Aug 29, 2012
It’s been a tumultuous year in the oil and gas markets as the price of Brent crude (AMEX:$BNO) has moved in two big waves of price, first up 25% then down 30%. It has recently recovered most of what it lost, standing just $13 per barrel below its March peak. Natural gas in the U.S. has seen its price collapse on massive over-supply and a local market un-equipped to deal with it. As a result rig counts are down. This is an issue for not only Baker-Hughes (NYSE:$BHI) but their closest competitors, Schlumberger (NYSE:$SLB) and Halliburton (NYSE:$HAL).
That’s the bad news. The good news is that the rest of the world can’ get enough natural gas pumped into their pipeline grids fast enough and the costs for liquefied natural gas are creating a huge arbitrage opportunity that will not be alleviated for a long time. Even in the face of a potential global recession natural gas demand from emerging markets is rising faster than supply can be brought online.
Tactically, the industry is dealing with the recent drop in the price of oil and gas, shutting down unprofitable wells, but this is a temporary phenomenon. The demand for energy is rising faster than new sources can be found. Asian oil companies like Malaysia’s (AMEX:$EWM) Petronas and Japan’s Inpex have been spending billions buying up shale gas resources in Canada to secure their country’s futures. While the short term rig count data may be shaky with commodity prices volatile due to uncertainty emanating from the U.S. and Europe, there is no doubt about the direction of prices for energy in the future. It is going up.
For Baker-Hughes their most recent earnings beat analysts’ estimates easily on steady rig counts by having shifted production away from natural gas and towards oil. Sequentially their revenue was down 1% but only because of shrinking North American rigs, where the number dropped by 10% during the 2nd quarter. So far in the 3rd quarter 104 gas rigs have been shut downs and only 41 oil rigs have replaced them. Revenue in every other area of the world, however, rose offsetting a 10% contraction in N. American revenue.
July’s rig counts do not point to a recovery as Europe (-4%) and Latin America (-5%) have contracted while Asia-Pacific (+2%) is up. These data point to slower revenue in the 3rd quarter. With rapidly recovering oil prices, however, those counts will begin to reverse during the second half of 2012.
But, regardless of rig type, oil or gas, Baker-Hughes’ revenue per rig has increased from $3.68 million to $4.46 million since 2008 and should increase because the price of oil and gas will continue to increase until such time that an alternative fuel source is developed to replace them for electricity generation. And, even then, the demand will still be there from a transportation perspective.
For all of the oil servicers the viability and profitability of their North American rigs at the current price for natural gas is extremely sensitive to the price of guar gum, which had risen more than 200% in the past year due to drought conditions in India and Pakistan. Both Baker-Hughes and Halliburton have announced synthetics that will free them from the vagaries of the weather. Guar gum is essential to the hydraulic fracturing process, and while the increased costs are big their effect on the total cost of the well’s operation is low. That said, however, when the price of gas drops like it has, that marginal increase becomes magnified exponentially.
The dollar price for oil not only has a structural demand supporting it there is also a currency effect in play. The U.S. Dollar price for oil will likely increase as the world shifts away from transacting exclusively for oil in Dollars. In order to sop up the dollar flow that is needed to maintain the Dollar’s international exchange rate, the price for oil will rise to match the loss of, for example, China buying Iranian oil with Yuan. This will be supportive for Baker-Hughes’ revenue per rig.
The Brent-WTI spread is back over $20 per barrel which is saying that the relative supply and demand between the U.S. and the rest of the world is widening. Investing in Baker-Hughes at this point should be based on whether they will expand their international rig counts as their North American business looks to be under pressure from low relative prices for the near future.
Since June 20th Baker-Hughes has outperformed the SPDR S&P 500 ETF (AMEX:$SPY) significantly, tracking with the price of Brent crude, up 15.75% versus 5%. Brent prices have risen 24% since then, while U.S. natural gas has been very volatile.