What's Ahead in 2005

Another good service/supply year on tap

Craig Ketchum, President, Red Man Pipe & Supply Co., and Chairman, Petroleum Equipment Suppliers Association, Tulsa, Oklahoma

Though not as lucrative as the robust price environment might suggest, 2004 has been a rewarding year for Petroleum Equipment Suppliers Association (PESA) members.

As the last quarter began, the futures price of West Texas Intermediate crude had jumped to $50/bbl from $29/bbl a year earlier, a 69% increase. Natural gas futures stood at $6.29/MMbtu on Oct. 1, up 32% from the same date in 2003. By historical standards, activity and spending did not match those gains. Still, 1,243 rigs were running in the US in early October, a 14% increase over the 1,091 rigs active a year earlier.

Some retreat is likely from the price levels reached in the early part of this fall. These levels resulted from low inventories and high global demand that, combined with continued sabotage of Iraqi pipelines and multiple hurricanes in the US Gulf of Mexico, exerted upward pressure on prices. Some of those pressures will ease in the year ahead, as economic growth in China and elsewhere moderates, and the Gulf returns to full production.

Nevertheless, for most service and equipment providers, 2005 looks like another strong year. But we will continue to face several key challenges in the year ahead:

• Spending growth limited by continued consolidation among producers, as the new entities sort through assets and prioritize work
• Fewer projects pursued, due to dwindling exploration and development prospects, especially in the US
• Security challenges never before encountered will be faced by companies operating outside the US, as well as those wanting to enter that arena
• Service and equipment providers are shouldering more of the R&D burden and must find ways to make investments pay off
• High demand for steel and other raw materials will increase prices and limit availability
• Cost pressures on the service/ supply sector and its customers will continue.

Why 2004 wasn't a boom. Prices that existed throughout much of 2004 traditionally would have driven drilling activity and spending considerably higher. But much has happened in two decades to change the traditional environment.

For example, many new technologies have reduced the number of wells needed to find or produce a given volume of oil or gas. Because there are now fewer operators, fewer projects will be pursued, even with high prices. Furthermore, not as many prospects can be generated, as staff and expertise shrink in the wake of the so-called “age wave” that is rolling through the industry. When drilling opportunities are scarce, companies often look to the market rather than the drill bit to acquire reserves.

Consolidation among operators also continues apace. When companies combine, it takes time to evaluate the new entity's expanded prospect list and assets, and decide which projects to do and when. The new company is also likely to do fewer projects than the two firms would have pursued separately. These conditions tend to slow activity and spending, in spite of sharply higher prices. This largely reflects industry's response to a new business environment rather than an anomaly in the price/ activity relationship.

There is a new challenge for companies with significant non-US operations – an elevated security risk. It is inevitable that some funds and considerable attention that might have been directed to drilling and development are now needed for managing that risk. In recent months, a tight steel market has also affected drilling activity, as economic growth in China and elsewhere fueled demand for a wide range of raw materials.

Impact of tomorrow's trends. Although finding costs have crept back up in the last few years, technical advancements have significantly lowered exploration risk and operating costs over the last two decades and boosted recovery. The service sector has led the development of such technologies as steerable drilling systems, horizontal wells, expandable tubulars, 4D seismic and deepwater subsea hardware. These and other tools, combined with sophisticated well and field monitoring and operating systems, eventually will make the “e-field” a reality that further optimizes reservoir performance.

As the service sector takes on a growing share of R&D responsibility, however, the funding of this activity – and the recovery of that investment – will be a growing challenge. While service companies and manufacturers do more of the industry's technology development, they must also satisfy clients that are focused increasingly on cost reduction.

In theory, the solution is to develop technology that helps clients reach their objectives. For example, a steady reduction in cost has helped drive the widespread use of leading-edge technology by independent operators, large and small. That's good news for producers, and consumers. But it also means that the technology developer's margin will remain under heavy downward pressure.

In tomorrow's cost-conscious environment, a key to success for PESA members will be finding ways to add value. For example, as a supplier of tubulars and oilfield supplies, Red Man Pipe & Supply has a Measurement Division that builds natural gas meter tubes from components manufactured by others and adds value by packaging them with a skid, house, valves, etc. Our company also adds value to its valve lines by providing valve automation systems.

For operators, total cost – not initial price – will increasingly influence decision-making. To better align its goals with those of clients, our firm, like other PESA members, has formed alliances to serve customers' producing areas, and has entered into MRO (maintenance, repair and operation) contracts with other firms. Information technology is also critical to managing the supply chain more efficiently, especially as other uncontrollable expenses squeeze profits.

Still focused on gas in 2005. More than 80% of US wells are drilled for gas, and 2005 promises to be another good year in many of the areas that have recently been active. The Rocky Mountain region was a hot area this year, as was the North Texas play. In East Texas, gas exploration has been very successful, and new technology has made it possible to recover more gas from mature fields. Oklahoma will continue to be attractive. For example, the most active US driller, Chesapeake Energy Corp., had 62 rigs running in early fall, most of them in Oklahoma.

Coalbed methane development will continue to expand, both in the US and Canada. Several advancing drilling capabilities – extended reach, rotary steering, etc. – can boost recovery, as well as ease environmental concerns by minimizing the surface footprint. Gulf of Mexico deepwater activity is also likely to pick up again after a relatively slow year in 2004.

In the broader view, as major operators sell US properties and look to other parts of the world for bigger opportunities, the US will become more of an independent operator market. In non-US operations, PESA members and their clients will face an increasingly complex security threat, along with the always-present economic, political and geologic risks.

The fundamentals are in place, global demand for oil and gas will continue to grow, and PESA members will play a vital role in meeting this challenge.

THE AUTHOR
	Craig Ketchum received his business degree from Central State College before joining Red Man Pipe & Supply Co. in 1979. He served the company in assignments at Ardmore, Oklahoma, Denver and Dallas before coming to company headquarters in Tulsa. He took over as president of Red Man in late 1995. Mr. Ketchum is on the board of directors for the Petroleum Equipment Suppliers Association and also serves on the Minority Business Round Table. In addition, he is a committee member with the Delaware Tribe of Indians, and is an active member of the Young Presidents Organization. He has completed an intensive Strategic Relationship Program at Duke University's Fuqua School of Business. Mr. Ketchum also attended the National Minority Supplier Development Council's (NMSDC) Advanced Management Education Program at the J.L. Kellogg Graduate School of Management at Northwestern University.