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The Coming Year: Oil Service Stocks Face Rough Start
By Mavis Scanlon
Staff Reporter
1/6/98 3:31 PM ET
As the first trading week of the new year opens, investors in
the oil patch should buckle up because the road ahead
looks bumpy.
A rambunctious nine or 10 months led the oil services
stocks to new highs in 1997, but they now find themselves
battling a sea of negative psychology. A brief selloff in the
spring of 1997 was not enough to turn investors away from
the sector, as buyers climbed back aboard for one of the
hottest rides of the year.
Things look different now, however. The overriding market
sentiment seems to be fear, and while many analysts
remain publicly bullish, others are reducing their 1998 oil
price forecasts and earnings estimates of the oil majors..... Questions
concerning worldwide demand growth for oil due to Asian
crisis fallout coupled with OPEC's increased output and new
Iraqi oil coming online are the dominant themes in the first
quarter so far. Also, El Nino is threatening a
warmer-than-usual winter, which can hamper demand.
The supply-demand equation for crude oil will be a major
consideration in 1998, especially for exploration and
production companies who, at some point over the next few
quarters, have to come up with production levels and
spending plans for 1999 and beyond. But the
supply-and-demand fundamentals of rigs, equipment and
workers will also play a major role, as exploration and
production (E&P) companies position themselves to take
advantage of available rigs. Rig dayrates do not move with oil
prices, as one drilling company executive said recently;
rather, they move with rig availability, and there is no doubt
rigs are still scarce......
In the first quarter, crude prices will be crucial in determining
the 1998 outlook on drillers and service companies, even
though most drilling companies have firm contracts for their
rigs throughout the new year. How quickly Asian economies
turn around as well as how the West handles the Asian
crisis will be two major factors driving the price of crude,
whose trickle-down effect to the profit margins of oil and gas
and E&P companies helps determine their exploration, or
drilling, budgets. ....
Since its inception in February 1997, the Oil Service Index
was up 59% through Dec. 31, compared with the benchmark
S&P 500, which rose 21% in the same period. The S&P has
climbed slowly and steadily throughout last year while the
OSX climbed and dipped several times before setting its
record high of 141.211 on Nov. 5. Then, two small bounces
led to the sickening slide that brought the OSX to 109.41 on
Dec. 1, then lower still, to a five-month low of 99.219 just
before Christmas.
Fluctuations in the stock price of Marine Drilling
(MDCO:Nasdaq) during the past two years show why
investors are concerned. In 1995, MDCO rose 82.6%.
Granted, that rise brought the stock to just over 5. In 1996 it
rose meteorically, gaining 248%. For 1997, it ended the year
at 20 3/4, up a scant 5.4%. Although analysts forecast
strong earnings growth for Marine Drilling, expectations of
reduced earnings growth in the sector in 1998 is what fueled,
in part, the selloffs in the past eight weeks. Sustaining
triple-digit earnings increases over a period of years would
be tough for any company, but estimates for many of the
drillers and service companies remain strong -- 30% and up
-- through 1999. The caveat: earnings growth for drilling and
service companies remain inextricably tied to outside
factors.
Drilling in deepwater Gulf of Mexico will begin in earnest in
1998, as drilling companies set up rigs on tracts in the
Western Gulf in water depths of 6,000 to 10,000 feet. The
record-breaking August lease sale for those deepwater
tracts netted the U.S. Department of the Interior's
Minerals Management Service (MMS) nearly $600
million. Shell Deep Water, Texaco (TX:NYSE), BP
Exploration (BP:NYSE), Exxon (XON:NYSE) and
Chevron (CHV:NYSE) are just a few of the majors who
snagged dozens of properties.
Those producers working in deep water "won't be so
concerned about monthly and quarterly price fluctuations,"
says Dan Rice, portfolio manager of State Street Research
Global Natural Resources fund. ....is now stocking up on
E&P companies. Efficient finding costs combined with a
long lead time to develop these properties -- not to mention
the possibility of major discoveries under that deep water --
generate a higher rate of return for deepwater producers,
Rice says.
The major psychological shift that hit investors in the drilling
and service sectors started with a quick selloff on Oct. 28,
the day after Gray Monday. Schlumberger's (SLB:NYSE)
trading volume on those two days shows how quickly
investors took the Asian economic tumble to heart. On Oct.
27, 1,830,400 shares of SLB traded hands. On Oct. 28,
volume rose to 5,362,500. Nevertheless, most of the drilling
and service stocks withstood the selloff and rose to new
highs by early November. But the fear had hit home and
negative psychology toward the sector became almost the
rule rather than the exception.
"The Asian crisis did have something to do with the price of
oil," says Simon Rose, a partner at Prime Charter in New
York, in reiterating the negative reaction on the price of
crude from Asia, Iraq and El Nino. But, he said, "The reality
is that there's still enough demand to support drilling
programs." And drillers are getting equal or better pricing on
the rigs they turn over, he added.
"Our concern is going to be centered around first quarter
1998," Rose says. "If there is no problem in the first quarter,
there's a 60% move" in stock prices. "Psychologically, it's
going to be oil and gas prices, but fundamentally it's going to
be what the [rig] turnover dayrates are and what the E&P
budgets are."
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