Rising Prices Are A Big Win For Oil Services Sector

By Aaron Levitt | April 20, 2012 AAA

With the recent price spikes due to political tensions in the Middle East aside, oil prices continue to rise. New sources of demand coupled with 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 become the standard bearers with regards to new reserves. However, drilling in these assets is expensive and requires expansive technological knowhow. These requirements ultimately drive up the price per barrel. Overall, higher capital expenditure (CAPEX) spending from major energy firms will greatly benefit those companies that operate in the oil services sub-sector.

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Rising Costs and Demand
As global demand continues to rise, exploration and production (E&P) firms 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.

According to research done by investment bank Barclays (NYSE:BCS), CAPEX by oil and gas industry is expected to increase 10% throughout 2012, reaching more than $598 billion. The investment banks estimates that the bulk of this spending will be by North American energy companies tapping into various shale reserves, specifically looking for natural gas liquids plays. However, the real aggressive driver of capital spending will be Latin American energy companies, with a 21% rise. Mexico's state-run oil firm PEMEX in Colombia's Ecopetrol (NYSE:EC) and Brazil's Petrobras (NYSE:PBR) will lead the charge in the region.

At the same time, demand from emerging markets and non-OECD nations continue to skyrocket. China consumes virtually all of new crude oil production as it undergoes its rapid urbanization. Overall, emerging markets demand has caused world oil consumption to double over the past five years. Analysts expect that trend to continue.

SEE: Should You Invest In Emerging Markets?

Poised to Benefit
With billions needed to be spent to find and extract oil in harsh environments along with growing demand, the oil services sector is poised to benefit long term. For investors, the time may be right to bet on the sector. The recently reconfigured Market Vectors Oil Services ETF (ARCA:OIH) makes an ideal broad starting point for an investment. The fund tracks 26 different oil service firms including industry stalwarts Halliburton (NYSE:HAL) and Schlumberger (NYSE:SLB). Expenses for the fund run a cheap 0.35% and liquidity is brisk. For those investors looking for more of a broad option, the iShares Dow Jones US Oil Equipment Index (ARCA:IEZ) spreads its assets out to 45 firms.

So much of the oil service industry is about drilling equipment and no one does it better than National Oilwell Varco (NYSE:NOV). The firm is the leading maker of drilling rigs, bits and other necessary drilling equipment. The parts and components find themselves into about 90% of all drilling rigs on the planet. That domination has allowed it to operate with very little debt and more than $8.33 per share in cash on its books. Overall, the firm trades at a relatively cheap price-earnings ratio of almost 17 and yields 0.60%. Likewise, rig equipment maker Dril-Quip (NYSE:DRQ) has benefited from the expansion of deepwater and offshore drilling.

The shale boom in the United States has been kind to CARBO Ceramics (NYSE:CRR). The firm manufactures ceramic proppants, which replaces the sand used in the hydraulic fracturing process. At its core, CARBO is making artificial sand that helps drillers improve productivity. With the bulk of new wells doting the U.S. landscape of the hydraulically fracked variety, CARBO is seeing huge demand for its cost saving products. That trend should continue as the shale revolution continues to play out.

SEE: A Guide To Investing In Oil Markets

The Bottom Line
Oil prices are on the move. In response to these rising prices, many E&P firms have doubled their capital spending programs in order to meet demand. For investors, this means betting big on the oil services sector. Funds like the SPDR S&P Oil & Gas Equipment & Services (ARCA:XES) or individual stocks like Oil States International (NYSE:OIS) make ideal plays for the trend

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At the time of writing, Aaron Levitt did not own shares in any of the companies mentioned in this article.

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