Higher Natural Gas Prices Could Pump up Oil Services Demand

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Don't look now, but the prolonged cold snap in the U.S. has pushed natural gas prices toward multi-year highs above $4/btu. At the same time, most of the domestic oil services stocks have slumped to multi-month lows. The combination could present a buying opportunity for the domestic oil service firms of Baker Hughes (NYSE: BHI  ) , Weatherford (NYSE: WFT  ) , and C&J Energy Services (UNKNOWN: CJES.DL  ) to name a few that are intriguing.  

A major reason for recent weakness in the stocks has been less-than-robust capital expenditure plans by exploration firms to end the year. The general guidance for the fourth quarter wasn't overly robust, but the recent cold weather and reduction of natural gas inventories has pushed levels below prior years. The latest weekly report from EIA showed inventory levels 3% below the 5-year average levels. Also, the inventory number is already a substantial 7.2% below the levels of last year.

It is still too early to tell if a new trend is forming, but investors need to remember that abundant supplies in the ground don't ensure abundant reasons to spend the capital in order to get the resource out of the ground. These three stocks should benefit once spending does pick up, and higher natural gas prices will ensure this eventually occurs.

Domestic focus
Of all the major oil service firms, Baker Hughes provides solid upside potential from a greater focus on domestic natural gas services. In the third quarter, Eastern Hemisphere revenue surged 20% compared to last year, mainly from growth in the Middle East and Asia Pacific. However, North American revenue only gained slightly over the last year, but for the first nine months revenue is actually down for the year.

The company would be hitting on all cylinders if North American revenue, which accounts for nearly 50% of all revenue, were contributing decent growth. The percentage has dropped nearly 200 basis points in the last year. More importantly, North America accounts for nearly three times the revenue of the next largest region, Middle East and Asia Pacific.

Turnaround major
Weatherford trails considerably behind Baker Hughes with half the market valuation. Weatherford, though, has a business closer in size than the valuation would suggest. The company hopes to wrap up a tax issue that has hampered management's focus on operating efficiencies for more than a year.

While Weatherford is much more focused on international operations with 60% of revenue from outside North America, the stock is nonetheless situated to benefit from a rebound in domestic demand. As with Baker Hughes, North America is by far the largest region at over 40% of total revenue. The impact of slower domestic business can be clearly seen in the $128 million year-over-year decline in North American revenue while the company as a whole had a slight gain. Again, the growth in the Eastern Hemisphere was strong all around.

Domestic focused start-up
C&J Energy Services has always had impressive margins, but the domestic hydraulic fracturing services company went public right at the peak of the market. Considering the company obtains 100% of its revenues from the U.S., the results have been in a continual decline over the last two years. In fact, earnings declined from $3.46 in 2012 to lowly expectations of only $1.34 this year.

The one intriguing part about C&J Energy is that management has been aggressively expanding during the lean times of the last year. The company bought the wireline business of Casedhole in 2012 to provide geographic expansion into the Bakken and services expansion into the wireline business. Amazingly, the company is even adding a small amount of horsepower into the fracking business at the start of 2014. Other plans call for growing units in the other service lines of coiled tubing and wireline. At the recent energy conference, the CFO suggested that C&J Energy could add units into an oversupplied market due to the demand for its higher quality of work.

Bottom line
The fundamental backup for oil services demand in North America is picking up with natural gas inventories declining below 5-year averages and extremely cold weather in the U.S. The combination is beneficial to Baker Hughes, Weatherford, and C&J Energy Services that have been hurt by weak demand in the U.S. Combined with already strong international demand, 2014 could be a strong year for the domestic oil service stocks.

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  • Report this Comment On December 14, 2013, at 11:41 AM, JeanDavid wrote:

    At the retail level where I live, it will take a lot more than higher natural gas prices to get me to switch back to #2 fuel to heat my house and hot water. I am about to spend about $50,000 to do the remediation necessary to satisfy the DEP of my state from the leaking 1000 gallon oil tank I had. I would have to save $2000/year on my natural gas bill to break even, not counting the cost of replacing my boiler, getting a permit to install another tank (the state is trying to get rid of all the in-ground oil tanks, but any tank over 275 gallons must be in-ground). So the cost of fuel oil would have to be about $7/gallon less than the cost of an equivalent amount of natural gas to make sense to switch back to oil. And oil burning boilers are less efficient than gas ones because gas ones can get up to about 98% efficiency, where oil burners rarely make it up to 90%. And that matters too.

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