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Oil's Selloff Is Our Contrarian Buy-Signal - But Not Yet!
Thursday, January 22, 2015 by Scott Fraser

We’ve been talking a lot about emotion in relation to our share positions and trading strategies – and oil’s steep decline is yet another poignant example of the emotion game. Many of you have wisely sold oil-share positions and have held off on new purchases from this sector. Many of you also wisely implemented protective sell-stops on your energy related positions, which have no doubt been activated by now.

This is an astute strategy as there’s nothing wrong with selling a stock you believe in and then buying it back at a lower price point as the macro-environment improves for that particular sector.

In our collective mantra of trading with a sense of direction versus a sense of urgency, the disciplined and aware investor is not concerned with attempting to call a bottom in oil prices. Conversely, we are mere observers of the oil sector’s steepest decline in recent memory because we know there will be ample opportunity as calm Contrarian investors to profit from oil’s imminent rebound.

Luc Olinga of the Association of Financial Professionals wrote an outstanding article entitled “US oil services firms slash jobs as crude prices plunge” detailing the current state of the oil patch:

Big winners in the US shale-oil boom, energy services providers now are slashing jobs to preserve their profits and margins from the rapid dive in oil prices. Over the past month, the sector's three largest companies have announced 17,000 job cuts in the oil patch even as they notched up robust earnings in 2014.

Schlumberger, the world's largest oilfield services company, has ordered the lion's share of layoffs: 9,000, or 7.5 percent of its workforce. Baker Hughes, the number three firm, which is being acquired by number-two Halliburton, is shedding 7,000 employees, representing 11.3 percent of its staff, with most of them to be shown the door by the end of March.

As for Halliburton, 1,000 jobs are being eliminated outside the Americas and the company has signaled that was just the beginning. "We expect our headcount adjustments to be in line with our primary competitors," the company warned.

Second wave of layoffs?

The wave of layoffs is expected to be followed by another of similar scope, analysts say, pointing out the energy industry in Texas and Gulf of Mexico states was being particularly hard hit by the price crash.

Crude oil has lost more than 60 percent of its value since June. The free fall is forcing energy companies to cut back on exploration, hammering the business of services contractors. The number of land rigs drilling for oil has fallen 15 percent in the United States over the past 60 days, according to Dave Lesar, Halliburton chairman and chief executive.

Halliburton's clients have reduced their capital spending by as much as 30 percent and are delaying new projects, particularly in offshore exploration, he said.

Ratings firm Standard & Poor's, in a recent review of 23 US oil and gas companies, found some producers could face significant liquidity pressures if oil prices do not rebound in 2016. S&P lowered the credit rating on eight firms and put others on watch for a downgrade.

Lesar, speaking to analysts Tuesday, noted a sharp slowdown in activity in producer countries such as Angola, Australia, Malaysia and Russia, and particularly in offshore production. Faced with this slowdown, the major oil companies are demanding that services firms lower their fees, especially in hydraulic fracturing, or fracking, to extract natural gas from shale rock.

"We are starting to certainly have some serious discussions with customers around bringing down the prices and helping them adjust their costs," said Martin Craighead, chairman and CEO of Baker Hughes, in a conference call Tuesday.

Halliburton's Lesar said that price discount discussions with customers began in the fourth quarter and have accelerated over the past several weeks. "Price reductions are now occurring across all product lines," he added.

Profits under pressure

"In this environment we would expect to see most of our margin degradation occurring over the first couple of quarters and more margin stability in the back half of the year," Lesar said.  All three Houston, Texas-based companies are expected to write down assets and book heavy charges.

Baker Hughes is planning a charge in the $160-$185 million range in the first quarter, while Schlumberger will post $296 million in charges for the employee layoffs. "Our industry is clearly in the early stages of a down cycle," said Craighead. Baker Hughes is already hunkering down, planning to close sites and scale back investments around 20 percent from last year.

Halliburton intends to cut operating expenses and demand sacrifices from its own suppliers. Schlumberger is reducing its fleet of specialized vessels used in marine seismic operations. In the longer term, consolidation is expected in the oilfield services sector as companies face competition from emerging players, including in China and South Korea.

Halliburton and Baker Hughes already are joining forces, with Halliburton agreeing in November to buy its smaller rival in a $34.6 billion deal that is expected to close in the second half of 2015. The companies see the combined company producing business savings of nearly $2 billion annually and raising Halliburton's competitive edge in the tough global market.

Clearly there is no rush to jump back into oil stocks. While there is no doubt there will be plenty of money to be made on U.S. oil stocks at some point – that point is not now. It will be interesting to watch OPEC’s actions over the next several months. Iran has already hinted at $25 per barrel oil – while BP Capital chairman and renowned energy maven T. Boone Pickens is predicting a powerful resurgence in oil prices back to $100 per barrel in the next 12 to 18 months.

Again, as a collective of calm, self-directed individual investors, our only mandated action at this juncture is to observe the gyrations of the oil sector. We are armed with the full knowledge that our forthcoming Buy-Signal will be clearly revealed when our emotions tell us to hit the BUY button with a sense of direction and not a sense of urgency.

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