WHAT'S AHEAD IN 2001

Pace picks up for service / supply firms

Rhys J. Best, Chairman, President & CEO, Lone Star Technologies, Inc., and Chairman, PESA, Dallas

As we began this year, increased oil and natural gas prices signaled new and growing demand for oilfield products and services. OPEC’s commitment to higher prices, along with increasing global demand for energy from all sources, outpaced most forecasts. New inquiries for energy products and services came at an unexpectedly fast pace. Consumer fuel prices rose to such an extent that energy supplies and production evolved into a major issue in the U.S. presidential campaign.

And now, as we approach a new year, the energy industry finds itself challenged by corporate consolidations, competition for available capital resources, and escalating demand for new technologies to provide an extraordinary level of products and services to meet increasing global market demands.

"Energy firms will require critical financial and operational mass to overcome these challenges."    – Rhys Best

Continued consolidation. Our industry, during a time of extreme volatility over the past few years, experienced some of the largest mergers in history. These E&P mega-mergers were undertaken to achieve strategic and tactical objectives. The stated motives included reducing operating costs and leveraging complementary assets and operations to enhance shareholder value and assure future viability.

Large size is also linked directly to negotiating power and access to global capital markets. Strategic alliances with producer countries might require investments of more than $100 billion over a 10-year period. Usually, only super-majors, such as ExxonMobil, BP, or Royal Dutch / Shell, have the resources to support such large, long-term investments.

For the equipment manufacturers and service suppliers of the Petroleum Equipment Suppliers Association (PESA), dramatic changes in client needs and (more important) customer expectations have accompanied the continued consolidation process in the E&P sector. Our customers are outsourcing more technical services and seeking to reduce the number of suppliers by demanding reliable integration of product lines from a single, competent, reliable source. Customized, low-cost, supply-chain management is the new minimum standard.

Additionally, the bulk of industry research and development (R&D) is migrating from producers to the service / supply sector. These requirements generally call for substantial financial capability. As a result, the service sector has experienced a similar wave of consolidations, as companies seek "full-service" competency to meet customer expectations. Halliburton, Schlumberger, Baker Hughes, and many others have led the industry in merger and acquisition activity by combining capital-market transactions with internal growth to expand their products and services.

Companies often neglect core business activities while meshing two cultures, two balance sheets and two customer lists into one focused enterprise. For example, Salomon Smith Barney’s 2000 E&P Spending Survey: Mid-Year Update reported that ExxonMobil was one of a handful of companies planning lower spending in 2000 due to integration associated with the merger. However, the firm simultaneously announced major capital budget increases for 2001 and beyond.

Many industry analysts project that oil demand is likely to increase by 25 million bpd over the next 20 years. The (U.S.) National Petroleum Council’s recent report projected 3% annual growth in natural gas usage, resulting in 29 Tcf of demand by the end of this decade. To meet this demand, the search for energy will lead to exploitation of more capital-intensive reserves in deeper water and harsher environments. Energy firms will require critical financial and operational mass to overcome these challenges. Thus, the consolidation process will continue for our industry and our customers.

Service and supply industry drivers. Prospects for service / supply companies over the next year will depend on the interaction of several factors. While oil prices grabbed many of the headlines over the past year, natural gas supply and demand imbalance may be where the true crisis and, therefore, the opportunity lie in the near future.

At the annual Dain Rauscher Wessels energy conference in Houston last September, analysts reported that supply-and-demand dynamics were not in balance, especially for a peak demand period in early spring. A cold winter this year could produce a "disaster scenario," as the resulting drawdown could force inventories to historic lows. The natural gas imbalance and oil prices above $30/bbl created the conditions for Dain Rauscher Wessels analyst James Wicklund to predict that the U.S. rig count would be up 45% in 2000 and another 20% in 2001. Additionally, Salomon Smith Barney’s E&P Expenditure Survey reported that planned worldwide capital investment was increasing 18.6% in 2000, while U.S. spending plans were up 22.7%, the largest annual increase in the survey’s history.

If these trends continue, they will have considerable impact on the service / supply sector as PESA companies are called upon to build new rigs, provide equipment, produce tubular products and expand services to respond to customer requirements. The volatility of oil and gas prices makes capital flow to service firms unpredictable. Shortages of equipment and capable, trained people may materialize as the next significant constraint facing this industry.

Technology is key to the new frontier. Deepwater drilling is the most exciting new frontier for our industry, and records are being set with each new well. If it were not for significant advancements in technology developed by the service / supply industry, the opportunity to find large, new, offshore oil and gas fields would never have been possible.

Twenty years ago at the Offshore Technology Conference in Houston, predictions were made that the majors would be able to drill in 3,000 ft of water by the end of the century. This is one occasion when forecasting in the energy business was almost correct. Today, fields are being produced in water depths as great as 5,000 ft, and some in the industry believe the capability exists to drill in 10,000-ft water.

Because of the large investments necessary to explore and produce in deep water, a premium is placed on speed and efficiency. PESA member-companies have invested millions of dollars in R&D to design the technologies that make these projects economically feasible. Recent developments include pipe racking systems that can handle pipe stands more than 120 ft long without any human intervention; composite risers that are 60% lighter than steel; and the first dual-gradient riser that uses composite material for auxiliary lines.

Earlier this year, Enventure Global Technology set two world records during a solid, expandable tubular installation for Shell E&P Co. in South Texas. The new records are 2,016 ft in a single installation and the most connections (54) expanded in a single installation. The field test was designed to prove expandable tubular technology for deepwater applications.

When I wrote this, oil was more than $30/bbl, natural gas prices exceeded $5/Mcf, and the U.S. rig count was above 1,000. The PESA companies are committed to meeting the challenges of deep water, new exploration horizons and the demands of producing from existing reserves. Technological advancements will continue to enable service-and-supply companies to substantially lower customers’ costs and expand the area of E&P to regions that were unthinkable just a few years ago.

While commodity price volatility still imposes timing risks for customers, the coming years offer more promise than the recent past. The high demand for energy in all forms and the strength of current hydrocarbon prices will support an even greater level of activity in North America and around the world.

Rhys J. Best is chairman, president and CEO of Lone Star Technologies, Inc., as well as chairman of PESA. He began his career in banking in Dallas and later worked for a major New York bank. In 1982, he joined First City Bank Corp. When he became president, First City Dallas was the fourth-largest bank in the Dallas / Fort Worth metroplex. He became president and CEO of Lone Star Steel Co. in 1989 and served in that role until he was named president and COO of Lone Star Technologies in August 1997. He became chairman and CEO of the parent firm in January 1999. Mr. Best graduated from the University of North Texas (UNT) with a BBA degree, and he earned an MBA at Southern Methodist University. He serves on the College of Business Administration Board of Advisors at UNT and is a director of Maguire Energy Institute. He is active in additional community and civic organizations.