Concentrated oil services sector looks to shrink, again
The best way to think of oil services companies: a levered bet on the marginal cost of oil production relative to the price of oil. And with oil prices falling sharply, it is no surprise this concentrated industry is looking to shrink again as Halliburton and Baker Hughes hold deal talks.
Explorers use the expertise and equipment of companies such as Halliburton, Schlumberger, Baker Hughes and Weatherford to get oil out of the ground. If explorers can’t make it economical to drill, there is no need for support services. Since peaking in July, the shares of these four services companies have fallen by an average of 24 per cent.
The companies’ tone in their third-quarter conference calls was oddly bullish. Even with slowing global GDP, Halliburton and Schlumberger predicted that oil demand would remain healthy, citing International Energy Agency world oil demand growth expectations of 1 per cent in 2015. The recent price collapse has been a function of excess production, they asserted. But the supply glut could reverse quickly because of risk in Iraq and Libya.
The US is the main cause of the service companies’ underperformance. Ninety per cent of worldwide oil supply growth in the past three years has come from the US. This had been a boon to the companies because of the complexity of recovering that oil from “unconventional” shale deposits. Third-quarter results from US explorers made clear that cash concerns will curtail investment. Credit Suisse has lowered its US oil rig count estimate by 15 per cent for 2015.
Still, the bank forecasts oil production will pick up in 2016, as 2015 supply cuts leave demand unmet. With Baker Hughes’ current forward earnings multiple down 36 per cent from its peak, it is understandable why Halliburton would come knocking. Why Baker would sell at this moment is less clear.