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Energy services are not responding to the traditional catalysts that would normally spur a valuation expansion. Global monetary policy is hyper-reflationary, as measured by our global monetary policy barometer. Typically, energy services stocks have outperformed when liquidity conditions are flush. So far, the relative share price ratio has only been able to manage a lateral move, despite emerging from deeply oversold conditions. Does this tepid performance represent a potential ‘catch-up’ opportunity, or is it reflective of a new paradigm?
Our US Equity Strategy service is leaning toward the latter.
Excess slack is preventing the industry from generating enough pricing power to expand profit margins to a meaningful degree. The decline in the global oil & gas rig count has pushed our idle rig proxy below one, defined simply as the number of rigs as a share of the prior peak. This is consistent with modest excess capacity. Pricing power gains have been difficult to generate when this gauge is below one, and major declines have been associated with industry deflation.
The odds of a sustained reacceleration in the global rig count appear low. Non-OECD product demand has slipped and the growth in Chinese oil imports is close to nil. Total OECD oil supplies are rising on a growth rate basis, similar to the trend in total U.S. energy inventories. OPEC spare capacity is creeping back up as Saudi Arabia reins in production to try to defend Brent oil prices. The message is that the physical oil market appears to be well supplied at the moment.
Bottom Line: Downgrade the S&P energy services index to neutral, as there are few remaining catalysts to break the index out of its sideways funk.
This post was originally published by the BCA Research blog.