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Oil patch is drowning in cash
Profits off $70 crude are great, but it's getting harder to plow that back into exploration. The reason: not enough drilling equipment. The solution: Buy oil-service stocks.
By Jim Jubak
You can have too much of a good thing. Just ask the companies that produce oil and natural gas.
They're facing a squeeze that threatens to cut production and pinch profit margins. As a result, the shares of some oil and gas production companies could actually lag the price of oil if that commodity breaks above $70 on its way to $80, as technical analysis now suggests is likely.
The culprit is the flood of revenue and the gusher of earnings created by oil prices in the range of $60 to $70 a barrel. At Occidental Petroleum (OXY, news, msgs), for example, revenue climbed 34% in 2005, following a 22% increase in 2004. Earnings per share climbed 102% in 2005 and 56% in 2004. Total increase from 2003? In revenue, 63%. In earnings per share, 214%.
All that has produced a rush to expand production, drilling and exploration. The more oil an oil company can pump at $70 a barrel, the more profit, after all. And the more new oil a company can find and lock up now, the higher future profits will be. That's especially true if the peak-oil folks are right and we're near the point at which new discoveries fail to keep pace, leading, in time, to a decline in production and a jump in prices that will make the last two years look like a dress rehearsal.
Short-handed in the oil patch
For example, at Occidental Petroleum, the company increased its capital spending on oil-field development by 29% in 2005. Development spending in 2005 was 69% higher than in 2003. The much smaller exploration budget grew 526% over the same time.
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Too bad there isn't enough exploration and drilling equipment to go around. The demand for everything from drilling pipes to oil engineers is forcing oil-production companies to postpone or cut back plans for development and discovery of oil and natural gas. These companies simply can't get the people and equipment they need because there simply aren't enough to go around. Energy-services companies, which cut back their investments in equipment and laid off staff during the 1990s, have been caught short by this boom.
Make that "caught very short." Baker Hughes (BHI, news, msgs) announced plans to add 4,000 workers this year for its oil-services business. I hope the company isn't counting on getting very many petroleum engineers in that group. The U.S. produced only 200 petrochemical engineers in 2005. (Hey, it could be worse, the United Kingdom turned out just 88.) And it's not just engineers that are in short supply. There just isn't much new blood available anywhere -- which is why the average age of an oil-industry worker is now north of 50.
This shortage of workers isn't the only problem, either. The oil-service industry was so badly burned at the end of the last cycle that these companies have been slow to get off the dime and invest in new equipment. The reluctance is understandable: In the 1980s, many were pushed to the wall by overbuilding that pushed prices in the oil-service industry at the same time as falling oil prices cut demand for the sector's products and services. That left CEOs in the sector -- at least the ones who survived -- determined not to spend too much on adding capacity this time.
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