This Industry Keeps the Oil Boom Humming (And Here’s My Favorite Play)
Don’t look now, but the rig market for oil and gas projects is heating up again.
After suffering through a period when rigs were being “retired” from the field, the pendulum is swinging back again. With the growing U.S. oil boom, rigs are suddenly back in high demand.
But that’s not too surprising. Without a rig, a well is nothing more than place marked on map.
That’s why the oil field service (OFS) business always improves before the fortunes of field production companies.
But did you know there’s an even earlier link in this profit chain?
Without it, the OFS business wouldn’t exist and neither would the all of those oil wells. Yet what goes on in this portion of the business rarely gets reported on.
Nonetheless, it’s the home of one of my favorite oil and gas plays…
The Equipment That Keeps it All Running
Of course, I’m talking about the companies that manufacture and distribute of all the massive the equipment each well requires.
From pressure pumps to drill bits, down hole motors and more, these are the companies that keep the OFS business humming
It’s part of an ongoing move by the big OFS outfits to consolidate access and increase profitability.
But the market for equipment in general and rigs in particular is a very fluid one.
There is also another factor to consider: when there’s an upsurge in equipment demand like the one developing right now, there is also an inflationary factor.
Put simply, as the demand heat up, so does the pricing spiral. But that’s good news for the individual investor in the equipment sector.
In this case, the returns on the equipment slice of the business are registered up front while the downward drag takes place further down the chain.
It is also important to remember that the oil and gas equipment market is global. While rig demand is growing in North America, the need to develop fields is even more pressing in other parts of the world.
That’s only adding even more overall demand to business with already limited availability. And unconventional production (shale and tight gas, tight oil) has only made this situation even worse.
Since the pay zones in these fields are horizontal rather than vertical, drilling equipment is more expensive and subject to more frequent delays in availability.
And then there is the peripheral footprint on the surface.
Fracking work at unconventional sites requires water pushed downhole under heavy pressure. That, in turn, requires a large array of pumping trucks and ancillary equipment surrounding the well head, along with compressor stations (to maintain pipeline pressure levels), retention basins (for flowback water) and a range of site specific processing and separation units.
A working well is a massive array of parts and machinery.
In fact, this is what only a portion of the pumping footprint at a small frack operation looks like.
And this picture does not include everything else that is needed on the surface.
All of these things have major implications for the use and rates of a broad range of equipment. Add to this the repair/maintenance component and there are solid prospects for a retail investment return.
How to Play the Spike in Oil and Gas Field Equipment
The obvious question is how the average individual investor can tap into this trend.
With all the M&A going on in the OFS sector, and its reach further “upstream” into the manufacturing and distribution segment, being able to comb through all of these opportunities could be a full-time job.
But it doesn’t have to be with these two suggestions.
The first is to use exchange traded funds (ETFs) that focus on the equipment and its utilization. The second identifies a company likely to be in the center of this move up.
Remember, however, that this trend is cyclical. Once costs reach a certain level, the profitability of equipment application declines. At that point, inflationary pressures have moved into supplies, labor, transport, and other elements and the field applications begin to taper off.
Still, there is money to be made in the interim.
First up, are the ETFs.
I have periodically recommended toEnergy Advantage and Energy Inner Circle members two standouts in this sector – the SPDR S&P Oil & Gas Equipment and Services ETF (NYSEArca: XES) and the Market Vectors Oil Service Holders ETF (NYSE MKT: OIH).
Both of these funds encompass the equipment and OFS sides of the business, although XES may be the more focused play if you’re looking to focus on primarily the equipment prospects. But XES has been performing better than OIH of late, making it the better move.
It is important to keep in mind that ETFs also charge fees. While those fees are merely deducted from the share level realized, they nonetheless also reduce your returns returns.
But there is one individual company that stands to benefit most directly from what is happening in the equipment sector.
It’s National Oilwell Varco (NYSE: NOV). This is one of the primary stand-alone (i.e., has not been acquired by an OFS bug boy) providers of oilfield equipment and service.
The company had been sluggish until recently. Over the last two weeks NOV is up 6.17%–but given the business it’s in this one is likely head much higher.
Just be sure to use a trailing stop. I typically recommend my readers use a 30% trailing stop for most investments.
Trailing stops dictate when to sell based on a percentage from its highest level since acquisition. That protects your profits while limiting your risk.
And be sure to keep an eye on the equipment side of the business. It’s not exactly sexy, but that’s not always the best way to make money in the markets.