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Oil and Gas Drilling Industry Report


Introduction

This essay presents an overview of the Oil and Gas drilling industry. Some of the peculiar aspects of this industry are the price unpredictability of oil. The industry grows in a cyclical way and is largely oligopolistic. The industry is money and labor intensive thus only companies or individuals with access to huge capital venture into the industry.

Politicians and other market players have a lot of interest in the industry thus very many manipulative forces determine operations. However, in the drilling industry building a competitive advantage is depended on technological superiority.

As discussed in the last section of this paper, building a competitive edge depends on peculiar industry characteristics. There is no perfect strategic fit or strategic approach that can be proffered for companies in all industries.

Industry Analysis: Oil and Gas Drilling Industry

This first section offers a PESTLE analysis of the oil and gas drilling industry. The section establishes that the oil and gas industry is largely unpredictable. Due to political and economic manipulation, it is not easy to determine future trends. The industry is oligopolistic due to bloc control of oil resources (Hawdon 1985, p7).

This industry is currently at its peak because technology enables full capacity extraction and exploitation of oil resources. However, the resources are non-renewable. Coupled with the idea that the industry contributes substantially to environmental degradation, some analysts suggest that the industry will soon be on decline.

Decline will be occasioned by resorting to alternative sources of energy plus depletion of resources or tendency towards controlled exploitation of oil reserves.

The oil and gas drilling industry is a section of the larger oil and gas industry. The oil and gas industry is very diverse. Some of the key products produced in the industry and consumed around the world are gasoline, fuel oil, plastics, fertilizers, chemical products, and gases for both industrial and domestic use (Hawdon 1985, p7).

Petroleum the major raw material in the industry is found under or within rocks. Oil and gas result from decomposition of fossils under rocks that happened over millions of years (Yergin 2008, p8). The oil reservoirs formed overtime as layers as a result of heat and pressure actions.

Before the industrial revolution, coal and wood were the major sources of energy. During the industrial revolution oil and gas replaced wood and coal as major sources of energy.

The industrial revolution led to increased energy needs, which in turn led to more usage of petroleum products (Falola & Genova 2005, p6). By the 20th century, oil and gas were the major energy source and playing a very critical role in the world economy.

The oil and gas industry is divided into five sectors. There is the upstream sector which deals in exploration for oil and gas but also extraction of crude oil and natural gas. The second sector is the downstream sector. This sector deals with oil tankers or transportation of oil; it covers consumers, refiners, and retailers of the oil.

The third sector covers pipeline services, the fourth sector deals with marine oil activities while the final sector in the industry deals with service and supply in the industry.

The major players in the industry are oil companies that either do exploration and extraction or distribution of oil and gas. The oil companies are classified into two categories; the national oil companies and the international oil companies ((Falola & Genova 2005, p23).

Many rights to oil and gas reserves, as per now, are in the hands of national oil companies. Although oil companies own rights to reserves, oil extraction and drilling is contracted to some other companies that specialize in oil field operations.

The oil and gas drilling industry consists in companies that manufacture products used in drilling or companies that do the drilling itself. Some companies in the industry only specialize in leasing rigs and other tools used by drillers (Falola & Genova 2005, p56).

Other companies specialize only in drilling or transportation of crude oil and gas from wells. However, there are companies that are diversified and provide an array of goods and services in the industry.

The oil and gas markets do obey ordinary market forces of demand and supply but rather market manipulators (Falola & Genova 2005, p162). The oil and gas industry is tightly controlled by political players. The oil industry in itself is oligopolistic in nature; major players are organized into a controlling bloc i.e. OPEC.

This organization regulates and lobbies for higher prices on behalf of the oil producers. There are a number of countries that dominate oil production. Any disruptions or conflicts of any sort in those countries, necessarily, translate into problems in the whole industry.

Apart from OPEC countries related manipulation, the United States plays a critical role in the control of the world wide oil and gas industry.

For a long time is has been the greatest producer of refined oil but also the greatest consumer of petroleum products. America emerged a key player in oil due to the toll of World War I and II on Britain. Due to lowered reserves in the US, there has been continued reliance on foreign oil sources.

Oil and gas as sources of energy are the most demanded commodities all around the world. The drilling industry heavily depends on the prices of oil and gas on the international market. These prices are largely determined by geopolitical factors in oil and gas producing countries or nations.

The oil and gas industry is a largely profitable industry that attracts the interest of all sorts of investors. Apart from the investors, it has also attracted myriad forms of regulation. Due to the myriad manipulative forces any tumble of any sort by any economic player leads to fluctuation in prices.

For example, it does not require the key oil producers to hoard oil for prices to rise. Any threat to or indication that they would hoard is tantamount to oil prices soaring.

Another source of confusion in the oil market is what Yergin (2008, p88) calls arbitrage. This is where powerful politicians manipulate player into securing distribution contracts and then sell the same contracts at more exorbitant prices to other players.

In the recent past, between 2004 and 2008, the drilling industry flourished due to high oil and gas prices on the world market. The economic downturn that took a toll on most industries did not spare the drilling industry.

The prices of oil have plummeted leading to many oil drillers reducing operations. The price of oil plays a critical role in determining the performance of companies in the drilling industry.

The prices of oil are largely determined by geopolitical interests and world wide demand. Economic fluctuations have a direct impact on the operations of oil companies. The recent economic downturn necessitated reduced use of energy by both corporations and individuals.

Low demand often leads to lowering of prices and as a result oil companies halting operations to avoid major losses. Oil companies contract oil drillers or lease or buy drilling tools plus related services from companies in the drilling industry. When oil companies halt operations, necessarily, the operations of companies in the drilling industry are halted as well.

Termination of contracts not withstanding, unavailability of credit facility to companies in the drilling industry greatly affects their operations. Drilling or production of drilling equipment is a financially intensive exercise. Many companies in the drilling sector do not have the necessary cash flow to finance major drilling operations without support of credit.

The recent economic downturn saw many companies in the industry halting operations because they could not get credit to finance operations. Even if oil companies were interested in continued operations, lack of access to credit facility necessitated some form of go slow in the industry.

The contracted drillers are not immediately affected by fluctuation in oil prices due to security of contracts. Often contracts are signed during the good times, when oil companies are out to explore and extract as much as possible.

However, when prices plummet, some companies in the drilling industry are protected by contracts which hedge off the bad effects. For this reason, the drilling industry tends to be a very stable industry.

However, when oil companies are affected, they tend towards terminating contracts, they seek to renegotiate terms, or seek bankruptcy protection (Falola & Genova 2005, p 156). Therefore, although the industry is somehow stable, any changes in oil prices have a direct gradual effect on their operations.

The drilling industry has continued to grow and diversify; Technology has buoyed the industry. Currently, offshore drilling is the new sector in the industry that is growing very fast. Off shore drilling has provided a new avenue or arena that was previously untapped.

As companies go into offshore exploration and extraction the drilling industry companies have buoyant business. Companies that specialize in production of equipment continue to innovate as to meet new market spheres and niches.

Technology has greatly driven the industry through facilitating towards identification of new avenues but also enabling utilization or exploitation of existing reserves.

The industry is technology intensive because only drilling companies that promise quality work get contracts. Quality work in this industry is guaranteed by equipment designs and durability, crew competency and capacity to finance operations (Falola & Genova 2005, p114).

Legal stipulations determine operations in the oil and gas drilling industry. Energy is a field of interest for every socio-political entity (Frank 1966, p15). For well functioning political organizations, policy is only supported and enforced through legislation.

Legislation plays a critical role in entrenching and augmenting or cementing political interest or positions on any given issues. In the run up to the 2008 elections in America, there was heated debate on the issue of off shore drilling.

Despite the challenges or opposition to offshore drilling from a number of interest groups, the current government has instituted legislation that favors offshore drilling.

Most drilling companies operate in more than one country. Each country has its own legislation on drilling and exploration activities. Unless legislation is followed, many challenges follow in terms of contract related complications.

The oil and gas drilling industry is one of the most competitive industries. Competition among players is high stake because any venture means investing a lot of resources (Frank 1966, p65). The industry also follows cyclical trends. The cycles are determined by the fluctuation in the oil prices.

Often when prices go up, drilling and related companies make huge profits and make heavy investments. When prices plummet, the companies that can not sustain the huge investments made e.g. equipment maintenance are taken over or are auctioned.

Environmentally, the oil and gas industry is under great attacks from environmental activists. The oil and gas industry contributes in a big way to climate change. Current environment related legislation and regulations tend to limit exploration and drilling exercises.

Progressively, environmental concern and regulation is tending towards minimizing use of oil as a product (Orszulik 1996, p188). Environmental degradation associated with the oil and gas industry starts with the extraction process.

The debate on offshore drilling has been intense because the effects of such like drilling on tectonic stability are not clear (Orszulik 1996, p181).

Secondly, the drilling and crude petroleum transportation and refining process involves consumption of enough energy and emission of harmful gasses. The oil and gas drilling industry is associated with a lot of energy consumption, enormous generation of waste, and more critically, emission of harmful gasses into the atmosphere.

Considering the Oil and Gas drilling industry’s life cycle, the industry is at its peak. The industry is at its peak because most oil and natural gas producers especially the OPEC countries are operating at greater capacity than ever before. However, capacity is expected to lower due to depletion of the oil and gas reserves around the world.

Many oil fields are depleting faster than has ever been imagined. Petroleum and natural gas are non-renewable sources of energy. It is estimated that the vastest oil and gas reserves, going by current consumption rates, will be depleted in the next 100 years.

The oil and gas industry has reached its peak and will enjoy peak performance due to ease of oil exploration and extraction enabled by technology. However, competition and depletion of the non renewable resources is likely to lead to the death of the industry.

Smith International, Inc.

Having analyzed the oil and gas industry, this section will deal with strategy making or formulation challenges for operators in the industry. By analyzing the five forces that shape strategy in Smith International Inc. will help in responding to the statement “The competitive position of a company is determined by the industry structure in which it competes.”

From the analysis in this section, it follows that a company’s competitive position is largely determined by the industry structure. Each industry has its own peculiarities that inform strategic decision making. Some industries are more stable and can allow for more classical related strategizing.

In the oil and gas drilling industry, there is both stability and flux. The stability enjoyed due to huge economic gains when times are good coupled by unpredictability in terms of oil prices require that strategist employ a fusion of methods or assumptions in designing for a competitive edge.

According to Porter (1979, p7), industry analysis should aim at establishing the competitive forces that determine profitability. There are five competitive forces that should inform strategy. These five forces are customers, suppliers, competitors, new entrants, and substitute offerings (Porter 1979, p5.

Strategy has to be build around dynamics in the five forces. The competitors have to be elbowed, new entrants scared, suppliers’ power has to be neutralized, substitute offerings have to be rebuffed and customers understood (Porter 1979, p2).

Smith International Inc. was founded by H. C. Smith who was basically a blacksmith in the early 1900s (The Gale Group 2006). His first shop was in Whittier, California and he served drillers by sharpening and repairing their tools.

As his corporate customers (oil drilling companies) increased, smith incorporated H.C. Smith Manufacturing Company. Due to expansion needs, a Smith industry International, Inc. was incorporated. Later, the name of the company was shortened to Smith International Inc.

Smith international is a widely respected fortune 500 company. It has its headquarters at Texas. The company specializes in the supply of tools used in drilling and extraction of oil and gas (Smith International, Inc 2009). Smith International has a number of divisions that deal in different things or aspects of the trade.

The diversification helps in harnessing customer power as they can get all they need from one supplier. Some divisions like M-I SWACO own mines, which is a good strategy aimed at neutralizing supplier power.

The oil and gas drilling industry is not easy to penetrate into. However, established companies have continued to wad off new entrants either through high tech technological edge development or acquisition of upcoming companies.

To have a competitive edge against competitors, Smith International provides diverse products targeting the gas and oil industry. To work against customers being lured by substitute offerings, smith international has invested heavily in research and development to develop unmatched goods and services in the industry.

This industry being technology driven, technological advantages give a strong competitive edge against any new entrants, substitutes or competitors.

There is a division called Sii Bits that produces drilling bits used in drilling of oil and gas. The second division, called M-I SWACO, which is a joint venture, owns mines from which it obtains bentonite and barite used in making of drilling related fluids.

The fluids are used in the drilling industry to lubricate and cool drilling equipment, to prevent pipes used during drilling from clogging and general technical purposes. The third division is called Sii services and it offers drilling services or services related to drilling.

Sii technologies are a division that produces drilling equipment especially bits while Sii Wilson, the final division, is a supplies unit that offers fittings, pipes, maintenance, janitorial supplies and tools used by mining or drilling companies (Smith International, Inc 2009).

The products are used in drilling and well completion. Such products include fluids, drilling bits, control equipment, separation equipment, chemicals used in oilfields, three- cone, waste management, liner hangers, tubular, pipes, maintenance products, safety gadgets valves, fittings, and drill bits of all kinds.

The products can be divided into environmental, completion fluids, process and drilling solutions (Smith International, Inc 2009).

Smith international also provides distribution services to the petrochemical, power generation, mining, and refining industries. Smith international has a global presence with its divisions or units operating in over four hundred locations around the world.

Smith Internationals strategies or decisions to the top are based on an infusion of assumptions borrowed from all the four theoretical schools of strategy. The four schools or theories of strategy, namely; classical, evolutional, process and system have different assumptions on which to base strategic decision.

Whichever approach to strategy, the motivating end normally is that a company is able to fair favorably against competition or in relation to customer expectations. The different approaches to strategy may proffer different outcomes; however the push for strategy is prosperity, stability, or general competitiveness of a company.

For classical thinkers in the field of strategy, good planning by managers is the sure way to attaining a competitive advantage. Evolutionist defines strategy as capacity to meet correctly with environmental demands; Strategy provides an environmental fit and it is not about long term plans (Whittington 2001, p4).

Processualists agree with both the classical and the evolutionists. They argue that strategy requires planning and survival propensity in an environment characterized by change. However, none of the two approaches in itself is capable of providing the optimal strategy as people are conditioned.

Systematic strategy theorists posit that strategists are always informed by factors beyond profit maximization. The social context in which they operate determines the driving motives in designing strategies. Some design strategies that fulfill personal egos, serve nationalistic interests, or amass managerial power (Whittington 2001, p5).

From the kind of developments reported about Smith International over time, it holds true that due to peculiar characteristics of the industry, a fusion of theories have been applied at different times. But more predominantly, the classical strategic thought has been guiding operations.

The journey to the top for Smith International has not been easy. Many years of strategic planning or decision making and luck have supported Smith International to attain global leadership. Smith international’s success can closely be linked to the investment in people and in technology over time.

Smith international approaches innovation from a classical way. Classical theorists link innovation to research and development. Innovation is done with the market in mind (market oriented innovation.)

The classical theorists, evolutionists, processualists and systemists, respectively, posit innovation, emergence, efficiency, and imperialism as the key movers in organizational growth (Whittington 2001, p79). The Classical market oriented approach to growth relies heavily on market flexibility as well as organizational flexibility (Whittington 2001, p80).

Classical theorists advocate for use of given financial techniques in strategic decision making. Such techniques include break even analysis, investment appraisal methods and sensitivity analysis (Whittington 2001, p58). Research and planning go hand in hand.

The only challenge is that researches are not always accurate. Other theorists have doubted the relevancy and criticized hype given to market oriented innovation as a strategy to gaining competitive advantage.

As an alternative to market oriented innovation, they encourage organizations to develop internal capacities so as to be able to meet with any challenge.

For processualists, especially, Opportunities need to be defined in terms of the internal organizational capacities and not necessarily according to market needs (Whittington 2001, p82)

However, in the drilling industry, market oriented innovation seems to hold sway. The capacity to anticipate changes and design in tandem with the changes is what gives some companies an edge over others. The culture of innovation and improvement in technology is reliably what helped young smith found the big corporation.

Smith was able to perfect his tools by listening to drillers. From them he learnt about the shortcomings of the tools they were using and also enlisted from them possible ways of improving the tools. The information gathered from drillers themselves helped smiths’ shop to have a competitive advantage over all other shops.

When H. C. Smith was incorporated, it specialized into providing customized tools to drillers (Smith International, Inc 2009). Through specialized, undivided attention and serving a niche market, the company was able gain a competitive edge in the market.

When Smith international was incorporated, it thrived on the niche created by mother outfit. A lot of development and innovation has taken place since Smith International’s incorporation.

Apart from internal capacity building and innovation, Smith International has pursued acquisition and diversification as ways of attaining market competitiveness. Classical theorists and processualists support diversification because they identify it with optimal resource utilization (Grant 2005, p 76).

Systemic theorists identify diversified conglomeration with tendency towards managerial empire building. In case of diversification, classical theorists advise that the functioning of different divisions has to be optimized for efficiency and general competitive edge building.

System theorists’ advice that strategists have to consider shareholders’ interest before diversification. Smith international’s experience teaches that diversification and acquisitions work in the interest of organizations but they have to be done with utmost care. When diversifying, considerations should be about industry peculiarities.

In the 1970s, the company registered enormous revenues. It was already established as a leader in development and design of drilling equipment and other tools needed by oil and gas drillers.

By early 1980s Smith International was enjoying great revenues occasioned to a large extent by enormous internal growth (The Gale Group 2006). The good revenues had also been enabled through important acquisitions and expansions in the industry generally.

However, by mid 1980s, oil prices dropped drastically leading to many drilling companies halting operations. As mentioned in the industry analysis, the oil market is very capricious. Oil prices fluctuate a lot; sometimes shooting up while other times going really down.

When oil prices go down, the oil companies, drillers and explorers tend to halt operations. Such happenings really dampen earnings for a drilling equipment company, as it happened in the 1980s. At that time, oil markets remained depressed for some relatively long period.

Apart from the severe market environment, Smith International also made a wrong overture of trying to acquire Gearhart Industries (The Gale Group 2006). Their acquisition attempt failed leading to a big loss and debts. This is an example of classical planning not working.

The systemic theorists would have advised them to look more into social factors or social embedded meanings. The owner of Gearhart industries’ opposition to the Smith International’s take over bid is what led to their losses.

By 1984, Smith International was fighting closure through such measures as down sizing. It had made big losses and the industry remained stagnated. Bad years were yet still to come due to a tumultuous court ruling that required Smith International to pay Hughes Tools, the other big competitor, huge sums due patent rights violation (The Gale Group 2006).

Organizational structure matters in determining strategy implementation success (Leontiades1987, p178). Smith international survived going under because it aligned its structure to the strategic needs of that time. Evolutionists and classical theorists advocate for changing of organizational structure to match strategic needs.

However the success of restructuring was largely depended on industry peculiarity. The conglomerate was easily cut down to basic research and development units and plants that continued the core business of the organization.

Generally, processualists argue that organizations do not just change by decree, a lot of care and patience is required. Smith International operates many divisions and has thus had to change structure often to accommodate multidivisional management.

Multidivisional set ups help in providing a general framework but also allowing for opportunities i.e. being able to effectively diversify (Leontiades 1987, p185). Administration in smith international is decentralized to divisions.

Decentralization is important because, operation costs are reduced as hierarchical transaction costs are eliminated. Decentralization of functions ensure lean operations and closer, efficient management of operations (Whittington 2001, 102).

Having survived from the dark times of bankruptcy, Smith International developed and made gains due to lean operations and huge investment in research. By the 1990s, Smith International was well positioned with very innovative products that had ready market (The Gale Group 2006).

The drilling industry is a technology driven industry and thus research and innovation pay dividends unlike in other industries (Grant 2005, p385). Smith International regained stature after bankruptcy because it had invested heavily in the innovation and development of technological tools that had great appeal in the market.

Smith international continues to make huge profits due to the new technologies they have been developing or adopting e.g. investment in directional drilling, which was an emerging technology (Smith International, Inc 2009).

However, Smith International did not have a competitive advantage in directional drilling technology because other companies i.e. baker Hughes and Halliburton had already invested more in the technology. Lack of competitive advantage in the field led to Smith International selling its investment in the technology and diversifying business by investing in drilling fluids.

The decision to curve a niche led to the acquisition of a 64% stake in M-Drilling which specializes in production of drilling related fluids. Smith International has been able to curve a niche for itself in production of drilling fluids and other well completion fluids/ services (Smith International, Inc 2009).

Considering the developments in Smith International over time, it is clear that effective managers, in the Oil and Gas Drilling Industry, can not entirely align itself or base strategic decisions on only one theoretical school on strategy.

At Smith International, although careful analysis is done when it comes to the nature of strategy to be adopted, certain changes in the market dictate the strategic management’s response.

Due to its international presence, it some countries, units have been more concerned with being politically correct that technologically correct (Leontiades 1987, p153).

Conclusion

This paper presented an analysis of the oil and gas drilling industry. This industry is closely affected by what happens in the oil and gas markets. It is a stable industry because prices fluctuations only have an indirect effect on operations.

However due to the heavy vested interests in the oil industry, the market is often very unpredictable. As discussed while analyzing Smith International, different times call for different measures. Each industry has its own peculiar characteristics that determine strategic focus.

For example, in the drilling industry, investment in research and development of better tools plus building the capacity of employees is a sure way to a competitive advantage. However, as a general rule, openness and flexibility seems to be a favorable approach to strategy in whatsoever industry.

Reference List

Falola, T & Genova, A 2005, The Politics Of The Global Oil Industry: An Introduction, Greenwood Publishing Group, New York.

Frank, JH 1966, Crude Oil Prices in the Middle East: A Study in Oligopolistic Price Behavior, Praeger, New York.

Grant, RM 2005, Contemporary Strategy Analysis, 5th Ed, Wiley-Blackwell, New York.

Hawdon, D 1985, The Changing Structure Of The World Oil, Rutledge, New York.

Leontiades, J 1987, Multinational Corporate Strategy: Planning for World Markets, Lexington Books, New York.

Orszulik, TS 1996, Environmental Technology in the Oil Industry, Springer, New York.

Porter, EM 1979, The Five Competitive Forces that Shape Strategy, Harvard Business Review. Web.

Smith International, Inc 2009, About Us, Smith International Inc. Web.

The Gale Group 2006, Smith International, Inc, 2006, Funding Universe. Web.

Whittington, R 2001, What Is Strategy, And Does It Matter? 2nd Ed, Thompon Learning, London.

Yergin, D 2008, The Prize: The Epic Quest For Oil, Money & Power, Simon & Schuster, New York.

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