What Do You Say We Switch From Politics to Rig Counts?

 | Jun 09, 2017 | 3:36 PM EDT
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Well, after yesterday's column, I am finished with political prognostications. With only one constituency still to be decided at this writing, Theresa May's Conservatives are eight seats shy of a majority, and the dreaded "hung Parliament" is upon us. That has hammered the pound and driven the FTSE-100 up 1% today, but I believe such gains will be ephemeral. 

As promised yesterday, I am working on a new Real Money Best Idea, but I still have one or two more numbers to run on that stock. So I'll have that in one of my columns next week. Since I am not qualified to make political predictions, I'll focus on something much more predictable: the Baker Hughes rig count data. 

This week's figures, unsurprisingly, showed the 21st consecutive week of an increase in rigs in operation. What is going on? Do these cowboy-hatted wildcatters not realize their exuberant drilling is what is keeping oil prices below $50 per barrel? 

Managements at exploration and production companies are not as stupid as loafer-wearing New York-based hedge-fundies make them out to be. Any E&P executive can quote you exact figures on the internal rate of return (IRR) on any individual well at any time. I know many of these guys, and they are the most financially savvy capitalists I have encountered. 

Obviously, though, IRRs would be higher with a higher commodity price, and basic economics tells us that increasing supply never will increase the price of a commodity. 

So why is there so much drilling going on in North America, and especially Texas? Because well economics is driven much more by the cost side than the revenue side. Revenues can be hedged, and please do not ever own an E&P stock whose management does not carry on a robust hedging program. 

Costs, on the other hand, are variable, and wells being drilled today are based on invoices -- AFEs in oil industry parlance -- that were generated months ago. 

Today's wells are being drilled at much lower costs than prevailed in the go-go years of 2013-14, and that is supportive of well economics. That cannot last forever, though, as the balance of power shifts from the drillers to their suppliers. 

To play that transition, one could buy the big boys, like Baker Hughes (BHI) and Schlumberger (SLB) , but, as usual, I find more opportunity among the smaller names. 

Much like human beings, oil wells cannot exist without water. High volumes are needed for the hydraulic fracturing process, and even higher volumes are produced along with hydrocarbons over the life of the well. So a new well needs many gallons of water pumped downhole, and an existing well produces huge quantities of water that need to be disposed of. (Schlumberger is part of TheStreet's Action Alerts PLUS portfolio.) 

The water transfer and treatment companies were hit even harder than their customers in the oil crash. As the pace of oil drilling has increased, though, oilfield water service companies have experienced much better results. 

To play this renaissance, the market has provided ample opportunities via "new" oilfield water service companies. Select Energy Services (WTTR) came public in 2017, and Basic Energy Services (BAS) and Key Energy (KEG) both emerged from bankruptcy within weeks of each other as the calendar changed from 2016 into 2017. 

So check out those high-quality H2O plays if you are looking for exposure to America's energy renaissance.

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