Essential’s objective in 2012 was to execute a clear plan to grow business results. We wanted to simplify our business and focus our services to meet the well servicing needs of our customers using coil tubing, service rigs and downhole tools & rentals. Despite a year of solid business performance and strategic execution; as I will outline in this letter, our share price at December 31st remained relatively flat year-over-year, increasing slightly from $2.06 at year end 2011 to $2.10 at the end of 2012. We do not believe this adequately reflects the financial performance and value of Essential.
The year started out strong. At this time last year, there were many reasons to believe 2012 would be as strong as 2011. However, after a busy first quarter, the second quarter had a wet and prolonged breakup, and then world economic events created uncertainty in the market and oil price instability. Oil prices were falling with the magnitude of the oil price differential impacting our customers’ cash flow. In addition, capital markets became skittish, making it difficult for our customers to raise money for well completion and workover spending. This resulted in exploration and production (“E&P”) companies tightening their budgets mid-year and curtailing or deferring spending. As the second half of the year unfolded, drilling and the demand for oilfield service activity slowed. That being said, while 2012 finished slower than initially anticipated, Essential finished the year with a relatively strong fourth quarter and $74 million EBITDA for the year.
The year of 2012 included a number of highlights, including:
- Strong operating performance from each of our divisions; Coil Well Service, Service Rigs and Downhole Tools & Rentals;
- Growth in our equipment fleet since last year including the addition of:
- 2 deep coil tubing rigs
- 1 high capacity, innovative coil tubing reel trailer
- 6 new nitrogen and fluid pumpers
- 3 double mobile service rigs;
- Sale of our non-core wireline assets in February 2012;
- Sale of our non-core hybrid drilling assets in November 2012;
- A strategic decision to exit Colombia and seek buyers for the business;
- Year-end debt of $35.6 million; a $28 million reduction from a year ago; and
- Implementation of a quarterly dividend ($0.025/share), paid throughout 2012.
Our intention is to increase the depth of our well servicing capabilities as our customers continue to drill horizontal wells that are deeper and more service intensive than the industry has ever seen. Our customers look to us to help them complete these wells in innovative, cost-effective ways. Although Essential commenced building several new deeper coil tubing rigs during 2012, we did not see any of them enter our fleet in the year. Industry deep coil tubing fabricators continued to struggle with their delivery commitments for Essential and our competitors.
With our focus on deep wells, late in 2012, we reached a new record with a masted coil tubing rig of 5,460 meters with two inch diameter coil. We also introduced our first coil tubing reel trailer late in the year. The reel trailer is a stand-alone unit that carries the coil tubing reel and works alongside a deep coil tubing rig. This new reel trailer can carry up to 6,000 meters of two and seven-eighths inch diameter coil. Successful design and implementation of innovative technology required for this large capacity reel trailer is a critical step as Essential designs and builds the next generation of deeper, masted mobile coil tubing rigs.
Our service rig business continued to perform generally well in 2012, although certain regional areas had greater success than others. Changing industry dynamics caused us to reduce the number of shallow-focused rigs in the fleet, replacing them with new, light-weight mobile double service rigs. Introduction of Essential’s service rigs to the oilsands and SAGD operations presents an exciting new market growth opportunity for Essential’s service rig operation.
As the industry was looking for solutions to minimize horizontal well completion costs, in 2012 we offered an innovative Tryton MSFS product suited to work in shallow, low pressure well conditions. Demand for the Tryton MSFS product line and sustained demand for conventional downhole tools and rentals resulted in increased revenue, despite a significant decrease in industry drilling and completion activity.
After almost 2 years of operating in Colombia, we decided it was time to initiate a process to dispose of our Colombian operations. Our decision was dictated by economics, but caused by poor utilization. Unfortunately, we could not count on the customers in our operating area for steady utilization. This decision was difficult for us and comes with sadness for the dedicated expatriate staff and 50 Colombian staff that we employ. Over the two year period of operating in Colombia we executed well on safety, customer service and efficiency. We also concluded that it would be too costly and disruptive to re-locate our operation within Colombia and that the basic cost structure required to operate profitably required a minimum level of utilization that we could not obtain.
All in all, we were quite pleased with our 2012 operational performance. We attribute this success to:
- our good people and safety focused culture;
- our emphasis on both completion and production work; and
- our market positioning in today’s horizontal driven market - with the right services in the right locations.
Overarching all that we do is an emphasis on safety and in 2012 we continued to meet new milestones. We continued to improve on our key health, safety and environment measures through building a culture of safety.
While the industry drilling and completion well count was down in 2012 relative to 2011, the number of horizontal wells increased. We expect 2013 activity to be similar to 2012 with continued horizontal well development. This drives the demand for masted coil tubing rigs and the Tryton MSFS, as both services are instrumental for completing horizontal wells. Looking forward, deep coil tubing and/or service rigs and downhole tools will be required to work-over these wells to offset rapid production declines.
Looking beyond spring break-up, it is difficult to assess oilfield service demand for the remainder of 2013. The concerns that slowed E&P spending in the latter half of 2012 remain unresolved. Global economic concerns are still prevalent, impacting the stability of oil prices, and there is no short-term solution for the oil price differential. Infrastructure and commodity take-away projects are underway that could narrow the differential towards the end of 2013 and into 2014. Just as take-away limitations impact the net cash flow of E&P producers, they also impact the demand for oilfield services.
Beyond 2013, there is growing optimism with the recent increase in foreign capital and joint venture activity in the Western Canadian Sedimentary Basin to develop some of the more difficult and ultimately service intensive natural gas plays including the Duvernay, Horn River and Montney. In addition, if the recently announced liquefied natural gas (“LNG”) projects on the west coast of Canada come to fruition, this should increase the demand for oilfield services to produce natural gas to supply those facilities. Currently, as has been the case for the past few years, natural gas storage remains high, pricing remains low and investment in natural gas production remains low.
Essential’s $45 million equipment expansion program for 2013 will add significant growth to our core service offerings in high demand deep coil tubing and mobile double service rigs. We expect to add four new deep masted coil tubing rigs, two nitrogen pumpers and five service rigs. Three of the service rigs will be focused on oilsands (“SAGD”) operations, an area of recent growth for Essential. Although the outlook for the second half of 2013 is unclear, Essential is optimistic that the years beyond will require industry fleet expansion to meet E&P development opportunities for growth. We will use 2013 to increase our fleet, establish and train crews to be prepared for this significant growth opportunity.
Essential has a very solid balance sheet with $36.6 million of debt outstanding on March 6, 2013. The recent asset sales and eventual sale of Colombian operations will allow us to focus entirely on the core services of well servicing with coil tubing, service rigs and downhole tools and rentals.
Industry changes in 2012 once again demonstrated the unpredictability of the oilfield services sector. It also affirmed the importance of prudent and focused management, strong customer relationships and dedicated, hard-working employees as key elements for an oilfield service company to succeed. Essential has succeeded. As always, I offer a sincere thank you to our 1,150 employees – for their dedication and hard work, our Board of Directors – for their support, and our investors – for believing in and investing in Essential.
President & CEO
March 6, 2013