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Oil Service Companies’ Gusher

Investors Alley
Oil Service Companies’ Gusher
I continue to love the sector Wall Street seems to hate: energy. Analysts are saying oil has peaked and…

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Investors Alley
Oil Service Companies’ Gusher

I continue to love the sector Wall Street seems to hate: energy. Analysts are saying oil has peaked and bad times are directly ahead for the sector. I believe that oil markets are more fragile than the recent price decline might signal.

The same factors that sent energy prices higher over the past year remain in place. Global stockpiles are low and the energy supply system is running near flat. The OPEC+ alliance has very little spare capacity, and what’s left is held almost entirely by Saudi Arabia and the United Arab Emirates. Refiners are producing about as much fuel as they can. And governments (including the U.S.) are drawing down their emergency supplies at a record pace.

All of these factors leave little room for the market to absorb any future supply shocks, which I think are likely.

So the reality, away from Wall Street, is that these are good times for the industry—especially oilfield service providers. These are the companies that carry out the grunt work of drilling and servicing oil and gas wells.

These companies suffered a near-death experience in 2020, when the pandemic shattered demand for oilfield activity and upstream spending by oil companies. The collapse in demand prompted the oil service companies to sack tens of thousands of workers and idle their equipment. But now their fortunes have completely reversed.

The large energy producers, having initially opted to take advantage of the oil price rally to repair their balance sheets and return money to shareholders, are finally expanding again.

This increasing demands from drillers, coupled with widespread shortages in everything from the sand used in fracking shale wells to rig hands and drivers, have greatly improved profit margins for oil services providers.

Of the three major U.S. oil servicers, only Baker Hughes is struggling (its equipment division is still a laggard). The other two companies—Schlumberger (SLB) and Halliburton (HAL)—are doing quite well, thank you.

Schlumberger

In fact, Schlumberger reported a fantastic quarterly profit and sharply raised its outlook for the year.

Schlumberger’s second quarter showed net income of $959 million, more than double the level in the same period last year. Revenues of $6.7 billion were up by a fifth. North American sales rose 42%. The company posted 20% year-over-year revenue growth and an operating margin of 17%—a level not seen since 2015!

CEO Olivier Le Peuch said that the world’s biggest provider of services to the oil and gas industry anticipated its revenue growth rate this year to be in the high-teens, resulting in revenues of “at least” $27 billion, compared with $23 billion in 2021. The company also expects adjusted EBITDA margins to be 200 basis points higher than they were in the fourth quarter of 2021.

Le Peuch added that the industry was in the middle of a “multiyear upcycle [that] continues to gain momentum with upstream activity and service pricing steadily increasing both internationally and in North America.”

In a true sign of management confidence, Schlumberger raised its dividend by 40% in the first quarter of 2022, to $0.70 annually, making the current yield 2%. I expect the dividend raises to continue for the foreseeable future. My eventual target is the company’s pre-pandemic dividend rate of $2.00 per share annually.

Add to that Schlumberger’s exceptional investment history. Over the years, it has rather consistently generated shareholder value through use of its R&D capital investment dollars to develop a wide variety of new products and services. Roughly 25% of revenue comes from new technology each year.

That makes the stock a compelling buy anywhere in the mid-30s per share.

Halliburton

Jeff Miller, CEO of Halliburton, reiterated the concerns about the shortages facing the oil industry.

He said that the North American oil services market remains “all but sold out” this year and that there was no indication of that changing next year. He further pointed out that the shortages of labor and equipment at U.S. oilfields are likely to get worse next year, adding: “What we see in our business is activity [and] demand moving up. We see a tighter [20]23 than we see in 2022,” he said. Keep in mind that Halliburton is the largest domestic frac fleet operator.

His comments came as Halliburton reported revenues of $5.1 billion for the second quarter, up 18% on the previous quarter and 37% on the year-ago period. Net income of $117 million was about half of last year’s income as a result of impairment charges from the company’s exit from Russia. Excluding these costs, it roughly doubled to $442 million.

And Miller dismissed those Wall Street fears of an impending slowdown. He said company discussions with operators were focused on demand for “more equipment or more services” in 2023, “not recession—I can promise you that is not the discussion.”

And like the Schlumberger CEO, Miller reaffirmed his view that the company was entering a “multiyear up cycle” both domestically and internationally. While Halliburton is less exposed to international markets than its peers, it is one of the top players in markets like the Middle East and Asia, where long-term growth is forecast to be the strongest.

The company’s optimism, like Slumberger’s, has spread to its dividend policy. Halliburton tripled its dividend in January, to $0.48 per share annually (the current yield is 1.73%). I expect more shareholder and dividend-friendly announcements over at least the next year or two. My target for now is the company’s prior annual dividend (pre-pandemic) of $0.72 per share.

Halliburton shares are a buy in the $28 to $32 range.

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Oil Service Companies’ Gusher
Tony Daltorio

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$265 Billion In Added Value To Evaporate From Germany Economy Amid Energy Crisis, Study Warns

$265 Billion In Added Value To Evaporate From Germany Economy Amid Energy Crisis, Study Warns

A new report published by the Employment Research…

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$265 Billion In Added Value To Evaporate From Germany Economy Amid Energy Crisis, Study Warns

A new report published by the Employment Research (IAB) on Tuesday outlines how Germany's economy will lose a whopping 260 billion euros ($265 billion) in added value by the end of the decade due to high energy prices sparked by Russia's invasion of Ukraine which will have severe ramifications on the labor market, according to Reuters

IAB said Germany's price-adjusted GDP could be 1.7% lower in 2023, with approximately 240,000 job losses, adding labor market turmoil could last through 2026. It expects the labor market will begin rehealing by 2030 with 60,000 job additions.

The report pointed out the hospitality industry will be one of the biggest losers in the coming downturn that the coronavirus pandemic has already hit. Consumers who have seen their purchasing power collapse due to negative real wage growth as the highest inflation in decades runs rampant through the economy will reduce spending. 

IAB said energy-intensive industries, such as chemical and metal industries, will be significantly affected by soaring power prices. 

In one scenario, IAB said if energy prices, already up 160%, were to double again, Germany's economic output would crater by nearly 4% than it would have without energy supply disruptions from Russia. Under this assumption, 660,000 fewer people would be employed after three years and still 60,000 fewer in 2030. 

This week alone, German power prices hit record highs as a heat wave increased demand, putting pressure on energy supplies ahead of winter. 

Rising power costs are putting German households in economic misery as economic sentiment across the euro-area economy tumbled to a new record low. What happens in Germany tends to spread to the rest of the EU. 

There are concerns that a sharp weakening of growth in Germany could trigger stagflation as German inflation unexpectedly re-accelerated in July, with EU-Harmonized CPI rising 8.5% YoY. 

Germany is facing an unprecedented energy crisis as Russian natural gas cuts via the Nord Stream 1 pipeline will reverse the prosperity many have been accustomed to as the largest economy in Europe. 

"We are facing the biggest crisis the country has ever had. We have to be honest and say: First of all, we will lose the prosperity that we have had for years," Rainer Dulger, head of the Confederation of German Employers' Associations, warned last month. 

Besides Dulger, Economy Minister Robert Habeck warned of a "catastrophic winter" ahead over Russian NatGas cut fears.

Other officials and experts forecast bankruptcies, inflation, and energy rationing this winter that could unleash a tsunami of shockwaves across the German economy.  

Yasmin Fahimi, the head of the German Federation of Trade Unions, warned last month:

"Because of the NatGas bottlenecks, entire industries are in danger of permanently collapsing: aluminum, glass, the chemical industry." 

IAB's report appears to be on point as the German economy seems to be diving head first into an economic crisis. Much of this could've been prevented, but Europe and the US have been so adamant about slapping Russia with sanctions that have embarrassingly backfired. 

Tyler Durden Wed, 08/10/2022 - 04:15

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Will Powell Pivot? Don’t Count On It

Stocks are rallying on hopes that Jerome Powell and the Fed will stop increasing interest rates this fall, pivot, and start reducing them next year. For…

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Stocks are rallying on hopes that Jerome Powell and the Fed will stop increasing interest rates this fall, pivot, and start reducing them next year. For fear of missing out on the next great bull run, many investors are blindly buying into this new Powell pivot narrative.

What these investors fail to realize is the Fed has a problem. Inflation is raging, the likes of which the Fed hasn’t dealt with since Jerome Powell earned his law degree from Georgetown University in 1979.  

Despite inflation, markets seem to assume that today’s Fed has the same mindset as the 1990-2021 Fed. The old Fed would have stopped raising rates when stocks fell 20% and certainly on the second consecutive negative GDP print. The current Fed seems to want to keep raising rates and reducing its balance sheet (QT).

The market-friendly Fed we grew accustomed to over the last few decades may not be driving the ship anymore. Yesterday’s investment strategies may prove flawed if a new inflation-minded Fed is at the wheel.

Of course, you can ignore the realities of today’s high inflation and take Jim Cramer’s ever-bullish advice.

When the Fed gets out of the way, you have a real window and you’ve got to jump through it. … When a recession comes, the Fed has the good sense to stop raising rates,” the “Mad Money” host said. “And that pause means you’ve got to buy stocks.

Shifting Market Expectations

On June 10, 2022, the Fed Funds Futures markets implied the Fed would raise the Fed Funds rate to 3.20% in January 2023 and to 3.65% by July 2023. Such suggests the Fed would raise rates by almost 50bps between January and July.

Now the market implies Fed Funds will be 3.59% in January, up .40% in the last two months. However, the market implies July Fed Funds will be 3.52%, or .13% less than its January expectations. The market is pricing in a rate reduction between January and July.

The graph below highlights the recent shift in market expectations over the last two months.

The graph below from the Daily Shot shows compares the market’s implied expectations for Fed Funds (black) versus the Fed’s expectations. Each blue dot represents where each Fed member thinks Fed Funds will be at each year-end. The market underestimates the Fed’s resolve to increase interest rates by about 1%.

Short Term Inflation Projections

The biggest flaw with pricing in predicting a stall and Powell pivot in the near term is the possible trajectory of inflation. The graph below shows annual CPI rates based on three conservative monthly inflation data assumptions.

If monthly inflation is zero for the remainder of 2022, which is highly unlikely, CPI will only fall to 5.43%. Yes, that is much better than today’s 9.1%, but it is still well above the Fed’s 2.0% target. The other more likely scenarios are too high to allow the Fed to halt its fight against inflation.

cpi inflation

Inflation on its own, even in a rosy scenario, is not likely to get Powell to pivot. However, economic weakness, deteriorating labor markets, or financial instability could change his mind.

Recession, Labor, and Financial Instability

GDP just printed two negative quarters in a row. Some economists call that a recession. The NBER, the official determiner of recessions, also considers the health of the labor markets in their recession decision-making. 

The graph below shows the unemployment rate (blue), recessions (gray), and the number of months the unemployment rate troughed (red) before each recession. Since 1950 there have been eleven recessions. On average, the unemployment rate bottoms 2.5 months before an official recession declaration by the NBER. In seven of the eleven instances, the unemployment rate started rising one or two months before a recession.

unemployment and recession

The unemployment rate may start ticking up shortly, but consider it is presently at a historically low level. At 3.5%, it is well below the 6.2% average of the last 50 years. Of the 630 monthly jobs reports since 1970, there are only three other instances where the unemployment rate dipped to 3.5%. There are zero instances since 1970 below 3.5%!

Despite some recent signs of weakness, the labor market is historically tight. For example, job openings slipped from 11.85 million in March to 10.70 in June. However, as we show below, it remains well above historical norms.

jobs employment recession

A tight labor market that can lead to higher inflation via a price-wage spiral is of concern for the Fed. Such fear gives the Fed ample reason to keep tightening rates even if the labor markets weaken. For more on price-wage spirals, please read our article Persistent Inflation Scares the Fed.

Financial Stability

Besides economic deterioration or labor market troubles, financial instability might cause Jerome Powell to pivot. While there were some growing signs of financial instability in the spring, those warnings have dissipated.  

For example, the Fed pays close attention to the yield spread between corporate bonds and Treasury bonds (OAS) for signs of instability. They pay particular attention to yield spreads of junk-rated corporate debt as they are more volatile than investment-grade paper and often are the first assets to show signs of problems.

The graph below plots the daily intersections of investment grade (BBB) OAS and junk (BB) OAS since 1996. As shown, the OAS on junk-rated debt is almost 3% below what should be expected based on the robust correlation between the two yield spreads. Corporate debt markets are showing no signs of instability!

corporate bonds financial stability

Stocks, on the other hand, are lower this year. The S&P 500 is down about 15% year to date. However, it is still up about 25% since the pandemic started. More importantly, valuations have fallen but are still well above historical averages. So, while stock prices are down, there are few signs of equity market instability. In fact, the recent rally is starting to elicit FOMO behaviors so often seen in speculative bullish runs.

Declining yields, tightening yield spreads, and rising asset prices are inflationary. If anything, recent market stability gives the Fed a reason to keep raising rates. Ex-New York Fed President Bill Dudley recently commented that market speculation about a Fed pivot is overdone and counterproductive to the Fed’s efforts to bring down inflation.

What Does the Fed Think?

The following quotes and headlines have all come out since the late July 2022 Fed meeting. They all point to a Fed with no intent to stall or pivot despite its effect on jobs and the economy.

  • *KASHKARI: 2023 RATE CUTS SEEM LIKE `VERY UNLIKELY SCENARIO’
  • Fed’s Kashkari: concerning inflation is spreading; we need to act with urgency
  • *BOWMAN: SEES RISK FOMC ACTIONS TO SLOW JOB GAINS, EVEN CUT JOBS
  • *DALY: MARKETS ARE AHEAD OF THEMSELVES ON FED CUTTING RATES
  • St. Louis Fed President James Bullard says he favors a strategy of “front-loading” big interest-rate hikes, repeating that he wants to end the year at 3.75% to 4% – Bloomberg
  • FED’S BULLARD: TO GET INFLATION COMING DOWN IN A CONVINCING WAY, WE’LL HAVE TO BE HIGHER FOR LONGER.
  • “If you have to cut off the tail of a dog, don’t do it one inch at a time.”- Fed President Bullard
  • “There is a path to getting inflation under control,” Barkin said, “but a recession could happen in the process” – MarketWatch
  • The Fed is “nowhere near” being done in its fight against inflation, said Mary Daly, the San Francisco Federal Reserve Bank president, in a CNBC interview Tuesday.  –MarketWatch
  • “We think it’s necessary to have growth slow down,” Powell said last week. “We actually think we need a period of growth below potential, to create some slack so that the supply side can catch up. We also think that there will be, in all likelihood, some softening in labor market conditions. And those are things that we expect…to get inflation back down on the path to 2 percent.”

Summary

We are highly doubtful that Powell will pivot anytime soon. Supporting our view is the recent action of the Bank of England. On August 4th they raised interest rates by 50bps despite forecasting a recession starting this year and lasting through 2023. Central bankers understand this inflation outbreak is unique and are caught off guard by its persistence.

The economy and markets may test their resolve, but the threat of a long-lasting price-wage spiral will keep the Fed and other banks from taking their foot off the brakes too soon.

We close by reminding you that inflation will start falling in the months ahead, but it hasn’t even officially peaked yet.

The post Will Powell Pivot? Don’t Count On It appeared first on RIA.

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Airlines Are Going to Hate it if Biden Gets This Through

The administration is considering doing something about one of the things people hate most about flying.

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The administration is considering doing something about one of the things people hate most about flying.

The airline industry has had a very bumpy road back to whatever passes for normalcy in the covid era. This past weekend was a particularly bad headache for air travelers, as 950 flights were canceled on Sunday, and 8,000 were delayed. It was a tough weekend overall, as 657 flights were canceled on Saturday, and 7,267 flights were also delayed that day. 

In fact, according to the Bureau of Transportation Statistics, of the more than 2.73 million flights so far in 2022, roughly 20% have been delayed while 3% were canceled.

The reasons for this are myriad. Climate change is leading to increasingly unpredictable weather. While many people are beginning to act like covid is over, that’s just not the case, and many flights are still getting canceled because crew members have become infected and need to quarantine.

Additionally, the airlines are all understaffed, as the industry lost more than 400,000 workers during the pandemic. Many pilots retired, and the industry has struggled to attract enough people to replace them in a tight labor market. Additionally, the workers who stayed report that they feel burnt-out and overworked, and in some instances fear for their safety.

This leads to more workers quitting or calling in sick, and therefore flights get canceled because there’s not enough people to work them.

Cancelations are a headache no matter which way you slice it. But a proposal from Transportation Secretary Pete Buttigieg might make it easier for customers to get a refund in a timely manner.

Want A Refund For A Canceled Flight? Good Luck!

Getting a refund for a canceled flight is like pulling teeth. 

Technically, it is federal law that consumers are entitled to a refund if an airline cancels a flight and the consumer chooses not to travel, as the Department of Transportation has stated customers can get a refund if the airline “made a significant schedule change and/or significantly delays a flight and the consumer chooses not to travel,” according to the Department of Transportation.

But the problem, as noted by ABC News, is that the “DOT has not defined what constitutes a “significant delay.” According to the agency, whether you are entitled to a refund depends on multiple factors, including the length of the delay, the length of the flight and “your particular circumstances.”

It’s rare for an airline to just say “tough luck” and not give the customer anything after a cancellation. (Imagine the social media firestorm!) But while there’s no industry-wide standard, most airlines just issue vouchers or credits for a future flight instead of a cash refund, which ties the customer to that airline in the future.

What’s even more frustrating is that very often these vouchers will expire within a year, which doesn’t always work for many people’s travel plans. Though to be fair, Southwest  (LUV) - Get Southwest Airlines Company Report did recently announce they would be changing this policy, removing all expiration dates from flight credits.  

Win McNamee/Getty

Mayor Pete Wants To Make Refunds Easier

Buttigieg has announced a proposal that would expand customer rights in terms of protections cancelations and refunds for both domestic and international flights. “This new proposed rule would protect the rights of travelers and help ensure they get the timely refunds they deserve from the airlines,” states Buttigieg.

Under the proposal, passengers who do not accept alternate transportation (i.e. getting bumped to a later flight) will be eligible for a refund for any of the below circumstances. 

  • If your flight is canceled
  • Whenever departure or arrival times are delayed by at least three hours for domestic flights or by at least six hours for international flights, if flyers opt-out of taking the flight
  • Anytime the departure or arrival airport changes or the number of connections is increased on an itinerary
  • If the original aircraft has to be replaced by another but there’s a major difference in the onboard amenities offered and overall travel experience as a result

The proposal would require airlines to issue vouchers, with no expiration date, when passengers are “unable to fly for certain pandemic-related reasons, such as government-mandated bans on travel, closed borders, or passengers advised not to travel to protect their health or the health of other passengers.”

But if an airline or ticket agency received pandemic-related government assistance, they would be required to issue cash refunds instead of vouchers.

In an interview with The Points Guy, Buttigieg said “Every step moves us further towards passengers being more protected,” he said. “This is based on authorities that have built up over time, but it’s clear that the passenger experience isn’t good enough, and we need to do more to clarify airlines’ responsibilities and to make clear what we’re going to do to enforce them.”

While this is just a proposal at the moment, Buttigieg said “I think we can move this one pretty quickly, barring any surprises.” He added that “We are going to be responsive to feedback and the suggestions that come in.”

If you have thoughts on this matter, the public is invited to attend a virtual meeting hosted by the Aviation Consumer Protection Advisory Committee that’s scheduled for Aug. 22, 2022. Any comments you wish to make about this proposal can be submitted here under docket number DOT-OST-2022-0089. 

 

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