Forget About Natural Gas, Oil Field Services Sector Shows More Promise

The market's upward momentum this year has hordes of investors still looking for opportunities with good entry points. Finding them is tough because markets can turn quickly and many sectors are already fully valued. Nonetheless, with crude prices hovering around the $70 per barrel range, even with reduced demand, oilfield services remains one of the more promising sectors still with room to grow.

The following are some of the emerging trends setting the medium to long term outlook for the sector:

North America Natural Gas – Check Back in 2011

Baker Hughes (BHI) and BJ Services (BJS) $5.5 billion stock and cash deal is the first major merger in the oilfield services sector since energy prices collapsed last year and the biggest merger in the sector for a decade. It will boost the size of Baker Hughes’ pressure pumping business to provide more than 20% of its revenue, from less than 1% today. Baker Hughes once owned BJ Services but spun it off in the early 1990s.

This merger tells investors three things:

( 1 ) BJ Services is the number three player in the pressure pumping business with 73% of its revenue generated from the North America region. BJ Services’ exit at this point suggests the North America onshore shale gas market is not expected to rebound any time soon, and this is a marriage made in recession.

( 2 ) This is a strategic move by Baker Hughes, suggesting a diversified suite of services is becoming more important to compete and win contracts with majors and larger independents.

( 3 ) The better revenue prospect lies in the overseas market, as BJ Services has far less the international presence of Baker Hughes (click to enlarge).


In addition, as the graph indicates, natural gas has decoupled from the commodity and equities markets. (Fig. 1) Both the fundamental and technical signals are extremely bearish for natural gas with some analysts predicting a sub $2/mmbtu price scenario. Due to various market factors, it is likely that natural gas will stay on this bearish path at least through 2010, and unlikely to be a factor for the services sector, assuming no major hurricanes or an unusually cold winter.

Deepwater Oil to Drive Growth

BP PLC (BP) announced a major new oil find, called the Tiber well, one of the latest in a string of discoveries in the Gulf of Mexico (GoM) that cements the prospects for the Lower Tertiary region as one of the oil world's most promising exploration regions. Tiber, with an estimated 3 billion plus barrels, is at a depth of more than 35,000 feet, greater than the height of Mount Everest.

This is part of a new frontier in exploration where oil companies are spending billions of dollars to find oil on the bottom of seas offshore in places such as Brazil, The North Sea, and West Africa. These discoveries were made possible by new technologies now capable of unlocking deep deposits that were before either undiscoverable or too costly to exploit.

The U.S. also has lower taxes, royalties, oil payments and other levies than most other governments. This combination of financial and geologic advantages will support the continuing growth of the deep-water GoM. Since most of the oil majors have backwardly integrated services operations, and rely on third party services companies to supplement their own activities, this new find by BP could translate into more work for the deepwater services sector over the next couple of decades.

North America Onshore M&A to Intensify

The oil and gas sector has been hemorrhaging due to the factors of the economic downturn, the credit squeeze, falling commodity prices and an extreme pricing environment. For example, during its earnings calls, BJ Services indicated that the average pricing for its products and services was down about 35% during the 1st half of 2009. There are indications that the average oilfield services pricing was down another 10-15% from late 2nd quarter levels.

The Baker Hughes and BJ Services merger is one of the first signs that the valuation gap is finally narrowing between potential buyers and sellers. After free falling from the 4th quarter of 2008, the rig count in the U.S. has begun to creep upward, now breaking 1,000 from the low point of 876 in mid June. This could spur more M&A activity, particularly in the North America Onshore services sector, before values start rising again along with commodity prices.

From that perspective, both Schlumberger Limited (SLB) and Weatherford International (WFT) could be ready to acquire smaller players in the sector, with small niche players like Smith International (SII) and Newpark Resources (NR) as potential targets.

Sector Strategy

The entire oil patch is not likely to resume growth till oil prices stabilize for at least 6 months or longer around the $70-75 a barrel level, which seems to be the ‘fair price’ that OPEC demands.

Ergo, for investment in the services sector as part of a long term portfolio holding, investors should seek out companies with an international deepwater niche such as Transocean, Inc. (RIG), Technip (TKP), Oceaneering International Inc. (OII), and Tidewater, Inc. (TDW).

ETF investors should research whether the following Exchange Traded Funds meet similar investment objectives: Oil Service HOLDRS ETF (OIH), Dynamic Oil & Gas Services (PXJ) and SPDR S&P Oil & Gas Equipment & Services (XES), which can be less risky than investing directly in specific companies.

Comments

[pragmattist]

Will Obama reach his goal of zero oil imports from the Middle East within ten years?
www.ngoilgas.com/artic.../

Does Imported Oil Threaten U.S. National Security?
www.rand.org/pubs/rese...

The NAT GAS Act of 2009, H.R. 1835, was introduced in the House of Representatives on April 1 and has 77 bipartisan cosponsors. The Senate version of this bill, S. 1408, was introduced on July 8 by Senate Majority Leader Harry Reid and Senators Robert Menendez (D-NJ) and Orrin Hatch (R-UT).
www.businesswire.com/p...

Will NAT GAS Act of 2009 really pass in October?
www.msnbc.msn.com/id/3.../

What is the Putin Plan?
news.bbc.co.uk/2/hi/eu...
www.jamestown.org/sing...[tt_news]=34888&tx...
uk.reuters.com/article...

2009 Sep 08 05:28 AM

[AndrewBaker]

The position of natural gas right now reminds me of the expression "It's always darkest before the dawn," and given its credentials - which most of you will know anyway - it's got to be one of the best energy plays with the most potential of any at this time. I'm already long, and am staying so, but for those not yet with a position, you can wait, but remember, the price can drive higher a lot and very quickly.

2009 Sep 08 06:30 AM

[learnmoney]

As I keep saying............when the US wakes up to the potential of NG and the government gets its act together then there will be a surge in demand making it, just like us in the UK, a very valuable asset.
Reading all the blogs on NG it does seem to me that there are so many stale bulls with many being forced out at these price levels. What is needed is no more interference from the US authorities which will lead to a better market place for serious investors and short term traders.

2009 Sep 08 06:47 AM

[learnmoney]

I am long by the way at $12.

2009 Sep 08 06:48 AM

[Dian L. Chu]

SA changed the title. My original title was "Oilfield Services Sector: Forget About Natural Gas", which says natgas would not be relevant to the services sector at least for 2010. Things get lost in translation with a title change. I'm advising long on natgas as well, believing it is seriously undervalued.

You may see my original post & additional comments on Zero Hedge and my blog: www.zerohedge.com/arti...
dianchu.blogspot.com/
Thanks for your comment.

On Sep 08 06:30 AM AndrewBaker wrote:

> The position of natural gas right now reminds me of the expression
> "It's always darkest before the dawn," and given its credentials
> - which most of you will know anyway - it's got to be one of the
> best energy plays with the most potential of any at this time. I'm
> already long, and am staying so, but for those not yet with a position,
> you can wait, but remember, the price can drive higher a lot and
> very quickly.

2009 Sep 08 07:01 AM

[receipt]

Decreases in Natural Gas production are in the offing and prices positioned to explode to the upside. The author's naive view that natural gas production will continue unabated while prices sink to new lows doesn't incorporate the fact that the seasonally adjusted rate of change of natural gas production has been decreasing for about a year and is now right at zero. Evidence is prices on 9/4/09 and today 9/8/09! One way to play it is by going double long natural gas with Horizons BetaPro NYMEX Natural Gas Bull Plus ETF, avoiding the pitfalls of it's domestic competitors.

2009 Sep 08 09:04 AM

[Mad Hedge Fund Trader]

qety. Just when I get comfortable with my view on Natural Gas, I get a scratchy, reverberating cell phone call from one of the major formations telling me that I’m being way too bullish. Gas won’t bottom at $2. The free fall will continue until it hits $1. National storage will be completely full imminently top out, and when it does, the producers will have to shut down completely. Since these guys are leveraged up the wazoo, this will trigger a string of bankruptcies, and the majors will fall like dominoes. A hedge fund bust won’t define this bottom, as these guys are all playing from the short side. UNG can’t step in as a buyer of last resort, as the SEC won’t let it issue more stock, and the current shares are trading at a ridiculous 20% premium. One thing we do agree on is that the bottom will look ugly, whatever the spark is. You often get Armageddon type views near market bottoms, but this guy has been dead on right until now. Well, it takes two to make a market. Conclusion: keep NG nailed to your screen, as the widow maker is where the volatility lives.

2009 Sep 08 10:22 AM

[toobad41]

The current pricing and glut is a result of the intensive search for gas that has been going on for the past several years. The gas plays going on throughout the USA was sparked by good gas pricing. Now that there is an over abundance of the stuff the companies involved with drilling and production will cut back on their activity. Why sell their product at $3.50 today when they can get $12 next quarter or next year?

2009 Sep 08 10:33 AM

[digalert]

RIG is cheap here.

2009 Sep 08 10:43 AM

[NUCLEAR1929]

oil and gas go together, simply the fundamentals are reflecting reality of the energies market, thats why crude oil will go down as much as natgas long term

2009 Sep 08 11:59 AM

[Barbarous Relic]

I think I'd prefer to play the gas-related onshore service companies here. Oil-related stocks have already garnered good interest, and deepwater rig day rates are probably at or near peak levels.

Most of us agree that natural gas is due for a rebound once we get to the winter heating season. But while the gas commodity ETFs (UNG, HNU) already build in a rebound in pricing (through the impact of rolling contracts at higher prices), many of the gas service stocks have been effectively left for dead. That's where the opportunity lies.

2009 Sep 08 04:04 PM

[Mad Hedge Fund Trader]

utu. Since I have had such a hot hand in natural gas, many have asked me to comment on yesterday’s surprise announcement that the ETF, UNG, finally got permission to issue new shares. The easy answer here is that UNG will crater. There is no reason for the fund to trade at a premium whatsoever, which at one point traded as high as 20%, an overvaluation you normally only see in closed end funds at bear market bottoms. These ETF’s are simply pass through vehicles which make it easier for investors to own NG in stock form when they are legally unable, or too lazy to open a futures trading account. They should never trade more than 1% out of line with the underlying to account for the admin and execution costs of running such an instrument. The people who made the killing here were the handful of hedge funds that were able to borrow UNG shares, sell them short, and go long the futures, locking in a guaranteed 20% spread. They will cash in their profit next week. Something similar is still going on where smart industry players have locked up salt caverns to store gas, buy it cheaply on the spot market, and sell it forward. This is possible because yesterday you could buy October at $3.25/MCF and sell it for April delivery at $5.32, giving you an annualized return of 127%. Leverage that, and you are talking about some serious money. If you were wondering where the money was coming from to buy those G5’s, this is it. The fundamentals for the industry are still terrible, and there is a risk that the market could completely grind to a halt when the country runs out of storage, so the volatility will remain huge. This week’s move explosive 44% move from $2.40 to $3.44 was nothing more than pure short covering. I expect a quick double in NG once the storage issue is resolved, and the cheapest, cleanest, and most liquid way to participate is though the futures. If you need help in how to do this, e-mail me at madhedgefundtrader@yah...

2009 Sep 12 02:07 PM