Energy has been a no-brainer investment for the past few years, first on spiking demand and then on supply concerns. Either way, it's been fairly easy to throw darts at stocks in the space and hit a winner.
Now, however, with oil and gas prices easing, some believe the boom may be over. Indeed, over the past three months, the energy sector has been one of the worst-performing groups of stocks, posting only negligible gains.
But the rumors of energy's death may be exaggerated. In fact, a new boom may be on the horizon. Let's see where might be best to invest.
Image source: Getty Images.
There has been no letup in demand for oil and gas, and it could be argued that, especially because of the ongoing war in Ukraine, it might even increase. The invasion has certainly caused nations to put energy security top of mind, which is encouraging new investments. Yet supplies remain tight, and with China reopening its economy, demand might soar.
While some of these events, like the war, are of a more immediate concern rather than indicative of a long-term trend, there remains an inexorable movement toward growth. That means major integrated oil and gas companies like ExxonMobil and Chevron can benefit as can midstream players such as Enterprise Product Partners.
However, I think the best opportunities lie in those companies that sell the picks and shovels to these players -- the equipment and services stocks that keep the industry moving. Titans of the sector such as Schlumberger (SLB -2.31%) and Halliburton (HAL 0.78%) might just be the best way to play the coming boom.
Helping others help themselves
The oil and gas services space had a prosperous 2022, with Schlumberger, which provides the necessary equipment and technologies such as drilling rigs and software to companies who use it to extract oil and gas from the ground, enjoying a 25% gain in services revenue. Halliburton, a major provider of hydraulic fracturing services, saw a 33% gain. Operating profits for each soared 80% and 77%, respectively, with both also notching increases in operating margins from the year-ago period.
In contrast, the third-largest player, Baker Hughes, had more modest results with 8% revenue growth and 15% gains in operating income.
Management at the oil and gas services giants expect the good times to continue. Schlumberger CEO Olivier Le Peuch said, "Looking ahead, we believe the macro backdrop and market fundamentals that underpin a strong multiyear upcycle for energy remain very compelling in both oil and gas and in low-carbon energy resources."
That was reiterated by Halliburton CEO Jeff Miller, who said: "It's clear to me that oil and gas is in short supply, and only multiple years of increased investment in both stemming declines and reserve additions will solve short supply. I believe these investments will drive demand for oilfield services for the next several years."
The coming boom
According to the International Energy Agency, even with the prospect for a recession in some markets, demand is expected to grow by 1.9 million barrels per day this year to a record 101.7 million barrels per day. Most of that should come from China, which will likely account for half of all demand as it reopens after the severe COVID lockdowns in major cities over the past year.
At the same time, though, the world's oil supply growth is forecast to slow to 1 million barrels per day, with the U.S. being the leading source of that growth, though it won't be enough to offset the decline in production from OPEC-producing nations.
Because these market dynamics will spur new drilling activity, Schlumberger says it will be able to flex its pricing power as both land drilling and offshore activity increases, particularly in the Gulf of Mexico, where the services company has a significant presence.
Halliburton is also forecasting more activity and spending at the well bore, or the hole drilled to aid in the exploration and recovery of oil and gas, with most new activity coming from the Middle East and Latin America. That suits it just fine since half of Halliburton's revenue comes from international markets.
Image source: Getty Images.
Willing to share the wealth
Wall Street also seems bullish. Analysts forecast earnings at both companies with grow at a compound annual rate north of 40% for the next five years. And Schlumberger and Halliburton are willing to share their largesse with shareholders, with the two services companies recently hiking their dividends 43% and 33%, respectively.
While Schlumberger has made a continuous payout to investors since 1957, its record of increases has been spotty. Last year, it raised its dividend by 40% but it cut the payout in 2020 during the COVID outbreak; before that, it hadn't increased it since 2015. Today the payout yields a modest 1.3% annually.
Halliburton has consistently paid a dividend since 1972, and last year hiked it 167%, but that also followed a cut in 2020. Halliburton's previous dividend increase was in 2014. Its dividend yields 1.2% annually.
Both companies, though, expect to return a minimum of 50% of free cash flow to shareholders in the form of dividends and share buybacks in the coming year.
Ready, set, go!
The tailwinds behind the energy sector are stronger than any potential headwinds, and even if a recession were to arise, the need and demand for oil and gas will supersede it.
The world has under-invested in production for years as the economics didn't always make sense, but now there is an undertow of growth that can't be ignored. So investing in companies that will help the oil and gas industry achieve its production goals could be the best bet investors make this year.
