Weathering Oil Services' Storms

07/29/2009 1:00 pm EST

Focus: STOCKS

Elliott Gue

Editor and Publisher, Energy and Income Advisor and Capitalist Times

Elliott Gue, editor of The Energy Strategist, says one oil service firm is prepared to deal with the ups and downs of a risky, volatile industry.

The basic rationale for owning oil services firms is simple: Producing oil and gas is becoming increasingly technically complex as producers go after fields that are tough to produce or located in hostile environments. The oil services industry provides producers with the technical know-how and skills needed to produce such fields.

As you might expect, the oil services industry was hard-hit by the commodity price collapse in the latter half of 2008. As commodity prices fall, activity levels decline and that hits earnings.

As a rule of thumb, prices between $70 and $80 a barrel is key for international oil markets. Above that price range, activity should be relatively robust; below that range, producers cut back on projects and capital spending.

For gas, the key price point is likely around $6 to $7 per million British thermal units. With current gas prices hovering below $4 per million British thermal units, North America has been among the weakest markets in the world this year.

Weatherford International (NYSE: WFT) reported second-quarter earnings of ten cents per share, below consensus forecasts for 15 cents per share. The stock reacted negatively to the news, falling intraday in the wake of the report. But Weatherford has been a stellar performer so far this year. (It’s up nearly 70% and closed above $18 Tuesday—Editor.)

As expected, North America was a weak spot for Weatherford in the second quarter, especially Canada. Given that this weakness is already well understood, it shouldn't really factor into your investment decisions—the stock market is a forward-looking animal and this is old news. This is reflected in the fact that buyers quickly bought Weatherford in the wake of its post-earnings knee-jerk dip.

Although cost-cutting alone has not been enough to offset the decline in demand, Weatherford is increasingly becoming an internationally levered company—not a play on North America. This bodes well for its long-term profitability.

The company's strong position in resilient Latin American markets fueled an 84% increase in that region's revenues for the first half of this year. Weatherford's long-term deal to develop Mexico's Chicontepec field offers the company a stable base of revenues in Latin America.

More broadly, Weatherford indicated that while visibility and growth prospects for North America remain weak near term, conditions are improving internationally. Management was constructive on prospects for the latter half of this year and into 2010 based on trends observed in the second quarter. In fact, Weatherford indicated that growth and pricing trends outside of North America likely troughed in the second quarter; these markets should see a resumption of growth and better pricing.

Weatherford's prediction that international margins and activity have troughed is based on actual price renegotiations and conversations with customers. This bodes well for the oil services sector generally in coming quarters.

I continue to recommend buying Weatherford and would look on any dips as a gift to investors.

Subscribe to The Energy Strategist here…

Related Articles on STOCKS