The Fragility of Oilfield Services: Plug & Perf

I have been involved with the multi-stage frac completion business since 2011 when I joined Weatherford as a product manager.  In the boom years leading up to the end of 2014, we did $.25B (yes that is with a B) in revenues for US & Canada multi-stage completion equipment.  This was a ridiculously profitable time for oilfield services on the completion side.  Following the first crash in oil at the end of 2014, the business started the slide toward the chaos we have today.

I have been listening to the book Antifragile by Nassim Nicholas Taleb. This is a great book, though I found the first half to be very academic and will require another visit for me to fully absorb the message.  It is the ultimate combination of his previous best sellers Fooled by Randomness, The Black Swan, and Skin in the Game; all of which I have not read, but plan to now. The book is an exploration of how things, systems, decisions, companies, etc. are fragile, which he describes as something that is disproportionally hurt by random events. Also described as something that has asymmetry of risk vs. rewards; small up-side with large downsides.

While listening to this book on my morning runs, I cannot help but think about how the multi-stage completion business in North America is extremely fragile. And, based on the recent events at oilfield service companies, it is easy to see how disproportionally the business has been affected by the sudden shock to the oil markets.

Optionality

One of the main tenants of Anti-Fragility is optionality. The more options you have the more you can respond to unseen events.  Historically, the completion tools and services business has been diverse, smaller but diverse. Remedial work, new completions of various types (sand control, gas lift, multi-zone packers, openhole vs. cased hole, etc.).  Since 2015 it has largely, 90%+, become plug & perf.  The completion tools business has solely been focused on composite plugs. To compete, companies had to be all in on one product.

While the service companies had 1 option, the customers had an ever-increasing list of options when it came to plugs. Companies and individuals took notice that there was close to a billion-dollar market that could be served with just a few products.  The result was at least 30 providers vying for the business. What most did not realize when they entered the business was the customer’s switching cost was 0.  No cost to switch, no emotional loss upon switching, and no social loss

For US land, customers were not required to issue POs for plugs.  They are required to be on location, sometimes with 2 days’ notice, for the operation, and an invoice will be signed once the job is done.  If something goes wrong, (ANYTHING!) the customer will send you packing and call out another provide.

 In addition to the buyer power described above, there was de facto supplier power.  Because reliability is the key to success, the switching costs of suppliers was costly and filled with risk.  To change suppliers, you must build prototypes test in the lab and once successful with this run field trials.  Then there is a decision on telling customers of the change.  If your product is working well and you tell your customer you are making a change, they will most likely squawk.  If you do not tell them and there is an issue, then you are hosed.  The correct route is to tell the customer and perform field trials with the new vendor’s design until the customer is happy with the performance.  This can take many months and expense just to prove out a new vendor.  Is it worth all of this to save with the new vendor?  All of this gives the incumbent vendor power over the process of optimizing the supply chain.

Filament Winding is typically a major vendor for a composite plug manufacturer.

The Squeeze Problem

With a manufacturing lead time of at least 6 weeks, companies must build a significant inventory to sell a single job.  This larger order size increases volume for manufacturing cost reasons and provides enough inventory to serve the fabled next 5 wells if the first one goes well. If everything goes well and you do not have inventory for the next well, you are back at the beginning. If something goes wrong, you are stuck with higher inventory.  With six different sizes and in some cases 3 configurations, each faced with a chicken/egg problem, large inventories always ensue.

Large inventories put companies in a squeeze situation. If something happens and they cannot afford the inventory, then fire sales and lower pricing is the only option.  With 30 companies all experiencing this problem, pricing rapidly raced to the bottom.  Margins were driven from 65% in 2014 to as low as 10% today.

Agency Problems

The success of a composite plug in the Plug & Perf operation is reliant on several different services.  The wireline company which includes installing the tool, redressing the setting tool, controlling the speed of the wireline, the pump down truck.  The frac company and interpretation of whether a bobble on the frac chart a plug slipped or the reservoir response. And, the drill up company which includes controlling the fluids, weight on bit, speed of milling, bit selection, and many more variables.

These companies are being paid to perform their duties the best of their ability to ensure the best possible outcome for their customer.  However, many of these service companies could have an interest in running a different frac plug.  Whether they like another plug better, their company offers a plug, or they have a relationship with the sales professional for another plug, they may choose not to perform at the best of their abilities in hopes of getting their preferred plug on the job.  Does this happen overtly?  I am sure, but most of the time it is done unconsciously.  Any time there is an agency problem, and you are on the wrong end, it is an issue for your product. It makes your situation fragile.

Solution?

This is the $MM question.  What can a plug provider, or the industry, do to over come these challenges? The easiest answer is to have the highest quality product at the lowest possible price, which if possible, is the answer to any business issue.  Other options include partnering with other service companies to work towards eliminating the agency problem.  The likelihood of the customers switching to issuing Pos for the work and providing a longer lead time is low, however if all plug providers start to request this, maybe some change will happen.  Especially since many of the current options will be removed as companies close their plug businesses, removing some of the options for the operators. 

In the current environment, the first answer is to survive.  Create enough business to keep the lights on until the industry conditions improve.  While surviving, use extra time to focus on your technology and supply chain. 

• Review operations, testing, design, and your full experience to investigate how you can improve the product and the service that goes along with it. 

• Consolidate & document the best practices from field work into a solid work instruction to improve service.

• Build stronger relationships with your current suppliers, how can better communication between you and your suppliers improve upon the optionality and squeeze problems described above.

• Improve your team, is there a role on your team that is needed or needs to be replaced to make the team work better?  Either for experience or fit?  Could that role be filled with by a consultant while the industry is rebuilding?

Using this time to gain a detailed understanding of the customer needs, current technology, team dynamics, and supply chain will enable you to develop a thoughtful strategy to achieve success (market share) when the industry returns to a new normal.