The onshore and offshore rig services industry has gone through torrid times in the last 6 months due to a steep decline in oil and gas prices. The rig count data provided a good indication of the steep slowdown in drilling and exploration activity in the United States. In the last one year, the rig count has declined by 972, as energy companies have cut back on their capital expenditures due to lower oil prices. This article discusses the latest rig count data and the factors that are likely to determine the direction of oil prices in the foreseeable future.
For the week ended March 22, 2015, the US rig count declined by 3, an indication that the industry seems to have bottomed out. I also believe that the rise in stock prices of some onshore drilling services companies is another indication that the industry has bottomed out. Helmerich & Payne's (NYSE:HP) stock has trended higher by 23% from the day oil prices bottomed out (January 13, 2015). Patterson-UTI Energy's (NASDAQ:PTEN) stock has also surged by 52.5% during the same period.
It is important to note here that oil prices (BRENT) bottomed out on January 13, 2015 at $45.13 per barrel. Oil is currently trading 44% higher at $65. Therefore, the rig industry seems to have discounted the worst, and I don't believe that there will be further revisions in capital expenditures to the downside in the second half of 2015.
The first reason to believe that oil prices have bottomed out is the chart below that gives the global production and consumption estimates for 2015.
It is clear from the chart that the supply-demand balance is likely to improve by the end of 2015 and this factor is already being discounted by relatively higher oil prices. One factor that can offset the global supply-demand balance is production from Iran. However, I believe that it is too early to expect strong production from Iran in 2015 even if the nuclear deal goes through and the sanctions are lifted.
I must add here that markets have also discounted geopolitical factors in the current oil price. It was reported by Al-Jazeera that fighters from ISIL have set a large part of Iraq's largest oil refinery on fire. These events are likely to be oil price supportive and I don't see any decline in geopolitical tensions in the Middle East. I would also add to the global geopolitical tensions the fact that China is getting aggressive in staking its claim on the South China Sea and the US opposing the move. While I would rule out a direct conflict, continued "war of words" are enough to keep global markets on an edge and oil is likely to trend higher in such a scenario.
Another important reason to believe that oil might have bottomed out is the dollar. In few of my recent articles, I had discussed FOMC views and noted that policymakers see a strong dollar as a big concern for the economy. With some signs of weakness in the US economy, the dollar is likely to weaken in the coming months and I believe that this will support oil prices to some extent.
In conclusion, I don't believe that oil is likely to come down to $45 on the Brent. With oil likely to have bottomed out and the inventory gap likely to narrow, the onshore rig industry will possibly stabilize in the coming months. I don't see oil and gas companies cutting their capital expenditures again in the second half of 2015 and this will ensure that the rig count remains stable for the foreseeable future.
From an investment perspective, I had upgraded my view on Helmerich & Payne on April 3, 2015 and I continue to maintain a positive view on the stock. Helmerich & Payne has low leverage, premium land rigs and a good revenue visibility. In my view, the company is well positioned for growth considering that the modern rigs will find takers when market conditions improve.
I must also add that investors can consider exposure to the broad energy sector, with oil prices likely to have bottomed out in early 2015. The Vanguard Energy ETF (NYSEARCA:VDE) is a good investment option for broad exposure to the energy sector. I recently wrote on RSP Permian (NYSE:RSPP) and the stock is a good investment option among the relatively smaller players in the oil and gas sector.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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