The Other Gulf's Oil
27 Sep 2005
BJ Services should thrive -- eventually.
Please read this first: Following is an independent investment commentary and analysis from the Reuters.com investment channel expressing views that are not connected with Reuters News.
BJ Services (BJS) was having a great year prior to the massive hurricanes that ripped through the Gulf, as demand for oil had fueled growth in oil company capital spending. Its patented equipment processes and an expertise in pressure pumping helped drive business to BJ Services ahead of rivals. Then Katrina hit, leading to more uncertainty. Recently, BJ Services appeared on the Reuters Select Favored Value screen (as well as the Industry Leaders quality screen). While the damage to the Gulf oil rigs may slow it down in the near future, BJ Services should prosper in the long term.
BJ Service's presence in a value-category screen makes it eligible for inclusion in the Reuters Value Review Model Portfolio. This premium monthly newsletter highlights our top value stock selections, based on proven value and income screening criteria. To learn more about the Reuters Value Review Newsletter and see the full Model Portfolio, including whether or not BJ Services makes the grade, click here.
The Calm Before The Storm
On the one hand, BJ Services is easy as pie to write: The investment thesis remains the same pre- and post-Katrina (and possibly Rita; the storm hasn't really hit as I write this). Recent gas prices are a more or less direct result of insufficient supply. There was therefore an incentive to build more capacity, as higher prices will reward the market participants best able to supply fuel. In this respect, the only thing that Katrina did was to reduce supply even further: Eight refineries in the Louisiana area were taken out of commission, at least temporarily, and several are still out.
It is said that few struck it rich panning for gold in the Wild West. While thousands flocked to California to stake their claim, few struck it rich. In the economic history books, the pleasure of wealth went to those few who won the gold lottery and those who sold the equipment to all the hopeful.
Gold is nice and shiny, but oil is a cornerstone of our modern economy. Today, it's not the hopeful itinerant who buys the pan, it's the international oil conglomerates who buy the drilling equipment.
BJ Services is one of the companies who sell the equipment. Hopefully, the analogy will hold.
In any case, looking at the competitive landscape, BJ would seem poised to benefit from the developments in the Gulf, at least in the long run. Its primary competitors, Schlumberger and Halliburton, are off on adventures in the Persian Gulf or on adventures in information management. And, in any case, BJ has several patents to aid with drilling in inhospitable environments.
It developed a system called Excape, for instance -- whoops, there went my spell checker -- that helps companies to dig deeper. I'm no oil man, but it looks like it lets the oil rig dig through several layers of earth, each of which contains oil resources. Then it lets the companies recover the oil from each layer, top to bottom. I don't pretend to understand it, but it looks like a big deal on their Web site, and I bring it up only as an example of its patents.
The Storm
Now, all of this was true pre-Katrina. The big question is how this will play out post hurricane.
Equipment was, of course, damaged by the storm, but, as I understand it, the offshore oil rigs that were lost were old rigs with only dregs left. (As I said, I'm writing this during Rita -- what is she moving, one inch a day? -- so the situation could have changed by the time you read this.) However, because the pipeline network that runs underwater was damaged (and by Ivan, not Katrina), oil production in the Gulf of Mexico has been about halved.
I am far more of a techie than I am an oil man (as in, I've never worked on, around or seen a rig, though I do drive a car). Nonetheless, there's a principle when a computer component fails: replace upward. Truth is, there's little point sticking a straight BJS.Nnt in for, example, a burnt CPU. If a CPU dies even six months after purchase, it's hard to replace, and you can usually get a substantial upgrade for about what you paid originally. It is my opinion that the oil companies will find the same thing for their damaged rigs (is the field really dry, or dry only to 1960s tech?) and, ultimately, this will be a big deal for the oilfield equipment companies in general and, specifically, for BJ Services and its expertise in pressure pumping.
That's relatively long term, though. In the meantime, I repeat, production in the Gulf of Mexico is about half what it was earlier this year. Step one for the oil companies is probably going to be to get the refineries back up -- after all, the Federal government has tapped the oil reserve, so supply at the drilling stage isn't the true bottleneck right now -- and only then will they spend on drilling infrastructure, and then only if the price of oil rewards it. That translates, in my view, to a relatively poor fiscal fourth quarter for the company (ending September), an uncertain fiscal first quarter 2006 depending on how quickly the Gulf refining capability comes back, and a robust second quarter.
Oil Prices
I'm of the opinion that far more can happen to shock oil prices higher rather than lower right now. Still, oil prices are notoriously difficult to project, even for oil companies. Difficult as in "My guess is as good as yours." If your guess is that oil prices will fall sharply in the next three months, then my analysis is probably not going to appeal to you.
My analysis indicates a potential earnings growth rate of 16.0% for BJ Services, while the share price seems to reflect an 11.1% growth rate. This may well be enough of a discount for some value investors to take notice, but I think that BJ Services might well decline if its fourth fiscal quarter is underwhelming -- prior to Katrina, BJS was having a great year. In that case, the discount could be even more attractive, and well worth a look.
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