How to Play An Explosive Oil Field Services Sector

by | published October 22nd, 2010

The rise in crude oil prices is already ushering in another round of increasing drilling. Before the revenues from the oil itself start to flow, however, matters are improving dramatically for the oil field services (OFS) sector.

OFS includes all aspects of field preparation, drilling, and well completion leading up to the actual flow. And actually, this applies to drilling for both oil and natural gas.

On the gas side, prices are languishing, now down to less than $3.40 per 1,000 cubic feet for a standard NYMEX contract. Yet the huge prospects for unconventional flows from shale gas, tight gas, and coal bed methane production, combined with a likely push for additional gas as fuel in the production of electricity, are pushing drilling higher.

And you can be among the first to profit.

The Best OFS Indicator: The Number of Drilling Rigs in Use

During the depths of the financial crisis, drilling experienced a collapse in rig usage, with the decline in both demand and pricing. At its low point, we had barely one-third of the rigs being used in any capacity, many of them in injection or workover usages – that is, not drilling new wells for new volume.

That is now in full reversal. As of Monday (October 18th), the overall total of drilling rigs in use stands near five-year highs.

Even more significant are the field units involved in horizontal drilling. These operations are essential to shale gas and oil development, as well as a range of applications where lateral – rather than vertical – drilling angles are warranted, either for enhanced production or environmental reasons.

I’ll give you one of the main indicators I always apply in looking at the overall rig figures. Since November 2005 (when I first started calculating these figures, roughly with the beginning of major shale gas plays), having at least 500 rigs in North American field development applied only to horizontal drilling and hydrofracking operations is taken to mean a significant rise in the OFS market.

As that figure moves beyond 500, we tend to experience an OFS sector heating up, with expanding prices and equipment shortages. That puts OFS providers and their field availability at a premium, thereby increasing service charges… and profitability.

A total above 600 indicates an accelerating inflationary pressure in those charges.

And as of Monday, the horizontal rig usage stood at 641.

What is occurring in rigs is also taking place up and down the OFS provision chain, from seismic and geological survey services to well completions and logging (the generation of readings to determine a range of wellhead and pipe casing conditions). And the results are intensifying.

How to Profit

As with most situations of this kind, you look to individual companies and ways to invest in the sector as a whole.

The first approach obviously requires identification of primary beneficiaries of an upswing, while the latter allows you to partake in the broader sector improvement. This second consideration usually means exchange-traded funds (ETFs), although in just a moment, I’ll give you another way to do it.

With OFS, however, the disparity in prospects over the past several years has led to a rash of mergers and acquisitions (M&A) and joint venture (JV) moves. The lean times put mounting stress on smaller providers, especially those in specialized equipment, such as pressure pumping and increasingly complicated manifold applications (both necessary for any field operation, but especially so in the case of hydrofracking).

Through both M&A and JVs, the big boys have been getting bigger. That means the primary advantages of the current upswing should be reflected in improving performance by sector leaders, like Schlumberger Ltd. (NYSE:SLB), Halliburton Co. (NYSE:HAL), Weatherford International Ltd. (NYSE:WFT), and Baker Hughes Inc. (NYSE:BHI).

Weatherford is up a modest 3% over the last month. But the other three big providers are showing gains of 10% to 15%.

There are now broad-based expectations that we are into another major cycle of OFS demand.

Schlumberger is a good case in point. As the largest OFS provider in the world, it is often regarded as a bellwether indicator for the sector as a whole. Today, SLB reported figures that just about met market expectations – and its share price shot up 5%.

(This should come as no surprise to subscribers of my Energy Advantage: SLB is a part of our portfolio.)

As we have discussed, Schlumberger’s moves in Russia and the former Soviet region, along with JVs with the Chinese in Eagle Ford (the new Texas hot basin) have positioned the company well for the coming acceleration.

All four majors, however, will benefit from the rapid drilling rise in western Canada (where the decline hit hardest), as well as offshore. There, despite the problems in the Gulf of Mexico (including the lifting of the deepwater moratorium without finalization of regulations to govern it), projects are increasing elsewhere in the world.

For those wanting to invest in the sector as a whole, my recommendation is the Oil Services HOLDRS Trust (NYSE:OIH).

This is not technically an ETF, but a depositary receipt trust; OIH issues depositary receipts on the shares held by the Trust. A range of companies involved in drilling, well-site management, along with related sector products and services are covered. Included in the Trust holdings will be the stocks of the largest and most liquid OFS providers.

The advantages of OIH are twofold.

First, its own liquidity is high. On average, more than four million shares are traded daily. Second, as a provider of depositary holdings, its discounted return to actual market performance (the tracking problem) tends to be less than an equivalent ETF.

The disadvantage to the average investor may be the price – now pushing about $120 a share (with a 52-week high of $135.81).


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  1. Wilson Barrera
    November 5th, 2010 at 17:11 | #1

    I will love to know more where is the best places to invest in oil .

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