Is it time for the energy industry to follow the medical community into the HMO era? Instead of health maintenance organizations, think of hydrocarbon management organizations. That is the question Brittany Cummins, a Credit Suisse oil services analyst, poses in a provocative research report addressing the resource harvest era of the shale revolution.
The gist is that the shale revolution should alter the relationship between operators and service providers as the industry enters the harvest phase, with service providers sharing in the production gains the sector creates from reducing well cost, improving efficiencies and accelerating production.
It is not a new concept. A similar business model is employed on international projects and referred to as integrated project management. The large diversified oilfield service firms that manage field work serve as project managers for customers, lowering development cost in challenging circumstances and accelerating production. In theory, the diversified service firms are compensated out of the savings operators gain.
Domestically, an analogous business model was in vogue in the mid-1990s known as Shell's “Drilling in the '90s” program. Anyone remember the alliance movement? Contractors and operators would band together to shave well costs by reducing duplication through better planning, decreasing costs and increasing efficiencies. Contractors would share in the gains operators achieved. The phrase back then was “win-win.”
Contractors who survived the '90s, when low demand and an abundant supply of equipment extended the tough times from the 1986 industry collapse, used to joke that “win-win” under the alliance concept meant the operator won twice. The concept faded when a domestic natural gas supply shortage revitalized the services industry in the first half of the first decade of the 21st century.
Unconventional development in the second half of the decade opened another era in domestic oil and gas. Following the discovery and delineation of vast new tight-formation deposits, operators are now recognizing significant gains in developing expensive unconventional resources because of efficiency contributions from the services sector.
The result has been great for operators, and for the nation, although oil services firms haven't shared in a way commensurate with their contribution, thanks to a persistent oversupply of equipment and a drop in demand for natural gas field work.
Enter the managed care concept. Credit-Suisse' Cummins argues today's oil services market is analogous to where the health care system was before HMOs and their outcome-oriented approach came into vogue, subsequently defusing medical cost acceleration and improving results for both patients and the medical community.
Right now, the focus in oil and gas involves haggling over pricing, Cummins argues, rather than concentrating on outcomes.
“Pad drilling has driven fewer drilling days, which is punishing the land-drilling industry through fewer revenue days. The E&Ps are taking the vast majority of the value from cost efficiencies created by oilfield service companies,” Cummins says in an e-mail to Oil and Gas Investor.
“Oilfield service companies would benefit from taking a portion of production rather than a guaranteed fee—which would allow them to benefit from the efficiencies they create while also increasing production for E&Ps. This 'new' business model is very similar to the HMO model in managed care. In this situation service companies would benefit from creating efficiencies instead of being punished through lower revenue.”
So it may be time to envision a structurally different industry in the era of broad-based harvest for unconventional resources.
Exploitation of tight-formation hydrocarbons is a transformative event for oil and gas. Eventually that transformation should also be true for the structure of the industry five or 10 years down the road. It is already underway in terms of the tools the industry uses to develop unconventionals, particularly the pendulum swing to higher-specification rigs in the land-drilling fleet. The customer—the oil and gas operator—is driving that change.
But change won't stop there. Do unconventionals also imply a transformation of the operator side of the business into one that more closely resembles one vast industry MLP—master limited partnership—as the resource harvest phase entails less geologic risk and more emphasis on process and lower costs? Think of it as the transition from the era of the wildcatter to the era of the supply-chain manager.
If all stakeholders in the resource harvest model share in results, just as MLP unitholders do, that would be transformative indeed.
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