The very first millionaire in California -- Sam Brennan -- didn't make his money through the poetic endeavor of digging for gold and striking it rich. Instead, he did it probably the most boring way possible -- selling picks, shovels, beans, and bacon to keep the mines and men running. It may not make for a great story in a book, but it sure as heck made a lot of money.
Today, oil and gas equipment and services companies are continuing the business model used by Mr. Brennan. These companies provide all the tools and services necessary to do the dirty work of exploring and drilling for new oil and gas supplies, while making a pretty clean profit in the process.
For investors, the oil and gas equipment and services industry is a great way to dip your feet into the energy pool without worrying about getting splashed by commodity prices. Let's take a quick look at the oil and gas equipment and services sector, what makes it tick, and what investors need to know about this industry before making an investment.
What are oil and gas equipment and services?
Anything you want, they've got it; anything you need, they've got it; anything at all, they've got it.
This is pretty much the mantra of the equipment and services business. Like the men who kept prospectors supplied with everything they needed to keep the California gold rush going, oil and gas equipment and services suppliers will provide anything that exploration and production companies need to extract oil and gas from the ground -- provided, of course, they can make a profit from it. From drill bits to deepwater rigs, or from seismic surveys to sand proppant, there's a company out there ready and willing to supply it.
How big is the oil and gas equipment and services industry?
Because the process is so extensive, from exploring new oil reservoirs all the way to squeezing the last drop from mature fields, the oil and gas equipment and services industry is incredibly diverse. Combined, the entire industry has a market capitalization of more than $700 billion, and pulls in several hundred billion dollars per year in revenue. There are thousands of companies in this space worldwide, and they can vary from companies that are worth north of $100 billion all the way to very small niche players that may only be worth $2 million dollars.
How does the oil and gas equipment and services industry work?
There are loads of activities that are involved in the oil and gas equipment and services industry, but all of them can be generally classified into three distinct categories. Every company in the space is involved in at least one of these activities.
- Equipment manufacturers and suppliers: Oil and gas producers go through loads of equipment to get oil out of the ground. Things such as drill bits need to be constantly replaced after boring through miles of rock. Sometimes, it's just the simple things needed on an everyday basis, such as drilling fluids and hydraulic fracturing water and sand. Equipment manufacturing for oil and gas can range from simple things, such as pipes, to highly complex engineering projects, such as offshore floating production, storage, and offloading facilities.
- Equipment renters: The job of these companies is to own equipment that an oil and gas producer needs to get the job done, but most likely cannot justify owning one themselves because they can't keep it working 100% of the time for the lifetime of the asset. Equipment renters normally work with things such as onshore and offshore drilling rigs, but it can also include equipment that may not be needed very much, such as underwater remote-operated vehicles.
- Service providers: Like renters, service providers do the things to keep the oil and gas industry running. Services in this sector can range from general drilling and hydraulic fracturing services to more specific things, such as seismic surveys and geological analysis, or on-site waste disposal.
A large part of this industry runs on contracts. It could be a supply contract for items in constant use, or an agreement to employ a drilling rig or a service crew for a certain duration of time. Contracts for equipment rentals and services charge the client a per-day fee known as a dayrate. In some cases, these contracts can last for years -- which is something investors should look for.
What drives oil and gas equipment and services?
Equipment and services companies may not be directly exposed to commodity prices, but they are indirectly affected by them. Equipment and service providers get their revenue from oil and gas producers' capital expenditures. Because the producer makes many of its capital allocation decisions based on the price of oil and gas, the price of oil can have an impact on the prospects of the industry.
The entire equipment and services industry is quite cyclical. All it takes is a few companies getting overexcited during the boom times and building one-too-many rigs, or employing one-too-many service crews, and the supply of these things becomes too much for the industry; then, dayrate prices start to flatten out or fall. Companies that have more advanced technologies, and those that service niche markets, tend to do better during these oversaturated times, though.
The fact that oil and gas equipment and services is a cyclical industry doesn't mean it's a bad place to invest; it's just the nature of the beast. If Mr. Brennan's history with the gold rush is any indication, equipment and services can be an extremely lucrative industry. Just be aware that the industry can go through boom-and-bust cycles when you make long-term investment decisions in this sector.