Oil Service Stocks Likely to Fall Near-Term

First let’s look at the performance over the last several months. The 100-day EMA for the OIH ETF has fallen from a mid-November value of approximately $140 to a mid-March value of approximately $88. The downward rate is lessening demonstrably, but the direction is still downward. Over the last several months we have seen rallies to $85.20, $83.90, $86.71, and $79.68. The bottoms OIH has rallied off of have been $66.67, $68.26, $67.37, and $65.72. This seems to be a fairly stable sideways channel pattern. The peaks have averaged $83.87. The valleys have averaged $67.00. We are currently at $82.66, but OIH hit $83.53 intraday on Friday. This value was very close to our average high in our sideways channel pattern. If the sideways channel remains in place, this likely means the OIH ETF will head downward again at some point this week.

One reason OIH may head downward is that this is the start of Q1 earnings season, which will not get any help from the mark to market rules changes. These take effect only for Q2 and beyond. Earnings for Q1 are forecast to fall by 35% with every sector joining in the fall.

A second reason OIH may head downward is the analysts’ downgrade of earnings estimates. I looked at 8 stocks as a sample. The data are from Yahoo Finance. The results are below (click to enlarge):

Clearly these data do not indicate a quickly growing sector. They also indicate that the direction of the earnings revisions is strongly downward overall. S&P recently cut RIG’s earnings estimates by $1.07/share in 2009 to $14.27 and by $4.54/share in 2010 to $14.10. S&P commented that RIG has a backlog of $38.7B of which 94% is from investment grade customers. Deep Water Rigs were mostly booked through 2010. However, Jackup rigs were only 69% booked in 2009 and 30% in 2010. S&P kept its strong buy rating on RIG, but doesn’t this action make one think that S&P has put RIG on the equivalent of a credit watch for a downgrade (i.e. for its rating of RIG).

BJS was recently a Zacks’ Bear of the Day. Zack’s comments were:

Our continued Sell recommendation for BJ Services (NYSE: BJS - News) shares reflects the weakening outlook for the North American pressure pumping market. Weak natural gas prices and continued credit market turmoil have prompted E&P players to curtail spending plans, significantly affecting the outlook for players such as BJ Services.

While the company should fare better than many of its smaller peers, given the size and scope of its operations and its strong financial health, it is nevertheless faced with pricing pressures and margin compression in the coming quarters.

This brings up yet another point, oil prices have been rising, but natural gas prices have been falling recently. The natural gas prices are now at less than $4. This is too cheap to make it profitable for most companies to drill for natural gas. A good portion of the oil services business is drilling for natural gas. I have not heard anything that leads me to believe that natural gas prices will skyrocket anytime in the near term. This part of the oil services sector should put a lot of downward pressure on oil services stocks.

Now let’s look at oil. It has risen steadily from February’s low in the low $30 range to the recent highs of about $55. Currently it is at about $53.4. The EIA recently reduced their demand estimates and average price targets for 2009 and 2010. The EIA 2009 average price estimate was in the $42-$43 range last I looked. The EIA apparently commented recently that the IEA was likely to lower their demand forecast for world oil demand on April 10. This seems likely to send oil prices lower in the near term. This in turn is likely to send OIH prices lower in the near term. I think people have been concentrating on the oil prices to the exclusion of the natural gas prices. The effect of the natural gas prices relative to the OIH stocks has likely not been fully accounted for in the stock prices yet. This argues that the OIH stocks are likely to move down in the near term.

One of the factors which may have been pushing oil prices up recently has been the recent fall in the US dollar versus the Euro (most importantly). If the Euro price for oil stays the same, the price in US dollars has to go up, if the US dollar is going down with respect to the Euro. This effect is actually magnified by speculation about the future direction of the US dollar versus the Euro (and other currencies). Some people are probably also using oil as a hedge against inflation. This has likely increased demand recently. This Euro versus US dollar movement has generally been causing further increases in most commodities.

This might make us want to know what the likely direction of the US dollar relative to other currencies is may be in the next week. Relevant to that, the following events are on tap for the coming week:

1. Tuesday the Bank of Australia is expected to lower its rates by 25 basis points to 3%.
2. Wednesday the Bank of Thailand is expected to lower its rates by 50 basis points to 1%. The Bank of Japan is expected to leave rates unchanged, but it is likely to have negative news to report.
3. Thursday the Bank of Korea is expected to lower its rates by 25 basis points to 1.75%. The Bank of England is expected to leave its rates unchanged at .5%. However, it’s likely Quantitative Easing announcements may be inflationary for the British Pound. There are also expectations that the US Trade Deficit may shrink again since imports are thought to have been lower recently. If this does not happen, it will likely be due to the higher price of oil in March. One could argue that either instance might lead to lower oil prices.
4. Elsewhere in Europe, people are hoping slightly improved car sales translate into improved manufacturing data in Germany. Also the airline industries in Europe are doing very poorly. This should be a negative for the Euro.

Virtually all of this news is positive for the outlook of the US dollar versus other currencies. The US dollar seems likely to do reasonably well over the next week versus the other currencies. This is likely negative news for the price of oil in US dollar terms. A lower price for oil is likely negative for the OIH stocks. The US still has Quantitative Easing, which has tended to drive the price of oil upward. However, many other countries are participating in the same actions. Plus those that are not may soon experience severely worsening economic problems. The Eastern European countries are prime examples. Everyone celebrated that the G20 allocated a $1T to fight this and other problems. This was good news in one way. However, in another way it clearly highlights the fact that there are many countries in severe trouble. Since many of these countries are European, this will negatively affect the Euro. This train of thought may find itself more in vogue with investors in the weeks ahead (as Q1 earnings come out). The euphoria over the $1T pledged to fight problems may be short lived as the problems begin to appear more prominently.

In sum, the charts tend to indicate, although not conclusively, that the price of OIH is likely to fall in the near term. The analysts’ earnings estimates, etc. indicate the same thing. A lot of these companies are fairly stable, but cracks are starting to appear in their armor, especially with the price of natural gas so low. The job numbers keep worsening, and they are forecast to continue to do so. This should lead to decreased demand for oil. In fact the IEA is supposed to announce another decrease in their world demand estimates for oil for 2009 on Friday, April 10. TradingMarkets.com has listed the OIH ETF as one of the sectors that is extremely overbought. These things should lead to decreased oil prices. The totality of all of these negative factors should lead to a retracement in OIH stocks. The land based drillers are especially vulnerable.

I should say I actually like OIH stocks, especially the deep sea drillers. I am not sure I would want to short a relatively strong sector. However, I would definitely consider taking profits at this time in a sector which seems likely to be under near term pressure downward. As long as the unemployment rate keeps rising, the downward pressure on oil demand should remain intact. Further downward revisions seem likely in months to come. This argues for the continuation of the channel pattern (or even the continuation fo the downward trend. It does not argue for a break out to the high side. Of course, markets are forever surprising those who stick their necks out to make predictions. I have simply tried my best.

Comments

[Mad Hedge F...:]

The pros agree. Daniel Yergin of Cambridge Energy Partners says that crude prices will stay in a $40 to $60 range for the foreseeable future. The author of the Pulitzer Prize winning “The Prize”, the best business book I have ever read, believes the recent 26% rally in the stock market is what dragged crude up from $35 to $54. Another downdraft in stocks, or a realization that the recession will be longer than expected, could take crude back to $40 in a heartbeat. Inventories are at a 16 year high, with possibly 80 million barrels at sea, as demand has shrunk from 86 to 83.5 million barrels a day over the last two years. Spare capacity is now huge. Don’t expect to break out of this range until a recovering economy eats into these supplies, and inflation makes its inevitable return. Then all commodities will roar, not just crude.

Apr 06 02:06 PM

[Conan the B...:]

Natural Gas prices have been falling, yet LNG related stocks have been rising. I hold 3 which have been bucking your trend.

LNG, CQP, MMR and TGP.(MMR is a special situation)

Over Bought? what metric are you using? An oversold condition has been alleviated but there is no inkling of an overbought condition that I can see.

When the IEA forecast comes out, it will be on the Global outlook. US unemployment will not influence it unduly. IMHO

Apr 06 02:22 PM

[Conan the B...:]

What continues to amaze me is the total lack of consideration being given to the increased demand from China and the rest of the Undeveloped countries.

Inventories are at 16 year highs? Globally or in the USA? World Demand is down 2.5 Million brls, OPEC cuts are greater and have been verified from Shipping records.

80 million brls. at sea? That's less than 1 day's worth of Global demand.

Oil doesn't need a pickup in demand, just the perception that it will pick up.

The Pros agree? They agreed last year too.

Apr 06 02:40 PM

[David White:]

Some more data:
Marketwatch:
February retail-sales data for the 16-nation euro zone underlined worries about the area's own economic outlook.
February sales volume declined 0.6% from the previous month, the statistics agency Eurostat reported. The decline slightly exceeded the consensus forecast for a 0.4% fall. Compared to the same month last year, sales were off by a record 4%.
Meanwhile, inflationary pressures continue to fade, giving the European Central Bank room to further cut interest rates, analysts said. Eurostat said producer prices fell 0.5% in February, for a 1.8% drop compared to February 2008. The decline was the biggest annual fall on record.


A further decline in the Euro, which the above news portends, is likley to lead to further oil price declines. The OIH ETF will likely go along for the ride.

Reuters:
Oil prices have gained roughly 40 percent since mid-February as equities markets rose and OPEC producers cut output, though oil's gains have been limited by continued weak global demand and rising inventory levels.

U.S. commercial crude stockpiles hit a 16-year high last week, according to the Energy Information Administration.

Goldman Sachs said in a note received by Reuters on Monday that crude oil price rallies would be short-lived until the second half of 2009 because of weak fundamentals.

It said recent oil price rallies had been fueled by optimism over future stabilization in the financial system and in global economic growth, but for the time being these rallies were unlikely to be sustained.

"We continue to expect that a more stable demand environment, reinforced by the likely need for the industry to restock during second-half 2009, will help push the oil market into a sustained deficit later in the year," it said.



This would seem to agree with my thoughts that the increasing unemployment rate is likely to lead to decreased demand. This should keep oil prices low. It seems likely to have the same effect on the OIH stocks, especially since they are overbought.

The overbought comment actually came from TradingMarkets.com. However, the Williams%r indicator is at 20 (as of trading at the end of Friday). This is an overbought condition. The Fast Stochastic is at about 80 (as of trading at the end of Friday). This is also an overbought condition.

Apr 06 04:02 PM

[David White:]

Conan: Part of my reasoning was that OIH has been going up for the last month, but the earnings revisions on OIH stocks have almost all been going down during that time. At the end of trading Friday (or better at the OIH intraday high on Friday), OIH was basically at the top (or near the top) of its recent sideways channel pattern. Given the negative news on earnings for these stocks during the run up, it seemed likely to me that OIH would continue in its sideways channel pattern. If this is a correct analysis on my part, the direction seems likely to be downward for the near term. Admittedly there is a possibility of a slight further rise. However, I see no big impetus for a break out from the channel pattern. In fact, the most recent news would tend to argue against that. Don't forget that the drillers are seeing some order cancellation. This situation doesn't seem likely to improve with increasing unemployment. The increasing unemployment should decrease gasoline demand. Fewer people will be driving to work.Those that do drive to work will have less traffic to face during rush hours. All of this should cause the US (and others) to use less oil. In addition those out of work will be pinching pennies. Gas will likely be one of the areas in which they try to conserve.

Apr 06 04:45 PM

[Conan the B...:]

David: I concur with everything you just uttered as it pertains to the USA. I also know that a Continued Banking Sector rally will cause a Drop in the USD as Risk Aversion continues to evaporate.

I do not see a Dollar drop or the quickly approaching driving season as a Backdrop for lower oil prices any time soon.

So my scenario is dependant on the Banking Sector to a great degree on a short term basis. But Seasonality and Demand rising again 12 months down the road also plays an important part.

Infrastructure stimulus will continue for 2 years, it is very energy intensive.

Present, bah humbug. Future, buy,buy,buy.

Apr 07 02:20 AM

[yank:]

Daniel Yergin is considered a pro? The man is an idiot. He completley misjudged the explosion in oil prices last year so now he proclaims that oil prices must remain lower for the foresseable future? He is not a credible source for energy price forecasting. PERIOD. As for the author, his article is riddled with false hopes, dubious claims to permanent oil demand destruction, etc. "Job losses will continue to mount leading to lower oil demand?" Sorry to burst your bubble but unemployment is a "lagging indicator" and has never been used credibly to forecast oil demand. As for your comments on the USD please consult any "technical" stock pro who will patiently explain to you what a classic "double top" looks like in a stock chart. The USD is precisely that right now and will be heading below 80 very soon. Here is some advice for you. Wishing for lower oil prices is pretty much a waste of everyone's time.

Apr 07 08:56 AM

[David White:]

Conan: I tend to agree with the summer driving season comment, as well as many of your other comments. However, this article is more of a market timing article.

The OIH stocks were overbought on the run up. Their earnings estimates have been going down. Many of the mostly land based drillers have FPE's over 10, which is probably on the high side considering earnings revisions are headed downward. The recent run up in the Euro, which aided in pushing oil prices up seems to be reversing itself. There was more news out today that was negative for the Euro. The IMF's coming forcast for $4T in toxic debt also seems likely to push the USD up and oil prices down. $900B of the toxic debt is estimated to be from Europe and Japan. This shows those areas are worsening. This worsening in those areas should push the USD up. The oil demand in those areas should also be hurt.The fact that the world still tends to see the USD as the safe haven during financial crisis should also tend to push the USD up during this new wave of bad news. The IMF report is due out April 21. The bank of Australia lowered its lending rate by 25 basis points today. The BOJ announced another $100B in stimulus spending. Both of these actions should buoy the USD.

Your point about LNG is well taken. I will have to look into this more. With natural gas at very cheap prices it is only natural that people will want to transport it to places it can be used. I would tend to agree that the current situation might be stimulating for that. However, few of the OIH stocks are very involved in LNG. Instead stocks like FWLT, etc. build such infrastrucuture. Instead the OIH stocks are involved mostly in getting the natural gas out of the ground (or the sea floor). Big natural gas fields such as those off the coast of Brazil may delay some of their development due to the current low prices for natural gas. I think you can see why some companies might want to put off developing natural gas fields, especially expensive to develop natural gas fields. Everyone is trying to cut down on their CAPEX at this point. Only a few of the really big companies have kept their CAPEX high (such as XOM). As worsening unemployment leads to further decreases in oil and gas demand, we are likely to see more cuts to CAPEX. As the recession lengthens, we may see more cuts to CAPEX. This is all a negative for the OIH companies. This argues for them to stay in their trading channel, especially with earnings estimates clearly going down. Staying in their trading channel means that short erm they should be going down.

The petroleum stocks numbers come out tomorrow. They are supposed to show another increase in crude stocks. The IEA is likely to report a further world oil demand decrease on Friday. A number of important analysts downgraded the banking stocks recently. The bad economic news this week (the $4T for example) should also push oil lower. I am not saying oil will stay there. I am just saying there is time for oil to cycle down before the summer. Then it can rise to trade in the $50 to $60 range during the summer. If oil goes down to say $40 near term, OIH stocks are exptremely likely to follow it downward.

I read a historical article today. It pointed out that all of the deep recessions have retested their lows at least once. The author did note that one moderate recessions did not. The author's prediction for the likely retest date of our recently established lows was approx. May 20, based on the historical patterns. If the author is correct, it seems extremely likely that oil is headed lower (and OIH stocks with it). The $4T toxic debt news out of the IMF today would tend to make me believe the author may be correct.

Apr 07 12:13 PM

[David White:]

Now that I have seen the relatively good prediction for a second bottom test on approx. May 20 (backed up by the $4T toxic assets problem to be announced by the IMF), I would think of shorting OIH. For those of you who consider this, you should know that of the ETF's in this sector OIH's performance was the second to worst over the past year. It lost -56.58%. This bodes well for a repeat performance of negative results. If you are a shorter, this is good. The Street.com has a "Sell" rating on OIH currently.

Apr 07 04:38 PM