in the right direction and amongst these the most important force is Digitalization. Thus the setback with the Porters framework is the absence of the digitalization force which has revamped the industries with the introduction of modern technology. Though from the above discussion it may appear that Porter five forces is outdated as it does not consider digitalization. But if we consider both its assumptions and limitations, it is one of the effective management tools that can be used in business and can easily be understood by the managers. Porters Competitive Framework: There are different strategic frameworks available which would be helpful for doing a competitor analysis. The most prominent among them are Porters Competitive Framework and SWOT analysis. Porters Competitive Framework is a management tool which is used to analyze the industry on four basic elements namely: future goals, current strategies, assumptions and capabilities. Future goals discuss what drives the competitor, current strategy discusses what a competitor is doing or can do, assumptions focus on the supposition made by the firm about itself and the industry and capabilities discuss about the strengths and weaknesses of the firm (Porter, 1980). This is one of the most prominent frameworks but a lot of researches are based on assumptions about competitor analysis which is discussed below. A lot of scholars have defined what a competitors analysis is but the most difficult part is the evaluation of the competitor at a firm level (Tsai, Su and Chen, 2011). A number of studies have been conducted on how a competitor could be analyzed at a firm level. Porac et al, 1995 presented a cognitive model which is developed on the basis of the observation the firm makes about its competitors actions and reactions and then decide on its strategy. Also, Baum and Lant (2003) as cited in (Tsai, Su and Chen, 2011) illustrated that resemblance in geographic location, price and size are sufficient for a firm to have an idea about their competitors. Chen in 1996 gave a different perspective of competitor by introducing the two-firm concept explaining that a competitor analysis is mainly based on market commonality and resource similarity. But many researchers found the two-firm concept to be difficult to relate with the competitor analysis. Competitors analysis is necessary for every enterprise as because there may be certain gaps which the company might not foresee while making competitive decisions. Zajac and Bazerman(1991) discussed the relation between the strategic decision making process and competitive analysis and named the gap between them as competitive blind spots. They discussed how a wrong assumption by a firm about its competitor may result in blind spots. Rothschild (1979) too discussed on where the companies many miss the link and what are the questions to be posed for a proper competitor analysis. Tsai, Su and Chen, 2011 gave a different perspective with regard to the competitor analysis by introducing the concept of competitor acumen. It illustrated about the relationship between the different firms in the same industry and also the extent to which a firm can understand its competitors. Every researcher mentioned above has challenged the Porters framework but none of these have the same prominence as Porters framework. However, there exists a challenge which in the Porters framework that cannot be ignored. Porter does discuss about the fact that when a competitor analysis is done, a firm should know both its direct (current) and indirect (emerging) competitors. However, it does not discuss whether a firm should consider all its competitors or only the top three or four or just a bunch of them. Thus the firm has to analyze the industry first, identify its competitors and then go for competitor analysis (Rao, 2011). The SWOT analysis focuses on the Strength, Weakness, Opportunity and Threats which a firm faces and its advantages in comparison to other competitors in the marketplace. SWOT analysis has a lot of advantages, for example its framework is extremely simple which helps a firm to identify its focus and can be applied to many intelligence reports like market intelligence. The analysis has a drawback as well. It can be too private and disconnected from the realities that are impacting the company (Evans, n.d, p7). Since Strength and Weakness part is been covered in the Capabilities part of the Porters framework and Opportunities and Threats are also discussed, it is an important competitor analysis tool despites its limitation. Chapter 2: Oilfield Service (OFS) Industry and its trends: 2.1 Background of the Oil Field Service Industry The energy sector comprises of the petroleum (oil and gas industry), electric power, coal, nuclear power and the renewable energy industries. The petroleum industry plays an important role in this sector as crude oil and unconventional natural gas account for a large percentage in worlds energy consumption which is around 56% (BP, 2012). Thus, the work of the petroleum industry is primarily classified into two main activities namely- upstream and downstream activities. The upstream activities in this industry are the exploration and production activities. The exploration activities include locating of the hydrocarbon reserves, such as oil and gas reserves, which can be done through desk study, aerial survey and seismic survey. After locating the reserves, the next step is to drill the surface and pump the hydrocarbon out of the reserves. This can be done both on the onshore (water) and offshore (land) through drilling rigs. After the drilling and getting an idea about the size of the oil field, the next step would be production and development activity where the oil and gas is produced through various techniques and services. After the oil and gas has been extracted from the reservoir and brought to the surface, it is then taken to the refineries where the downstream activities begin. The downstream activities in the industry include refining and processing of the oil and gas products and then further distribution of these products through various distribution channels like the retailers, distribution companies, chemical plants etc. The important industry which supports the upstream activities is the oilfield service industry. The oilfield service industry provides equipment and services which are utilized in the exploration and extraction of the hydrocarbons mainly oil and gas. This industry is thus the backbone of the oil and natural gas industry providing various services and equipments for the proper running of the industry. (Etechinternational, n.d.) 2.2 Demand for the oilfield service industry: The demand for the oil field services industry in the market can be measured in terms of the revenue generated by the industry over the years. Given below is the revenue generated by the industry in USD billion over the years from 2007-2011 and it also states about the forecast of the industry for the next five years till 2016. (Source: MarketLine, 2012) Figure 1: Revenue of the Oilfield Service Industry in Billion $ The global revenue of the industry increased till the 2008 where it reached the highest point of USD 361.9 billion. Then there was a decrease in the revenue in 2009 to USD 256.9 billion where the revenue declined by 29.1% mainly due to the global economic and financial crisis resulting in the drop of the oil price. The WTI Crude Oil Price for past few years (refer Appendix 1) indicates that the oil price was once at its peak in 2008 at $145.16/barrel (Yahoo Charts, 2012) and then there was a sudden drop in the oil price and this price drop did sustain in the industry for quite sometime. This drop in the price of the oil led to loss of billions of dollars due to various macro and micro-economic factors in the market (Hamilton, 2009). But later on after the financial crisis, the industry started to improve its business and now since the market has been stabilized and it seems to be rising and expected to reach global revenue of $638.4 billion by 2016 (MarketLine 2012). Knowing the basics of the oilfield service industry, gives us a brief idea about the indicators which is extremely useful for understanding the growth of the industry and the factors influencing its growth. 2.2 a Upstream Capital Expenditure: The growth of the oilfield service industry also depends upon the capital expenditure of the companies in the upstream industry. The companies in the upstream industry is basically segregated into large integrated super-major oil and natural gas companies, international independent oil and natural gas companies which are also known as the International Oil Companies(IOCs), and the national or state-owned oil companies known as the National Oil companies(NOCs). Thus the upstream expenditure will result as a combination of all these three types of companies. The upstream capital expenditure appears to be rising over the past few years and is expected to be profitable over the next few years as well. The total capital expenditure was estimated to be USD 450 billion in 2011(Brown, n.d), which was at an all time high over the years and the oil field service industry seemed profitable at this juncture. The oil and gas exploration and production capital expenditure (CAPEX) for the past decade and for the next few years is shown below. (Source: Combination of WoodMackenzie Corporate Analysis Tool and Upstream Service cited in Brown,n.d and Energy Equipment and Support Services Oilfield Services Sector Report, 2010, please refer Appendix 2 and 3) Figure 2: Upstream Capital Expenditure from 2001 2013 In the above figure we see that the upstream capital expenditure does not include the exploration and appraisal spend. In this graph, we see that the expenditure was increasing until 2008, after which there was a dip in 2009 due to the global economic and financial crisis. 2.2b Rig Count: There are many indicators where the investors of oilfield service industry can gauge the growth or the demand of the industry. The upstream capital expenditure is one of the principal indicators which provide insights on how the industry is generating the revenue but the major concern with the upstream capital expenditure is that the figures are not released on a timely basis as it is shown in the quarterly or the annual report. So it is difficult to have updated information for a particular period of time like weekly or monthly about the industry. Thus, to have timely updates about the industry, another important indicator which helps the investors to know about the global demands of the industry is known as the rig count. The rig count indicates the number of rigs which are currently active in the industry and this shows the number of active rigs, and the specific areas has more demand indicating the demand for more labor. It is very easy and the quickest way for accessing the growth in the oil field service industry. It is used by many companies, analysts like for example Wall Street analysts use the rig count for profit projections from the oil field service companies (Sprehe, 2004). There are a number of rig counts available to serve the industry like the Baker Hughes, Smith Tools but the most commonly used rig count is the Baker Hughes (BHI) rig count as it is one of the oldest rig counts in the industry. Baker Hughes Rig count gives a weekly update on the North America rigs and a monthly update on the International rigs. Area Last Count Count Change from Prior Count Date of Prior Count Change from Last Year Date of Last Years Count US 17-Aug-12 1914 -17 10-Aug-12 -60 19-Aug-11 Canada 17-Aug-12 326 +27 10-Aug-12 -160 19-Aug-11 International Jul-12 1264 -21 Jun-12 +114 Jul-12 (Source: BHI Rig Count as on 20-Aug-12, Baker Hughes Investor Relations, Rig Count) Table 1: Baker Hughes International Rig Count displaying the active rigs As we see in the above table, it shows the update on the active rigs in America, Canada and in the International arena as well where we can see that the last count for the America rigs is on the 17-August 2012(weekly) whereas for International it is July 2012(monthly). This table also analyses the changes in the active rig count from the date of prior count. This table also presents before us a clear picture on how the industry has grown comparing from previous years figures (Baker Hughes Investor Relations, Rig Count, 2012). The Baker Hughes rig count measures the number of rigs which are actually being drilled at a give point of time on a weekly (North America) and monthly (rest of world) basis. This indicator also provides additional information like rig count in different states, or whether the rigs were used for drilling the oil or the natural gas from the surface. A lot of products and services are required for an active rig and thus the use of these products and services show the demand for the services provided by the oilfield service industry (Brener, 2008). An increase or decrease in the rig count also shows the fluctuations in the job market of the oilfield service industry. Increase in rig count increases the job opportunities in the oilfield. The BHI count considers the count of active rigs which means the rigs which are actually drilling holes on the land or the sea to extract the oil or the gas. Therefore, if a rig is being transferred from one location to another, or is being involved in non-drilling activities like casing or completion and production activities, then Baker Hughes does not count the rig as active, even if the activity is still being performed at the field by a number of suppliers and outworkers. Though the rig count provides us with a brief idea about the drilling activity, it does not show many other important factors. The factors which the rig count does not focus on are production activities, depth, cost and location (Brener, 2008). The chart shows the average rig count worldwide from 2000 to June 2012 and we can observe that number of rigs have been on the increasing trend apart from when there was a dip during the financial crisis which hit the industry adversely. (Source: Baker Hughes Investor relations, Rig Count 2012). Figure 3: Global average Rig Count (Oil + Gas + Misc) according to Baker Hughes International The average rig counts for 2011-present from various geographical locations is shown in Appendix 4 where we observe that North America has been leading all the way and that is where the companies generate the maximum amount of revenue. 2.2c Current Industry Trend: The trends of an industry help us to understand what are the current issues and their effect which help us to speculate the likelihood of its impact in the future. There have been many other micro and macro factors which affect the industry trends like government rules and regulations, the oil and gas demand and supply etc which ultimately are the main reasons for the fluctuations in oil and gas price. Thus the trend of the industry can be known from the fluctuations in the oil and gas prices. High prices are beneficial for the industry and vice-versa. The following table shows the relation between the WTI oil price, upstream capital spending and the rig count. Avg. oil rig count Int. N.A. Canada Avg. WTI Oil Price 2007 768 297 127 76 2008 814 379 161 87 2009 764 278 103 55 2010 825 591 199 80.5 2011 897 984 278 95.5 2012(August) 946 1344 260 93.5 (Source: Avg.WTI Crude Oil Price Average WTI crude oil price Yahoo Charts. Upstream CAPEX Combination of WoodMackenzie Corporate Analysis Tool and Upstream Service cited in Brown, n.d and Energy Equipment and Support Services Oilfield Services Sector Report, 2010, please refer Appendix 2 and 3. Average oil Rig Count Baker Hughes Investor Relations) Table 2: Relation between WTI crude oil price, upstream CAPEX and oil Rig Count The above table shows the main trends in the industry indicating that the its demand is dependent on the Upstream CAPEX and Rig count which depend on the WTI crude oil price. This shows that when crude oil price increase, there is a tendency for the investors to invest more in this industry. We see a dip in 2008 due to the economic crisis but in this year we saw that the highest price was $145.16 per barrel in July and the lowest was $30.28 per barrel in December. The average rig counts has also seen a dip during the year 2009 from 2008 indicating that there was less demand of labor during that year. Thus we can suggest that the Rig Count depends on the Investment in the Upstream Industry which in turn is dependent on various factors such as crude oil and gas price fluctuations. Having known the trend in the industry we need to analyze how a company will maintain its profitability in different economic situation which holds good for the future as well. This can be analyzed in the next chapter using the Porter Five Forces Model. Chapter 3: Porter five forces analysis: In order to know the profitability of an industry, the corporate strategists suggest using the Porter five forces model as it is the best way for anticipating the competitive environment. Porter (2008) said Understanding the competitive forces, and their underlying causes, reveals the roots of an industrys current profitability while providing a framework for anticipating and influencing competition (and profitability) over time. The Porter 5 forces are: Rivalry among existing customers, Threats of substitutes, Power of suppliers, Power of buyers and Threats of new entrants. The impact of the forces on this industry is shown in the following table: Forces Impact Rivalry among the existing competitors HIGH Power of Suppliers MODERATE Threat of Substitutes LOW Power of Buyers HIGH Threat of New Entrants LOW Table 3: Impact of each force on the oilfield service industry (Source: 12manage, n.d.) Figure 4: Porters five force model 3. a Threat of new entrants: If we consider this particular industry, then one thing that is pretty clear is that the competitors have been operating in this sector for many years and giving them a tough challenge is not an easy task. An ideal new entrant tries to enter and capture the market share and put pressure on the competitors directly by applying new technology and new ideas. The impact of the new entrants in the oilfield service industry is low. The presence of