Risk Management of Patterson UTI Energy - Term Paper Example

COVER PAGE ______________ _______________ ________________ Patterson UTI Energy was established in 1978 as an organization providing land-based drilling services to a diverse industrial segment. The company was reincorporated in 1993 as a Delaware corporation and as of December 31, 2009, the company is now subject to Delaware General Corporation Laws. Patterson-UTI Energy provides contract drilling services to major and independent oil and natural gas operators in Texas, New Mexico, Oklahoma, Arkansas, Louisiana, Mississippi, Alabama, Colorado, Arizona, Utah, Wyoming, Montana, North Dakota, South Dakota, Pennsylvania, West Virginia and western Canada.[1] Since its establishment, the company has progressed by leaps and bounds and has now become a major market share holder. Patterson UTI Energy attributes its revenues and it assets to industry segments which comprises of contract drilling services, pressure pumping services, oil and natural gas exploration and production and drilling and completion fluids services. The company discontinued its operation of providing fluid services in January 2010 and sold off all of the substantial assets pertaining to the operation. The financial statement of the company for the year ended 2009 has been adjusted accordingly and the fluid services has been presented as a discontinued operation. The drilling and pumping industry is highly dynamic and competitive and an inclination is forecasted in the coming future. Patterson UTI Energy has always strived to provide services which transcend its competitors through unmatched quality and prudent safety rules. The customers of the company comprise primarily of oil and natural gas services operators, both major and independent, and as at December 31, 2009 no singly customer accounts for more than 10% or more of the consolidated revenue. In addition, the company is regulated by the federal government through numerous state and foreign laws and rules and regulation. These laws ensure that the company carries out its operation safely and in such a manner which does not adversely affect the environment and its inhabitants. During the year 2009, the company faced some financial challenges as a result of which it reported a net loss of $48.2 million. The primary reason behind the financial difficulties faced by the company is the deterioration in the commodity prices of oil and gas. As a result the company had to lower the prices of their services and thus curtailing the revenue generation. Another reason behind the declining financial position is the uncertainty in the capital market and difficult access to financing. The volatile economic environment in its entirety caused the demand of the company’s drilling services to decrease significantly. The depressed financial outlook of the company can also be substantiated by the fact that monthly average rigs have decreased from 283 on October 2008 to 60 on June 2009. It is imperative for any organization to practice sound risk management tactics in order to safe guard its assets, to maintain its integrity and competitive edge and to operate in the most efficient and effective manner. In this era, where the economic and political scenarios are changing at rapid pace, decision cannot be based merely on instincts as the repercussions of such uneducated and unplanned decision can be devastating for an entity. The word risk, in terms of an organization, can be described as an expected variability in the anticipated results which can cause potential loss or vulnerability in the operations. There are various classifications of risks which are all sub categories of the ‘Business risk’. Business risk can be defined as the risk that the company will not be able to generate sufficient cash flow from its operations in the future. The business risk, externally, can be linked to the current capital market conditions, monitory and fiscal policies, legal and financial regulations and related variables of economy. Internally, a company can be subject to various risks one of which is pure risk. Pure risk can be described as a type of risk in which the result can only result in out flow of economic benefits. In most cases pure risk is out of the control of the entity and the organization is unable to adopt precautionary measures to protect it from such risks. Keeping the business activity of Patterson UTI Energy into consideration, there are several pure risks which are faced by the company. The most threatening of them is the impairment and damage of its long lived assets. Patterson UTI Energy operations are primarily dependent on the functioning of the drilling rigs and their failure can cause some serious doubts about the entity’s ability to continue as a going concern. Precautionary measure can be adopted by the company to save the assets from being destroyed from fire or excessive wear and tear, but damage from the natural disaster such as flood and earthquakes cannot be curtailed by adopting such measures. The asset risk can cause direct and indirect losses to the company. In case of damage to an oil rig (asset risk) the direct loss for Patterson UTI Energy is the monetary amount, represented by carrying value of the asset at which it was being carried in the balance sheet of the company, whereas an indirect loss would be the decrease in the revenue due to the incident. In addition to asset risk, another pure risk faced by Patterson UTI Energy could be the legal liability risk which can be described as circumstances which can result in loss or injury to another party due to the negligence of the company. For Patterson UTI Energy, the liability risk can result from carelessness over the safety conditions of the worker and unsound professional conduct with its customers in providing services. Worker injury is regarded the most significant pure risk faced by the company as it has a direct impact on the life of the worker. In most situations, it is quite difficult to measure the causes and certainty of such risks but the companies are now adopting modern risk management models in order to quantify such risks and adopting the best possible techniques in order to divert them. Price risk is another type of business risk faced by the companies which is directly related to the prevailing interest rate and the stability of the commodity market in general. Keeping the operations of Patterson UTI Energy in to consideration, the price risk can be further classified into commodity price risk, exchange price risk and interest rate risk. Commodity risk can be defined as the volatility in the future market prices of commodities which can cause adverse impact on the future revenue of the company. As mentioned earlier, Patterson UTI Energy’s customers comprises of oil and natural gas explorators and the prices both of these commodities, oil and gas, are highly uncertain and volatile. During 2009, there has been a significant decline in the oil and natural gas prices worldwide. As a result, a major number of the customers of Patterson UTI Energy discontinued their drilling ventures which caused adverse effect on the financial outlook of the company and such events in the future are capable of doing the same. Another price risk is the exchange rate risk or the currency risk. The exchange rate risk can be defined as the fluctuation in the exchange rate of the currency of the country, in which the company operates, against another foreign currency. Although the analysis of the financial statement of Patterson UTI Energy explains that the company has operations in Canada as a result of which the company can face undesirable financial circumstances in case of devaluation of USD, which is its functional currency. Interest rate risk is another major price risk which can have unfavorable consequences for the company. Interest rate risk can be defined as the risk born by a loan or a bond due to the change in the market interest rate. The company has obtained borrowing facility during the year on which it pays finance cost as presented in its consolidated income statement. In case the borrowing facilities have been arranged based on prevailing market interest rate, increase in such rate can cause inclination in the finance cost of the company resulting in the reduction of net income. The most major price risk for Patterson UTI Energy is the credit risk which can be defined as risk of financial loss on account of a borrower who does not make payments according to the terms and on time. For Patterson UTI Energy, the instruments which expose the company to such risks comprise primarily of demand deposits, temporary cash investments and trade receivables. These instruments are against customers involved in the exploration and development of oil and natural gas properties. Several risk management techniques have been adopted by the organization in order to minimize its adverse repercussions. The management of risk is essential in this era as the economic scenarios are becoming more and more volatile, complex and vague. Companies which do not adhere to following the prudent risk management techniques are often faced with problems such as destruction of their valuable assets, financial loss, loss of competitive edge, loss of customer base, disclosure of confidential information of its employees and customers and non-compliance of legal and regulatory requirements. Patterson UTI Energy competes in a very dynamic and competitive market, and in order to survive, prudent risk management is highly essential. In order to divert the risk, Patterson UTI Energy must adopt the risk management methods such as loss control, loss financing and internal risk reduction. Loss control can further be classified into two major sub-categories of reduced level of risk activity and increased precautions. The major loss that can be faced by the company is the damage of its assets, which are oil rigs, and injury of its work force. In order to cover these risks, the company has acquired various insurance facilities, but the given the magnitude of the operations, the company is not certain whether the insurance would be sufficient to indemnify the company against all the expected losses. Another suitable method of diverting the risk of operational hazard is to adopt precautionary measures. By adopting such precautionary measure the number of accidents will significantly reduce in addition to the increased efficiency of the labor force and lower turnover. These precautionary measures may include training of the work force in order to equip them with education essential for protecting themselves against any operational hazard or accident. Regular maintenance of the tools and equipments to check for unexpected wear and tear can also significantly reduce these types of risks. Apart from the loss of personal workforce and asset, a company can also suffer heavy financial losses if it does not formulate a strategic financial risk management plan. Insurance against losses caused by future events is considered to be the most effective risk management tool in the corporate world. Almost every organization has its major assets insured in order to protect itself financially and operationally. A company insures itself when it does not have a control on the expected future event which can bring loss. However, in certain circumstances, the company might be able to quantify the expected loss in case of future unexpected events. Self insurance has become a prominent risk management policy where the company set aside a predetermined amount of funds in order to reimburse itself from the future losses. The primary difference between a self insured risk and transferable risk is the ability of the company to rate or quantify the risk. Patterson UTI Energy can adopt both risk management strategy of self insuring and of acquiring insurance from commercial insurers. Keeping the operations of Patterson UTI Energy into account, the company will not be able to forecast or quantify the enormity of damage which can be caused by a catastrophic event such as earthquake, flood or hurricane. The catastrophic risks are always underwritten by the re-insurance and the adoption of such strategy would be most suitable for Patterson UTI Energy. Other forms of risks for which the company can acquire the services of re-insurer are explosions, oil spillage and environmental damage. In addition to the above mentioned, the company can also acquire the services of re-insurers for weather and commodity price risks solutions. The solution to such risks can include offering deep knowledge of energy markets and multiyear contracts to reduce opportunity costs. [2] In order to enhance the financial outlook, the companies are now adopting strategic measures to curtail its expenditure through any means possible, and self insurance is one of them. The main reason behind adopting such policy is that it is cheaper than buying commercial policies from the insurers. Patterson UTI Energy can adopt self insurance for its employee benefits programs. Although Patterson UTI Energy has a large work force, but the company can quantify the compensation payable to the employees in case of any operational hazard having direct and adverse affect on the life and health of its employees. Another form of risk management technique which is gaining popularity is the transfer of risk management in which the service provider, during the signing of the contract, add clauses according to which the other party will be liable to reimburse on the happening of certain unseen future events. Patterson UTI Energy, while signing of contract of providing drilling services, can add such conditions according to which the customer will be liable to reimburse the company for certain loses. Example of such losses would be the damage to the oil rigs or the company’s workforce due to the negligence of the customer. Hedging is another risk management tool through which the company can save itself from financial turmoil. As discussed earlier, the oil and gas prices are highly subjective and volatile based on the demand and supply position in the market. While entering into a contract, the company should agree with the customer the price on which the drilling or pumping service will be provided in the future. Moreover, if the contract price is subject to the currency rate, the company should fix the contract price at the spot rate of the currency if it is foreseeable that it will devalue in the future. As per the latest development, as published in the financial statement of the company for the nine months ended September 30, 2010, the company’s financial position appears to be gaining momentum as it reported a net income of $63.1 million compared to the net loss of $20.6 million for the quarter ended September 30, 2009. The average number of operable oil rigs of the company has increased to 178 and the increase is expected in the coming future. Moreover, Patterson UTI Energy, following its strategic objective of expanding its core business, has incurred major capital expenditure on the acquisition of pressure pumping and wire line assets amounting to $238 million. With this acquisition the company’s business has now expanded throughout Texas. For the acquisition, the company acquired a revolving credit line of $400 million and a four-year $100 million term loan. Patterson UTI Energy strives to become the leading name in drilling solution and to become a name which is considered an alternate for quality service. Although, the company operates in a highly dynamic and competitive market, but its commitment to safety and investment in advanced technology will bring beneficial results in future. Works Cited [1] “About Patterson-UTI.” patenergy.com. Patterson-UTI, n.d. Web. 26 Sep. 2010. [2] “Weather and Commodity Price Risk Solution” swissre.com. Swiss Re, n.d. Web. 26 Sep. 2010. Read More