Offshore Drilling Bits
February 26, 1999
Number 29
Written by: Mike Simmons, Offshore Rig Broker and Consultant
It's The Oil Price Stupid! -- Revisited
Most of you "seasoned" subscribers are well aware of my mantra "It's
The Oil Price Stupid!". This simple explanation of gloom and doom --
or prosperity -- in the oil patch cuts to the root of economic
conditions in the oil patch. Forget the predictions, the
explanations, the analysis. The money oil companies make from selling
oil pays ALL the bills and provides ALL the profit for those companies
in the patch.
Most oil service companies are dedicated to the oil business. As a
group, they have very little diversity in other lines of business.
They stick to what they know -- for better or for worse. And in some
cases, till death do us part!
The stocks of oil service companies move and groove to a slightly
different drummer. As with other industries, oil service stocks are
subject to the daily influence of a wide variety of players, agendas
and assorted poppycock that have nothing to do with the underlying
business (fundamentals). The oil service stocks DO have a lot to do
with the current and future expectation of the price of oil.
But how does a person know when to buy the stock? Do you wait until
the oil price moves higher and miss what could easily be a 30-40%
stock increase? Or do you just buy now and hope for the best and hope
it doesn't take 2-3 years for higher oil prices to come?
Maybe it is worthwhile to read the tea leaves. Maybe there are a few
things to keep an eye on that will signal an improved environment in
oil prices. Don't get me wrong, I'm not saying one should be
predicting oil prices -- no one can. But I think there are a few
things to watch for.
My pal "Slider on the Black", an internet legend, asks if anyone is
watching the E&P's as an - "It's The Oil Price, Stupid" indicator? He
continues...
Maybe they should be. Salomon Smith Barney just upgraded the sector
and raised natural gas price estimates to $2.75 from $2.35 for 2000.
(Near-month natural gas price is $1.65.) The forecast is based
primarily on a falling drilling rig count, which has cut the number of
wells drilled and will curtail future production. Plus, with current
onshore rig activity don't expect gas reserves to be fully replaced.
This is simply a grade school math problem. No rocket science needed.
SSB says it raised the ratings on natural gas companies in
anticipation that gas prices are close to, or have hit bottom.
The lack of drilling will diminish production to where it can only
support average demand draws. Is this an early indicator? Could be,
but this song has been sung for 20 years. But if logic prevails, this
is a great time to be buying the low-debt, low-cost Natural Gas
producers.
When we see support in these E&P's, it may be the time to feel
confident in buying oil service stocks on dips and into selloffs -- to
start building a position. If the E&P's follow oil service stocks down
in lockstep, it may not be the time to buy. Watch the stock prices of
E&P companies for early signals.
All things considered, there is a good window of opportunity here to
make well hedged, risk/reward bets. The oil service stocks as a group
have strong technicals -- Bollinger Band violations, Stochastic buy
signals and even the virtually "impervious quadruple bottom" (those
were the words CNBC used!).
If one is a long-term "value" investor - it rarely gets any better
than this. We have fundamental and technical support ranges virtually
cut into stone here with a 4-peat bottom trading range. Added to that
are the early-signal indicators starting to take shape.
Granted, "demand" (or lack of demand) has been the keyword of late.
However, crude prices require just one side of supply/demand to be
"flat" and the other side to be "addressed", managed or recovering for
oil prices to improve.
You do NOT have to have positive, simultaneous, supply/demand
scenarios. But when you do - you would then have a roaring Bull-Crude
market. If that's what you're waiting for - "leave now" - as you are
NOT a true cyclical commodity, or value investor! The "Mo-Mo" game is
an entirely different game.
For shareprice appreciation to occur from present levels, we merely
need the forward looking expectations of the oil price "drivers" to be
positive. Currently we have, at worst - "flat" demand indicators. Asia
is no longer declining and the conservative argument can be presented
that it has even moved upward after actually bottoming.
Asia may just now be actually rearing her head towards more than just
mild upside demand surprises. As with South Korea's mere two-month
revision of -2% growth to +1% growth, we have success stories popping
out all over Asia.
Yes the "Bears" keep shouting - "It's All About Japan, Stupid". Of
course Japan is THE catalyst to global "business as normal". But do
the math as the Philippines', S Korea's and Thailand's start showing
upward growth revision after upward growth revision. Their combined
numbers, coupled with an indisputable worst-case bottom in Japanese
oil demand, presents an ever growing demand driver. These drivers are
slowly progressing to increased global demand numbers that can no
longer justify $10-$12 oil prices at present production levels.
Production may actually be the key early-indicator to watch. We can
only "manage" the demand side to a minor degree. (We can immediately
cut production, but we can't immediately ramp up demand.) However,
with global reflation, international interest-rate cuts coordinated by
Greenspan & Rubin et al - demand, growth, liquidity and inflation will
once again ride into town.
The factoring of this global pump of money into the system has not
been seen and will not start to show it's inflationary face for a few
months. But watch other extra-early indicators such as the currencies
of commodity exporting countries like Canada and Australia for upside
inflationary commodity signs.
And guess what? They are already showing up! The "Old World Smart
Money" is starting to point out these indicators and are selling Big
Caps and rotating to the papers, the chemicals, other cyclicals and,
you guessed it -- energy stocks.
For anyone to discount the move by Warren Buffet here into chemicals,
may be to miss one of the World's great early indicators. Yes, Mr.
Buffet is also of the - "arrive early to the party crowd".
The signs are here, right here - right now. One has to do more than
simply keep an eye on the OSX index, or to wait for $15 Crude before
buying these stocks. Most of the "real money, and most importantly
what is likely the "safe" money, will already have been made when the
rest of the world acknowledges that yes indeed, the Oilpatch is once
again the place to be.
**********************************************
...A Few Thoughts on R&B Falcon
The company getting the most attention these days in the press and
around the water cooler is R&B Falcon (FLC). FLC's size, the high
degree of leverage, the numerous construction projects underway, rig
utilization and day rates showing no promise, lack of capital
access -- you name it, FLC's got it. The biggest company in the
drilling business could be the first casualty of this bust if oil
patch conditions don't improve in time. Or if FLC doesn't manage its
way out of the "mess". The following is a look at FLC through the
eyes of a stock trader, "Slider".
This is a historically tight financial market right now -- especially
in the energy industry. Reportedly, there are major players in the
banking business that can't get a dime. Credit/liquidity has possibly
never been this tight in corporate high finance.
The prospect of FLC issuing convertible preferred stock (in accordance
with a shelf registration filed late 1998) may be the reason for the
FLC sell off of late. The market couldn't be thinking Chapter 11.
Anyone who does the math knows bankruptcy isn't a near-term factor -
not even close. The company will have strong cash flow even beyond the
worst case model of any analyst out there. And will still be
profitable.
While the speculated issue of preferred stock is not great news - it's
no longer even news - as it has been fully factored into the price of
the stock.
What FLC will likely do is use it's industry-leading leverage position
to "re-do" its debt maybe 9-12-18 months from now. Their cash flow
and earnings will be upside leveraged to expected rising oil/gas
prices and increased drilling activity. The company will have a better
banking and financial market in which to negotiate as well as a lot
more internally generated cash to work with.
While FLC is hardly the posterchild example of a Widow & Orphans
Drilling Stock, the market presents the highest return opportunities
in just these types of scenario's. The emotional downside
over-reaction, doom and gloom to the high-debt companies, offers
disproportionate discounts to their inherent real value as opposed to
other companies. Read -- high risk, high reward.
If we return to $15-16+ crude prices within 12-18 months, few, if any,
other oilpatch company will have more upside appreciation leverage
than FLC. On the other hand, if we stay in a 3-5 year window of $10-12
oil - it's 1929 in the 'Patch. That's the bet.
FLC gives the highest odds on the track in an 18-month race towards
merely a stable $12-14-15 oil price environment. A gamble for sure,
but then again, just being in the oilpatch is a gamble! |
