A Buying Opportunity in Oilfield Services Stocks?

The oilfield services sector has not been kind to investors this year. Only a handful of companies can boast a strong ROI in 2012, the remaining majority is sitting in the red. There’s a long list of variables responsible for this state starting with an uncertain macro environment. However, with valuations in the trough, this could be an opportunity to establish a strategic position in the oilfield services sector.

Essential Energy well servicing rig.

So what happened this year? The third quarter report from Cathedral Energy Services CET.TO 4.35 [-0.01] sums it quite well:

‘The reduction in Q3 Canadian activity levels can be attributed a spring breakup that extended in July due to wet weather and the June decline in commodity prices that resulted in producers suspending and/or cutting back their capital programs as they reviewed their cash flows and balance sheets.?? Despite recovering oil prices and, to a degree, natural gas prices, activity levels in the Canadian market have been significantly reduced from levels of 2011 Q3 and Q4.?? Producers remain focused on their balance sheets with many limiting capital expenditures to their cash flows.?? In addition, producers have had limited access to the capital markets to fund their capital programs.’

Typically, a seasonal recovery kicks in following spring breakup but not this year. The sector got a double wham from extended wet weather and a decline in commodity prices. In October, Canadian industry drilling activity was down 29 percent from last year. Halfway through November activity rebounded as drilling rigs in Canada sat at 384, still down 21% from 2011. One thing is clear here, if you thought Q3 results were dismal dont set your expectations too high for Q4!

The extended wet weather did not help a natural gas market in the process of balancing supply with demand. E&P balance sheets got hit with record low NG and NGL pricing. Ethane and Propane pricing won’t be coming back above $50/bbl in the near term. Macro worries about Greece, Europe and <insert favorite media worry> have left the whole energy sector in the dust with limited access to capital.

As a result, customer demand weakened leading to an oversupply of rigs and services. You will notice from reading many Q3 reports that this reflects in 10% to 30%??lower service costs for E&Ps.??The final cap on most of the oilfield services sector comes in the form of tax loss selling.

But with oil prices hanging on above $80 WTI and the outlook for natural gas prices improving, is this the right time to buy into the sector?

It depends as there are mainly 3 risks to account for;

  1. We have the fiscal cliff to get through first.
  2. Widening Canadian oil price differentials might trigger reductions in capex programs during 2013. Not to forget that a collapse in the price of oil would be devastating for the sector as a whole.
  3. The weather will have the last word when it comes to natural gas. If it becomes clear that this winter is yet another miss, don’t expect any improvement in customer demand. The bears won’t be hibernating this year!

On the other hand, NBF reported that so far 75% of their 17 company survey group increased their 2013 spending budget by 17% compared to 2012. Drilling forecasts are also positive for 2013; PSAC the Calgary-based Petroleum Services Association of Canada says??11,400 wells will be drilled in 2013, up from the expected final tally of 11,250 wells in 2012. While it may not look like much of a bump, keep in mind that 70% will be HZ wells which are longer than vertical wells. That means a??total of 22 million metres of drilling depth will be about equal to 2008, when 16,933 wells were drilled.

Kevin Lo, a services analyst for FirstEnergy Capital Corp., is even more aggressive with his prediction at 12,200 wells for 2013.

In my opinion, investors in the buyer’s camp should focus on the dividend payers. To start with, the balance sheet of these companies are generally in a better shape than E&Ps. That explains why you’d be getting a 3%-6% yield on average rather than 8%+ with E&Ps. ??Go for the established boring outfits:

  • The once promising Gasfrac turned out to be the top loser at -82% in YTD returns.
  • The king that was Poseidon Concepts is so far sitting on -57% in YTD returns.

There are defensive stocks in this sector like the work camp providers??that are also a call on Albertas oil sands. Exposure to water management solutions can be acquired through competitors of Poseidon. The idea is to go for companies with multi-business segments.

Finally, E&P companies cannot afford to sit on their hands; they need at a minimum to maintain production especially if theyre paying a dividend. If not, the growth model implies ??growing production year over year or no one would hold their stock. Getting over the fiscal cliff coupled with an improving picture for natural gas prices would lift the whole sector. In my opinion, dividend paying OFS stocks provide another low risk call on higher natural gas prices.

What is your top oilfield services stock pick?