67 WALL STREET, New York - February 7, 2012 - The Wall Street Transcript has just published its Oil & Gas: Exploration & Production Report offering a timely review of the sector to serious investors and industry executives. This Oil & Gas: Exploration & Production Report contains expert industry commentary through in-depth interviews with public company CEOs, Equity Analysts and Money Managers. The full issue is available by calling (212) 952-7433 or via The Wall Street Transcript Online.
Topics covered: International Increase in Capital Expenditures - Rising Costs of Equipment and Services - Shale, Offshore and Deepwater Drilling - Consolidation to Achieve Economies of Scale
Companies include: Anadarko (APC); BP (BP); Baker (BHI); Cameron (CAM); Cenovus Energy Inc. (CVE) and many more.
In the following brief excerpt from the Oil & Gas: Exploration & Production Report, interviewees discuss the outlook for the sector and for investors.
James West is the lead oil service and drilling Analyst for Barclays Capital. Mr. West joined Barclays Capital in September 2008, and prior to that he was at Lehman Brothers beginning in October 2000. His broad coverage universe includes large-capitalization, diversified oil service companies, niche technology providers, offshore and onshore contract drillers, supply vessel providers and energy capital equipment companies. Prior to joining Lehman Brothers, Mr. West worked at Donaldson, Lukfin & Jenrette. He earned a B.A. from the University of North Carolina at Chapel Hill.
TWST: What other factors or themes will drive this international upcycle? Which companies are best positioned to benefit as these themes play out?
Mr. West: There are a variety of kind of major themes going on in the industry right now. One is that international cycle that I mentioned, but I think within that international cycle we are seeing a push in the offshore markets, and particularly in the deepwater. And that has to do with several factors: one being the resource nationalism that's occurring in certain markets around the world, where the IOCs can't operate; number two, the technology advancements that have been made in the industry in the last 15 to 20 years have allowed us to explore and drill in deepwater in an economic fashion; and three, the commodity prices of course support of the major deepwater campaigns, and so we think that a lot of the kind of growth will be above and beyond the industry growth is going to occur offshore, and a lot of that is going to occur in deepwater and the deepwater subsea-type markets, and we think that because this is an offshore theme because it is international because it is subsea, there's two areas of the industry.There are three areas of the industry that actually benefit pretty significantly from this.
One is the large-cap diversified service companies, so Schlumberger (SLB), Halliburton (HAL), Baker Hughes (BHI) and Weatherford (WFT) clearly are the leaders in the service industry internationally. In North America, you tend to have more smaller competitors. Internationally, it is the Big Four, as we refer to them, and these are the companies that supply a lot of the high-end technologies that use offshore deepwater rigs. And the second area is the capital equipment suppliers, the companies that build rigs like National Oilwell (NOV), the companies that supply a major piece of equipment like Cameron (CAM), and Cameron is the leader in blowout preventers - which following the Macondo incident, the focus on blowout preventers has increased dramatically, and as a result Cameron's aftermarket business on blowout preventers has also increased somewhat dramatically and we think will increase further from here. And the third area is of course the rig companies and the logistics providers, so the rig companies that drill these wells. We just saw recently that Noble (NE) signed a contract for an ultradeepwater rig with Shell (RDS-A) in the Gulf of Mexico, which if they achieve their bonus, which is about 15% potential bonus, they would be above $600,000 per day - that is the day rate for that rig. Right after the Macondo incident, deepwater day rates were about $400,000 a day, and the last kind of eight to nine months, we have been bouncing around $450,000 to $500,000. It was only recently that we hit $550,000, that was probably two months ago, and now we are looking at potentially about $600,000 a day, so you've already seen the benefits of that growth in deepwater and a shortage developing for deepwater rigs, so companies that have either deepwater rigs like Transocean (RIG), Noble and Ensco (ESV) we think are well positioned, and then the companies that support those rigs like the supply vessel providers. Tidewater (TDW) is the biggest, the largest and a global provider, and they should clearly benefit from just supplying crew and equipment and services to these rigs, and Hornbeck Offshore (HOS) is actually one of our favorites. It's more levered to the domestic market of the U.S., Gulf of Mexico, and is a premium asset provider as well.
TWST: Your coverage broad and there are several subsectors you follow within oil services. Is there one in particular that you would say is the best way to get exposure to the space in 2012 and why?
Mr. West: There is, and it is the big-cap diversified service companies. And it really has to do with: one, they are positioned internationally; two, the technology they provide to the offshore market in the deepwater markets; and number three, they are actually, in terms of valuation, are amongst the cheapest in the overall group. The Big Four oil service companies - just based on current multiples, current forward 12 months, price-to-earnings multiples are trading at about 11 times earnings - their historical average over the last five years is about 16 times earnings. So these stocks have decoupled from the overall oil service group, and they decoupled from the oil prices well, and so we think they recoupled to both of those - that will provide an outsized performance for those four, that will be Halliburton, Baker Hughes, Schlumberger and Weatherford.
TWST: You expect the North American market to remain resilient in 2012. What are going to be the growth drivers?
Mr. West: North American markets have changed dramatically in the last decade, and the first change is, of course, the explosion in shale drilling activity, and the second change was the oil renaissance, the move back into oil-directed drilling activities. So first we unlock the shales with natural gas. We use a lot of service intensity to make that happen, and of course, we have driven down natural gas prices as a result. As gas prices weakened, these big companies shifted their portfolios towards more oil or liquids, which plays where the economics are superior to gas plays at this point, and so over half of the U.S. rig count today is directed towards oil. We think a large chunk of the rig count classified as gas rigs is actually joined for liquids, and so liquids that are associated with gas and so they are probably unlikely to be affected by the falling gas prices. And the actual number of rigs joined for pure dry gas, which would be most impacted by very low gas prices, is fairly small at this point. So we think spending will increase on oil plays because economics at oil plays are very good.Oil prices have rebounded in the U.S. to close to $100 per barrel, and we also see increased interest from the major oil companies and from national oil companies and the interests are somewhat varied. I think the majors see North American acreage as great assets in their portfolio, and they want to invest in them. National oil companies want to be part of this investment cycle, but the national oil companies and the majors also want to take the learnings that they are going to have from shale development in North America and take these abroad into international shale plays as international shale plays develop all the time.
TWST: What are the most significant potential headwinds you are going to be monitoring this year?
Mr. West: I think a lot of risks are on the macro side. The European debt situation and the concerns around China are valid and they are real, and we are watching the situation closely. If we were to see credit contagion like what we had in the global markets after the collapse of my former firm, that would put some slowdown on the growth in the industry and could cause oil prices to come down and perhaps come down significantly. So like everybody else who covers any kind of equities, any kind of investments, we are closely monitoring the macro. I think on the micro side, natural gas is probably our biggest concern right now. Natural gas in the mid-$2 range makes most gas areas uneconomic and most forecasts and most investors are pretty bearish on natural gas and believe natural gas can fall lower from here. So if it were to fall lower, if we were wrong about the kind of demand destruction for the natural gas rigs, that could put a damper on earnings estimates and certainly share prices for companies that have large exposure to North American natural gas.
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