China oilfield services: private champions emerge from downturn with global ambitions
July 2017 | Kevin Chan, Giovanni Bruni, and Ji Chen
Overall, the Chinese oilfield service (OFS) sector has experienced hard times since oil prices began their slide in the second half of 2014. Before that the OFS market in China had been growing at 5-6% per year, but has since seen a sharp contraction.
OFS revenue is closely related to operator capex, and the big Chinese national oil companies (NOCs) - PetroChina, Sinopec, and CNOOC - have all slashed expenditure. PetroChina, the biggest of the three in upstream, cut E&P capex by more than 45% between 2014 and 2016.
This reduction in state operator spend has had a major impact on OFS players, restricting growth options in the home market. In order to compensate for this shrinkage, many OFS companies have turned to international markets (following the nation’s One-Belt-One-Road strategy), or into new business areas, such as natural gas and oilfield environmental services, to survive and in some cases even prosper.
The degree to which Chinese oilfield service companies have been able to do this has been key in determining their levels of resilience to the oil downturn. Leading state-owned oilfield service companies, which make up more than 70% of the market in terms of revenue, are more heavily reliant on their parent NOCs, so their fortunes have been most closely tied to NOC spend. They have fared less well in response to the crisis. For example, state-owned COSL shrank by 29%* per year in 2015 and 2016 (see Exhibit 1). State-owned Sinopec SSC, which is three times the size of COSL and still over 10 times the size of any of its smaller private rivals, also contracted sharply, and was still left with margins of negative 29% in 2016.
Some leading local private service and equipment providers on the other hand, especially specialized local private companies, have proven most resilient of all towards the industry downturn, helped by rising technical barriers to entry, especially if they have leading positions in their given segment. This has helped shield them from competition domestically, while they have also been able to expand into other markets. LandOcean, for example, saw yearly growth of 32% between 2014 and 2016, and a margin of 12% in 2016.
Exhibit 1: Local Chinese OFS companies show different levels of resistance to the oil downturn
Source: Expert interview; Bloomberg; company website; McKinsey Energy Insights
Key adaptations to downturn by successful local private OFS companies
Leading local private companies have been able to adapt to the difficult market conditions in a variety of ways, including aggressive cost reduction, business transformation, and/or overseas expansion. Examples of this include Anton, which spun-off its Middle East business to fellow private Chinese OFS specialist player, HBP, and managed a 25% overhead reduction during 2014-2015. So, although the company shrank by 15% per year in 2015 and 2016, its margin was a healthy 17% in 2016.
Jereh, which is twice Anton’s size, expanded its business into other segments, such as LNG EPC through the acquisition of Sichuan Hengri, and oilfield environmental services, helped by the acquisition of Huaxia Caiyun. It also expanded into the Middle Eastern, Russian, and Central Asian markets. Although it still lost 23% of its size in 2015 and 2016, Jereh’s 2016 margin was a sustainable 8%.
LandOcean was the best performer and expanded its business from core G&G (Geological and Geophysics) business into drilling and completion, as well as new regions such as Korea (geothermal drilling) and Myanmar. This kept growth at LandOcean to 32% per year and generated a healthy 2016 margin of 12%.
Specialist, Tong Oil, has pursued an acquisitive expansion strategy almost exclusively in the dynamic US onshore, moving into the North America perforating and fracturing market in 2015, helped by acquisitions, including 96% of Cutters, 90% of RWS, and full ownership of APS.
Implications for established international oilfield service companies
With continued and likely growing capabilities and expansion, local Chinese OFS companies appear increasingly competitive in both domestic China and globally, and the established international players need to be ready to work with this new force.
It is possible that we would witness a number of Chinese and international OFS companies forge partnerships going forward, and there are a number of strategies that might be pursued to achieve a successful outcome. One possibility is to link up with a Chinese private integrated solution provider with a global footprint (such as Jereh) and enrich the company’s product and service lines with improved product quality, reliability, and service capability (talents and project experience). This would leverage its established cost competitiveness for the global mass market.
Another possibility would be to invest in or partner with leading specialized players with growth potential, such as LandOcean or Tong Oil, and build on leading positions in their segment. Barriers to competition can be built through research and development and targeted acquisitions. An international partner could also consider bundling the offering from such a specialist into a broader OFS platform company, to enhance its broader position in the global market.
Global OFSE companies themselves need to prepare to compete with this new force by building up barriers in high-end markets - mostly in the offshore, unconventional and general HPHT geo-environments. This should help differentiate their offering from Chinese players. Alternatively, they can try and keep downward pressure on costs to compete, although that may prove difficult in some geographies and in more basic service areas.
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About the authors
Kevin Chan is an partner in McKinsey's Shanghai office. Giovanni