Revenue Generation Structure
The revenue of OSCs is generated by the services provided to customers such as IOCs or NOCs. Oil services company revenues are essentially the capital expenditure (CAPEX) of international oil companies (Hermann et al. 2008).
Oil services companies do not generate revenue in a way that is tied directly to the amount of oil and gas produced; their revenue is dependent on time spent and on the cost of the service provided. Most OSCs contract their work either by day-rate or on a ‘meterage’ basis (e.g., a fixed rate per day or a fixed rate per meter drilled).
Drilling services provide a good example of the revenue relationship between OSCs and IOCs. International oil companies do not own their own drilling equipment or employ drilling staff. Instead, they contract drilling companies to drill wells on a daily rate basis. Day rates for new rig contracts are announced by drilling companies. Contract drilling companies, therefore, generate revenue based on the amount of time they are contracted to work for IOCs (Harman 2007). As of December 2013 there were over 500 offshore working rigs worldwide, typically working on an average contract length of less than a year. There are contract announcements each month that provide valuable leading indicators on where oil industry costs and OSC revenues are heading. In the last years, the high price of oil has led to a surge in demand for all classes of rigs and has driven up daily contractor rates to record levels. As drilling demand increases, the cost of all other associated services (such as supply boats, helicopters, cementing, mud and wireline logging) also increases. IOCs often have many rigs working for them simultaneously, all at different rates and with different contract ending dates. Large increases or decreases in day rates take time to fully impact the cost base because there is a time lag between changes in day rates and their implementation across the portfolio of contracts (Hermann et al. 2008). Revenues of OSCs are therefore tied to the level of activity within the oil and gas industry, sometimes measured by the ‘rig count’ or the number of rigs working across the globe at any given point in time (Harman 2007).
Oil services companies generate revenue during the realization of the project. They need to generate revenue on each project during activity such as construction, drilling or seismic services. There is no upside potential once the activity is finished. Thus, the bulk of risk associated with oil exploration and discovery is borne by the IOCs, as oil service company revenues are only exposed to fluctuations in daily drilling rates.
Conversely, in the case of IOCs, the amount of oil discovered directly impacts their revenue. IOCs start generating income once the production of oil and its sale take place, and continue to do so over the years according to the production rate. The upside potential for their earnings is linked to the amount of oil as well as the price of oil. Because new reserves are the primary source of future revenue, IOCs invest significant effort and time into searching for new petroleum reserves. If an IOC stops exploring, over time it will naturally generate declining revenues from a finite number of depleting petroleum sources.
While OSCs do not generate revenue directly linked to the price of oil, they benefit from high oil prices just as IOCs do. For IOCs, the benefit is obvious; high oil prices mean the value of their assets and their revenue stream (which is directly linked to the price of oil) are worth more. For oil services companies, high oil prices also lead to increased revenues as large producers typically increase investment in new facilities in a high oil price environment. Some large oil companies increased their capital expenditure by 25 to 30% in 2007 and 2008 to bolster their chances of finding and exploiting new reserves. In a high oil price environment, rates as high as 1m$/day have been contracted to offshore drilling companies (Hermann et al. 2008).
The cost of oil projects is to a great extent the revenue of OSCs. International oil companies have a spending budget for each project, and they aim to reduce their capital expenditure (CAPEX) by qualifying several OSCs during the tender process and ensuring competition.