Buy These Domestic Oil Services Firms

Several trends are colliding to make 2014 likely a lucrative one for investors in domestic oil services firms. First, natural gas inventories have plunged 40% below five-year averages. Second, domestic drilling rig counts are starting to move up. Third, there has been a pullback in deepwater capital budgets despite high oil prices. All of these scenarios set up the need for increasing domestic drilling budgets, at least short-term.

Despite the bullish trends and the bull market in stocks, a lot of the domestic oil service stocks trade below levels of the 2011 peaks. The firms of intrigue include: C&J Energy Services (NYSE: CJES  ) , Baker Hughes (NYSE: BHI  ) , and even lowly Key Energy Services (NYSE: KEG  ) .

The confluence from built up investor demand and the above colliding trends should help turnaround what has been several years of weak demand prospects for domestic drilling. Low natural gas prices has kept the domestic drilling rig count steady while oil drilling has rocketed higher. Thus, production firms might have a need to return to drilling for natural gas.

Natural gas inventories plunge to multi-year lows
Probably the most influential data point on where oil services stocks ultimately trade during 2014 will be the natural gas storage levels over the summer. The weekly chart, seen below, from the EIA provides a clear indication that drilling for natural gas needs to pick up with inventory levels plunging below prior year levels prior to reaching the peak withdrawal date.

On top of the inventory issue, the whole U.S. economy has planned for a shift to utilizing natural gas in everything from chemical plants to LNG exports. These shifts were going to require more drilling even prior to these low inventories.

Rig count increasing  
Last week, Baker Hughes reported that the number of domestic rigs drilling for oil and natural gas rose by 23 rigs to reach 1,792. The amount drilling for oil hit a new record of 1,443 rigs, while the natural gas totals are still near decade lows of only 345 rigs. The encouraging news for the oil services sector is that more rigs equals more work, but also that the natural gas rig counts are probably at unsustainably low levels. Ultimately more drilling needs to take place or natural gas prices could soar.

Though Baker Hughes is one of the major domestic oil service firms, its position in terms of scale compared to Halliburton and Schlumberger and its domestic slant have held the stock down. Even with international operations expanding 14%, Baker Hughes obtained roughly 50% of 2013 revenues from domestic operations setting it up for a better 2014.

C&J Energy Services has been very aggressive during the downturn, which probably was not noticed by many investors. The stock went public back at the market peak in 2011 and has fallen off most radars since then. The hydraulic fracturing specialist has branched out into a more full service firm in the last two years. C&J Energy Services was 100% domestic during 2013, but it is working on a test contract in the Middle East. Regardless, the stock hit a 52-week high last week based on increased domestic demand. With revenue set to soar over 18% this year, the stock could continue rising.

Beaten down Key Energy
Key Energy Services is a leading onshore, rig-based well servicing contractor focused on services such as coiled tubing, fishing, and rental services. The company is shifting operations away from Mexico, leaving it almost exclusively a domestic-focused firm. In the February earnings release, management discussed an improving operating environment with an increase in inquiries for services. The stock trades near multi-year lows at around $8 after reaching $20 back in 2011.

Bottom line
A trend is typically the friend of investors. In the case of the domestic oil service stocks, several trends are converging to snap this sector out of a couple of weak years. With natural gas inventories plunging, drilling rigs growing, and the deepwater drilling segment pulling back on spending, the firms that service the domestic drillers are perking up. With the above three stocks still off from peaks in 2011, investors should expect plenty of more upside in these stocks.

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