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Oil Field Investment Steadier Than Service Stock Rout Implies

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NEW YORK (Dow Jones Newswires), October 16, 2008

The six-year boom in oilfield services spending is over, but exploration and production budgets aren't being slashed to the degree plunging service company shares suggest.

The oilfield services sector has been hit hard by expectations that falling oil prices will force delays on greenlighting new oil projects worldwide. Oil prices have dropped 50% since peaking in July on declining demand, and forecasters now expect prices to remain in the $70- to $90-a-barrel range through 2009.

The drop comes at a time when new barrels are more expensive to discover and produce than ever before. A few of the most expensive projects, involving oil sands, are already below the break-even point and are likely candidates for delays, and natural gas producers in the U.S. have cut back recently due to weaker demand and problems securing credit. The Oil Service Sector Index, which tracks 15 companies' shares, is down 45% in the last four weeks, about twice the decline in the S&P 500 or major oil companies over the same period.

Declining oilfield services stock prices reflect a widely held belief that a global recession will force oil majors and national oil companies to cap budgets that have expanded steadily for years. Yet there is little evidence of imminent, widespread spending limits outside North America. Recent statements by some of the world's biggest producers indicate oil prices have further to fall before long-term plans must change. Forecasters also still generally see oil prices rising above $100 a barrel in the next few years, providing the stable outlook companies need to approve new projects.

"If you look at international activity, most of it is oil-related and most of these are fairly large, multi-year projects," said H. Gene Shiels, assistant director of investor relations at Baker Hughes Inc., one of the world's largest oilfield services companies. "Those don't, from a historical perspective, ebb and flow with commodities prices."

Full Speed Ahead  

Analysts see a recession hobbling oil prices in 2009, but expect tight supplies to force the market higher after that. Goldman Sachs Group Inc. analyst Arjun Murti and Credit Suisse analysts both forecast an average oil price of $75 a barrel in 2009, rising to $100 in 2010.

Exploration ventures aimed at addressing concern about future supplies have provided the backbone for what Andrew Gould, chief executive of Schlumberger Ltd., the world's largest oilfield services company, has characterized as a "stronger for longer" boom in spending.

"Our conviction stems from the belief that current investment levels are insufficient to both stem declines and to explore and develop new reserves," Gould said at a recent conference. But he offered the caveat that "a severe global recession leading to a major drop in demand would materially affect this scenario."

Schlumberger is scheduled to report its third-quarter earnings Friday.

Many of these exploration projects remain viable even at oil prices significantly lower than today's levels. Offshore fields usually require oil prices to stay above $40 a barrel at most, compared with price supports as high as $90 or $100 a barrel for some oil sands projects.

Total SA would only reconsider its slate of oil projects if prices fell below $60 a barrel for an extended period, Christophe de Margerie, the French oil major's chief executive said Tuesday. He called that scenario unlikely.

His view is thought to be similar to those held by most international oil companies, which tend to take a conservative approach to capital budgets that changed little as oil prices approached $150 a barrel this year.

Oilfield services companies are counting on the deep pockets and steady nature of companies like Total, which along with nine other oil majors and national oil companies account for about one-third of global exploration and production spending, according to a survey by Lehman Brothers Holdings Inc. at the start of the year. Many of Lehman's U.S. assets, including its energy analysts, are now a part of Barclays PLC.

This month, oil companies continued to sign contracts for drilling rigs as far out as 2011, even as stock markets and oil prices crashed.

"The wells a lot of these companies are drilling ... won't even start production for three, four or five years, so frankly what difference does it make what the price of oil is (today)," said Mike Breard, an analyst with Hodges Capital Markets, which operates a mutual fund with large holdings in oilfield services.

The producers with the biggest budgets also can rely on cash flow to finance new projects, which could render the companies immune to the frozen lending market that has dogged U.S. gas companies. Many gas producers expanded in recent years by borrowing, and have been forced to scale back drilling plans as credit lines vanished.

Although international spending on oilfield services has grown rapidly over the last six years, the U.S. remains by far the largest single market. With the exception of Schlumberger, all large service companies generate at least 40% of their revenue in North America. That portion of their business is far more vulnerable to even a short recession, helping to explain the selloff in oilfield service stocks.

"Domestic ... companies are much more aggressive - quick to accelerate, quick to pull back," said Dan Pickering, head of research at Tudor, Pickering, Holt & Co. "Domestic is more of a speedboat, international more of a tanker."

The international oil isn't entirely free of credit issues. Petrobras postponed the release of its strategic plan detailing investments through 2013 amid speculation the Brazilian state-run energy company would have difficult raising the funds to develop vast offshore reserves.  

Copyright (c) 2008 Dow Jones & Company, Inc.

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