As our global population continues to grow and modernize, finding new and reliable sources of energy remains a paramount issue. Dwindling supplies from traditional fields have put pressures on producers to find new viable reserves. Unconventional sources of supply, such as shale oil, deepwater drilling, and bitumen production have now all become the standard bearers with regards to new reserves. However, drilling in these assets are expensive and requires expansive technological knowhow.
These drilling requirements have continued to drive up capital expenditure (CAPEX) spending by various Exploration & Production (E&P) firms. Overall, increased spending from major energy firms will greatly benefit those companies that operate in the oil services sub-sector as well as their investors.
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The declining yields of "legacy" wells and rising complexity of pulling of new oil out of the ground has sent many E&P firms scrambling to find new sources of production. Have had to look to unconventional sources in order to keep the oil flowing. These assets are often located in remote areas of the world and require complex drilling techniques to access the hydrocarbons. Places like Russia's frozen Kara Sea, shale formations in Pennsylvania and deepwater fields in Ghana, have now become the major sources of supply.
However, tapping these regions come at a pretty hefty price tag- one that’s been rising exponentially as well.
According to a new study published by consultant Ernst & Young showed that despite recent low natural gas prices, U.S. energy firms spent a record amount on exploration, development and production activities in 2012. Analyzing upstream spending and performance data for the largest 50 energy companies, E&Y found that total capital expenditures reached $185.6 billion. That’s a 20% jump from 2011’s numbers and the highest amount in the study’s history.
Despite that monster increase and record amount, the E&Y study is still just a drop in the bucket when looking at the entire globe.
That number spent by energy firms on CAPEX is a staggering $716.3 billion in 2012. That huge number was driven by increasing exploration and development efforts by firms- such as Petrobras (NYSE:PBR) and Anadarko (NYSE:APC) -in deep and ultra-deep offshore areas. Additionally, the high cost of coaxing tight oil and natural gas liquids (NGLs) from shale formations have been driving those costs. All in all, market researcher Global Data estimates that global E&P sector CAPEX will witness year-over-year growth of 18.7% in 2013. Ultimately, reaching $850.5 billion by years end.
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Playing The Record Spending
With billions needed to be spent to find and extract oil in harsh environments, the oil services firms are poised to benefit long term. For investors, the time may be right to bet on the sector. A great starting point could be the iShares Dow Jones US Oil Equipment Index ETF (ARCA:IEZ). The fund tracks 48 different oil service stocks from contract drillers like Ensco (NYSE:ESV) and support plays like Bristow Group (NYSE:BRS). Overall, the IEZ can provide broad access to the sub-sector and has managed to outperform rival funds- like the PowerShares Dynamic Oil & Gas Services (ARCA:PXJ) –over long periods of time. Expenses run 0.47%.
When it comes to drilling equipment, National Oilwell Varco (NYSE:NOV) gets the nod from nay investors. However, it’s plucky smaller rival Dril-Quip (NYSE:DRQ) could be a better bet from investors. The firm manufactures all the drill bits, valves, risers and a host of other equipment needed for every oil well and has consistently increased its order back-log over the last few years. Recently inking contracts with Petrobras and Royal Dutch Shell (NYSE:RDS.A, RDS.B). Analysts predict that this trend will continue throughout 2013 as energy demand maintains its upward trend. There’s another reason to be bullish on Dril-Quip’s chances- M&A. With no debt on its balance sheet and relatively small market cap, the company could be the perfect target for a larger firm wanting to expand its footprint.
Finally, the shale boom in the United States has been kind to those firms that supply one of the basic ingredients needed to frack a well- sand. Both U.S. Silica (NYSE:SLCA) and Hi-Crush Partners LP (NYSE:HCLP) mine monocrystalline sand for the process, while CARBO Ceramics (NYSE:CRR) manufactures ceramic proppants used to help improve productivity. All three firms have enjoyed robust earnings and demand growth over the last few years.
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The Bottom Line
As global energy demand continues to trend higher, more pressure is being placed on finding new sources of supply. That fact is driving energy firms to open up their wallets in spades. Overall, the recipients of this higher CAPEX spending- the oil services sector- offers investors a way to play the advances in new technologies that will be required to extract these resources.
At the time of writing, Aaron Levitt did not own shares in any of the companies or funds mentioned in this article.