Entry Strategy for

Engineering Service Providers

in the Energy Sector

--------------------------------------------------------------------------------------------------------

Table of Contents
Abstract

.....................................................................................................................................................

Industry Landscape ...................................................................................................................................

R&D Landscape ...........................................................................................................................................

M&A mergers and acquisitions of Big4 ................................................................................................

The North American Market ....................................................................................................................

Market Trends

...........................................................................................................................................

Challenges ...................................................................................................................................................

Solutions Proposed to Drive Outsourcing ................................................................................................

References ..................................................................................................................................................

10

Author Info ...................................................................................................................................................

10

2013, HCL Technologies. Reproduction Prohibited. This document is protected under Copyright by the Author, all rights reserved.

Entry Strategy for Engineering Service Providers in the Energy Sector / 2

Abstract
Engineering services providers in India are waking up to the demands in the emerging energy vertical. Today,
energy as a business segment is a major revenue driver for many engineering service providers and is also
attracting the attention of many smaller players.
Energy as a business majorly consists of these four sub-domains: oil and gas, nuclear energy, renewable
energy, and power generation. Of these four, oil and gas thrives highly on outsourcing. In nuclear energy,
process engineering is sacrosanct and hence not outsourced. Renewable energy and power generation
havent seen the quantum of R&D investment which oil and gas has been witnessing over the past few years
and will witness over the next few decades.
For new entrants, there is no easy answer to which areas to invest in and which areas to focus on for optimum
protability. This paper attempts to guide the Engineering services organization on how to manage their R&D
investments based on the challenges, industry drivers, and the market trends existing in the oil and gas
industry.

2013, HCL Technologies. Reproduction Prohibited. This document is protected under Copyright by the Author, all rights reserved.

Entry Strategy for Engineering Service Providers in the Energy Sector / 3

Industry Landscape
When a market penetration strategy is developed, it encompasses targeting a set of companies which are
normally Tier-I suppliers to the big players in that industry and gradually moving up the value chain to become
a Tier I supplier. However, the same strategy cannot be applied to the oil and gas industry, which comprises of
Upstream, Midstream and Downstream sectors. Here, a large amount of R&D investment is owing in Oil and
Field Services (OFS) and upstream sectors. Despite environmental concerns and lack of viability of alternate
fuels, oil dominates global energy consumption with 33.1%, natural gas with 23.9%, and coal with 30%. The
focus is shifting more towards oil because coal is replacing the consumption of natural gas and coal alone
cannot suce all the needs of global energy2. Global oil trade accounted for 62% of total global Imports in
2012 i.e. up from 57% a decade ago1. Hence, there is an increased pressure on the worlds O&G companies to
extract more and more oil. This in turn, is driving investment in Exploration and Production (E&P), eventually
resulting in major investment in OFS and drilling.
The usual suspects for investment are big E&P players like Chevron, BP etc. Before proceeding further, we
need an understanding of the companies placed in E&P and OFS. The global E&P majors can be classied3 as
follows:
a) National Oil Companies (NOC) are fully or majority owned by national governments. NOCs can be broadly
classied as
An extension of Government or operating as Government Agency like Saudi Arabian Oil Company
(ARAMCO) or;
A company operating with strategic and Operational Autonomy like Petrobras in Brazil and Statoil
from Norway.

b) International Oil Companies (IOC) / Supermajors / Big Oil are the six largest, non-state owned companies.
They include BP (UK), Chevron Corp. (USA), ConocoPhillips Company (USA), ExxonMobil Corp. (USA), Royal Dutch Shell
Plc (Netherlands-UK), and Total SA (France).

Of the top 10 largest oil producing companies, only 3 are IOCs. NOCs control as much as 90% of global oil
reserves which is in contrast to the situation in the 1970s when 7 IOCs used to control 85% of global oil
reserves.4 In the last couple of decades, NOCs have taken help from OFS companies to claim best acreage from
oilelds which was once a signicant oering of oil majors. A tightening market also drew demand for new
technology in drilling and 3D seismology, which helped OFS rms to grow faster. Shrinking oil wells and
increasing demand for oil prompted the oil and eld services (OFS) companies to invest signicantly to come
out with more accurate drilling solutions which had greater eciency. Gradually, IOCs themselves became
dependent on the expensive OFS kits in the 1990s. The urge of IOCs and NOCs to explore new avenues has
resulted in their partnering up to explore remote locations. This can be summarized in Figure 1.

2013, HCL Technologies. Reproduction Prohibited. This document is protected under Copyright by the Author, all rights reserved.

Entry Strategy for Engineering Service Providers in the Energy Sector / 4

Demand of OFS services

far outstrips supply
in geographically
Oil rms are searching

remote areas

harder in remote places

like Arctic and deep
Impending future

seas of Brazil

oil supply shock

demanded OFS companies
OFS companies were

to extract more

relatively very small till

1980s when tightening
OFS companies were
relatively very small

Oil market drew demand

for new technology

till 1980s when Oil

majors decided to
outsource drilling

Figure 1 - The Rise of OFS Companies

Typically, OFS companies involve in risk sharing model with NOCs. For e.g. Schlumberger will agree to a
measure of payment-for-performance. If it can drill more oil, then it can charge a premium.

R&D Landscape
The propensity of R&D Spend is way higher in OFS companies (who are committed to accurate drilling and
reduced TTM) than in exploration and production companies - be it IOCs or NOCs. Major IOCs are cutting their
budgets and are depending on OFS companies for new technology. Therefore, OFS companies have increased
their R&D expenditure. This is also demonstrated by the high number of oil and eld (OFS) patents as
compared to those led by IOCs/NOCs.
The contrast for all these rms is shown in gure 2 as of FY 2012.

2013, HCL Technologies. Reproduction Prohibited. This document is protected under Copyright by the Author, all rights reserved.

Entry Strategy for Engineering Service Providers in the Energy Sector / 5

R & D Spend as % of Net Sales

0.00

0.50

1.00

1.50

2.00

2.50

Schlumberger

Big 4

Baker Hughes
Weatherford International
Halliburton
Aker Solutions
Technip
Cameron International

Supermajors

Total
Conoco Phillips
Chevron
Oileld Services (2012, $Mn)

Royal Dutch Shell

Exxon Mobil

O & G Exploration & Production E&P Co.s

BP

3.00

Revenues

R&D Spend

42,149

1168

21,360

497

15,215

257

28,503

460

7,519

121

10,992

92

8,502

63

268,082

1079

62,004

221

231,000

648

467,153

1314

453,123

1042

375,580

674

Figure 2 - R&D Landscape

Now, OFS rms are pushing technological boundaries to

extract more oil from unexplored landscapes and are
building prowess by re-engineering their E&P processes.
This investment in higher eectiveness will lead to higher
revenues. All this can be achieved through sustained and
increasing R&D spend. This has been illustrated in Figure 3.

Figure 3 R&D Spending of OFS Firms

M&A mergers and acquisitions of Big4

The oileld Services market is fragmented. Each big OFS
160

100

$200

80

$150

60

$100

40
20
H2 2010

H1 2011

H2 2011

H1 2012

Average Deal Size

No. of. Deals

$250

120

rm has dierent strengths, and plenty of smaller ones

$300

140

have niche specialization. There is a fair amount of

competition in most parts of the oileld services industry.
From advanced drilling to deep sea rigs, a dwindling

$50

number of OFS rms are providing such services through

$0

technology acquisition as shown in Figure 4.7

Figure 4 M&A in oileld equipment services

2013, HCL Technologies. Reproduction Prohibited. This document is protected under Copyright by the Author, all rights reserved.

Entry Strategy for Engineering Service Providers in the Energy Sector / 6

Overall, a lot of consolidation has been taking place in the market over the past 2 to 3 years. The average no.
of M&A deals varied between 60 to 140, with deal sizes ranging from $100 Million to $260 Million. It was also
observed that the maximum M&A deals took place in North America almost double that of Europe.

The North American Market

For all of the Big 4 in Oil and Field services (OFS), North America has been a big market, with the US being the
main geography for Schlumberger, Baker Hughes and Halliburton. A more economical reason for the due
importance to North America is its resources in the form of oil and shale gas in US, shale gas in Canada and
oil exploration in the Gulf of Mexico.
The North American market is suering from
excess capacity in pressure pumping and
hydraulic fracking market. Moreover, the market
appeal is prompting new entrants to enter the
market increasing pressure on the existing
players to reduce the prices. This has hugely
impacted the Big 4 as shown in Figure 5.

NA Operating Margin

Baker Hughes

Halliburton

Q3,2011

27%

23%

Q3,2012

14.1%

10.5%

Q3,2013

10.8%

Yet to declare

Figure 5 Impact on Big 4 due to price reduction

Market Trends
1. Capital Spending
Oil prices govern the viability of E&P projects
Customers are demanding advanced equipment and technology to keep pace with the challenges of
expanding frontiers and harsher operating environments. The pressure on OFS companies is very high
to innovate and increase capital investment. These Companies continue to spend capital in excess of
operational cash ow with only a modest increment in Return on Capital Employed (ROCE).

2. Periodicity
Capital budgets govern new exploration projects
Oil producers delay exploration-related new expenditures, until they have ascertained their scal budget.
This situation is corroborated by a steady increase in the oil-directed rig count in the rst two quarters
and the subsequent fall in later half of Q3 and complete Q4.

2013, HCL Technologies. Reproduction Prohibited. This document is protected under Copyright by the Author, all rights reserved.

Entry Strategy for Engineering Service Providers in the Energy Sector / 7

3. New Business Segments

Business Intelligence, Consultancy Services are the next big avenues to help mitigate risks
OFS companies like Schlumberger sell technology and software to analyze raw seismic data and
consulting services to help customers plan drilling. With prevailing charter rates on ultra-deep water drill
ships exceeding $600,000, high-quality geophysical data is critical to saving money and avoiding a DRY
HOLE.

4. Fall in US Rig Counts

Gas prices hit bottom in 2012, leading to closure of many oil and gas projects. Increasing eciency and
rising production of gas in oil-rich places have oset the sharp decline in US gas rigs. Availability of
relatively inexpensive substitute fuels like coal in utility plants has marred business prospects. Producers
dont see an upside in pricing to start production.

5. Aggression among NOCs and Small OFS Firms

NOCs are muscling with IOCs, claiming best acreage in past decade with OFS, which they used to do
before with IOCs. Small OFS rms have become aggressive for e.g. Mitchell Energy has developed
hydro-fracking technology for shale gas.

6. Smaller Projects
Move towards risk mitigation with safer technology. Raised prices not an issue.
Smaller projects are oered instead of long term contracts and partnerships which turn out to be
inexpensive in the long term. This is also a move towards not playing with new technology as
demonstrated by the Macondo disaster.9

Challenges
1. Thought Leadership Position Not yet Occupied
Oil producers began outsourcing drilling and allied activities to oil and eld services (OFS) rms.
This resulted in them minimizing their R&D expenditure and losing their innovation focus. In the process,
OFS rms started prioritizing R&D investment which is a signicant growth avenue. Market fragmentation
is observed even in technology landscape. The development of hydro-fracking technology by Mitchell
Energy is a good example.

2013, HCL Technologies. Reproduction Prohibited. This document is protected under Copyright by the Author, all rights reserved.

Entry Strategy for Engineering Service Providers in the Energy Sector / 8

2. Commoditization of Market
Due to low entry barriers, many small players have entered into oil and eld services (OFS) market. There
is an oversupply of once premium services like Pressure-Pumping. The OFS companies are trying to
maintain prot margin by operational expertise, and stay put on prices.

3. Shift in Regional Focus

Middle East and Asia lead the pace with an upbeat outlook, posting a 7% increase in revenue and
expanding margins by 126 basis points for oileld major Schlumberger. The stagnant North American
market has proved to be a sales challenge.

4. Cost Management
Cost of Goods Sold (COGS) as a % of revenue, has increased by over ve points since 2008. Selling,
General and Administrative Expenses (SG&A) as a % of revenue has remained in check. Raw material costs
including steel, MRO, pipes, fuels, manufacturing and labor have escalated and eroded protability. Oil
eld services companies are redoubling their eorts to improve operating performance and, in many
cases, adopting proven methods and tools.

5. Economic Health of Companies

The debt levels of companies have gradually risen up. The aftermath of economic slowdown and low
interest rates have resulted in leveraged borrowing by the oil and eld (OFS) rms.

6. Scale Of Operations
Supply chains with new operating bases in the Northeastern and North Central U.S., West Africa, Central
Asia, and Brazil, have become increasingly complex and expensive. Demand for robust products which
can perform in harsh conditions is increasing with a renewed focus on products displaying superior
capabilities in remote environments.

7. Talent Crisis
An aging workforce and lack of interest towards working in oil and gas industry among young graduates
has resulted in reduced talent pools10, 11. Almost half the workforce is retiring in Oil & Gas Industry. This
problem is resonating across dierent business segments and companies in O&G Industry.

2013, HCL Technologies. Reproduction Prohibited. This document is protected under Copyright by the Author, all rights reserved.

Entry Strategy for Engineering Service Providers in the Energy Sector / 9

Solutions proposed to drive outsourcing

1. Innovation Arbitrage
As it has been the seen, the thought leadership position has not been occupied yet. An ESP can also be
relied upon to propose innovation breakthroughs than just using them as a provider of cheaper labor.

2. Monetize R&D Investment

Return on Capital Employed (ROCE) is very low as compared to 4 years back. Investments have resulted
in huge debts. Almost $780 bn. in oil & gas supply infrastructure is going to be invested every year12.
A potential ESO partner can help monetize R&D Investment through its services.

3. Convert xed costs into variable costs

As most of the workforce in the oil & gas industry is on the verge of retiring, the O&G companies will need
short term solutions to cope up with this talent crisis. Thus, a potential ESO partner can help convert
workforce xed costs into variable costs by outsourcing.

4. Globalize Operations
Oil and gas companies have operations located globally in far away locations
like Arctic, North Sea, and Middle East. An ESO partner can help globalize
operations and revolutionize maintenance with cloud services, electronic
manuals, and smart product services and technology convergence.

5. Addressing policy regulations and compliances

With the changing regulations and monitoring progress involving huge
turnover times and unjustied capital expenditure, ESPs can be used for
helping with regulatory compliance and permit management.

6. Infrastructure Upgrades
Companies are focused on identifying areas to upgrade and reduce old
infrastructure. ESPs can protect valuable capital infrastructure by way of
enterprise architecture platform.

2013, HCL Technologies. Reproduction Prohibited. This document is protected under Copyright by the Author, all rights reserved.

Entry Strategy for Engineering Service Providers in the Energy Sector / 10

References
1. BP Statistical Review of World Energy
2. A Tale of two Energy Commodities
3. E&P Major Classication
4. Global Share of Oil Reserves
5. Oil Gas Reality Check 2013 by Deloitte
6. Annual Reports of Big 4, Supermajors and OFS Companies
7.Oileld Equipment &Services Report by Clearwater Corporate Finance LLP
8. Risks in Recovery A report from Alix Partners
9. The unsung masters of the oil & gas Industry
10. Outsourcing in the Oil & Gas Industry by Tholons Dec.2007
11. The Big Crew Change Managing the Talent Crisis in Indias Oil & Gas sector by Booz & Co.
12. What is next in the Oil & Gas Industry by Chatham House
13. How is Outsourcing fueling the Oil & Gas Industry by HfS Research
14. OFS Analysis and Outlook
15. BHI Earnings Call Transcript Q3, 2013

Author Info
Vishal Balani
HCL Engineering and R&D Services

This whitepaper is published by HCL Engineering and R&D Services.

The views and opinions in this article are for informational purposes only and should not be considered as a substitute for professional business advice. The use herein of any
trademarks is not an assertion of ownership of such trademarks by HCL nor intended to imply any association between HCL and lawful owners of such trademarks.
For more information about HCL Engineering and R&D Services,
Please visit http://www.hcltech.com/engineering-rd-services
Copyright@ HCL Technologies
All rights reserved.

2013, HCL Technologies. Reproduction Prohibited. This document is protected under Copyright by the Author, all rights reserved.
Designed By: Mayuri Infomedia