Drilling for Dollars

09/02/2005 12:00 am EST

Focus:

Elliott Gue

Editor and Publisher, Energy and Income Advisor and Capitalist Times

Rather than focus on oil producers or explorers, which have already seen large gains, Elliott Gue says, "There is a boom in earnings for oil service companies, and I think those stocks now have the most upside." Here he looks at the best plays in the oil service sector.

(Editor's note: Elliott Gue's speech was made prior to the hurricane, and many of the stocks mentioned have risen sharply in price.)

"Exploration and production companies have benefited a lot from high prices in recent years. Cash flow has exploded. At the same time, however, these companies have very low reserve replacement ratios. They are not finding enough in terms of new reserves to make up for the reserves that they are selling. This is starting to become a problem. I think that some of the majors and independents are getting concerned that they're not finding new reserves, which is needed for the next generation of oil.

"As a result, we are starting to see a new exploration cycle, where companies are actively going out to look for new reserves and ways to increase or squeeze more oil out of existing reserves. That is really the province of the oil services companies. The first step is to find new sources of oil. Thus you need seismic services and companies that scan the bottom of the ocean to find deepwater reserves. And also companies that look on land for new pockets of energy and gas.

"Schulmberger (SLB NYSE) is one of the largest companies operating in the oil service space. They have operations all over the world. What I like about that is that they are not overexposed to any one particular market. WesternGeco, which is a big seismic company, is part of Schulmberger. They have some of the most advanced ships, which tow seismic equipment and can search below the bottom of the ocean to find areas that could be productive for drilling.

"On the other side, squeezing more out of mature wells, I like Weatherford (WFT NYSE). This company is a world leader in under balance drilling, which is a way of drilling into older reservoirs in a way that you don’t damage the reservoir itself. The also provide wireline services, which is essentially lowering equipment into a well to test the well.

"The major integrated oil firms, contrary to popular belief, don’t actually own their own drilling rigs. These are owned by another set of companies called contract drillers, which lease rigs to the major oil companies at a price called the day rate. TODCO (THE NYSE) has rigs that are used in the Gulf of Mexico. This is a very hot market right now and what they have is a lot of rigs that are being stored. They have been getting long-term contracts for these rigs and bringing them back online.

"On the deepwater front, I particularly like a company called Noble Drilling (NE NYSE). This company owns semi-submersibles that are designed for drilling in very, very deep water – waters over 7,500 feet in depth. This is a very advanced type of rig. The fact is that about 30% of all major discoveries in the world right now are in very deep water – that’s the new exploration frontier. In the shallow water offshore area,

"Global Santa Fe (GSF NYSE), a contract driller, is one of the cheaper stocks in the sector. What I really like about them is that they have a huge operation in the North Sea, off the coast of Britain and Norway. This a very hot drilling market. They have seen some of the best day rate appreciation of all. They also have a number of contracts that are coming due just over the next six months. This means that they are going to roll over these old contacts at much higher day rates than they were getting before. So they have a lot of earnings leverage."

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