A Look at 1986, and the Climate for ’87 : Oil Services

An industrywide depression prompted by rock-bottom oil prices turned 1986 into a year of layoffs, write-offs, consolidations and bankruptcy for oil service companies in Orange County.

And analysts aren’t forecasting an end-of-the-storm rainbow until at least 1988.

The year began with a federal judge ordering Irvine-based Smith International Inc. to pay Hughes Tool Co. $204.6 million in damages for infringing on a Hughes-patented O-ring seal used in oil-drilling bits. Although Smith is appealing the judgment, the financial sting of the award and its own flagging business forced Smith into a Chapter 11 bankruptcy reorganization.

In an equally dramatic move, Orange-based Baker International in October said it had agreed to merge with Houston-based Hughes Tool to achieve greater manufacturing economies and a larger market share for its main products, most notably oil-drilling bits. If approved by federal regulators, the $1.2-billion merger will be the largest ever in the oil services industry.

Reflecting depressed levels of oil drilling and price-slashing competition, Baker reported a $273-million net loss for its fiscal 1986, while Smith posted a third quarter loss of $64.4 million.

Varco International, another oil service company in Orange, reported a net loss of $6.3 million for the first nine months of 1986--nearly triple the net loss of $2.2 million it sustained during the same period of 1985.

Baker’s loss came despite a consolidation of facilities and a 30% work force reduction in the past year. The bulk of the company’s annual loss came from a $340-million write-down of assets and inventories in the second fiscal quarter to acknowledge the declining value of oil-producing facilities and equipment.

In similarly painful cost-cutting measures taken in 1986, Varco and Smith slashed their worldwide work forces by more than half, with Varco reducing its staff to 200 from 440 and Smith cutting its ranks to 3,500 from 7,500 employees.

Fluor Corp., based in Irvine, managed to substantially shrink its fiscal 1986 losses to $60.4 million from $633.3 million in its 1985 fiscal year, largely by restructuring to diversify its engineering and construction activities into industrial and commercial projects and away from oil refineries and other energy-related facilities.

Despite renewed efforts in 1986 by OPEC to cut overseas oil production in the hope of eventually boosting oil prices, analysts are figuring 1987 to be another difficult year for the surviving companies.

They point out that while the price of domestic oil has climbed from an all-time low of $10 a barrel during the summer to about $17 a barrel, it is still only slightly more than half the $30-a-barrel that oil producers were getting in December of last year.

And the price of domestic oil may drop again, although not as low as last summer, said Kevin Conboy, an oil service industry analyst with Merrill Lynch in New York.

Prices depressed by an oil glut, Conboy said, will give oil producers little incentive to drill and thus little need to buy drilling equipment from oil service firms.

Jim Crandell, oil service analyst with Salomon Brothers, predicts that although oil companies will spend somewhat less on oil production in 1987 than in 1986, such expenditures will gradually increase throughout the year as the industry heads toward a recovery.

As oil drilling picks up, Crandell said, he expects that the newly merged Baker Hughes company will return to profitability before the end of 1987. But he said it will take longer for Smith, which is loaded with debt, and for Varco, which manufactures expensive rig products, to get back in the black.

After 1987, Crandell predicts, money spent on domestic oil drilling will increase by 10% to 12% annually and oil prices will climb to $20 a barrel by 1990.

Edward Lefferman, securities analyst with First Manhattan Co., said oil service industry stocks may do better as investors begin to bet on a recovery.