Long Term Shareholders:
Hopefully we will find support here in the 29-31 range. My personal opinion is that this is an abberation <sp> , end of the year selling by a few funds to lock in gains and maybe a little fear on the part of some other investors who really feel the price of oil will tank and effect the drillers.
I keep referring back to this article which came out a few weeks ago.
The oil co.'s are apparently flush with cash right now and it would take a major drop in oil prices to effect the capital spending in the sector. According to one analyst oil prices would have to drop to $13-$14 per barrel to have any effect.
Consumption: One analyst says that if oil prices drop it usually creates an even stronger demand for fuel.
I think we have more upside potential but it may not happen until towards the end of the year or after the first. Meantime it's a traders market with the volatility.JMO
Here is the article:
Panelists
James K. Wicklund, Senior Vice President, Senior Oilfield Service Analyst and head
of Energy Research at Rauscher Pierce Refsnes. Mr. Wicklund spent eleven years
in the oil and gas industry working in the areas of finance, geophysics, and engineering.
He has covered the industry as an analyst for the past eleven years.
Thomas R. Bates, JR., President and Chief Executive Officer of Weatherford
Enterra. Mr. Bates has twenty two years experience in the oil and gas industry, holding
various positions with Schlumberger Limited and Shell Oil Co. He has published a
number of papers on drilling technology and other subjects.
Q&A
Briefing: Oil service companies, particularly in the offshore segment have recently seen
extremely strong earnings growth. How long do you anticipate this boom continuing?
What obstacles might curb this growth?
James Wicklund: The oilfield service industry went through more than a decade of
recession/depression following the oil crash of 1986, adding virtually no capacity or
equipment and going through a number of reorganizations to try and stay alive. There
was a brief but unsustained recovery in 1990-1991 but when it failed to continue, again
the industry went through a final round of cost reductions, rationalization of obsolete
equipment and started to focus on computer-aided technologies that were increasing
productivity in other industries. In early 1994, the effects of significantly lower drilling
levels over several years started to be felt, constraining supply of oil and gas, and
demand for these hydrocarbons, which had been moving up steadily for years,
accelerated with higher demand growth for natural gas in North America and crude oil
in developing countries worldwide.
With no capacity added for years, continued attrition of marginal equipment and
increasing demand driving prices higher, activity and utilization of the offshore drilling
rig fleet started to increase significantly. With a fixed operating cost base, higher
dayrates provided dramatic earnings leverage. If a rig with a daily operating cost of
$10,000 per day and a dayrate of $17,000 had its dayrate move up, and today that rig
gets a dayrate of $60,000, operating income increased seven-fold. This increase over
only about 2-3 years has provided the dramatic earnings growth seen. And with
dayrates expected to move up to $85,000-$95,000 per day before new capacity is
added, this growth should continue. About the only potential weakness we see is a
substantial drop in natural gas demand and pricing but with the current reserve base in
decline, continued switching to natural gas as a clean fuel and the shut-down of nuclear
capacity over the next few years, the possibility is remote. An increase in supply of rigs
could shift the economics but with dayrates not justifying new construction and lead
times in excess of two years, there is no near-term potential for over-supply.
Thomas Bates: Sustained growth will continue as long as the supply and demand trend
in the oil and gas sector stays healthy. The underlying fundamentals are stronger today
than they have been at any time in the recent history of the oil industry. Crude oil
demand, for example, has increased by 11 million barrels per day in the last ten years
and it is forecasted to increase by another 16 million barrels per day over the next 20
years. So this demand driven recovery could last 10 years, 15 years or even 20 years
powered by the growing economies in the Pacific Rim. I think the biggest obstacle that
we have to worry about is if the price of oil drops outside of, say a range from
$17-24/bbl, either on the low side or on the high side. At $20/barrel for oil, energy is
very affordable, both in developing countries and in the already developing nations.
Briefing: What role has technology played in the resurgence of the oil service industry?
James Wicklund: Technology has played a very dramatic role and in more ways than
conventionally assumed. Three-dimensional (3-D) seismic technology is the more
heralded and discussed technology of the oil and gas industry over the past several
decades and rightly so. 2-D seismic was the primary method of detecting potential
oil/gas reservoirs for many years but was similar to the old adage of describing an
elephant by feeling its tail. The technology told us that a potential oil/gas bearing
anomaly was in the area but did not define its location. 3-D technology is similar to
throwing a sheet over the elephant. While you cannot directly see the elephant, you do
know its location and shape. As a result, a great deal of unsuccessful drilling is now
avoided. The success rate of finding oil and gas has increased. The cost to the oil
company of finding oil and gas has dropped significantly.
In a broader sense though, this is just a single example of what is happening in the
oilfield service industry. While the oil/gas industry has always been very technical,
desktop computing capability to boost productivity did not come into the industry until
about 4-5 years ago because of the very large processing requirements. While grocery
stores and video stores made use of computer and software technologies to improve
their businesses years ago, the oil/gas industry was still using paper analog displays to
locate oil and gas. With computing costs dropping dramatically over the past few
years, we have seen all facets of the oil/gas service industry enter the computer age,
bringing the same efficiencies and improvements seen in other industries. Inventory
control/bar coding of equipment, CAD/CAM design of equipment, simulation of well
treatments, the ability to steer the drillbit to the exact location and increased
predictability of production have all had dramatic impacts on the efficiency and
productivity of the industry.
Thomas Bates: Technology really has been integral to the growth of the industry over
the last ten years. In the early to middle 1980s, there was demand for additional oil at
moderate prices, but oil companies couldn't produce oil economically for less than
about $30 or $35/bbl in some swing producing locations, like the North Sea and the
deepwater Gulf of Mexico. In the interim, technologies have evolved, including 3D
seismic, horizontal drilling, subsea wellhead and subsea completion technology, and
extended reach drilling. Those developments have made $20/bbl very profitable for
our company clients.
Briefing: Oil service companies have been raising prices as the strong demand for oil
services and equipment outpaces supply. How long do you think this imbalance will
persist? Do you see a point where supply is greater than demand and if so, who will
this effect growth?
James Wicklund: The fiscal discipline of the oil service company managements is
having the greatest impact on these concerns. In previous cycles, oil service companies
would use free cash flow to build more of whatever equipment they offered because
demand was high and they could. Greater emphasis is now placed on return on capital
employed, return on shareholder equity and other measurements that cause
managements to examine potential returns before new investment takes place. This has
had the effect of keeping supply/demand of equipment in much tighter balance and for
a longer period of time, pushing prices higher so that when new investment is made,
adequate returns are generated. This means that there is no real imbalance just a closer
balance than we are used to seeing in the industry. If the company management adhere
to these types of fiscal discipline, the potential of too much supply coming onto the
market is reduced. When the cycle does eventually roll over and the industry has
always been cyclical in nature, than there will be some over supply of equipment but it
will be minor in comparison to the levels seen at the end of past cycles and the
recovery from that point should be sooner and less painful to industry participants.
Thomas Bates: First of all, I don't believe that a strong imbalance exists between
supply and demand. The price movement that has taken place merely reflects the
returns that the service industry requires to maintain its capital base. If there were an
imbalance, you would see speculative increases in capacity and that is not happening.
As a result, I don't see that supply will exceed demand by any significant margin unless
there is a collapse in the oil market.
I think a more important issue is whether today's price increases for rigs, equipment
and services will result in underlying inflation which forces the price of oil up.
Technology is the key to sustained moderation on the price of oil. As long as
technology improves production efficiency faster than prices rise, there will be no
impact on the cost of producing oil.
Briefing: To what level would the price of oil need to drop to pose a threat to the oil
service business? Is this group in a better position now than it was in the 1980s to
weather a slowdown in oil production?
James Wicklund: The increased use of technology we have mentioned has brought the
finding and development costs of oil/gas down dramatically meaning that the economic
break-even point for oil companies is much lower. As an example, all of the deepwater
Gulf of Mexico projects have economic thresholds at about $8-$9 per barrel. Subsea
completions, multi-lateral completions, directional drilling, marginal field development
systems, 3-D and 4-D seismic, all technologies offered by the service industry, help
boost the returns to oil companies in low commodity price environments. The fact that
most of the R&D effort is now done by the service sector rather than the oil
companies, putting the technologies into the public domain much faster, also provides
protection against drops in activity from lower pricing.
All of these factors taken into consideration mean that oil prices would have to drop to
about the $13-$14 per barrel level and stay there for some time before there is a real
threat to the service sector. If commodity prices two years ago had dropped, and they
did in 1992, oil companies would have shifted or cut capital spending budgets in
uncertainty over the future, having a detrimental impact to the service sector. Today, oil
companies are convinced that based on their view of engineering and physics, oil and
gas supply/demand are in such a tight continued balance that any near-term weakness
in commodity pricing would not justify changes in capital budgets.
These continuing improvements in technology combined with memories of the
mid-1980's and the focus on performance based-results will keep the service sector
lean, competitive and in much better shape to weather future shifts in production and
pricing.
Thomas Bates: I think that if we saw a sustained price of less than !16/bbl, it would
create some damage to the prospects for growth. That problem should be
self-correcting because as the price of oil gets lower, it creates an acceleration in
demand for energy. If we go back to the decade of the '80s, we can clearly see the
impact of extremes of price on demand. When the price of oil went up in 1980,
demand dropped by 15% in the space of five years. Then, when the price of oil
crashed in 1986, energy became more affordable and demand recovered very quickly.
Is the group in a better position now than it was in the '80s to weather a slowdown in
oil production? The answer to that is definitely yes. Let's look, for example, at the
drilling rig business. I think it is characteristic of the reticence to over capitalize the
industry. In December of 1981, there were roughly 500 rigs working in the offshore
market, the dayrate for semi-submersibles was $80,000-$100,000/day, and there
were 239 new offshore rigs under construction. Today, we have more or less 500 rigs
working in the offshore market, the dayrates for semi-submersibles are essentially at
the same inflation-adjusted price and today there are only 20 or so rigs under
construction. So I think there is certainly a great deal more restraint in the industry.
There is a whole industry full of executives who have been tempered by the downturn
that we saw in the 1980s. So I think there's a reticence on the part of the management
teams to invest at overcapacity at this stage and that clearly puts us in a better position
to weather any slowdown that might occur.
Briefing: Which companies are you recommending and /or avoiding?
James Wicklund: We are recommending exposure to the offshore and onshore drilling
contractors specifically Falcon Drilling (FLC), Transocean Offshore (RIG), Noble
Drilling (NE), Rowan Companies(RDC), Atwood Oceanics (ATW), and UTI Energy
(UTI). Tidewater (TDW) continues to be our top pick in the transportation sector.
Mainstream oilfield service equipment and supply companies including BJ Service
(BJS), Weatherford Enterra (WII), and Tuboscope (TBI) still represent excellent
investments. 3-D Geophysical (TDGO) is currently our only seismic technology
recommendation but that sector is looking more attractive and American Oilfield
Divers (ADGI) represents our participation in offshore construction. The well service
sector is seeing significant increases in demand due to new re-entry technologies and
Key Energy Group (KEG) and Dawson Production Services (DPSI) are our plays in
that sector. |
