The three largest oil-field services firms–Baker Hughes (NYSE: BHI), Halliburton (NYSE: HAL) and Schlumberger (NYSE: SLB)–account for roughly 64 percent of the global market for pressure pumping, a service that’s critical to extracting oil and gas trapped in shale and other tight formations. The quarterly results and subsequent conference calls from these companies often serve as the Rosetta stone for oil and gas investors.

In a process known as “fracking,” exploration and production companies book pressure pumping capacity to pump large volumes of water mixed with sand and chemicals into the field, fracturing the low-permeability reservoir rock and enabling the hydrocarbons to flow into the well.

In recent years, frenzied drilling in unconventional oil and gas fields such as the Bakken Shale in North Dakota, the Eagle Ford Shale in Texas and the Marcellus Shale in Pennsylvania has allowed the US to boost its annual oil output for the first time in decades and overtake Russia as the world’s leading producer of natural gas.

Source: Energy Information Administration

Even more impressive, oil production has increased despite plummeting output from the US Gulf of Mexico.

Source: Energy Information Administration

This surge in drilling activity has significantly boosted the revenue and margins of Baker Hughes, Halliburton and Schlumberger. In 2011, global spending on pressure pumping soared to $31 billion, up 63 percent from 2010. However, the outlook for 2012 is less sanguine: As reported by Platts and Bloomberg, respected energy consultancy Spears & Associates estimates that the global market for pressure pumping in 2012 will grow by a considerably less robust 19 percent, to $37 billion.

Pricing Pressure on Pressure Pumping

With natural gas prices at depressed levels and unlikely to improve for at least two to three years, Chesapeake Energy Corp (NYSE: CHK) and a host of other operators have announced plans to scale back drilling once again in gas-rich basins such as the Haynesville Shale.

Producers already generated thin margins in these regions, limiting services firms’ ability to push through price increases. Wellhead economics in gas-focused plays will worsen in 2012. In the past, hedges had bolstered producers’ price realizations on natural gas. Today, futures prices are far less attractive, accelerating the industry’s exodus from gas-focused basins and into oil and natural gas liquids (NGL)-rich plays that offer superior wellhead economics.

A corresponding migration is occurring in the pressure-pumping market, with services firms shifting capacity to established plays such as the Bakken Shale and the Eagle Ford Shale, as well as the Utica Shale in Ohio and other emerging basins. The industry consensus calls for increased activity in liquids-rich basins to at least offset the slowdown in gas-producing fields.

Disregarding the near-term revenue hit from relocating service capacity, the big question centers on the extent to which the influx of hydraulic-fracturing equipment to liquids-rich fields will weigh on the oil services industry’s pricing power. The rising cost of sand, ceramic material, gels and other inputs likewise present a challenge to pressure-pumping margins.

During a conference call to discuss fourth-quarter results, Schlumberger CEO Paal Kibsgaard acknowledged these new realities and cautioned that developments in North America could weigh on margin growth in the pressure pumping segment:

[I]f you look at pressure pumping pricing levels, as I said, we continue to see downward pressure on pricing in gas in Q4. The liquid basins, we saw pricing basically being flat, some contracts being up and some contracts being down. Now, how this is going to go to hold, I think, is still uncertain at this stage, right? There is obviously a chance that the continued [in]flux of capacity from the gas basins into the liquid basins is going to have an impact on liquids pricing as well. We haven’t really seen any downwards trend yet, but clearly, over the past quarter, the pricing has been flat. So that’s basically where we stand on that.

Halliburton CEO David Lesar sounded incrementally more bullish during a conference call on Jan. 23, 2012:

As we look at the market dynamics today and even apply a down side scenario to how it might play out, based on frac [hydraulic-fracturing] equipment adds as well as reduced gas drilling, which would accelerate the equilibrium in the market for pumping, it is clear to us that the strength of liquids demand will provide a cushion to equipment coming out of the dry gas basins. We also believe that there will be a net overall increase in rig count in 2012, meaning that in our view, the increase in liquids-directed rigs will more than offset the decline in natural gas rigs.

Lesar asserts that the ongoing migration from dry-gas fields to liquids-rich plays should help preserve the existing supply-demand balance and prevent a collapse in pressure-pumping prices. However, the Halliburton chief also acknowledged that profit margins faced headwinds:

The problem, I think, that we face as we look forward is what will inflation do? As Dave commented, we’re going to have continued challenges with logistics, with the supply chain and moving proppants and gels and other things into those basins, because they’re in short supply, and we’re fighting back inflation as hard as we can.

Most of the price increases that I think that we’re being able to achieve right now are serving to basically offset that inflation. We’re going to have to work hard, as Dave commented, to really push back and see if we can get some relief from some of our suppliers as things soften in the gas basins. But we’ll have to continue to work to make sure that we can get all of that passed through with the price increases that we get.

So I think that as I said, it’s a little early to comment as to how much we can move pricing on a net basis north–I just can’t–I can’t speculate at this point whether we’ll be able to go back and get them back above those levels that we had in Q3 or even higher.

The International

Perhaps in response to concerns about pressure-pumping margins in North America, Halliburton and Schlumberger chose to highlight the growth opportunity that’s emerging as exploration and production firms attempt to apply the American experience to international shale oil and gas fields.

At first blush, this trend offers plenty of potential upside to revenue and margins: Spears & Associates estimates that the North American market in 2011 accounted for 87 percent of the global market for pressure pumping, while a study sponsored by the US Energy Information Administration (EIA) estimated the technically recoverable shale gas resources in 32 countries at 5,760 trillion cubic feet. The table below lists the 10 countries with the highest amount of recoverable shale gas volumes. Note that the report excludes Russia.

Source: Energy Information Administration

During Schlumberger’s conference call to discuss fourth-quarter results, Kibsgaard noted that demand for pressure-pumping capacity has increased in international markets at a much faster rate than management had anticipated. Much of this pilot and early-stage work involves reservoir characterization and drilling test wells to help operators formulate a plan for extracting these resources as efficiently as possible. Kibsgaard identified China and Argentina as two countries where activity would pick up.

Timothy Probert, Halliburton’s president of strategy and corporate development, on Jan. 23 told analysts that the firm had screened 150 unconventional plays worldwide, 60 of which it examined in detail. When asked to describe the growth opportunity in international markets, Probert referred to developments in Latin America:

In 2012 it sort of feels to us like there are somewhere between 75 and 100 wells which will be drilled for shale activities in Latin America, and I just–if we put that in perspective with respect to a Haynesville [a gas-rich shale play in Louisiana], for example, which is just sort of about 99 rigs or thereabout at the moment, and clearly if you divide that or multiply that 99 rigs by 3 or–let’s say 4 to 6 wells per year–we’re dealing with a significantly smaller opportunity today. But the opportunity is growing, and…we’re in the sort of primarily exploration appraisal phase, low horse power requirements, primarily vertical, now shifting to horizontal where horsepower requirements are doubling as well as an increase in activity. So we think 2012 is a pretty good transition year for unconventionals, and we’ll see the most significant uptick in ’13 and ’14.

In next week’s issue of The Energy Letter, we’ll examine unconventional resources in China and Argentina. Investors, take note: exploration and development of many international shale oil and gas fields likely represents a longer-term growth opportunity.

The US shale gas revolution was abetted by ample reservoir data and elevated natural gas prices–five yeas ago, the nation faced a shortage of the thermal fuel. But a lack of geological information and a challenging price environment, among other difficulties, means that these emerging plays are unlikely to enter commercial production within the next five years.