Oil Service Stocks: Not a Bargain

Written By Christian DeHaemer

Posted July 16, 2010

The one thing I love about the markets — and industries in general — is that they never fail to surprise you. 

Just when I was thinking the low price of natural gas at around $4 a mmbtu would ensure the underdevelopment of fracking reserves…

And that Obama’s newest anti-business move to shut down offshore drilling would necessarily translate into a decimation of the rig count…

It goes on and hits a new record.

For those who don’t know, the rig count is simply the number of oil or gas drilling rigs that are currently being used at the moment.

According to Baker Hughes, the on-land rig count in Louisiana has reached an all-time high in the second quarter with 174 rigs. That’s up from 163 in the first quarter. 

And even more startling, the number has doubled in the last year.

This is directly due to the development of Haynesville shale. Not only are these sites economically viable at the current low price of natural gas, but many operators must drill in order to hold their leases.

And it looks like these drill rig rates will continue to expand unless the price of natural gas drops precipitously.

That’s just not going to happen.

Natural gas cooking

Nat Gas

As you can see by the chart above, the price of natural gas in the U.S. has put in a floor at $4. 

Just yesterday, the front month contract for natural gas jumped 23 cents to $4.85 based on storage news from the federal government.

It appears that natural gas in storage is lower than it was for the same week last year. The EIA says that there are only 2.68 trillion cubic feet of working gas as of June 25, 2010. This represents a 1% decline from the previous year.

One percent might not seem like a lot to you, but it was enough to push prices as high as $4.92 yesterday, up from $4.53.

I believe it was two weeks ago in this space that I told you that natural gas had bottomed.

In fact readers of my Crisis and Opportunity trading service made 59% in four days on this move. (Not that I’m bragging, of course.)

But the past is the past; that move is over.

The question now is how you can benefit from the new move in the number of rigs. Or more specifically, how can you benefit from the companies that lease rigs or make products for the natural gas fracking industry.

Because the shale companies that use the horizontal rigs are the ones seeing the activity — service companies like Smith International (SII), Halliburton (HAL), and Baker Hughes Incorporated (BHI).

These companies have p/e ratios of 144, 40, and 25, respectively.

You would think that after the past year of flat oil prices, these companies would be dirt cheap, but that just isn’t the case.

Smith saw revenues decline 11.30% last year and earnings dropped 88%. Even Halliburton — with its liability hangover with the Gulf of Mexico spill — is doing quite nicely, thank you very much.

Take a look:


As you can see from the chart above, it’s only about 10% off its 52-week highs. 

Halliburton reports earnings on July 19. We will know how this rally stands after that.

Schlumberger Ltd. (SLB), the country’s second biggest oil service company, reported profit of 28 cents per share in the first quarter of 2010 — 2 cents above the consensus estimate. The stock is down $2 today, to $57 and change.

The upshot is that despite the record number of land rig rates and the fact that the oil service market is bouncing back off its lows, Wall Street has priced this in and is punishing even those that beat expectations.

You would expect that with all the negative press and Obama’s ban on deep water drilling that there would be tremendous buys in this field. 

But there aren’t. Take your money elsewhere.

Heck, even Big MO is paying a 6.6% dividend (NYSE: MO).


Christian DeHaemer
Editor, Energy & Capital

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