Supply is the big tailwind for energy right now, not demand, explains Elliott Gue, a leading expert on the energy markets; here, the editor of Energy & Income Advisor reviews his two favorite play in global oil services.
The only way to address the current supply shortfall, and for Europe and other regions to enhance their energy security and reduce reliance on Russia, is for oil and natural gas prices to remain elevated enough to encourage development of new sources of global supply.
That’s a trend that plays right into the hands of the global oil services industry – these are the companies with the technology, equipment, expertise and experience needed to help large producers develop and produce oil from new projects.
In Q1 2022, Schlumberger earned $0.345 per share, which was around 9% above Wall Street estimates. One major point SLB brought up on its earnings call is the growing importance of energy security.
In other words, rather than just sourcing oil from the cheapest suppliers, or prioritizing environmental factors when buying supply, countries increasingly care about diversifying their oil and gas supply to prevent over-reliance on any one producer.
That, in a nutshell, is the main driver of Europe’s current mess — with the region garnering as much as 40% of its natural gas supply from Russia. The effect of this is that more countries will likely seek to develop their domestic supply to cut reliance on imports.
It will also spur development or new oil projects in new markets. And, all of these shifts mean more spending in more markets, which plays directly into services providers’ hands.
SLB indicated the initial consequence of the recent spike in oil and gas prices, and new-found prioritization of energy security, was an uptick in short-cycle spending — primarily “short-cycle” refers to US shale producers.
What’s also needed is more investment in conventional long-cycle supply — oil and gas projects that can produce sizable volumes at a steady and predictable rate for many years. Thus, SLB sees international long-cycle spending ramping up fast in the second half of 2022.
What’s really important, however, is that SLB sees exploration activity picking up starting this summer. Services related to exploring for and developing new fields, particularly more complex and technically hard-to-produce oil developments are SLB’s core competency.
Given the uptick in international spending and investment needed over the next few years, it’s even possible that the current energy investment cycle could drive profit margins to the levels seen in the last “golden age” for the group in 2006-08. Against that backdrop its not hard to make a case for SLB’s earnings to approach the $4 to $5 range by 2025.
SLB has often fetched multiples in the 15 to 20 times range at the peak of an oil services cycle; simply put, it’s not tough to maker a case for SLB to eventually trade to trade to the $70 to $90 range over the next few years. We’re raising SLB to a buy under $47.
Baker Hughes narrowly missed Q1 estimates, and the stock fell 3.84% in the day following its release. It appears the main headwind for BKR in the quarter was Russia, which accounted for about 4% of Q1 revenues.
The company is halting new operations there and its likely sanctions will make it difficult for it to operate there, perhaps even forcing a full shutdown in operations there later this year.
However, it’s worth reiterating that Russia is only around 4% of revenues and only generates an estimated 7% of BKR’s annualized EBITDA. We’d expect the Russian hit to be more than offset by increases in oilfield services spending in other major global markets. Russian impacts are also already well-known and factored into expectations for BKR’s earnings.
Moreover, our primary rationale for recommending BKR remains the company’s liquefied natural gas (LNG) business and the news on that front continues to get better. Management estimates that global LNG liquefaction capacity will need to grow to around 800 million metric tonnes per annum (MTPA) from 460 MTPA currently just to meet anticipated demand for the fuel.
However, there are only 150 MTPA of new capacity currently under construction worldwide and, in order for new capacity to be in service by 2030 a company would need to make a final investment decision by 2025. That implies that, over the next 3 years or so, an additional 200 MTPA of project awards and considerable growth for BKR’s business. We rate BKR a buy under $40.