Dear Shareholders,

In 2013, Essential focused on executing our capital plan and further refinement of our strategy. Demand in well servicing continues to be driven by oil wells and horizontal completions, with an increasing shift to deeper, more complex wells. Essential’s 2013 capital plan was focused on offering innovative technology to complete and service these wells. During the year we completed our exit from Colombia and began an organic expansion of our downhole tools business into the southern United States. From a return to shareholders perspective, we were pleased with our share price performance in 2013, as it increased from $2.10 at December 31, 2012 to $2.92 at December 31, 2013. For the 2013 fiscal year our shareholders also received an average return of 4.4% from our dividend payments.  

2013 started out strong as we reported record EBITDA of $33 million in the first quarter. However, the second quarter brought a prolonged spring breakup with significant rain in many of the areas that we operate. This wetness continued into the early part of the third quarter and activity was slow to pick up. By the fourth quarter, operations were similar to 2012. 

From an industry perspective, 2013 activity was fairly flat to 2012. The number of wells drilled was flat and completion activity decreased 8%. These are relevant industry activity indicators for Essential. The West Texas Intermediate oil price remained relatively strong for much of the year, but exploration and production (“E&P”) companies in the Western Canadian Sedimentary Basin continued to be challenged by the oil price differential as takeaway capacity constraints negatively impacted the Western Canadian Select oil price. Natural gas pricing began to show improvement later in the year, but these gains had little impact on natural gas-related service activity in 2013. In addition, challenging equity markets for many of the Canadian E&P companies overshadowed the industry. This impacted the amount of cash flow available for our customers to spend on our services. Uncertainty around capital access often leads our customers to be cautious and defer drilling and completion programs.

Strategic Highlights for 2013

2013 included a number of strategic highlights for Essential, including:

  • Growth in our equipment fleet including:
    • the addition of:
      • one Generation III masted deep coil tubing rig
      • two nitrogen pumpers
      • four double mobile service rigs
      • one double rod rig
    • significant progress on the construction of three additional masted deep coil tubing rigs;
  • Expansion into the United States with our downhole tools, opening three field offices in Texas and Oklahoma;
  • Completion of our exit from Colombia;
  • Preserving our strong balance sheet with year-end debt of $39 million, slightly higher than one year ago. Debt to EBITDA at year end was 0.6x, a healthy and low level of debt for an oilfield services company; and 
  • Increased the quarterly dividend from $0.025 share to $0.03 per share in August 2013.

Operations in 2013

Masted Deep Coil Tubing Rigs

We continued to focus our attention on increasing the depth capacity of our deep coil tubing fleet to meet the growing demand for rigs to complete and service complex, long-reach, horizontal wells. While Essential had expected to take delivery of four masted deep coil tubing rigs in 2013, deliveries were delayed as we worked closely with the fabricators to refine and commission the new technology coil tubing rigs. We took delivery of one rig in 2013, one in February, 2014 and the other two rigs are expected by the end of the first quarter and in the second quarter of 2014. We are excited to get these new rigs to work. These rigs have industry leading large diameter coil-carrying capacity making them uniquely capable of working on long-reach horizontal wells. They are also well-suited to work in deep, high pressure basins including the Montney, Horn River and Duvernay. These basins are expected to supply gas for the proposed liquefied natural gas (“LNG”) export facilities in British Columbia. In addition, customers are drilling in the Duvernay for oil. 

Conventional Deep Coil Tubing Rigs

Our conventional deep coil business continues to be an important part of our coil tubing strategy. We offer our customers a full suite of coil tubing options with varying cost structures and operational advantages depending on their needs. Our conventional fleet continues to offer a training and development opportunity for crews as they have the opportunity to progress to the more complex and deeper operations. Conventional deep coil tubing started the year off well with a strong first quarter, but began to experience lower sales and utilization in the third quarter. These rigs have a shallower depth range and typically operate in the less technical 2” diameter coil tubing market. This market has not seen as much customer growth and has become more competitive with Canadian service industry competitors adding more equipment in 2013. 

Service Rigs

Our service rig business continued to perform well in 2013. The three service rigs that work on SAGD operations did notably well as they often work 24-hour operations. We built four new double service rigs in 2013, three of which are capable of servicing SAGD. In 2014, we expect to continue to maintain the three SAGD rigs and we are working to expand our involvement in the active SAGD market. In the meantime, the new double service rigs are working on conventional wells.

Downhole Tools & Rentals

Our downhole tools business had a very good year, with revenue increasing 6% in a relatively flat industry period. This reflected growth in both the conventional tools business and the Tryton MSFS® business. With a relatively low capital investment, this unique and valuable segment of Essential’s operations continues to impress by providing a 32% gross margin during the year and a correspondingly high internal rate of return.  

In October 2013, we were served with A Statement of Claim against our Tryton MSFS® from an industry competitor. We believe the claim is without merit and are defending our position. This claim does not apply to our conventional tools or rental operations.

Outlook

Activity in 2014 for Essential started off slower than 2013. The strength of the 2014 first quarter will also be dependent on the timing of spring breakup which typically occurs in mid-March. Last year, spring breakup did not come until early April, supporting strong first quarter results in 2013. Delivery delays of our new masted deep coil tubing rigs, combined with associated incremental costs for commissioning, crews and training, are expected to adversely impact earnings in the first quarter of 2014.

Generally speaking, 2014 E&P capital budgets are consistent with 2013. Essential believes there are reasons for optimism for the second half of the year including: a weaker Canadian dollar which would increase E&P cash flows, improved access to equity capital markets for E&P companies and the rising price of natural gas. 

We see Essential’s growth opportunities coming from the following areas:

1.  An industry trend of deeper and more complex horizontal well completions;
2.  Completion of wells for  LNG development; and
3.  Workover and maintenance requirements for the growing number of horizontal oil wells. 

Industry trends in 2014 support Essential’s strategy of introducing deeper, larger diameter masted coil tubing rigs. Our $50 million capital program for 2014 will add significant growth to Essential’s masted deep coil tubing fleet. In addition to the four masted deep coil tubing rigs that were part of the 2013 capital plan, Essential plans to build one Generation III and three Generation IV rigs in 2014, with delivery of one of them sliding into 2015. 

While the longer term outlook still remains positive for the development of proposed LNG projects in British Columbia, anticipated development has been delayed beyond 2014 expected timeframes. Development of the Montney, Horn River and Duvernay basins for LNG export is expected to increase the demand for oilfield services, including the demand for Essential’s deep coil tubing and downhole tools and rentals.

With the growing number of horizontal oil wells in recent years, the industry has been expecting an increase in demand for service rigs and coil tubing to perform work-over services on these wells. This demand has not yet materialized possibly due to new technologies prolonging primary production and capital allocation decisions made by E&P companies to focus on new drilling rather than maintaining existing production.  Essential believes, in time, these wells will require work-over services, increasing the demand for service rigs and coil tubing rigs.

Essential is in a great position to take advantage of these future opportunities and our strong balance sheet facilitates this growth. 

2013 was a year of preparation for changes in the ever-evolving oil and gas industry. We are excited to be a part of these changes and are on the leading edge of offering innovative completion and production services to our customers. 

As always, I offer a sincere thank you to all of our employees – for their dedication and hard work, our Board of Directors – for their support and our investors – for believing in and investing in Essential.

Sincerely,

“Garnet”

Garnet Amundson
President and CEO
Essential Energy Services Ltd.
March 5, 2014

Refer to Forward-Looking Statements and Information in the March 5, 2014 news release

® MSFS is a registered trademark of Essential Energy Services Ltd.