Time to Buy Oil Drillers?

From Andrew Berlin: “I have heard and read a lot about the surging demand for oil rigs and all the money oil drilling companies are going to earn in the next few years. Is it too late to buy oil drilling stocks now?? Parker Drilling Company was brought to my attention. Are the oil drilling companies really going to make a lot of money??

Oh, sure. Like I really know.

But I know guys who might — Texans — so I asked them. The only reason I think this might be of interest to folks other than Andrew Berlin is that it gives a glimpse of how the bigger boys talk about these things.

Texan #1 writes: ———————

1. There is a boom in the oil and gas business. Wellhead gas is well over $3. Wellhead oil is over $20. Natural gas liquids are through the stratosphere (ps…extremely good for me). [Make a note to hit him up for more money. — A.T.]

2. Activity is up, to the extent equipment is available. Rig rates are up. [Wellheads, rig rates — I only barely get the gist, but enjoy this kind of talk. Makes me want to go out and rent Giant. — A.T.]

3. Parker (PKD) just did an acquisition of Mallard, a very good marine contractor. Spent $400 million on acquisitions in November, including an oil tool company. Its market cap is only $650 million [meaning that the whole company is valued at little more than a tenth of, say, Netscape — A.T.].

4. At 9 5/8, stock is almost double the 1996 low of $5 [meaning that you’d have done better thinking of this a few months earlier –A.T.]

5. Two problems: oil business is cyclical….and as a provider of services for capital expenditures in the industry, PKD is in a cyclical spectrum of a cyclical business. [I.e., doubly cyclical. When the cycle turns, watch out. — A.T.]

6. Another…although the growth of worldwide demand for hydrocarbons, and the revolution of 3D Seismic is fueling a powerful upturn now, part of Parker’s business — historically — has been drilling dry holes for its clients (who pick the locations). To the extent 3D remains effective, there will either be fewer wells drilled after a few years — or much lower hydrocarbon prices, resulting in decreased demand for drilling services. [Oh, no! It will become so easy to find oil, drillers will have to drill fewer holes to find it. Bad news for drill-rig suppliers, good news for everybody else — unless you think it will lead to too-low oil prices, environmentally. — A.T.]

7. The roller coaster’s headed up, but it’s not a one way ticket to heaven. [Well, a roller coaster may be better than musical chairs, which some other parts of the market seem to be playing. — A.T.]

Texan #2 writes: ———————

Regarding the land drilling industry, I know it quite well. I remember well fearing — as Sadam was rolling tanks into Kuwait — that Bank of America would change its mind about selling us the land-drilling company it had repossessed in 1990. But we got it . . . and I’m still waiting for my chance to gloat.

Between 1990 and 1996, watching the profit margins improve has been second only to watching grass grow, in terms of excitement. During the last year, there has been a major recovery in certain parts of the market. Technically speaking, the 1500 horsepower diesel electric rigs which are used to do the deeper, more technical horizontal drilling, are very popular right now and almost non-existent for new oil companies that are trying to start programs. There is a difference, however, between “almost” and “totally” non-existent. As with any mechanical object that is owned by contractors, the land drillers can make something out of almost anything and at one time there were over five thousand rigs working, so there are a lot of spare parts around, although not many 1500 hp diesel electrics.

Land drillers are like penguins: they all look alike unless you are one. I would agree with the current consensus that the time has come for the land drillers, but would be fairly selective. I would focus on companies with larger rigs, strong, proven track records and good cash flow. I would also concentrate on companies with a strong North American presence. Nabors Drilling is the largest and actually has the best overall management. Some of the Canadian land drilling companies, such as Kenting, Precision and Ensign, are also excellent. Some of the smaller U.S. companies have seen a tremendous run up in their stocks recently; on a market capitalization basis, their rigs are probably selling on an equivalent basis close to new replacement [meaning, I think, in effect, it’s no bargain buying used cars at nearly-new car prices. — A.T.].

————

So there you have it, Andrew. In answer to your question, “Are the oil drillers really going to make a lot of money?” you have a firm, “yeah, maybe. Probably. Some of them.” And on the only loosely-related question of whether that makes their stocks these days a buy, I’ll step up to the plate and give you an even firmer answer. Not a “yeah, maybe” or an “I dunno — maybe” but a flat-out, unqualified maybe.

Tomorrow: The Value of Free Investment Advice