Oil & Gas Drilling Industry Outlook Not Appealing to Investors

The Zacks Oil and Gas – Drilling industry consists of companies that provide rigs on a contractual basis to explore and develop oil and gas. These operators offer drilling rigs (both land-based/onshore and offshore), equipment, services and manpower to exploration and production companies worldwide.

Let’s take a look at the industry’s three major themes:

•    The slump in oil prices and coronavirus-induced demand shock has pushed drilling activity lower by introducing tremendous uncertainty around the exploration and production (E&P) spending outlook. From supermajor ExxonMobil (XOM) to smaller players like Oasis Petroleum (OAS), all have made drastic cuts to their capital expenditures in an attempt to preserve cash and stay afloat. Obviously, this translates into lesser work for the companies that make it possible for upstream players to drill for oil and gas. In a nutshell, the oil and gas drilling fundamentals remain extremely bearish with most of the companies entirely focused on survival. With no real chance of E&P capex cut reversal this year, drilling activity is expected to remain weak over the near-to-medium term.

•    However, one of the key positive arguments for drillers is the focus on reserve replacement rate. Over the past few years, the supermajors have struggled to replace all of the oil and gas they churn out, raising concerns about future production. In this context, Chevron and Royal Dutch Shell’s 2019 oil reserve replacement ratio of just 44% and 76%, respectively, indicates the inability to add proved reserves to the amount of oil and gas produced. This clearly calls for a calibrated approach in meeting reserve shortfalls in the long run. Consequently, a gradual improvement in drilling activity looks likely.

•    The highly cyclical nature of the industry makes its participants — who generally build big and expensive drilling rigs — heavily dependent on the prevailing business environment. In other words, it’s extremely difficult for any driller to perform well during a commodity downturn. However, the ability to come up with technologically superior products with higher efficiency can help companies gain a competitive edge in the market. Within the industry, it’s interesting to note that the volatility associated with offshore drilling companies is much higher than their onshore counterparts and their share prices are more correlated to the price of oil. But investors should keep in mind that these stocks are prone to quick falls, unlike the stocks of land drillers.

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