Energy stocks led the way last year. The energy sector of the Standard & Poor’s 500 Stock Index soared 55% in 2021, nearly double the 29% return posted by the overall stock market. 

In the energy industry, however, there was a marked dichotomy between producers and service companies. It reflected the woes experienced by service companies, including those in the offshore industry. Those woes, however, may soon be gone.

The energy sector last year saw oil and gas producer stocks (Dow Jones U.S. Oil & Gas Index) climb 48%, while oilfield service stocks (S&P Oil & Gas Equipment & Services Select Industry Index) gained only 11%. The performance disparity reflects the capital-intensive nature of the service industry compared to the commodity-leveraged earnings of producers. Higher oil and gas prices are reflected almost immediately in improved earnings outlooks for producers and thus higher share valuations, while service companies struggle with excess equipment that restrains pricing power and earnings improvement, thus limiting share price appreciation. It’s the root of the offshore industry’s woes.

During 2021, oil and gas prices experienced a robust recovery driven by the global economic rebound following pandemic-depressed 2020. Tight oil and gas markets drove prices dramatically higher – increases of 59% and 33%, respectively. A recent survey of 132 oil and gas executives by the Dallas Federal Reserve Bank shows they expect oil prices to remain stable or rise further in 2022. The global natural gas supply shortage ensures U.S. LNG exports should remain strong this year, supporting healthy domestic gas prices. Positive oil and gas price trends underlay a positive outlook for the industry in 2022.

The problem in recent years for the offshore industry was similar with what has been experienced across the entire oil service business – too much capacity that depresses prices and erodes negotiating leverage with customers. That past is beginning to become history.

The Dallas Fed survey showed, on average, service companies expect the price of their primary service or product to increase by 8.5% this year in response to rising demand. Controlling input costs will be critical for improved profitability, but well within the ability of managers.

For offshore drillers and workboat operators, their largest cost component is the equipment they own and operate. Those high costs were largely addressed in recent years via debt restructuring efforts, either under bankruptcy court protection or negotiated arrangements with lenders.

Another financial solution was industry consolidation, such as the merger of Noble and Maersk that will create the third-largest offshore drilling rig company when completed at midyear. The new company will possess the second-youngest fleet with an 80% utilization. Analysts are speculating on which older, less-capable rigs the new company management team might decide to scrap as it aligns its fleet for the future offshore drilling market. Such a move would help future earnings.

G. Allen Brooks is a managing director at PPHB LP, Houston, which provides energy investment banking. In his over 45-year career in energy and investment, he has served as an energy security analyst, oil service company manager, and a member of the board of directors for several oilfield service companies.