See Jim's new portfolio to help navigate the treacherous interest-rate environment.
Jubak's Journal Recent articles: • 5 stocks for the coming retirement boom, 4/12/2006 • Bad for GM, bad for America, 4/11/2006 • 3 new global hot spots for investors, 4/7/2006 More... | Jubak's Journal 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
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. Related news and commentary on MSN Money
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 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. A big rig shortage As a result, critical pieces of the oil development and exploration puzzle are missing, despite soaring oil prices. For example, the supply of offshore drilling rigs has remained almost flat since 1999. The supply of mobile offshore drilling rigs remained the same in 2005 as it was in 2004. Now, of course, there are plans, lots of them, to increase the supply of these missing pieces. But don't count on the supply to materialize overnight. First, thanks to the worker shortage, it's going to take a while to man these rigs even once they're built. Oil-industry consultant PFC Energy estimates that it will take 7,000 to 8,000 new workers to staff the 82 new rigs now under construction. And second, the backlog is now so large -- and growing larger so fast -- that even if all the new rigs now planned are actually built, the oil-service industry will continue to fall behind demand for years to come. In the market for offshore jack-up rigs, newly built rigs scheduled for 2006 delivery will add 2.4% to supply this year and another 7.9% to supply in 2007, according to Friedman, Billings, Ramsey. At the same time, the order backlog for jack-up rigs has been growing at a rate of 2.5% a month. Even the 13.4% increase in supply scheduled for 2008 won't be enough to catch up. This shortage in supply has driven prices to record levels. For example, BP To spend or not to spend? The result puts oil producers between a rock and a hard place. There's no doubt that rising costs make spending on development and exploration less attractive. Higher costs reduce the return on the oil producers' invested capital. One option is to cut back spending on development and exploration. Encana, for example, has cut its capital spending plans for 2006 by $800 million, or about 12%, from earlier projections. That saves money, but it comes at the price of slower growth in production and proved reserves. Encana also announced a reduction in its projected natural-gas sales for 2006 of about 75 million cubic feet per day, because the company will be drilling fewer wells in 2006, just as it did in 2005. Another option is to bite the bullet and spend the money, even if the company's development and exploration dollar isn't going as far. That seems to be the plan at Chevron Why the difference in strategy across the oil-production industry? I think you can explain it by looking at how fast each company has been adding reserves and increasing production. Encana grew its proved reserves by 18% in 2005 and replaced 271% of its production with new reserves. The company has the leeway to cut back on capital spending because it has a strong track record of growing its reserves and production. Chevron has a lot less room for cutting its capital spending. Most of that spending, as at all oil companies, goes to developing fields -- rather than to simply finding fields -- so it can produce oil. The knock from investors is that the company has had a hard time converting its reserves into actual production. You might say the company is good at finding oil but not so good at actually getting it out of the ground. That, of course, gives the company and the stock tremendous upside potential -- if it can get the oil to market. In 2005, Chevron managed to replace 175% of its oil and natural-gas production -- a very good mark. But the company's goal for the next five years of increasing production by 3% annually is already extremely modest. Chevron can't afford to spend less while it waits for the price of oil-field services and equipment to come down. I think there are three lessons in all this:
Updates Sell TOTO The shares of TOTO New developments on past columns 3 new global hot spots for investors The critical question of who will wind up No. 2 in Peru's presidential election is still up in the air five days after the country voted on Sunday. With 88% of the votes counted, Ollanta Humala, who has promised to raise taxes or to seize 49% ownership stakes for Peru in the projects now run by the foreign mining companies that dominate the country's mining sector, is the clear leader with 31% of the vote. But two candidates, former President Alan Garcia and ex-congresswoman Lourdes Flores, were locked in a virtual dead heat. Under the nation's election laws, if no candidate receives a majority in the first round of voting, a run-off pits the No. 1 and No. 2 vote-getters. Most election handicappers believe that Humala would beat Garcia but lose to Flores. As of April 12, Garcia led Flores 24.4% to 23.3%, but nearly 10% of the votes cast have been challenged and are now before the National Election Board, which is expected to take 10 to 15 days to decide the count. Meanwhile, the international mining industry twists nervously in the wind. Peru is the world's fourth-largest copper producer, the fifth-largest gold producer, the third-largest zinc producer and the second-largest silver producer. Stay tuned. Editor's Note: A new Jubaks Journal is posted every Tuesday, Wednesday and Friday. Please note that Jubak's Picks recommendations are for a 12-to-18 month time horizon. See Jubak's CNBC Picks for shorter six month recommendations. For suggestions to help navigate the treacherous interest-rate environment see Jim's new portfolio Dividend stocks for income investors. For picks with a truly long-term perspective see Jubak's 50 best stocks in the world or Future Fantastic 50 Portfolio. E-mail Jim Jubak at jjmail@microsoft.com. At the time of publication, Jim Jubak owned or controlled shares of the following equities mentioned in this column: Encana. He does not own short positions in any stock mentioned in this column. | |||||||||||||||||||||||||||||
|
|
||||||||||||||||||||||||||||||
MSN Money's editorial goal is to provide a forum for personal finance and investment ideas. Our articles, columns, message board posts and other features should not be construed as investment advice, nor does their appearance imply an endorsement by Microsoft of any specific security or trading strategy. An investor's best course of action must be based on individual circumstances.