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By Justin Dove

Oil Services Industry Set for “Gusher Of Profits”

As Ian Cooper’s recent article for Wealth Daily stated, the world isn’t necessarily running out of oil. It’s running out of “easy to get” oil.

Oil companies aren’t chasing the vast amounts of fuel trapped in shale or tar sands because they want to…

These sources are becoming the only ones left as production at the largest inland oil fields is declining, or is at least expected to soon.

In its 2010 World Energy Outlook, the International Energy Agency estimated that approximately 40 percent of the oil production needed by 2020 has yet to be found or developed. By 2030, it will likely be closer to 60 percent.

For the foreseeable future, oil companies are going to need plenty of services to help them procure the “hard to get” resources from deep waters, tar sands, or shale.

The companies most likely to benefit from this trend will be the oil and gas exploration services.

A June article in The Economist stated, “National oil companies often lack the skills to [seek out unconventional oil and gas]. The world’s big independent oil firms struggle, too. So they turn to the oil-services industry, which is set for a gusher of profits.”

Biggest Unconventional Projects

There are a great number of unconventional oil plays already in the works around the world. The following are some of the biggest and most important:

  • Offshore Brazil – Petrobras (NYSE: PBR) claims the sub-salt fields in the South Atlantic hold up to 13 billion barrels of oil. The problem is, these fields are an engineering nightmare. A February article in The Economist stated that “these ultra-deep deposits must be drilled at up to three times the normal pressure for offshore oil. The salt often shifts and closes up after drilling. Some of the chemicals in the oil are highly corrosive. And the distant fields are hard to reach, for both people and pipelines.” The engineering feats needed to make these oil wells workable should employ plenty of oil field services.
  • The Bakken and Marcellus Shale formations – The USGS estimates that each of the formations contains between three and four million barrels of natural gas. Fracking is still relatively new and the methods are still being perfected and improved. Plus, the North American formations are by no means the only ones in the world. These two factors should keep oil and gas service companies busy for a very long time.
  • The Alberta Oil Sands – The IEA reports that there are 178 billion barrels of oil within Canada, mostly in the oil sands of the Athabasca Deposit. That would make it the third-largest deposit behind Saudi Arabia and Venezuela. The problem is that it’s in the form of bitumen, a heavy partially solid mix containing silica and clay. This also should play well for oil service companies.

Timing

Oil prices are down in the $80s and there are recession fears being priced into oil services companies, such as Halliburton (NYSE: HAL), Schlumberger (NYSE: SLB) and Baker Hughes (NYSE: BHI).

Considering the importance that these companies should have in the next 20 years, this may be a relatively low point for the sector.

According to Zacks’ Investment Research, of the 52 firms listed in the oil and gas service sector, 11 hold a Zacks #1 Rank, and nine more have a Zacks #2 Rank.

Yet the latest sell-offs in the market have hammered these stocks. It’s hard to imagine this sector will stay down at these levels over the next 10 to 20 years.

But a benefit to low values and increasing need for new technologies is the flurry of merger and acquisition activity expected in the industry.

M&A Activity

There are already been a handful of mergers after the latest sell-offs.

  • Halliburton recently announced its intention to buy Multi-Chem. Multi-Chem provides chemicals and services to more than 30,000 wells in North America.
  • Lufkin Industries (Nasdaq: LUFK) announced last week that it was acquiring Quinn’s Oilfield Supply and Affiliates. Quinn’s will help expand Lufkin’s product portfolio in artificial lift systems and gain exposure to western Canada, namely Quinn’s home base of Alberta.
  • Cameron International Corporation (NYSE: CAM), an oilfield equipment leader, acquired the drilling-rig manufacturing segment of LeTourneau Technologies from Joy Global (Nasdaq: JOYG).

National Oilwell Varco (NYSE: NOV) CFO Clay Williams told Bloomberg on August 31 that his company expects to spend “well over” $1 billion on acquisitions this year.

“The silver lining to the market downturn and volatility is that perhaps it’ll make some companies that we’re interested in more reasonably valued, and some interesting targets may emerge,” Williams said. “We’re working hard to make those transactions happen.”

Adding to that is the situation in Brazil with Petrobras. Bloomberg reported recently that merger activity is expected to increase in the area. This is partly because state-run Petrobras is requiring that international companies must have local content in their production. Brazil hopes that this move will help drive economic growth in the region.

“The big suppliers like Halliburton, Schlumberger and Baker Hughes need a Brazilian company providing them with technology for them to be able to declare that the technology has the presence of local content,” Ernst & Young’s Carlos Assis told Bloomberg.

Possible Targets

With the timing perfect for mergers and acquisitions, one has to wonder which companies are next. Here are a few possible targets for the bigger companies:

  • Rowan Companies (NYSE: RDC) recently sold LeTourneau Technologies to Joy Global. But some analysts think they may be an attractive takeover target themselves. However Rowan doesn’t feel the same.

“We believe we have critical mass,” Rowan CEO Matt Ralls told Bloomberg. “We don’t need to be part of a larger organization.”

  • Quicksilver Resources (NYSE: KWK) provides services in the natural gas and inland oil industries. Lately the stock has been drilled, losing almost 40 percent since the end of July. Could be prime pickings for a large company with plenty of resources.
  • Energy XXI (Bermuda) Limited (Nasdaq: EXXI), on the other hand, has enjoyed success. It’s still relatively small with a market cap of 1.76 billion and is experienced with both onshore and offshore drilling.
  • Bolt Technology Corp. (Nasdaq: BOLT) manufactures and sells marine seismic data acquisition equipment. They make rovers and other equipment that helps drilling companies know if it’s a safe area to drill under water. They have a market cap under $1 billion and could provide one of the big boys with a substantial benefit.

These are purely speculative targets, but expect plenty of merger activity to go down in this sector going forward. The industry is likely going to consolidate and companies are sure to take advantage of low valuations in the market.

Disclosure: Investment U expressly forbids its writers from having a financial interest in any security they recommend to our subscribers. All employees and agents of Investment U (and affiliated companies) must wait 24 hours after an initial trade recommendation is published on online - or 72 hours after a direct mail publication is sent - before acting on that recommendation.

Source: Oil Industry Mergers And Acquisitions 2011