Rig count no longer a reliable bellwether for risk in oil and gas services lending

For decades, commercial lenders relied on a simple rule when evaluating credit risk in oil and gas support services: follow the U.S. rig count. When drilling activity surged, service companies prospered. When rigs went idle, defaults followed. This relationship became embedded in credit models, risk ratings and portfolio stress tests across the banking industry.

But something fundamental has changed.

Since 2021, upstream capital spending has remained at historically subdued levels. Yet many service companies are reporting healthy operating margins and stable cash flows. This pattern defies decades of precedent and reflects a structural transformation in how leading service companies generate revenue and manage risk.

Historically, revenue streams rose and fell with rig count

To understand why the current shift matters, consider how exposed service companies traditionally were to industry cycles. Unlike upstream producers who own reserves or midstream companies with long-term contracts, service firms operated in a spot market for drilling services.

Service firms generated income through equipment rentals, consumable products and technical services. All three revenue streams moved in lockstep with active drilling. When oil prices rose, upstream companies increased drilling budgets, and service companies enjoyed robust demand.

When prices fell, upstream companies slashed budgets immediately. Service companies faced lower volumes and compressed pricing as competitors fought for shrinking work.

This dynamic made the U.S. rig count, published weekly by Baker Hughes, the industry’s most closely watched leading indicator. Many credit models incorporated rig count projections directly into cash flow forecasts and covenant compliance.

Multiple downturns proved sector couldn’t escape cycle

Service firms’ vulnerability to the energy price fluctuations has been demonstrated repeatedly over decades. Chart 1 shows establishment exit rates in the oilfield services sector from 1985 to 2023 alongside West Texas Intermediate (WTI) crude oil prices. The pattern was remarkably consistent: when oil prices collapsed, businesses closed.

The 1980s oil bust brought the most severe crisis on record, with exit rates reaching 27.7 percent in 1987. The sector stabilized during the 2000s shale boom, with exit rates falling to 8-11 percent even during the 2008-2009 financial crisis.

Then came the 2014-2016 collapse. As WTI prices crashed from over $90 to below $50 per barrel, exit rates surged to 18.8 percent in 2016—levels not seen since the 1980s. Exit rates remained elevated through 2018. The 2020-2021 period brought another wave, with exit rates reaching 13.9-15.1 percent.

The pattern became familiar to bankers and bank examiners. Companies that appeared well-positioned during good times deteriorated rapidly when the cycle turned. Equipment collateral lost value, working capital lines became impaired and covenants were breached.

By 2021, the conventional wisdom was clear: oilfield services carried inherent cyclical risk that no amount of underwriting discipline could fully mitigate.

Then, something unexpected happened. By 2023, establishment exit rates had fallen to 8.7 percent, returning to pre-2014 levels. This occurred despite upstream capital expenditures (CapEx) remaining 30-40 percent below historical peaks. The 2014-2016 downturn sustained elevated exit rates for four consecutive years. The 2020-2021 spike reversed in just two years—an unprecedented recovery speed.

Leading service companies show unexpected resilience despite subdued upstream spending

Service sector operating margins have typically moved in tandem with upstream capital spending, as shown in Chart 2. Because CapEx are expenses, they are conventionally shown as negative amounts. When upstream CapEx collapsed after 2015, falling by nearly 50 percent, service margins turned negative.

The 2020 Covid-19 pandemic and global response brought the most severe demand shock in modern energy market history. Upstream CapEx cratered, and service margins collapsed.

In 2021, upstream capital spending began recovering modestly, but remained well below prepandemic levels. Under historical patterns, service margins should have remained compressed. Instead, service margins turned decisively positive and remained healthy throughout 2022-23.

Upstream CapEx plateaued at levels 30-40 percent below the previous decade’s peaks. Historically, this would have signaled distress for the service sector. But by 2023 many leading service companies reported operating margins at or near cycle highs. This sustained divergence fundamentally challenges how we assess risk in this sector.

Upstream capital discipline forced service companies to adapt

The post-2020 environment created unique pressures that forced service companies to adapt or perish. The most important factor was the fundamental shift in upstream capital discipline.

Unlike previous downturns, upstream companies didn’t ramp up spending aggressively once oil prices recovered. The post-pandemic period brought a new paradigm. Investors demanded that producers prioritize free cash flow generation over production growth.

For service companies, this meant that the traditional recovery pattern of waiting out the downturn and then riding the next upcycle, was no longer viable. This lower-for-longer CapEx environment also brought deflationary pressures, squeezing margins even as revenue growth remained constrained.

Service companies faced a stark choice: accept permanently impaired profitability or fundamentally restructure their business models. The margin recovery in Chart 2 suggests that leading companies chose restructuring and executed successfully.

Three strategies for breaking the cycle

Three major firms illustrate different but effective approaches to breaking free from the drilling cycle.

SLB centered its strategy on digital technology and international diversification. The company’s Digital and Integration segment now delivers 35 percent adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) margins, which is significantly higher than traditional services at 20-25 percent. Growing digital revenue represents 7 percent of total revenue. Approximately 78 percent of SLB’s revenue comes from international markets, providing natural diversification from volatile North American drilling.

Halliburton focused on efficiency-driven technology while expanding into data center infrastructure projects. Management restructured customer contracts toward multiyear, performance-based arrangements that provide revenue predictability and reduce exposure to spot market volatility.

Baker Hughes pursued the most aggressive diversification. Its Industrial and Energy Technology segment now represents approximately 45 percent of total revenue. This includes gas turbines, liquefied natural gas (LNG) compression equipment and industrial process solutions, which are all businesses operating on entirely different cycles than upstream drilling. The company increasingly emphasizes long-term service agreements particularly within this segment.

In all three strategies, management emphasizes multiyear contractual revenue visibility that fundamentally alters risk profiles. The evidence supports their claims: measurably reduced revenue volatility, structurally improved margins and stronger free cash flow conversion.

The transformation is far from universal

While success stories from industry majors paint an encouraging picture, the transformation is far from universal. The gap between companies that have genuinely diversified and those trapped in traditional cyclical models has widened dramatically.

Earnings-call language reveals this divergence. Successful transformers provide specific metrics: digital revenue growth rates, margin profiles by segment and multi-year contract percentages. This is quantifiable evidence of genuine business model evolution.

Traditional cyclical companies tell a different story. They discuss maintaining equipment readiness for when activity rebounds and focusing on cost management. This signals continued dependence on traditional activity levels with no articulated diversification path.

Companies in the middle show measurable progress in international expansion or technology offerings. But they remain predominantly tied to traditional cyclical drivers.

Chart 3 quantifies the breadth of diversification strategies. An analysis of twenty-six oil and gas service firms reveals that while many are improving technological offerings or expanding geographically, a meaningful number are growing in fields related to AI and power generation.

Technology upgrades lead the way, chosen by 62 percent of firms analyzed. Geographic diversification follows at 31 percent. But the emerging trends are most telling: 23 percent are pursuing power generation opportunities, 23 percent renewable energy, 19 percent AI-related services and 8 percent battery solutions.

These aren’t just talking points.  For example, Atlas Energy Solutions deployed a patented hybrid battery solution that integrates with generators. They’re growing their energy fleet to over 500 megawatts by 2027, selling power under longer-term arrangements.

Similarly, ProPetro Holding Corp has diversified into low-emission power generation using high-efficiency natural gas generators and low-emissions modular turbines. Management views the market for reliable, low-emission power solutions as a significant growth opportunity beyond traditional oilfield services.

Twenty-five of the twenty-six firms analyzed are diversifying using at least one approach identified in Chart 3. This widespread adoption suggests the transformation extends well beyond the industry’s largest players.

Credit analysis must adapt to the sector’s transformation

The breakdown of the historical relationship between upstream CapEx and service profitability represents one of the most significant structural shifts in the energy sector in decades. Leading service companies have successfully reduced their dependence on drilling activity through diversification into digital platforms, adjacent industries and recurring revenue models.

However, the transformation is profoundly uneven. A portfolio classification of oil and gas support services now encompasses businesses with radically different risk profiles. Some are technology companies serving energy markets. Others remain equipment rental firms whose fortunes are still tied to weekly rig counts.

This evolution carries significant implications for lenders and bank examiners. Credit models built on historical relationships may overstate risk for companies that have successfully diversified. They may understate risk for companies that haven’t transformed. For bank examiners conducting loan reviews, historical peer comparisons may no longer provide reliable benchmarks.

Understanding revenue composition, margin sustainability, management execution and technology differentiation have become essential. When underwriting or reviewing these credits, service companies should consider requesting a breakdown of revenue by contract duration and end-market exposure. The rig count will always matter for this sector, but it no longer tells the whole story.

For credit professionals, the challenge is clear: develop a more nuanced analytical framework that can distinguish genuine transformation from cyclical noise. The companies have rewritten the rules. Now it’s time for credit analysis to catch up.