A Long-Term Play In Oil Markets

For those that follow energy markets it is often easy to lose sight of the timescale off which the major companies in the sector make their decisions. We tend to follow the daily gyrations of oil and natural gas and base our decisions on those movements. Large, integrated, multi-national firms, on the other hand, have learned that most of the time those short-term moves are irrelevant, and base their decisions on their outlook for decades ahead. That means that while energy stocks of all kinds respond to short-term moves in the price of oil, drops in stocks whose business is long-term in response to a drop in oil can often represent an opportunity.

We saw just such a drop this week. The news that Saudi Arabia had ramped up their production by more than generally expected and a lessening of short-term supply worries caused crude to collapse on Wednesday, posting the biggest one-day decline in two years. Energy stocks reacted as you would expect, and in many cases that sets up an opportunity to buy at a discount. The best opportunity there is in oilfield services, where the longer-term outlook combined with historical price action suggests that business will not be hit hard, even if, as I expect, crude continues to move lower in the immediate future.

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Even just a quick glance at the one-year chart for WTI futures above puts Wednesday's fall in perspective. Crude has been on a sustained upward run and in many ways a correction, even a quite large correction is overdue, but the fact remains that we have been trading above the $60 level since February, and the average price over the last quarter has been closer to $70. It is that, not daily moves that will be influencing the investment decisions of oil companies and that bodes well for oilfield service companies.

Keep in mind that supply, and therefore investment in field development has been kept artificially low by the agreement between OPEC and others to cut production in order to boost price. We saw at OPEC's latest meeting however, that that agreement is drawing to a close, even if gradually, so a boost in capex spending by major producers looks almost inevitable.

Everything seems to be suggesting that buying oilfield service stocks makes sense, but two questions remain. Firstly, which stocks to buy, and secondly when to buy them.

Because of the previous restriction, the biggest boost to investment over the coming months is probably going to be outside the U.S., so international exposure matters. On that basis one could make a case for Nabors Industries (NBR) but they have been struggling with cash flow for a while, so may not be positioned to take advantage of a boost to business. Schlumberger (SLB) also has big international exposure and has been piling up cash for a while. That would be my pick, but the question of timing is an interesting one.

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As I said, I expect crude to continue to correct for a while, which raises the prospect of a better entry point. Because of that, investors should look to average into a position rather than fire with both barrels immediately. Staggering your investment over a few weeks will allow you to smooth out short-term volatility and position for longer-term appreciation, so, much as I generally dislike averaging on the way down, in this case it looks like a smart trade.