Outlook for Oil Service Shares
Posted on January 9, 2007
As oil prices continue to be weak, and shares in oil service providers remain in the doldrums (i.e. check out the OIH performance over the last six months and year), we thought we’d share some interesting historical figures for those still bullish on the sector.
According to Simmons and Company, the leading independent investment bank in the energy industry (Note: Emphasis added by Envoy Global Research):
“During the 1970s, the oil service stocks realized stellar performance. For example, from 1970 through 1979, the stock price of SLB increased ten-fold. The ascent was dramatic in absolute terms as well as relative terms as SLB eclipsed the broad market (measured by the S&P 500) which rose a meager 16% over this period. Even so, the ascent was not a smooth climb. Oil service stocks enjoyed their most significant gains in the early 1970s and late 1970s due in large part to the Arab oil embargo of 1973 and the Iranian oil embargo of 1979. Our focus is on the less volatile stock price period from 1975 through 1978, a time when oil services experienced robust gains, but also hit a plateau for a 20-month stint during 1976 – 1978... The absolute returns on the oil service stocks were spectacular. The composite posted gains of nearly 300% between 1970 – 1973, 80% between 1975 – 1978 and 200% between 1979 – 1980…As shown below, the P/Es contracted meaningfully during the steady growth, lower volatility period from 1975 – 1978. Although a significant component of the contraction was driven by the broad market P/E retrenchment, the trend is clearly evident on a relative P/E basis as well. While one might argue that P/Es typically contract as up-cycles unfold and that the reduction in relative P/Es during this time was reflective of the maturation of the cycle, two pieces of data counter this position. First, relative P/Es were expanding during the explosive growth period of 1970 – 1973 and relative P/Es expanded rapidly in 1979 – 1980 as explosive growth and greater volatility returned.”
Source: Simmons and Company, Intl. 12/03, The More Things Change the More They Stay The Same
So what do we take away from all of this?
Well firstly, we’d caution like Simmons, that parallels between today’s environment and the 70’s are hardly perfect and it would be silly to simply extract findings from the 1970s and haphazardly apply them to today’s energy markets without an extensive comparative analysis. Nevertheless, on a simple level, and simplicity perhaps is the key to investment success, the above numbers suggest to us that if you missed the first big run in oil stocks earlier in the decade, not to worry, they’ll be another big run before the end of the decade. The culprit, sadly, will probably be some major geopolitical event. In the meantime, start gathering a list of the most attractive names in the energy sector for purchase during this period of price consolidation. We would expect that entry back into the sector will prove profitable late this year or in early 2008 after performance-chasing funds grow tired of the once hot sector.
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This is interesting. I tend to agree that oil shares will get hot again, but of course the timing is difficult. In any case, I favor the producers, rather than the service companies and I wonder what the performance of the oil producers was back in the 70’s.