If Michael LaMotte is right, this O&G downturn will not be the repeat of the 1980s that so many folks in the oilfield fear right now. LaMotte, a Senior Managing Director at Guggenheim Securities where he leads the firm's energy team, made waves with a big call on Monday. He upgraded 23 stocks to a Buy rating Monday morning.
For the first time in two years, LaMotte has has turned positive on the outlook for oil services. He thinks the return of $100 oil is in sight, and he upgraded the entire oil services sector to a buy.
Having covered oil services for about 20 years, LaMotte is known as one of the most thoughtful research analysts covering the sector. While Wall Street analysts as a whole have a reputation for playing fast and loose with their ratings, LaMotte is the exception. He rarely makes wholesale ratings changes like this. So when he does, people take notice. His call lifted the oil service index nearly 3% in trading on Monday.
In a note to clients, Guggenheim provided three reasons why oil is likely to hit $100 / barrel again inside of three years.
1. Delays in Production Turnaround
Guggenheim believes that restimulating production outside of the US, Russia, and OPEC will be much more difficult than most people expect. Two years of falling capex will be self-correcting the firm says. LaMotte wrote: “Specifically, we expect the net, managed decline rate for this 27.7 mmbd of production to decline -2.5 percent pa beginning next year."
2. War In Syria & Iraq
The ongoing conflicts in Syria and Iraq may not be directly threatening oil infrastructure, but they have second order effect many are missing, LaMotte said. He thinks the conflicts are detracting investment in the Middle East away from oil development and towards military and social services spending. He thinks Iranian production will only rise 1mmbpd over the next few years, a slower ramp than many expect. And he believes that production over 3.8mmbpd will require multiple years of investment / buildout.
3. US Tight Oil Production Growth Moderation
The US unconventional production boom is over in LaMotte's mind. A combination of slower drillbit response in 2016 and falling well productivity in 2017 means only modest growth in the coming years for US oil.
So what to do with the stocks? LaMotte advised his clients to buy them now before the recovery he anticipates gets underway. He sees 10% upside across the board for oil services next year given the group's exposure to oil prices. Here's an excerpt from his note on the stocks:
We have become bullish on the oil services sector for the first time in nearly two years, for three reasons: 1) we believe that the global oil market will begin to tighten in 2Q16 and that oil prices will rise further and faster than the “lower for longer” consensus expects, reaching $100/bbl by 2018; 2) energy’s low S&P weighting and high short interest suggest that supply and demand for oil services equities is out of balance and that the stocks have a lot of upside from sentiment simply getting less negative; and 3) as earnings bottom in 1H16, we expect investors will begin to look through the trough and focus more on the full-cycle upside evidenced by low price to tangible book value (TBV) and mid-cycle earnings multiples…
Offshore drillers. We believe these stocks will benefit more from the rising tide of fund flows into the energy sector than from any improvement in industry fundamentals. In fact, because of the magnitude of over-supply in the offshore rig market, and the significant reduction in the cost of stacking (vs. scrapping), we do not expect this segment of the market to show any improvement in utilization or day rates until the 2018-2019 time frame or return to mid-cycle earnings until 2020. Within this group, we prefer Atwood and Rowan, as 1) we believe their DP backlogs should help reduce near-term risk, 2) Rowan has no newbuild commitments and Atwood is finalizing a contract in Brazil for one of its two uncontracted rigs, 3) we think utilization in the Middle East (Rowan) and Australia (Atwood) should be resilient on a relative basis; and 4) both of the drillers have fleets (both in terms of rig specification and fleet size) that make them more interesting M&A candidates.