Get Ready to Pick Up Some Drillers

 | Sep 18, 2012 | 7:23 AM EDT
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Oil's down $5 per barrel. Sell all the oils. Sell the drillers. Anything oil-services-related has to be jettisoned.

That's how it would be if oil were down $5 over five days. It would be wrong to take such strong-headed action. But it would be especially wrong after the bogus trading we saw in the last half-hour of the oil pits Monday.

We know stocks are trading thinly, and despite endless protestations that somehow high-frequency trading enhances liquidity-something -- which even the worst perpetrators would admit it doesn't -- we know manipulation simply can't be helped. High-frequency trading exacerbates all natural directions because there is no counterweight, and because there are fewer and fewer players in stocks.

I just didn't think that there were so few players in oil.

Anyway, here's what matters. If you look at the sudden decline in oil from 2008 to 2009 -- the one that took the price down $100 pretty quickly -- you saw a decidedly low number of long-term oil-services contracts cancelled. Almost no rigs were cancelled at all.

That's because these projects require a long-term view on oil, and the long-term view for almost all companies -- whether national or private -- is that they can't maintain their production growth with just the current number of rigs. Yet production growth is a must for strapped budgeted countries, and it is a must for private companies, because almost all of them trade on production growth that replaces spent fields.

So they keep ordering and ordering, without much worry about the futures.

We know that pattern from just four years ago -- and yet, the stocks trade on every whim of the futures, regardless of how obviously manipulated or thinly traded they are, as we saw from the close of trading.

The names that are most buffeted tend to be the least likely to see cancellations -- stocks like National OilWell Varco (NOV) or Schlumberger (SCHL), which catch fast money out of the stocks as well as fast money into puts on the Market Vectors Oil Services ETF (OIH). The moves are instantaneous and they are devastating.

I am not telling you to take the other side of the trade just yet. The oil rally off the bottom at $80 to $82 has left the stocks on an unsustainable high that is now going to be repealed.

I am simply reminding you that, in the worst decline I have ever seen -- the trashing from $147 to $50, and even a few dollars below in the height of the lunacy -- we saw very few cancellations.

Some of that is due to new discoveries off the coast of Africa. Some is due to a resumption of drilling in the Gulf of Mexico. Some of it is the exploitation of massive finds in Brazil -- finds so large that they need a gigantic number of brand new rigs from National OilWell.

 Perhaps most important, a lot of it comes from the need to find oil in the U.S., where technology has opened whole new fields. Take one look at how Chesapeake needs to exploit its new fields in order to more than make up for the Permian acreage sold. This tells you a futures plunge is downright meaningless. It took forever for natural gas drilling to slow, and the price decline for oil has been nothing like that. So watch the hammering for a day or two, and then get ready to buy the best of the best OIH names -- namely, Schlumberger and National Oil Well Varco.

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