Commodities prices are becoming top-of-mind around the globe. November contract West Texas Intermediate crude closed today at $87.34. Brent closed at $91.74, according to Bloomberg. Earlier in the day Oil & Gas 360® spoke to Jason Wangler, Wunderlich Securities Equity Research, discussing some of the points in his research note sent to clients today. Wangler covers E&P/Onshore Oilfield Services.

OAG360:  In your note today, you said, “I guess we are contrarian because we like the $90/bbl oil and $4/mcf natural gas levels.” Why do you like those levels?

Wangler: I think $100 oil is too high. $4.00 gas and $90 oil is where we are. When you look at the E&Ps, all their announced drilling inventory, all their growth trajectories and particularly the funding ability they have right now—all that is based on $90 price levels, to maintain the activity level we see today. Plans will change dramatically if oil goes to $80 – $85. I’ve seen where Saudi Arabia needs $87 – $88, so they’re getting pretty close to break even.

Jason Wangler, Wonderlich Securities E&P/Oilfield Services Research

Jason Wangler, Wonderlich Securities
E&P/Oilfield Services Research

OAG360:  How sensitive are OilService companies to changes in commodity prices?

Wangler: They’re at the mercy of the E&Ps. The E&Ps are cyclical with oil. The service companies will earn revenue faster coming out of a down cycle because they’re just waiting for an E&P to call and tell them to get a drill rig working at their site, which takes 10 seconds. Heading into a down cycle it’s the opposite; service company revenues drop fast when the E&Ps stop drilling, but the E&Ps will continue to generate revenue from the wells that were drilled. For that reason, the service companies are a leading indicator of E&P growth. They start earning money before the E&P does, but they are a little more on the risk side.

OAG360:  Which of your covered OilService companies have the best business models for working through commodity declines such as we have seen since mid-2014?

Wangler: Natural Gas Services Group (ticker: NGS). They just rent compression. Once you put compression on a well it’s there for 30 years. They’re not rig count driven. Their model hasn’t changed. It’s fallen with the group so I like that one a lot.

I also like Seventy Seven Energy (ticker: SSE), Chesapeake Energy’s (ticker: CHK) oilfield service company spinoff. It’s going to be tied in with Chesapeake’s E&P activities for a long time.

OAG360:  What is the appropriate level of new build drilling rigs for the E&P space?

Wangler: Current domestic rig count is up 171 rigs from YE2013 to 1,922.  We’re mostly replacing a lot of older rigs. About 1,000 rigs are pad-capable and we’ve only been building those for about 5-6 years; that’s about half the fleet. So there are about 900 older rigs out there. We are seeing about a 200 build a year, replacing the older rigs. That’s a good number. If they go much beyond that, the risk is on the service companies.

OAG360:  In your note this morning you said, “What’s even more impressive is that the [rig] count is growing so nicely, even with the efficiency gains for OFS equipment/services really pushing the activity levels higher on a per-rig basis as well.” Are the efficiencies being driven primarily by pad drilling?

Wangler: A lot of it is just moving things around. If it takes a day or two to put a rig together and a couple days to tear it apart and move it, by leaving it intact on the pad you’re saving all those days. Even if you can save 2 hours, it makes a difference.

Also they’re getting more efficient at drilling these wells. If you’ve drilled tens, hundreds or thousands of these wells, you learn how to do it efficiently and you’re constantly fine-tuning to make it more efficient.

Zipper fracs are the newest thing being done to maximize use of equipment, but you can only do it if the wells are pretty close together, or a couple hundred feet or maybe a couple hundred yards apart. After you drill the well, you either use a workover rig or coil tubing to set the plugs, but you can’t have the frac equipment on the well at the same time—it’s only one or the other—so you’re paying for equipment that’s waiting. So somebody said, “What if we drill two wells [or four wells] side by side and we set the plugs on one at the same time as we frac the one next to it.” So you can go back and forth, setting the plugs and using the frac equipment at the same time on different wells and then switch. On a pad you’ve got hundreds of trucks and a ten story drill rig and a lot of other equipment all working on a couple of acres. It’s all about learning how to minimize downtime.

OAG360:  You talked about the need for more gathering and processing systems as well and short- and long-haul pipelines in today’s note: “This bodes well for companies like MasTec, Inc. (ticker: MTZ), and Primoris Services Corp. (ticker: PRIM), given their construction capabilities as we enter a potentially multi-year cycle of build out.” Could you expand on that?

Wangler: On the infrastructure side, companies like Kinder Morgan (ticker: KMI) and Enbridge (ticker: ENB) and others have significant plans for the next 3-4 years. I look at 2014 as a year for engineering and permitting for major pipelines and other infrastructure projects and 2015, 2016 and 2017 are going to be the build-out years.

OAG360:  What are OilService companies doing with their Master Service Agreements to retain and support their E&P customers?

Wangler: On the completion side, a lot aren’t signing very many now. The service companies aren’t looking to sign long term deals because they don’t like the pricing and those contracts can be broken if the E&P wants to. On the drilling rig side, the 3-year contracts are in demand and popular, for the brand new rigs especially.

OAG360:  Any thoughts on the rumors of Pioneer Natural Resources (ticker: PDX) selling its Eagle Ford assets?

Wangler: If they want to focus on the Permian, it’s a good way to add $3-$4 billion cash in order to do that.

OAG360: Thank you for your time.

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Analyst Commentary

Jason Wangler - Wunderlich Securities Note - (10.8.14)

$90/bbl Oil Sure Keeps the OFS Names Rather Busy Too...Where We Want to Be

Following our piece yesterday about the E&Ps and how their growth profiles, at least at this point, are seemingly unchanged we thought it would be helpful to also discuss what those activity levels mean for the oilfield service (OFS) companies. These stocks have had an equally interesting, and recently depressing, run in the last 10-12 months as the industry cycle has continued to improve out in the field, but lately the stocks have told a very different story. Much like with the E&Ps we think this presents a nice opportunity for investors if they can get comfortable in the world of $90/bbl WTI oil and $4/mcf NYMEX natural gas (the world we live in today), given that most all of the E&P companies are running their programs on this level and that provides a considerable amount of work for the OFS names. As such we remain bullish on multiple names as we feel the revenue, EPS, and EBITDA growth should continue as the workflow continues to be robust. Below we walk through a few industry data points and the companies we like in this environment.

Key Points

Activity hasn't skipped a beat as the shale plays (specifically the oil and liquids regions) continue to run hard. Believe it or not the actual activity levels in the oil patch remain strong and frankly unaffected from the recent declines in oil price. Natural gas markets remain muted given the price but oil/liquids plays are still running strong as evidenced below in the rig count. We feel this shows the OFS companies continue to generate high utilizations that should grow revenues, EPS, and EBITDA in 3Q14 and beyond, assuming oil and natural gas remain at these levels or press higher.

Even with all the efficiency gains in the oil patch the drilling rig count is at 1,922 currently, which is up 166 rigs (or 9.5%) from last year, up 171 rigs from YE13 (or 9.8%) and only slightly off the two-year high of 1,931 counted just two weeks ago. The activity level can possibly be summed up best by the fact that in late September the rig count reached 1,931 which was the highest since August 2012. Since then it has fallen all of just nine rigs and is still about 10% higher than where it was when we started the year. What is even more impressive is that the count is growing so nicely even with the efficiency gains for OFS equipment/services really pushing the activity levels higher on a per-rig basis as well.

Channel checks indicated pressure pumping is getting healthier and is further evidenced by higher build-outs and acquisitions of late. The last few years have been tough for the pressure pumpers given the fact that there was so much supply in the market and not even increasing demand was able to swallow it up. That seemingly has started to change as our channel checks indicate strong utilization rates for most of the pressure pumpers and even slight upticks on price (though admittedly as of now that's mostly to account for higher costs). Additionally, market transactions like recent deals by Patterson-UTI Energy (PTEN-$29.14, Hold) to buy assets in the market as well as many players contracting for new horsepower could indicate an improving market.

The need for infrastructure remains apparent and should lead to ample announcements and workflow for the companies with oil and gas construction capabilities. The continued discussion of the US having ample and growing oil supply (we don't want to hear about oversupply given our import figures) only puts a bigger need on the transportation of oil as well as natural gas from where it is produced to where it is refined, consumed, exported, etc. The high differentials for oil of late in the Permian or for gas in the Appalachian regions are examples of regional oversupply and the need for more gathering and processing systems as well as short- and long-haul pipelines. This bodes well for companies like MasTec, Inc. (MTZ-$27.82, Buy) and Primoris Services Corp. (PRIM-$25.72, Buy) given their construction capabilities as we enter a potentially multi-year cycle of build out.

Despite all of these bullish data points the OSX chart looks like basically the opposite as sentiment toward energy has a dramatic downward bias. The OSX started 2014 at about 280 and shot up to the 310 level by mid-year before falling to the current 255 level. That would mean the oilfield space rose about 11% before falling about 18% from the peak and now sits down about 9% on the year despite all the bullish data explained above. As such, we think there is ample value in the space. Below we highlight names with compelling valuations.

I guess we are contrarian in that we like the $90/bbl oil and $4/mcf natural gas levels and continue to like names with high-spec equipment as it garners strong pricing, good margins, and high utilizations. We believe there is ample value in names like Pioneer Energy Services (PES-$12.02, Buy) and Seventy Seven Energy (SSE-$22.22, Buy) at these levels; given the drop in the stock due to macro factors believe Patterson-UTI Energy is becoming more compelling. These names have high-spec drilling rigs and completion crews (except PES), they provide other oilfield services that are vital to the industry, and they are seeing high utilizations today.

Additionally, names with a technological advantage or unique structure also give us confidence in their value. We like differentiated stories like Superior Drilling Products (SDPI-$5.64, Buy) given its Drill-N-Ream technology that could become a force in the industry; Natural Gas Services Group (NGS-$23.30, Buy) due to its strong presence in the compression market, growing revenues, and EBITDA and unique C-Corp structure in the space; and TETRA Technologies (TTI-$10.17, Buy) as its recent acquisition at the MLP level could drive strong gains due to its GP ownership and Maritech is finally nearing an end.  

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