IEZ: Oil Equipment and Services Profits Dependent on Rising Crude Prices

With oil prices romping to record highs almost daily, pressure is mounting for increased production. Fields once deemed too costly to operate are suddenly in demand, as are new technologies to extract oil out of difficult places and materials. The U.S. government is calling on producers around the world to pry their spigots wide open.

That’s been good news for shares of the upstream energy firms that dominate iShares Oil Equipment & Services ETF (IEZ). IEZ is up 44.7% since its May 2006 inception and nearly 58% since March 30, 2007. The fund invests in the stocks of about 50 companies that build and maintain the massive infrastructure that produces and distributes the world’s oil, such as rigs and pipelines.

Many of these firms are huge and diversified with operations that stretch across the energy sector—such as top holding Schlumberger (SLB), the shares of which are up 20.5% in the last 90 days. But IEZ tends to avoid companies that are primarily refiners or exploration/production specialists and does include firms that limit themselves almost strictly to the oil patch, such as No. 2 holding Transocean (RIG), which focuses on the offshore drilling industry.

Most of IEZ’s stocks perform best when oil prices are climbing, and black gold traded as high as $139.89/barrel on Monday—yet another record. IEZ hit an all-time high on June 9 and approached that high again in recent days, leaving it with a year-to-date gain of almost 17% (through June 13), slightly better than the average energy fund.

For months, if not years, analysts and investors have debated how high oil prices—and the stocks tied to them—can go. That debate continues, with forecasts ranging from below $100 up to $200 and higher. Stocks in the sector tend to move with prices, sometimes in an exaggerated fashion, and high valuations in the industry potentially mean that a dip in prices could bring a major sell-off.

Saudi Arabia’s announcement last weekend that it will substantially boost its oil output could lead to a softening of prices. Many industry analysts, however, believe the fundamentals of the market don’t warrant such a production increase. In this view, soaring prices are being caused by a weak dollar, speculative trading in commodities markets and the interest-rate policy of the Fed, rather than unmet demand, according to The Wall Street Journal.

If that analysis proves correct, causing pressures for production increases to fade, IEZ is likely to suffer. But with both supply and demand deeply influenced by geopolitics, environmental factors, broader economic conditions and a range of other matters, there’s no way to know for sure how prices will move in the coming months and years.

Oil equipment firms spend a lot on research and development as they seek to provide new and more efficient ways of producing oil. Because that R&D process is often lengthy and costly, many companies have been shopping around for smaller firms that already have attractive technologies.

Two of IEZ’s recent top holdings announced plans in recent weeks to acquire smaller oil-field services firms. Recent No. 3 holding Halliburton (JAL) is making a $3.4 billion bid for British firm Expro International, while No. 8 Smith International (SII) plans to buy out W-H Energy Services for $3.3 billion. Industry insiders say that more buyouts are likely to come in the next few months.

Smith’s purchase of W-H Energy, expected to close in the third quarter, should supplement the firm’s already impressive product portfolio of drilling bits and fluids. Although Smith has struggled to compete with its larger competitors like Baker Hughes (BHI), the firm has earned a reputation for offering extremely high-quality specialized diamond bits. Stock in Smith gained nearly 25% in the three months ending June 16.

Halliburton, the world’s second largest oil-field contractor, is being challenged in its bid for Expro International. On Monday another British firm, Candover Partners, offered a 6% premium on Halliburton’s price, leaving Halliburton with the rest of the week to come up with a counteroffer. Purchasing Expro would allow Halliburton to offer its clients yet another way of gaining access to hard-to-reach oil. The firm produces equipment that tests oil wells in water up to 1,000 meters deep, further down than most firms have explored in the past. Halliburton’s stock gained about 27% in the three months ending June 16.

If oil prices continue to climb, or even hover, firms in the oil industry are likely to devote an increasing amount of their resources to the equipment required to produce the commodity. That scenario would keep IEZ’s recent momentum from flagging. But it’s worth noting that IEZ is an extremely concentrated fund (recently, 63% of assets in the top 10 holdings) and—like most energy offerings—is extremely volatile. It’s best-suited to be a niche holding, and one approached with caution after the long run-up in prices and stock values.

Comments

[jjason]

Today's news is full of negative results for truckers, fisherman and those who have to drive to and from work.

High oil prices are the cause.

Have you done any research on Market Manipulation of oil futures?

Please read:

www.star-telegram.com/...

Then read Michael Greenberger's report to the US Senate on June 3, 2008 titled "Energy Market Manipulation and Federal Enforcement Regimes" at:

www.commerce.senate.go...

Then help to bring oil prices down and stop speculators from hurting our economy.

[long_on_oil]

If you follow the Relative Strength Indicator you will find that most oil related stocks like RIG NOV Hal etc are still way below the top which is usually about 75. Most of these stocks are currently in the 50's which indicates they still have room to run.
Even though the oil services companies seem to run opposite the price of oil, the long term prospect for all these companies has to be up. Because we have to discover more oil to keep the world economy going.
If you are a trader and make your money via short term swings in stock prices then you have to sell on the weakness of oil. But, if you are an investor you must buy and hold this sector.
If you sell you have to be vigilant in watching for the recovery because the recovery is always faster than the dip.

Another thing to consider, Brazil is tieing up all the deep water rigs for their new discoveries and this sector is in long term bull mode.

[John Egan]

User 151634 .... True, but if you follow Weekly Slow Stochastics, they're all pretty much overbought. You pays yer money and you takes yer chance!!

Thx jegan

[SA2]

One important point not mentioned above is that the entire group is very inexpensive with a trailing PE of less than 14. That PE is based on much lower oil prices... Reduces risk.

[McKoac]

I stopped reading this when he used the words "high valuations"
All of the drillers sport single digit PE's, which is half the SP average, and growth rates more than double the SP average. The pure service cos like SLB and HAL are at worst, near the SP average on PE and easily double that of the average growth rate.

Does ANYONE get to post articles here?

[Socialism cannot compete!]

jjason: BS. Period. Your linked-to article talks of the broken relationship between oil prices and *U.S.* inventory levels. Duh! Of course that relationship is broken - demand is sky-rocketing in India and China...which happen to be two of the most populous nations on Earth! Why do you think the U.S. should continue to have first call on the world's oil? The U.S. has kow-towed to whacko environmentalists, who are 30 years behind in their understanding of safe drilling, and we have therefore made no real moves to increase our own domestic sources!

Whine to me about high-priced oil when you get the politics of it into your head.

[Eric Fox]

"demand is sky-rocketing in India and China"

Demand in China is only estimated to grow 300-400K BPD in 2008 - hardly a skyrocket as you say. Demand in the OECD is rolling over as demonstrated in the April and May highway traffic reports released in the U.S.

OECD demand is 48 million BPD and any significant slowdown here will overwhelm any increase from China and India.

[Harrya]

The offiicers of RIG are selling their shares which tells me that it's time to bail out.
Harrya

[Socialism cannot compete!]

Harrya...insiders only buy for one reason. But they sell for many. You should be careful about making assumptions as to why they are selling.

[Socialism cannot compete!]

Eric Fox - Americans use about 20x per capita what Indians and Chinese use; do you really think that at over 1 billion people each, their demand is only going to grow by 400K BPD? Their middle classes finally are getting on the road...this is only going to accelerate - you better look for 2 billion BPD *each* in '09. Research, my friend.