Oil, gas market suppliers traversing sharp peaks, valleys

For Daniel Hertz III, the current conditions in the oil and gas sector are, in the words of the late Yankees Hall of Famer Yogi Berra, "like deja vu all over again."

The president of Seals Eastern Inc. in Red Bank, N.J.—about 25 miles as the crow flies from New York City—has been in the rubber business for 40 years, and he's seen similar cycles in oil and gas throughout his life, working his way up in the company founded by his father, the late Daniel Hertz Jr.

From the heights of 2018-19 when the operating rig counts were high and rubber goods makers servicing the energy sector were seeing high levels of business, to the depths of the early days of the pandemic in April 2020 when oil prices sank at one point to $10 a barrel and business came to a halt, only to steadily climb back to where things are now, it all seems like similar terrain to Hertz.

"With oil and gas, it's just a history of boom and bust," he said, noting that Seals Eastern has about half of its revenues tied to the industry. "You see what's happening now and, personally, I'm not surprised. It's been a bugger, because it's on the heals of those global lockdowns. And the labor market got destroyed and did not come back fast."

But this cycle was more extreme than anything he's seen, Hertz said, the way it fell to the lowest depths in 2020 and by mid-2021 it was like "drinking from a fire hose."

"I've been doing this 40 years and on the bridge of the ship for 25 years or so, and I have never seen anything like this," he said. "The customers can't get enough, and they can't get it fast enough."

He likens it to panic buying. He's not sure if customers are trying to get product on the shelf before prices go even higher, or if they're still reacting from the shutdown when they couldn't get anything.

"It's a sight to behold," Hertz said. "And in my opinion, this isn't going to end well. We're going to have another bust. It's not, 'Is it coming?' It's 'When is it coming?'"

There are stories of companies that service the oil and gas sector—both off-shore oilfields as well as on-shore fracking wells—that survived the deep downturn of the pandemic and now are enjoying the fruits of the market upturn.

The tales they tell are ones of perseverance and optimism mixed with caution and frustration. On one hand, they are enjoying growth, but they are experiencing a deeply fractured supply chain, shortages in vital raw materials and a labor pool that is improving but still loose.

Moss Seal Co. in Houston operates both as a distributor and manufacturer, with the vast majority of its business coming from all three segments of the oil and gas business—upstream, midstream and downstream—according to Jason Gonzales, an oil and gas specialist for the 50-year-old firm.

During the downturn, he said Moss Seal used the downtime to work with customers who were able to stay afloat, spending time doing research and development to make improvements wherever possible, a luxury not available when business is hot.

Company owner Bill Hogue has been through enough of the downturns over the years to know how to survive, Gonzales said. He sets aside money for a rainy day and keeps a core group of specialty employees on staff, so when hiring is necessary, it's more for areas like warehousing, shipping and handling.

These employees help move products in and out, but don't require as much training and experience as engineers, quality managers and machine programmers.

At Moss Seal, the rising price of oil has had a direct impact on business. Gonzales said the firm supplies components to exploration companies tasked with getting the oil from the wells.

"As the price of oil has gone up, there is more incentive for them to 'go get it,' " Gonzales said.

When oil hit the $50 to $60 a range in the middle of 2021, the firm saw increased demand not only from the major players but also from some of the smaller firms in the sector. And not unlike what happened at Seals Eastern, the change was sudden.

"It was almost like a switch turned on," he said. "It happened fairly quickly when things started turning back up. It felt like that because we were doing absolutely nothing. We went from not even being in the office to everybody back to full, normal schedules."

Both the distribution and manufacturing sides of the operation have benefited from the spiking gas prices, precipitating the need for increased capacity and new employees, Gonzales said.

In oil and gas, the price of oil impacts the number of rigs in play and that, in turn, offers opportunities for suppliers to the sector, including those supplying rubber and polymer parts, according to Neil Mendes, CEO of Fort Worth, Texas-based Alpine Polytech, a material and equipment testing firm.

"When people in the industry make money, they spend money. Sometimes it's as simple as that," he said. "When people aren't making money, even if activity is relatively high, people save every nickel they possibly can."

In the onshore shale market, Mendes said even marginal wells make money when oil is at about $55 to $58 a barrel, which is about what the price was in 2019 when there were more than 1,000 onshore rigs operating in North America. But when the prices bottomed out in 2020, the operating rig count sank to fewer than 250.

From that point, as oil prices started to climb back up, so did the number of rigs. Before the Russian invasion of Ukraine caused prices of West Texas Intermediate and Brent crude oil prices to spike near $130 a barrel in early March, supply-demand forces had oil in the $75 to $85 range, a level that brings in solid profits for all oil- and gas-related companies.

But even with those profit-making price ranges, the rig count in North America still was only at about 650 as of March 4, Mendes said, nearly 400 lower than in three years earlier.

"What's different about this upturn—and all previous upturns—is that the financial restraint in the marketplace is preventing this from being a boom cycle within the polymer activity levels," he said. "It's busy, and frankly the seal companies are quite busy and very profitable. Even if business gets better, I'm not sure they'll likely do that much better, because I think a lot of people are at capacity."

The financial restraint is coming for a few different reasons. Mendes said the operators of shale wells are being more disciplined when it comes to capital spending, as the fracking plays didn't pay off nearly as much as was projected, especially during the lean years when oil prices were low.

Capital also is being constrained, he said, because as the push gets stronger to move toward renewable energy, oil and gas has been "demonized" to a large degree.

"There's a political push on it, then there is pressure on lenders to not invest in oil and gas," Mendes said. "On top of that, the people who are in oil and gas—and have cash—are being restrained because they also know the war is spiking oil prices even more. War dynamics are very difficult to predict."

He expects the market discipline by well operators to continue, with the rig count increasing steadily but not reaching 2019 levels. This would mean oil prices would have a better chance of staying in the "sweet spot" of $75 to $85 a barrel, allowing firms to maximize earnings. When they overproduce and prices drop, so do profit margins.

Eutsler Technical Products Inc. is one of those rubber component suppliers that is enjoying an uptick in business with growing activity in the oil and gas market, but also dealing with market conditions that can make things difficult, said Mike Borski, president of the Houston-based firm.

While labor market woes have eased somewhat, the current problem involves materials, both in terms of shortages and volatile pricing. Eutsler has invested a significant amount of time and effort on a few new projects that have good potential for the firm. The company's technical director worked to get new compounds qualified for the projects, only to be told they might not be able to get the materials.

Some of the fluoroelastomers are going to microchips or to the automotive industry, Borski said, while nitriles and NBR are being diverted to making battery casings for electric vehicles. For some of the materials Eutsler uses, suppliers are enacting allocations based on historical usage.

"It's tough to get new business when you're on allocation," he said. "Now I'm concerned. We've invested money on new equipment, and are we even able to get polymers to make compounds with to run the equipment? You forge ahead and cross your fingers and kind of hope things will level out and straighten out. But I don't know, it's hard to really gauge what's going to happen."

Pricing is fluid as well, to put it mildly. Borski said Eutsler had placed some purchase orders for an FKM last November and December, and the materials are just now coming in. To make things more difficult, the supplier told them the price at the time of the order—but that Eutsler would have to pay whatever the cost is when the product is delivered.

"It makes it difficult to run a business, because how do you price something to your customer when you don't know what kind of increase you might get?" he asked.

Eutsler has been able to manage so far, but some customers are concerned about the price increases. Borski said he has to tell them that the firm has no choice but to pass the cost hikes on to them.

"Price increases have been across the board with everything," he said. "We're seeing anywhere from 30-40 percent price increases, and things are still going up.

"In years past, when we'd get a 2- to 3-percent price increase, we could eat that. But when you start getting up into the double-digit price increases, I don't think there is anyone who can swallow that without passing it through to the customers."

Others are dealing with similar circumstances. Gonzales said Moss Seal is seeing major delays in getting raw materials. Being a distributor for more than one vendor sometimes can allow Moss to offer an equivalent option from another manufacturer.

In other instances, the firm has had to machine a metal part out of a larger, more-expensive size bar because the standard size bar hasn't been available.

"We have to go up in size. The customer doesn't care. They just need that part and they will pay more because we had to cut it out of a bigger bar," Gonzales said.

When business surged at Seals Eastern in the middle of last year, Hertz said it took its order book higher than it's ever been. And while he thought they were dealing with pent-up demand, the orders kept coming in, with customers showing little concern for longer lead times.

But rather than material shortages being the main issue, Hertz said problems in the labor market were the main constraint that held back his company. He said potential employees would try the job, say it wasn't for them, then leave and file for unemployment. Even when the company's human resources team pushed back and fought the claims, the New Jersey Department of Labor still granted the benefits.

That tide has turned, he said, and the DOL has begun denying benefits in such cases. Now Seals Eastern is starting to get a steady stream of applicants looking for work.

During the pandemic, Hertz said the firm's work force contracted by about 40 percent, and the company has been able to hire roughly half the number of people than what had been cut.

"What's interesting is that, had we not been struggling so much rebuilding our labor force, there's no doubt material availability would have been a problem," he said.

There definitely is a difference of opinion as to what the future holds.

Gonzalez said he hopes to see some consistency of demand, with oil prices remaining higher for some time, maybe another year or two.

"I foresee it continuing to climb. I hope it also forces American sanctions to be lifted so we can drill here and be more independent, supplying our own oil and gas," he said. "We now have to import it, which is just dumb in my opinion. We have it here and we're able to use it. So we're able to fill it. We can't put that on the American people and expect them to keep paying these prices. They won't be able to get to work. They won't be able to travel. Companies will be having to increase prices on everything."

Borski remains optimistic because business is good, but he's frustrated by market forces.

"We're worried about those things that are out of our control: the possibility of being cut off and not able to get raw materials," he said. "That's a very real and possible thing that we could see toward the end of the year. I hope I'm wrong, but it's a major concern."

Hertz said he is afraid that history will repeat itself and that hard times are ahead. He said the economy is running too hot and that the Federal Reserve has lost control.

"Money has got to get more expensive," he said. "That's the Fed's job. When they finally start doing their job, money is going to get more expensive and the economy is going to cool off—probably real fast."

The Seals Eastern president believes there is a good chance the U.S. will be in a recession heading into 2023.

"Right now I'm loaded up with months worth of business," Hertz said. "Our factory is going to be busy through the summer, but come fall, it's anybody's guess."