cover curse and retrenchment

I felt a sense of wry amusement when I saw that that Schlumberger was featured on the most recent cover of BusinessWeek magazine. There are two major reasons for this bit of tragic amusement. The first is the purported BusinessWeek cover curse. It's enough of a joke that BusinessWeek is aware of this curse. (Please note that both of those links go back to 2005.) I became acquainted with the curse through what is probably my favorite financial blog: The Big Picture when the blogger speculated on whether the magazine had broken the curse a couple months ago. So, can Schlumberger break the BusinessWeek cover curse?

The other reason for this wryness centers on what I, and many others at districts across North America, had to do yesterday. To be vague and circumspect, we engaged in what I've been calling a 'force reduction exercise'. This included one man with more seniority in the company than years I've been alive for. Today was a day to address everyone and explain what just happened and why it took place. And now we move on. To celebrate, I'm watching Office Space tonight.

This is clearly a retrenchment. A very similar exercise played out last year for a combination of reasons. At the beginning of the year, 2007 was forecast to be flat on a year-over-year basis in North America. As such, efforts were made to reduce or freeze hiring. However, even under a hiring freeze, headcount often finds a way to creep up. Everyone has a special case, needs something extra, etc. The other major issue, especially in the segment I am in, high pressure pumping, is that a lot of capacity was added by all the service companies. This created a more competitive environment and impacted pricing levels. Schlumberger responded with a plan that included personnel cuts as well as other actions and was largely successful.

Looking at the market now at the beginning of 2008, many of the same issues face the oil and gas service companies. Furthermore, the macroeconomic environment isn't looking so great either. Oil and natural gas are two pretty distinct markets. Sure, they're related in a sense, but they have very different end markets and that largely explains why oil and natural gas have seen their prices significantly diverge in the last year. While oil keeps climbing, natural gas remains largely flat and well off of its highs from a couple winters ago.

Natural gas is being pinched by forecasts that the winter would be warmer than average and those forecasts have been mostly correct thus far. See, natural gas goes through an inventory cycle every year. Starting in the late spring, there is a build up in inventory levels that continues for about seven or eight months. Then, winter comes and everyone starts to use natural gas to heat their homes. This draws inventory levels down until the weather begins to warm up again in the spring and the cycle begins anew. There is an excellent chart of the natural gas storage levels for the past two years available on the Department of Energy website. You might notice that 2006 matches the high line and 2007 was very close to it or higher for the entire year. Inventory levels are high. If they stay high, it will impact prices which will then impact the drilling campaigns of operators working in natural gas basins.

Meanwhile, oil is tied more directly to the overall economic health of the world which is largely influenced by what happens here in the States. So, what exactly is the United States economy doing? Not well would be the short answer. One can ask whether a recession is unavoidable at this point. Some past indicators are not painting a pretty picture. The unemployment rate has ticked up and some have noted here and here that this level of increase in unemployment has historically preceded a recession. Of course, past performance doesn't guarantee future results. Nonetheless, the housing market, a big driver for job creation, has been sputtering for the last several months. And despite the National Association of Realtors attempts to call a bottom on the housing market, I suspect that their word cannot be fully trusted. They don't seem like impartial observers now do they? The point is that the economy is not well. It may not be unwell, but it is not well. There's robust demand for oil in many developing nations, but the United States may drag down overall demand and put a crimp on prices.

Not to be unduly bearish about the whole oil and gas services environment. It's great overseas. It's simply very tight right now in North America and what we did yesterday is once again part of our preparation for a very competitive year.