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Second Time’s a Charm? The Case for Selective Exposure to Oil-Field Services

By Elliott H. Gue on Dec. 4, 2017

Heading into 2018, we like the setup for US-levered oil-field service stocks, though investors will need to remain selective and avoid the problem spots and value traps that lurk in this industry.

What’s changed over the intervening months?

Our outlook for oil prices is certainly more bullish than in late 2016 and early 2017, when we warned that the US production response would surprise to the upside and offset OPEC’s production cuts.

Although oil prices have rallied on several occasions over the past three years, we (rightly) regarded these upswings as ephemeral because the oil market remained in contango—that is, longer-dated futures commanded a premium to near-term contracts. This environment encourages market participants to store oil for future delivery and makes it easier for producers to hedge expected output.

In addition to improving investors sentiment, the recent strength in crude-oil prices should support solid capital spending among US exploration and production companies, many of which have taken advantage of the rally in WTI to lock higher prices on expected production.

Nevertheless, sentiment toward the industry remains cool, with investors erring on the side of caution and viewing the group as a show-me story—one of the big reasons oil-field service stocks hadn’t participated in the rally in crude-oil prices until recently. At these levels, the downside risk in many oil-field service names appears limited in the event that our investment thesis doesn’t work out.

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