End of Fracking for Schlumberger

The post “Schlumberger Goes Geothermal” on  September 1, 2020, focused on the agreement by Schlumberger Ltd. (SLB:  NYSE) with its long-time collaborator Thermal Energy Partners to form a new geothermal energy development enterprise, STEP Energy.  Apparently, Schlumberger management had quite a bit more up their collective corporate sleeve.  The post was scheduled for publication just as the oil field services giant was announcing transfer of its OneStim hydraulic fracturing services division to Liberty Oilfield Services (LBRT:  NYSE).  Schlumberger is getting a 37% equity interest in the new ‘pumped up’ Liberty.

Some might view the geothermal power production joint venture and appearance of a divestiture of fracking services as cues that Schlumberger is making an existential shift to ‘green.’   Financial media headlines heralded a seminal change in the U.S. fracking business.  Inventor’s Business Daily cheekily announced “The World’s Biggest Oilfield Services Company is Getting the Frack Out of Here” and Barron’s looked to the future with “What Schlumberger’s Fracking Exit Says About the Future of U.S. Oil.”  

Yet Schlumberger is not exiting hydraulic fracturing at all given that the company retains a significant equity interest in Liberty.  Indeed, the argument can be made the Schlumberger is actually expanding its interest in hydraulic fracturing.  The combination of Schlumberger’s OneStim business with Liberty could create a formidable competitive force in the North American oil and gas market.  Liberty will get new pressure pumping and perforating capacity as well as SLB's Permian fracking sand business.  Liberty senior management will be running the show but the highly skilled engineers and operators from OneStim will be at their disposal.  It is likely that Liberty will be able to use its new girth to capture market share with competitive pricing and a ‘one stop shop’ approach.

The placement of the hydraulic fracturing services division into Liberty simply moves the risk from Schlumberger’s operating income to 'other' income in the form of minority equity interest.  In the company’s most recent quarterly report operating results did not look very pretty.  In the quarter ending June 2020, production revenue decreased 40% sequentially to $1.6 billion.  This was largely due to a dramatic decline in demand for pressure pumping services that are a part of OneStim.  During the earnings conference call to discuss these results Schlumberger management admitted its dismal profit margins and operating loss were due primarily to reduced profitability at OneStim. 

As the pandemic economic continues to threaten demand for oil and gas, clearly OneStim needed to be jettisoned.  The Liberty deal allows Schlumberger to pretty up its operating results and move the OneStim losses  to a lower profile location on its income statement.  If Liberty is able to make good on its plan to capture market share with the proposed combination, Schlumberger may even see improved income.  Granted Liberty has its own problems.  In the quarter ending June 2020, Liberty reported a $66 million net loss on $88 million in total revenue.  The top line in the quarter had declined 81% sequentially. 

During conference call following the earnings release Liberty management had confidently proclaimed that Liberty was well positioned to withstand the sector downturn.  It may turn out to be one of the survivors.  Hydraulic fracturing has become more or less a commodity service with little to differentiate one competitor from another.  Over the last two years the hydraulic fracturing sector has shrunk by as much as 75%, at least as measured by fracturing operattion sites.  The Liberty-OneStim combination may able to dominate this dramatically depopulated competitive landscape with scale and a more specialized offering.

Will the deal with Liberty spell the end of fracking for Schlumberger?  Well no, but it will shift those disquieting losses out of operating results.  If Liberty’s management is able to convince investors these can be a success, Schlumberger may even be able to make real its exit from fracking by selling its Liberty common stock.        

 

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.