A looming shortage in an essential commodity

We’ve been making our case on Livewire for investing in oil-related stocks since 2015. It’s been an arduous journey that dates back to 2013, but with the recent oil price strength, Livewire got in touch to get our updated thoughts on the sector.

When asked how he went bankrupt, a character in Hemmingway's The Sun Also Rises responded "Two ways. Gradually, then suddenly". Our oil experience has been like that. The market rebalancing took a lot longer than we hoped and then happened a lot faster than expected.

"While we are sitting on some gains, there should be plenty more upside"

The magnitude of surplus inventories that had built up through the glut years suggested 2018 was going to be another year of waiting. Due to strong demand, a collapse in Venezuelan production and Saudi Arabia and Russia cutting supplies further than expected, the surplus evaporated in the first few months of this year. Now everyone is looking to some very obvious shortages in 2020 and 2021. So, I didn't expect it to take as long as it did, and then I didn't expect the price to rally as fast as it has.

8 stocks exposed to an oil recovery

All our exposure has been through oil services. We're not geologists and understand the services businesses a lot better.

Being too early was expensive. One of our first investments, Norway listed Dolphin Geophysical, fell almost 90% before we sold, and it subsequently went bust in 2015. Since then the experience has been much better.

In the International Fund we've done well out of Halliburton, Subsea7 and KLX and exceptionally well out of PGS, another Oslo-listed stock that operates in the seismic sector. Here in Australia, our local fund owns MRM Offshore and Matrix Composites and Engineering. While we are sitting on some gains, there should be plenty more upside in both.

We have been chopping and changing a lot, particularly in the International Fund. Some stocks have run hard alongside the strong oil price (PGS has doubled since the start of the year) while others are still very attractively priced.

"I'm still finding great opportunities and constantly trying to optimise our portfolio exposure."

One good example is UK-listed Gulf Marine Services (GMS). Unlike most in the sector, the company has generated healthy positive cashflows right through the downturn. It hasn't rallied at all alongside the oil price and still trades at half book value. So, we've taken some profits on PGS and added to our GMS investment. I'm still finding great opportunities and constantly trying to optimise our portfolio exposure.

The outlook from here

Our thesis was that the oil industry needs investment, and that it was not going to happen at $40 oil. That has proven correct.

"The question now is whether the world replace the oil it consumes at $75 oil?"

The question now is whether the world replace the oil it consumes at $75 oil? I've seen evidence to suggest the answer to that is yes. The US shale industry is clearly increasing production. And many offshore producers are saying they have economical projects at $60 oil and higher. My rough guess is that at $60-$90 oil prices you are going to get enough investment to balance the market long term.

A short-term pullback from here wouldn't surprise me but, over the next few years, the risks are probably to the upside. Companies might be saying they have projects that stack up but I'm not seeing many making the call on a final investment decision.

"As an owner of oil services stocks, we just want to see investment."

Currently there is still new supply hitting the market from projects sanctioned back before the oil price crashed. That ends this year though, and the dearth of investment in the past few years will start showing up in 2019 and 2020.

My personal preference is for some stability. Too much higher and you will start to see prices crimp demand. As an owner of oil services stocks, we just want to see investment. If the industry gets confidence that these levels can hold, the current price should encourage plenty of that.

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