The oil and gas industry is as cyclical as any in the broader economy. And the North American sector is once again on the downward slope.
Activity across the energy sector has slowed since the start of the year, leaving the supply chain for both oil country tubular goods products and line pipe struggling to stay profitable. Moderating oil prices and an uncertain outlook have put the brakes on project work.
Pricing for both oil and natural gas are both on a downward trend. In mid-August, the West Texas Intermediate price was at $55.87 per barrel, below the second-quarter high of $66. The Henry Hub natural gas spot price fell to a $2.37 per million Btu in July, the lowest it’s been in more than three years.
Not surprisingly, drilling activity has followed suit. Since mid-August of 2018, the U.S. rig count total has fallen by 122 to 935 active rigs, according to oil patch analysts Baker Hughes. The drop-off was even more severe in Canada, with rig counts down 70 to 142 in mid-August.
The downturn hasn’t spared any geography or product type. Oil rigs are down about 100 rigs to 770, while natural gas rigs declined from 186 rigs last year to 165 in August. The decline has hit Texas the hardest, though that’s largely based on the Permian Basin being the hub of drilling activity for the past few years.
“There is a reduction on the drilling. We see it. We feel it,” says Don Baysal, president of SEBA Pipe, Inc., a Houston-based distributor of both OCTG and line pipe products. “Because of that, there’s a reduction in demand.”
“Most end users are operating within their cash flows. A lot of rigs are going down. Folks that were operating four or five rigs are doing two or three. Folks that were operating two or three are operating a half a rig or one rig,” says Naryan Bhargava, who handles sales for Houston’s SDB Steel & Pipe, which primarily stocks OCTG casing and tubing.
Yet, softening demand is not the major issue facing distributors of OCTG and line pipe. For them, pricing and supply is a much bigger concern.
The March 2018 imposition of Section 232 tariffs delivered a pricing boost to all steel markets, including those in the energy sector. But the retreat from those higher prices is causing quite a bit of angst this year. By summer, prices had reverted to pre-tariff levels.
“We’ve seen a steady decline in price since the start of the year,” says Bhargava. “A lot of folks in the industry were stuck with some inventory that was bought at the time that is now overpriced.”
“Prices have been creeping down over the last several months,” says Dan Hilliard, the North American editor for Kallanish Energy, a business media organization. Kallanish Energy is hosting its first energy pipe and tube conference, Kallanish New Horizons, Nov. 15 at the Omni Hotel in Houston.
Hilliard says pricing will not bounce back until the hot-rolled coil price rebounds. Executives hope the floor in HRC has been reached, and the $40 price hike the mills called for in July manages to stick.
“We feel like maybe they’ve bottomed out. They’ve come up $40 from what appeared to be the bottom,” says Mike Ellis, president and CEO of Mammoth Carbon Products, Scottsdale, Ariz. “We’re optimistic about that, because higher coil prices normally translates into higher pipe prices.”
Bhargava would like to share that optimism, but he’s not convinced. “Regarding the anticipation of HRC prices going up, I’m not holding my breath.”
Of course, as Russel President John Reid told investors at the company’s most recent conference call, even if the price has begun to creep back up, there’s a lag between then and when that plays out in the energy space. “OCTG and line pipe typically runs about 90 days in reserve on pricing, so they’re continuing to drift south, predominantly because of imports coming in. We see that falling throughout the third quarter.”
Any price increase would be more than welcome. Companies throughout the industry have been scrambling to simply move some of the higher-price inventory off the shelves. And there’s no shortage of inventory.
“If you’re sitting on 10,000 tons of unsold pipe and the end market goes south, you’re in a trouble. That’s when companies start selling dollar bills for 80 cents,” says Art Cressman, CEO of Cressman Tubular Products, a specialist in OCTG casing and tubing products based in Addison, Texas.
Virtually everyone in the supply chain talks of an ongoing glut of material. “We feel there is too much pipe on the ground. Before 232, people anticipated and bought too much. Stockists have too much cargo in the yard,” says Baysal.
And it’s not just service centers. Though the mills have seen their backlogs erode, they’re still producing material. Distributors talk of the issue of mills putting stock on the ground. “That’s bad, because distributors have to compete with that,” Ellis says.
“We see a lot of the domestic mills and some of the Tier 2 ERW mills that make OCTG, those guys are making pipe whether they have orders or not. Sometimes when I’m buying from these mills, it’s like I’m buying from another distributor,” Bhargava says. “They have it on the shelves, ready to ship when I need it. It’s kind of scary because they’re creeping into your space when they follow that model.”
The combination of all these factors, and a few others, is going to make getting the supply-demand balance in check more difficult. While some are hopeful that things will begin to level out with the start of next year, Cressman isn’t that hopeful. “My perception is there won’t be parity between supply and demand until summer of 2020.”
Contributing to the confusion is the ever-shifting import picture. “Energy tube got a little boost from Section 232 last year like all steel products. Now that has kind of leveled out and there’s been a little more crystallization of how quotas will work and what countries will be affected,” Hilliard says.
South Korea was the first domino to fall. The country, which is the leading offshore importer to the U.S., moved from tariffs to the quota system late last year. Both Korean producers and the domestic supply chain are adapting to the new structure.
“Korea kind of doubled down on tubing in the first half of the year. It’s not a strategy they can follow for the whole year, so Q3, Q4 you’re going to see more Korean alloy casing coming in,” says Bhargava, who expects Taiwanese imports to become a bigger player in pipe.
Earlier this year, the supply picture changed again with the removal of tariffs on Mexico and Canada, a decision that is a precursor to the ratification of the United States Mexico Canada Trade Agreement.
Baysal is concerned how all of this will ultimately affect capacity. “I still hear people trying to build mills here, which is incredible. 232 will disappear one day. There will be more material coming into the country. That plus what is produced here is really going to oversupply the market.”
But Hilliard believes that ratification of USMCA will ultimately help the industry, as it will remove some of the political uncertainty that continues to cloud the market. “It will give U.S. producers access to Canadian energy pipe. It will improve the supply situation a little bit. But what it mainly does is reduce some volatility.”
However, long-time steel distribution executive Dolty Cheramie believes that uncertainty will remain the rule, at least until November 2020. “Right now, I don’t think anything is going to happen, good or bad, until the election,” which he said looks like a 50-50 proposition on President Trump’s re-election. Cheramie sold his company, Houston’s Pipe Exchange, in 2012, but remains on the company’s board of directors.
“If he wins, he will double down on everything he’s done, which is not going to be bad for business. If you’re in the oil patch, I don’t think you’ll have anything to worry about,” he said. “If he doesn’t win, I think we’ll revert back to where we were before he was president, which means higher taxes and more regulation on business.”
That sense of the unknown is crippling to investment, particularly in the oil patch where projects take years, if not decades, to go from plans to completion. Investors are cautious to invest in a project if a new administration, or new opposition from outside groups, can delay or derail the endeavor. Or, as Cheramie asks, “Who in their right mind is going to dump billions on building a pipeline when they have no clue how long it will take them to get the spigot running?”
MRC Global, a Houston-based distributor of pipe, valve and fitting products and services to the energy and industrial markets, has seen Cheramie’s projection come to life. The company went into the year expecting U.S. capital expenditures to be up 10 percent, then lowered the forecast to down 3 percent after the first quarter and is now anticipating spending to be down 5-10 percent.
Ellis says this kind of ebb and flow is a natural state for the energy production and distribution industry. “It’s not uncommon to see these cycles, especially in a project-driven industry like oil and gas is. You just never know what’s coming down the pike.”
And while things are tough in the U.S., the conditions are even worse in Canada. MRC Global reported Canadian revenues were down 28 percent in its most recent quarter. “The upstream sector continues to be adversely affected by weak Canadian oil prices and government-imposed production limits,” MRC Global Executive Vice President and CFO James Braun told investors. “Canada remains our most challenging market, and we see little likelihood of near-term improvement.”
While conventional wisdom dictates that a major swing in pricing is always a Middle Eastern flare-up away, that is becoming less of an issue. In recent years, trouble in that part of the world has not done much to the price of oil. And a one-time industry behemoth has also lost a bit of its might, Baysal says.
“OPEC used to make a huge difference in our business. Now, if they reduce output, between Russia and the U.S., we compensate for the difference, so there’s no change.”
Thus, most eyes will be inward over the next 15 months, tracking the presidential campaign and waiting for an answer about what kind of environment will follow. “Anytime there’s an election, folks kind of sit on their hands. This one in particular is a little more contentious than most, so things will move a little slower on all fronts,” Hilliard says.
Ultimately, there is some optimism, but it remains mostly in the distance. “What I’m hearing, things should improve on the mid-term timeline, but in the near term no real movement,” says Hilliard.