For those of us that pay attention to the Baker Hughes Rig Count, as all energy investors should, it has been an interesting month or so. After one of the most precipitous falls in the number of active rigs in America ever, the rig count bottomed out towards the end of July and has now started climbing again.
As you can see from the chart above, we are still way below the highs, and even the average, but it is now clear that the closures were a bit overdone and there is a clear upward trend emerging. That is good news for energy investors, but it may not mean what you might think in terms of where to put your money.
Most people's reaction at seeing that would be to go out and buy some of the depressed stock in E&P companies or, if you are a bit more conservative, maybe some of the big U.S. integrated oil companies. That, however, may come up against a problem.
The reason for that big drop was essentially demand-based, and the situation there is not looking any better, and could even get worse. The U.S., and much of the rest of the world, is experiencing a serious second wave of Covid-19 infections and shutdowns, even if just on a localized basis are back in the discussion. That would quickly derail the recovery in oil demand, but even if there is not that drastic a response, the rate of recovery will at least be slowed somewhat.
So, what we will be left with is a situation where supply is increasing in anticipation of a demand surge that will,…
For those of us that pay attention to the Baker Hughes Rig Count, as all energy investors should, it has been an interesting month or so. After one of the most precipitous falls in the number of active rigs in America ever, the rig count bottomed out towards the end of July and has now started climbing again.
As you can see from the chart above, we are still way below the highs, and even the average, but it is now clear that the closures were a bit overdone and there is a clear upward trend emerging. That is good news for energy investors, but it may not mean what you might think in terms of where to put your money.
Most people's reaction at seeing that would be to go out and buy some of the depressed stock in E&P companies or, if you are a bit more conservative, maybe some of the big U.S. integrated oil companies. That, however, may come up against a problem.
The reason for that big drop was essentially demand-based, and the situation there is not looking any better, and could even get worse. The U.S., and much of the rest of the world, is experiencing a serious second wave of Covid-19 infections and shutdowns, even if just on a localized basis are back in the discussion. That would quickly derail the recovery in oil demand, but even if there is not that drastic a response, the rate of recovery will at least be slowed somewhat.
So, what we will be left with is a situation where supply is increasing in anticipation of a demand surge that will, at best, be delayed. You don't need an advanced degree in economics to know what that would do to the price of crude in the short-term, and therefore most likely the price of those E&P and big oil stocks.
Longer-term, though, the good news on the vaccine front suggests that a demand boom is coming, so is there a way to invest now, so as to get in early on what could be a strong recovery, without as much short-term risk?
The best solution is to look elsewhere in the oil business, most notably at contract drilling and oilfield service companies. Firms in those areas can benefit from the long-term trend towards more drilling, even if that leads to short-term dislocation in crude prices. Those stocks were hit hard as the rig count collapsed, as you might expect. They have begun to recover somewhat, but still have a long way to go should things improve significantly around the end of the year as many people expect.
In some cases, though, there is a problem. Smaller companies in these fields have been hit so hard that they have been losing money hand over fist for a few months, leaving many with liquidity problems that may hamper them when things improve.
There are two stocks, one in contract drilling and one in oilfield services where that doesn't apply though, and they would be my choices right now to benefit from the situation.
The contract driller is Helmerich and Payne (HP).
As you can see, HP has had a terrible year but, as the rig count has shown early signs of a bounce, so has the stock.
However, HP has managed so far to control losses and costs well and, more importantly, went into the crash with a strong balance sheet. As a result, they still have positive twelve-month free cash flow, almost as much cash on hand as they have debt, good short-term liquidity (a current ratio of over 4), and a debt to equity ratio (D/E) of around 15.5. For comparison, rivals Independence Contract Drilling (ICD) and Precision Drilling (PDS) have a D/Es of 51 and 97, respectively.
That good liquidity and balance sheet strength will give them a big competitive advantage if business expands rapidly and they are ideally placed to benefit. One note of caution; HP will announce earnings next week and, given the period the report will cover, they probably won't be pretty. There is even a chance that they will reduce or eliminate their dividend, which would obviously put pressure on the stock, but there is also a chance, given the turnaround in the rig count, of some upbeat guidance. Still, more conservative investors may want to wait and see what those earnings bring.
On the oilfield services side, I would again go big, with something like Schlumberger (SLB).
The chart for SLB looks remarkably similar to that for HP, and for obvious reasons. This stock too has been basically following the rig count.
One big difference is that the balance sheet isn't as strong as HP's but their liquidity situation is good, with cash flow of around $4 billion over the last year and close to that in cash on hand available to fund rapid growth should the opportunity arise.
The turnaround in the rig count does provide a much-needed ray of hope for energy, but there are still reasons to believe that there will be some short-term volatility. Stocks like HP and SLB may be the answer in that situation as they can still show improvement, even in a lower price environment as oil firms increase output in anticipation of the better day ahead.