Why Oil Sector Job Losses Are a Necessary Evil

By Adam GalasFool.com

One of the biggest ramification of oil's recent collapse hasn't just been reduced oil sector profits, but large job cuts as well.

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With 2015 capital budgets being slashed,by as much as 50%in some cases, recent headlines have been full of grim tales of oil sector layoffs includingBP'srecently announcing a $1 billion restructuring that would mean thousands of job losses.Meanwhile,ConocoPhillipshas announced a hiring freeze and is considering laying off employees as part of its efforts to cut 2015 capital costs by 30%.

The oil services industry has been hit especially hard with companies such as Halliburton , Schlumberger , Baker Hughes , and Weatherford Internationalannouncing: 6,400,9,000, 7,000,and 8,000 job cuts, respectively.

While these job losses have been brutal, especially for the families of those affected directly,I think there are two reasons the job recession in the oil sector is likely to get worse before it gets better, even if oil prices end up recovering within the next few months. In addition, as painful as such job losses are, I also think they represent a necessary evil, one likely to result in improved financial health of the oil sector in the long term.

A surprising double-edged sword that is driving layoffsWhile the immediate catalyst for this recent wave of oil industry layoffs is the plunging price of oil, there is another potentially surprising factor that means layoffs are likely to continue even if oil prices recover within the next few months. That factor is the immense increase in productivity that has occurred in the oil industry in recent years.

According to Rusty Braziel, president of the oil industry research firm RBN Energy, the average time to drill a new oil well in Texas's Eagle Ford shale has declined from 22 days four years ago, to just nine days today.In addition, the productivity per rig has improved by 156%, with each rig now capable of drilling 41 wells per year as opposed to 16. Finally, thanks to longer horizontal drilling techniques, each new Eagle Ford well is producing 44% more oil.

All of these productivity advances have greatly reduced the break-even price of shale oil production, but productivity is a double-edged sword. Greatly reduced shale oil production costs mean most Eagle Ford shale producers are just breaking even at oil prices of $45 per barrel. It also means oil companies can increase or maintain production with fewer workers, which might increase layoffs in the short-medium term.

On the other hand, had these productivity increases not occurred, it's possible the break-even price of shale oil would be much higher, and today's wave of layoffs potentially much greater. That could have meant not only more pain for workers in the oil industry, but greater economic damage to oil-rich state economies such as those of Texas, North Dakota, Oklahoma, and Alaska.

A wave of mergers and acquisitions could make things worse before they get betterIf history is a guide, then we can expect this most recent oil crash to lead to a wave of industry consolidation. For example, during the 1997-1998 oil crash, BP purchased Amoco, Total merged with Petrofina, and ExxonMobil was born from the largest oil merger in history -- a staggering $117 billion in today's dollars.

Already in this commodity cycle, we've seen the first megamerger announcedbetween oil service giants Halliburton and Baker Hughes. One of the biggest reasons for this merger, according to management, is the potential for enormous synergistic cost savings -- up to $2 billion per year once the integration of the two companies is complete in 2017.

Source: Baker Hughes investor presentation.

Most of these cost cutting measures are targeting administrative and operating units which likely involve the majority of Halliburton's and Baker Hughes' combined 142,000 global employees.Thus it's possible that more job cuts are likely in the coming quarters even if oil prices were to recover in the coming months.

Bottom line: Oil sector job cuts are a painful but necessary evil in this highly cyclical commodity businessEveryone who's ever been laid off knows the pain, fear, and misery such events can cause. However, it's important to remember that, as painful as job cuts are, they represent a necessary market mechanism to force the oil industry to become more efficient. This will likely set the stage for a future boom in profits, increased dividends and share prices, anda wave of new job creation once oil prices recover to more sustainable levels.

The article Why Oil Sector Job Losses Are a Necessary Evil originally appeared on Fool.com.

Adam Galas has no position in any stocks mentioned. The Motley Fool recommends Halliburton and Total (ADR). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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