Oil Service Stocks Hit by Market Pressure

The deeper you go, the higher the pressure, and the higher the pressure, the higher the costs. I could be talking about plummeting world equity markets here, but today it's all about oil and oil service stocks. Oil hit $100 recently, maybe as one trader's shot at Wikipedia immortality, and maybe because the geopolitical map of the world seemed completely ablaze at the end of 2007. Despite attempts on the part of governments around the world to increase efficiency and stimulate domestic production, and efforts by consumers now shocked by gasoline costs well over $3 per gallon here in the States, global oil consumption is set to continue increasing in 2008.

OPEC announced Tuesday that it maintains its 2007 figures for worldwide oil consumption at 1.2 million barrels per day (bpd), a 1.4% increase over 2006 levels. For 2008, despite a recession that has already been priced in to international stock markets and even depressed speculative activity in oil futures, the world's favorite cartel says we can expect another rise, to 1.3 million bpd. So why are shares of major oil services firms--the ones in charge of building new rigs and drilling to ever-deeper depths offshore--plunging along with the Dow instead of staying buoyant? There's an interesting trend at play, and the Oil Service HOLDRs ETF (AMEX:OIH) shows us a first glimpse of what's hitting this energy sector, as we see in the chart below:

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The HOLDRs ETF tracked not only oil price increases throughout 2007, but market optimism as well. Though the squeeze of oil prices on everything from morning commutes to plastic packaging (where prices are said to have jumped by a full 25% in recent months) would seem to have fed an economic slowdown, easy credit fed further market pep.

That is, until banks realized they weren't getting any of their money back, at which point we began to descend into the depths of a bear market.

As for stocks like Halliburton Company (NYSE:HAL), Schlumberger Limited (NYSE:SLB), and other top holdings of the broad-based OIH crew, the falling knife has cut them as hard as any other stock on the way down.

But here's the deal: Schlumberger's highest price-to-earnings ratios weren't at the top of this recent bull market, but rather in 2004, as the post-9/11 bear was finally going into hibernation.

Oil Service Stocks Hit Too Hard?

The contraction of SLB's P/E coincided with an increase in the company's net profit margin, which rose from 8.7% in 2004 to 21.8% by December 2007.

BJ Services Company (NYSE:BJS), another main holding of OIH, announced this week that its Q4 2007 profit was down by nearly 17%, primarily due to pricing pressure in the company's pressure pumping operations, which make it easier to extract gas from hard-to-reach pockets under the ocean floor.

Even as BJS turns up the pressure in its exploration operations, which is exactly what government-run and private oil companies need when it comes to reaching ever-deeper oil traps, taxation changes and unwillingness to change contracts to suit new drilling demands mean an increase in pressure on oil service company margins.

That is, except in places like India and China, where operating costs are already low so there is more flexibility in end pricing.

As Keith Kohl mentioned yesterday, the core tenet of Peak Oil Theory is that the world's fossil fuel consumers must prepare to spend more money to get to oil that is further and further down, and of lesser quality.

Schlumberger just raised its quarterly dividend on January 17 by 20% to 21 cents per share, telling me that the company isn't about to go belly-up anytime soon. Yet the stock has been hit hard. Too hard, in fact, with a nearly 18% decline in the past month.

Our technical trading guru here at Angel Research, Ian Cooper, tells me SLB is "insanely oversold." Based on relative strength and moving average convergence difference, SLB may be at a turnaround point.

chart

But then again, we're still in falling knife territory and no one wants to get cut. Once things settle down, these oil service stocks are screaming "buy."