Oil producers have risen with the oil price but oil services firms are still forgotten and maligned by most investors. And for good reason.
The world’s oil producers – especially the largest of them – are busy squashing costs and handing cash back to shareholders.
BP, Exxon, Shell and Chevron are all funding dividends with asset sales or debt. Each has made commitments to retain its dividend and all are ruthlessly slashing expenditure to meet that commitment.
The impact of falling capital expenditure is clear. Reserves are no longer being replaced and drilling, especially in deep sea locations, has all but stopped.
Last year, for example, saw the least number of global discoveries made in the oil and gas sector since 1952 because collective capital expenditure has been decimated.
Drillers have announced project deferments and cancellations worth US$740bn between now and 2020 with a further US$300bn cut from exploration budgets. That means about US$1 trillion dollars that was earmarked for new supply has been canned.
If we accept that demand for oil will sit around 90m barrels per day then an awful lot of production will ultimately need to be replaced. Fields decline and equipment needs maintenance. The global capital expenditure strike will ultimately lead to higher oil prices as supply dwindles. Oil services firms that look unprofitable now could be cheap if the cycle turns.
There are two main problems for oil service bulls. Firstly, more than 500m barrels of oil currently sits in storage around the world and will be the first source of supply when prices turn. Before any meaningful increase in expenditure, inventories must fall.
Then there is shale. It is true that a lot more output will come from shale and some of this will displace deep sea drilling but decline rates here are swifter than anywhere else and, so far, only the Permian Basin in Texas has attracted new rigs. Shale will be part of the supply response but it can’t the only response.
Eventually, oil producers will open their wallets again as higher prices make drilling attractive. For the thrill-seeking investor, the oil services sector is beaten down today and might make decent hunting ground.
To get more insights, stock research and BUY recommendations, take a 15 day free trial of Intelligent Investor now. You can find out about investing directly in Intelligent Investor portfolios by clicking here.