Looking for a contrarian bet? Try this battered oil play

The collapse in the oil price has hammered companies drilling for ‘black gold’.

And they’re far from the only casualties. Oil services firms build, install and maintain rigs, as well as doing all the other jobs that keep the oil pumping. Some also help the oil companies in their exploration efforts.

At the moment, oil projects are being scrapped and rigs shut down. So naturally, the services companies have been pummelled too.

Yet they could be a lot better placed to ride out the storm than most investors think. Some of them might even secure extra work.

And that could mean now is a great opportunity to buy in.

The oil services sector faces cuts, but not Armageddon

There’s no doubt about it, the sliding oil price has been bad news for oil services companies.

JP Morgan reckons that the amount of money being spent by oil firms on investment will drop by around 15% this year. Spending by smaller firms is expected to drop by nearly a quarter.

But while that’s bad news for the oil services industry, it’s not a total shutdown. Plenty of firms have already committed to new projects, or are in the middle of them. In many cases, the legal costs of pulling out would mean the projects still go ahead, even if they end up losing money.

So oil services companies have a backlog of work that is effectively guaranteed, despite the slump (assuming the companies they work for remain solvent, that is).

And because the oil price was at around $100 a barrel for so long, companies invested more heavily than normal during the good times. As a result, this ‘guaranteed’ backlog is larger than it has been for some time.

Finally, several oil companies are still operating on the basis that prices will rebound at some point in the future. And some are less price sensitive than others. For example, Kuwait’s state oil firm still plans to spend $40bn in the next seven years to upgrade its infrastructure. This will also help ensure that demand for oil services remains strong.

And while it may seem strange to say it, decisions to shut down rigs can also have a silver lining. Let’s be clear, I’m not suggesting that rig closures are a good thing for oil services companies. It’s obviously in their long-term interest for them to keep running.

But shutting down a rig isn’t a simple business. Oil companies can’t just ‘turn them off’ or leave them sitting there. Instead, they have to dismantle the rigs, shut the wells off, and clear the area.

None of this is easy – or cheap – even in the simplest cases. And in the most challenging cases, special equipment – extra-large tow ships, for example – have to be built.

All of this gives oil services companies a chance to make back some of the lost business from the closures. As the FT’s Lex column points out, the oil majors are expected to spend up to £14bn over the next eight years on decommissioning in the North Sea alone. Other sources think that the costs of shutting down the nearly 500 installations could be as high as £30bn.

Another factor that could cushion the pain for oil services companies is a boom in mergers. Halliburton and Baker Hughes have already announced a $34.6bn merger, which is still awaiting formal approval. There are plenty of much smaller firms out there – so the sector could face a major bout of consolidation.

One oil stock to consider

There’s no denying that this is risky. The oil price could fall further and there could be some nasty surprises if a wave of bankruptcies erupts. But at current levels, several oil services firms look interesting.

John Wood Group (LSE: WG) is an established oil and gas services company. North Sea oil-related operations account for a quarter of revenues, but most of these contracts have up to five years left on them. On top of this core work, Wood Group has won several contracts to dismantle rigs, which won’t be affected by the oil price slide. It has also developed a fast-growing sideline in maintaining offshore wind turbines. It trades on 9.4 time current earnings.

Oh and just before I go, I wanted to remind you that tickets for this year’s MoneyWeek Cruise are now available. The cruise last year was a big hit, and this year’s promises to be even better – as well as all your favourite writers such as Merryn Somerset Webb, Tim Price, and John Stepek, we’ve got Bill Bonner coming along too. Find out more here.


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