James HesterShares in oil services firms have had a tough time this year, with confidence hit by falling oil prices.
While there is certainly a strong historical correlation between the share prices of oil services firms and crude, investors should not solely focus on current oil prices when considering investing in such companies.
Stock price slump
Schlumberger, the world´s largest oil and gas services firm, has seen its stock price slump by 26% since the start of 2017.
The shares are around 47% lower compared with 2014, when oil was last trading at $100 per barrel. Brent crude oil futures are currently priced at around $52 per barrel, having eased from $57 since the beginning of the year.
However, beaten down oil services stocks should not be written off altogether, especially as many have been engaging in cost cutting, restructuring and consolidation over recent years.
In Schlumberger´s case, there has already been some tentative recovery in revenues.
Spending squeeze
There´s no doubt that the slide in oil prices since 2014 has had a big impact on the industry. A plunge from $100 per barrel to lows of $30 per barrel early last year brought about a sizeable squeeze in spending on the part of exploration companies.
Drilling was scaled back dramatically in the face of such a sharp turnaround in prices, resulting in a major fall in demand for the oil and gas services sector.
Schlumberger´s revenue is still a long way off from recovering to the heady heights of three years ago. It generated revenues of $36bn in 2015 and $28bn for 2016, versus around $49bn in 2014.
Nevertheless, sales improved 6% and 4% versus the year-ago period over the 2017 first and second quarters respectively.
Blessing and curse
For Schlumberger, a sharp pickup in North American exploration activity is making up for continued declines on a global basis.
Revenue from its North American operations is up by around a third year-on-year, as the region´s drilling activity enters a strong recovery. In contrast, international revenues are down by 4%.
Technology advances mean US explorers are able to break even at lower oil prices – below the $40 per barrel mark.
But this is both a blessing and a curse for the oil services sector.
Exciting trend
Rising US output is among the factors that have been weighing on oil prices this year, making investors more cautious on the energy sector in general.
Lower oil prices mean international exploration and development companies are still reining in production.
At the same time, the recent drilling upsurge in the US, which has been concentrated around the Permian Basin, is an exciting trend for oil services firms.
Consolidation
Along with cost cutting and restructuring, the slide in oil prices since 2014 has brought about a wave of consolidation across the industry.
Survival of the fittest is at play. The upshot though is that even a relatively modest uplift in oil prices by historic standards, say to $60 per barrel, could result in a big improvement to the bottom line for the industry survivors.
Again, Schlumberger has announced a range of acquisitions over the past couple of years that strengthen its long-term position in the sector. The most significant of these deals was its $15bn purchase of rival Cameron last year.
It´s a trend that´s been played out around the world as oil services firms across the market-cap spectrum struggle to recalibrate their businesses.
In the UK, John Wood Group and rival Amec Foster Wheeler, both of which are major players in the North Sea, are close to completing a £2.2bn merger. Prior to Wood Group´s takeover approach, Amec was considering launching a major rights issue.
Longer-term outlook
Earlier this week, Wood Group reported a 77% fall in pre-tax profits for the first half of the year.
For Wood Group, improvement from US onshore activity over the first six months of 2017 was more than offset by weaker activity in the North Sea.
While Wood is forecasting improved performance for the second half of the year, it also hopes the Amec merger will help diversify its client base across industries other than oil and gas. At the same time, the latter will continue to be the enlarged business´s main focus.
Again, while near-term prospects may appear subdued, the longer-term outlook for such firms could be more compelling, especially if we see a meaningful pickup in oil prices.
