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Falling production volumes from existing oil wells, coupled with high oil prices, have increased the incentive for big oil companies to invest more in exploration during the past two years. This has driven oil companies to some hostile environments, resulting in some very heavy capital spending. For example, the recently completed Kashagan oil field, the largest oil development outside of the Middle East, is estimated to have cost around $41 billion and is under constant attack from huge floating blocks of ice.
Indeed, the 300 or so companies that account for over 90% of capital spending within the oil and gas space are already showing 13% year-on-year gains in capital expenditure spending. What's more, this is the fourth year in a row of sustained, double-digit growth in capital spending within the sector, driven by high oil prices, which has allowed many companies to take on previously un-economically viable projects.
Offshore growth is fastest
It would appear that the majority of this capital spending growth is coming from offshore drilling projects. In particular, the Gulf of Mexico, where producers believe they will need an extra $16 billion worth of rigs to handle the current drilling programs in place until 2015. Indeed, according to one analyst, onshore oil and gas capital spending is expected to increase by high single-digits this year, while offshore oil and gas spending is expecting to see mid-teens double-digit growth
All this growth makes the oil service companies look highly attractive. Of course, the key companies set to benefit here are world's biggest; international oil services companies, Schlumberger and Halliburton (NYSE: HAL ) .
Unfortunately, Halliburton is still suffering a hangover from the Macondo disaster. That said, the company is working hard to shake off any association with the incident, already agreeing to pay $380 million in eight installments over the next two years to settle with the Department of Justice. Still, the company is yet to fully settle with the Planning/Steering Committee and the states concerned with the disaster. Halliburton has, however, been preemptive, already provisioning $1.3 billion for Macondo related fines. While the final fine could be larger, Halliburton's preemptive charge has removed some uncertainty.
Best in class
Of course, it would be foolish to write an article on rising capex in the oil and gas sector without mentioning National Oilwell Varco (NYSE: NOV ) . In many ways, National Oilwell, although smaller, is better positioned to benefit from rising capex spending than Halliburton. I say this because National Oilwell is only involved in the production of equipment and not the operation of oil wells, unlike Halliburton, which has a bigger role to play in the overall day-to-day operation of the wells.
Actually, a good example of this can be seen by comparing the gross margins of the two companies. Halliburton's trailing-twelve-month (TTM) gross margin stands at 14.4%, meanwhile, National Oilwell notched a gross margin of 24% for the same period.
Moreover, Halliburton has been faced with rising wages impacting margins as skilled labor becomes harder to find and the company has to offer workers more to stay with the company. In particular, since 2007 Halliburton's gross margin has been compressed from 24.5% to 14.4% as of the second quarter of 2013. During the same period, National Oilwell's gross margin only closed by 1.1%.
In addition, while Halliburton's growth has been strong during the past 10 years, revenue has expanded 76%, National Oilwell has grown faster, notching revenue growth of 996% during the same 10-year period. Based on its historic growth and recently announced order backlog of $13.95 billion, a record for the company, I am very excited about National Oilwell Varco's future. .
Greater risk, greater reward
One of the most active regions in the world for oil exploration and production is Iraq, which recently joined the elite club of countries producing more than 3 million barrels of oil per day. The country wants to triple this output by 2020, although many remain skeptical of this target and believe a lower estimate of 6 million barrels per day is more achievable.
Whatever the case, the oil industry is certainly going to be active within Iraq during the next few years. The major players are active within Iraq but so is smaller Weatherford International (NYSE: WFT ) . Weatherford's largest and most recent contract within Iraq was the $843 million Zubair Field contract. The company has been contracted to increase the field's output along with the general drive for higher rates of production throughout the country.
However, Weatherford is a somewhat risky turnaround play. Weatherford has been marred in the past by accounting troubles, and the company has only been profitable for two out of the past five years. Still, the company has recognized that it cannot compete with larger peers, such as Halliburton and Schlumberger, so instead it has decided to concentrate on higher-margin sections of the business by selling off non-core businesses.
Capital spending within the oil and gas industry is on a solid upward trajectory, and this is forecast to continue for many years yet. Order backlogs are building at oil service companies and it looks as if investors are going to see rapidly rising profits over the next few years as well.
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