It’s never easy to time any market, but it’s even tougher to predict peak and trough in energy markets. However, the risks for the oil markets have increased dramatically in recent days and the supply-demand dynamics are shaping up in a way that we could be in for another deep downturn in oil markets after a slow and gradual recovery since 2014.
The escalating U.S.-China trade war, increasing evidence that the U.S. economy has entered a slow patch, and U.S. President Donald Trump’s conciliatory tone towards Iran point to a tough summer for oil bulls and the stocks associated with the energy business. Indeed, the share performance of companies providing crucial services to oil producers is painting a grim picture of the outlook for the oil and gas industry.
Schlumberger Ltd. (NYSE:SLB), the world’s largest oil service provider, has seen its shares plunge more than 24% since the April high. The stock closed down 0.9% yesterday at $36.18, on its fifth consecutive day of losses. Its closest competitor Halliburton Co. (NYSE:HAL) is faring no better. After rising about 20% this year to mid April, its stock is now down 28%.
Companies in the Philadelphia Oil Services Index failed to sustain the April rally or to keep up with the overall recovery in the global oil market, and the index is down about 25% since mid-April.
Deteriorating Macro Environment
Schlumberger, which operates in more than 120 countries, supplying the industry's most comprehensive range of products and services, from exploration through production, was predicting a good year for the oil industry in its most recent earnings report last month.
"The return of international growth, and in particular the return of offshore activity and exploration, is what we have been waiting for," Chief Executive Officer Paal Kibsgaard told analysts and investors on April 18 on a conference call. "The last year we had growth internationally was in 2014, so this is five years of waiting, so we are more than ready for this."
But the deteriorating macro environment and the reluctance of big oil and gas producers to increase investments are thwarting the company's efforts to recover from the slump it's been stuck in since the middle of 2014.
The stock, which has fallen more than 60% in the past five years, may look quite attractive to some contrarian investors though. Its annual dividend yield at 4.69% is more than double than its five-year average, while its forward price-to-earnings multiple of 16.5 is the lowest in the past five years.
But historical data may not be too relevant for the oil service providers when the industry they work for is going through a fundamental change. Under pressure from shareholders, exploration and production companies are keeping spending in check, which is reducing demand for oilfield services, according to S&P GIobal, which cut Schlumberger's credit rating last week a notch.
"Oilfield services companies will no longer be able to generate the high operating margins they did in 2014," Carin Dehne-Kiley, an analyst at S&P, wrote in a report last Friday. Said Dehne-Kiley:
"The oilfield services industry has fundamentally changed due to permanent efficiency and productivity gains realized by E&P companies as well as investor sentiment calling for E&P companies to live within cash flow and limit production growth."
Bottom line
The stocks of oil services companies have become cheaper after a precipitous decline in the past five years. But despite their more attractive valuations, we don’t think the time has come to snap up their shares. In this uncertain global economic and geopolitical environment, oil prices may not sustain their recent gains. It would be better for investors to avoid entering this trade now.