For most of the last year, Core Laboratories (CLB) had been predicting that the oil market would experience a "V-shaped" recovery, which would result in higher oil prices. That rally would fuel increasing demand for its services, resulting in a similarly sharp improvement in its financial performance. Indeed, the recovery started taking hold at the end of last year and has continued into 2017.
Given the company's forecast for the oil market this year, its results should continue climbing higher for the balance of 2017. In other words, the best days for investors still lie ahead.
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Drilling down into what Core Labs sees in the oil market
In its most recent earnings report, Core Labs reminded investors that, as it had predicted, its financial results bottomed out in the third quarter of last year, setting the stage for a continued recovery in 2017. Behind the expectation for further improvement was the belief that the global oil market had shifted from oversupply to undersupply. That's confirmed by International Energy Agency (IEA) data showing that worldwide crude oil inventory had, at that time, declined for six of the seven most recent months, and it has continued going down according to more recent data from the IEA.
Core pointed out that, from July through December 2016, oil inventories fell by an average of 770,000 barrels per day. Notably, that decline was underway before OPEC stepped in and started supporting the market by reducing its output. In Core's view, those cuts could result in a market undersupply of 2 million barrels per day. According to the company, "the continued under-supply of crude oil should lead to extended worldwide inventory declines and a continuing rally in energy prices throughout 2017."
Already, increased spending by shale drillers has had a noticeable impact on U.S. supply, with U.S. production coming back much faster than anyone anticipated. One of the drivers is that shale drillers in the U.S. are beating their own expectations for productivity thanks to innovations such as drilling longer horizontal wells and using more sand per well. For example, Devon Energy's (DVN -0.59%) first-quarter oil output was up 7% sequentially to 261,000 barrels per day (BPD), fueled by a 17% increase in production from U.S. shale plays. Furthermore, Devon's output was a remarkable 5,000 BPD above the high end of its guidance range due to impressive well productivity from the Eagle Ford and STACK formations. Those results kept Devon on pace to increase its oil output 13% to 17% by the end of this year. The company's rapidly rising output, when combined with the actions of shale producers, is partially offsetting OPEC's output-reduction efforts.
What that forecast means for Core Labs' future results
While rising shale production has kept a lid on oil prices so far this year, Core's view is that, beneath the surface (and the headlines), market fundamentals for service companies are improving. Signs of this improvement have already appeared: Activity levels in the U.S. are rising, and conditions in international, offshore, and deepwater markets are stabilizing. The company noted that international rig counts increased by 3% during the first quarter, up for the second straight quarter after eight consecutive declines. Meanwhile, new-well permits in the Gulf of Mexico increased 13% year over year.
The company expects additional improvements in these regions during the second half of this year due to the start-up of several major capital projects. One example: Oil giant BP (BP 2.35%) finally sanctioned its Mad Dog Phase 2 project late last year, after delaying it in 2013 because the initial design was too complex and costly. While the slimmed-down project will still cost BP and its partners $9 billion, it will produce up to 140,000 barrels per day when it comes on line in late 2021. Across the industry, 20 major projects are expected to receive the green light this year, more than double last year's approvals.
With a slew of long-term projects coming down the pipeline, Core Labs expects its deepwater revenue to bottom out in the second half of this year. When combined with the rapidly improving North American onshore market and stable-to-up international markets, this should lead to a steady climb in Core's revenue, which should fuel accelerated margin growth throughout 2017.
Investor takeaway
Core Labs has been pounding the table that an oil-market recovery is starting to unfold, which would lead to an uptick in the company's financial results. While that recovery has hit a speed bump this year due to surging shale output, that hasn't diminished the company's confidence that market conditions are clearly on the upswing because fundamentals are steadily improving below the surface. Core Labs maintains the view that a "V-shaped" recovery in its financial results should happen this year, which could in turn lift its sluggish stock price.
