Oil service companies have had a good start to earnings season. I have been bearish on this sector but we may be seeing a turnaround, or at least a bottom. There are certain parts of this business that have more upside than others, so choose carefully the stocks you purchase.
Baker Hughes (BHI) produced an earnings surprise on Friday, that was much better than anticipated. Much of this was attributed to good results in Europe and the Middle East. Results were also better in North America than expected. Once broken down, these results paint a picture of why we should be bullish going forward.
In the United States, Baker Hughes reported increased revenues when compared to the first quarter. Although operating margins were down in North America, it improved in the United States. Pressure pumping costs continue to increase. One of the biggest drivers are guar beans, and given the difficult environment, these costs cannot be passed on to customers. The most competitive areas are the gas basins and the Eagle Ford. Baker Hughes reported all other basins have stable pricing. All other parts of its U.S. business reported very good results. This includes drilling, completion and production systems. It seems the change in emphasis from natural gas to oil production is increasing demand for services across the board. Differentials in the Bakken are a worry, but Baker Hughes believes a WTI price of $85 shouldn't slow down development. Below $80, many of the producers will begin to consider slowing down in the less productive areas. More importantly is the big 40% drop in the price of NGLs year over year. The majority of this has happened in just the past few months.
International results saw improvement in revenue and operating profits. Europe and the Middle East weren't the only areas with good results. Africa and the Russian Caspian, both saw drilling, wireline, completion and artificial lift all do well.
Back to North America, Baker Hughes is expecting an increase in drilling rigs by 3% from 2011 to 2012. It expects U.S. natural gas drilling rigs, at 2012 year end, will decrease by 321. This will leave 488. United States oil rigs will increase by 300 to 1430. International rig count is expected to increase 8% year over year.
Baker Hughes reported the strongest demand for services will be in the Middle East followed by Africa. In the Middle East, Saudi Arabia and Iraq will be the focal point of revenue increases. The strong areas of Africa are the Sierra Leone, Ivory Coast and deep water plays. After that, Latin America and Europe will also do well. Asia Pacific will be the fifth best area, although it does not see price increases in the near term. Specific areas of notable upside are the Saudi north gas fields, China and Argentina.
Schlumberger's (SLB) earnings mimicked much of what Baker Hughes said. International markets saw an increase in revenue and margins. Emphasis was seen in seismic, drilling and wireline. The Middle East and Asia saw revenue growth, but margins were flat. Iraq is expected to be very busy, but is now still in the bidding period. Saudi Arabia added rig and rig-less activity. China also got busier in both conventional and unconventional activity. Europe and Africa had increased revenues and margins. Libya also picked up for Schlumberger, as it did for Baker Hughes. Russia looks to be one of its fastest growing markets. Exploration activity remained high in Africa.
In North America, revenues and margins were down. Much of this was due to Canada as it was with Baker Hughes. The U.S. hydraulic fracturing market was down, but wireline, coiled tubing and drilling were all stable. The Gulf of Mexico had a strong showing, just as expected. Schlumberger did see a downward pricing trend in hydraulic fracturing, which has spread to several oily basins. Increased costs were also noted.
Schlumberger had a more pessimistic outlook in the U.S. Although it liked the Gulf of Mexico results, hydraulic fracturing saw pricing and cost challenges. It sees Q3 pricing to continue downward. Both liquids and gas contracts are being signed for 20% less than at its peak, but many contracts are yet to be completed.
Internationally, Schlumberger sees the most upside to Russian and North African land. This is also true for the North Sea and sub-Sahara Africa offshore. Offshore customers are also paying a premium for wireline and drilling.
There are several conclusions to be drawn from these two companies. The Middle East, Europe, Africa and Russia are all very busy and should continue to be going forward. Offshore work is providing better margins, as producers are willing to pay more for better technology and services. Oil service companies working these areas should continue to do well. North America is doing better than previously thought as the United States continues to see pressure pumping pricing decrease as there are significant trucks sitting. One point I would like to make about pressure pumping is on average it takes less hydraulic horsepower to do a liquids rich well than gas. This is why there are just as many total wells being drilled, but we see lower utilization rates.
In summary, I think it is important to look for oil service companies with leverage internationally like Haliburton (HAL). Deep water has also been good and should continue to have good margins. National Oilwell Varco (NOV) is a good way to play this. Given the price of guar, I would look to companies with leverage to competing frac fluids like Flotek (FTK). Companies with leverage to pressure pumping could continue to struggle in this pricing environment. Basic (BAS) and RPC (RES) could continue to struggle, until current hydraulic horsepower utilization is higher. We won't know for sure until more results are in as it is possible we will see a bottoming of prices.
Disclosure: I am long FTK.
Additional disclosure: This is not a buy recommendation.