Oil Service Companies: What’s Behind the Future Run-Up in These Stocks

The long-awaited relief rally in stocks may be here. The Dow shot up 9% last week, giving hope to traders that the hemorrhaging has stopped. If the heavy hitters of money such as Marc Faber and Peter Grandich prove to be correct, the current rally may be a big one.

Most sectors should rally strongly when money begins to enter the market in earnest, but stocks with a bright future beyond the technical liquidity play will enjoy capital inflows well beyond the flows of the fickle momentum players controlling these markets. Index players make money in bull moves, but is it enough reward for the risks taken? Even the turkeys fly with a strong enough wind.

Consider trading and investing in oil service companies, instead. The fundamentals underlying this sector are strong on a long-term view of pricing and future demand, according to Ernst & Young LLP.

“It’s critical to maintain a long-term outlook [of oil and gas companies] to take advantage of the right investment opportunities and bargains that will undoubtedly be available in the medium term. Be disciplined,” Jon McCarter, transactions leader for Ernst & Young LLP’s Oil & Gas Center said in a December 15, 2008, press release. “Take the emotion out of it. And stay the steady course.”

The government of China doesn’t appear to have a problem with its emotions regarding the future direction of the oil price; the country’s central planners have been making deals left and right this year in their attempt to secure oil prior to the eventual upturn in the world economy. The Wall Street Journal reported in February:

“China reached a long-term deal to lend $25 billion to two Russian energy companies in exchange for an expanded supply of Russian oil, highlighting how the world’s No. 3 economy is using its financial muscle to lock up access to natural resources.

The agreement, part of a broader Sino-Russian energy cooperation pact signed Tuesday in Beijing, follows several overseas resource deals in recent weeks that combined involve nearly $50 billion in Chinese capital. The moves, which promise to make China a much bigger player in global commodities industries, are leveraging China’s relative financial strength at a time when most other big economies are in recession.”

Another recent Time article encapsulates the mood surrounding the Beijing mad rush to secure not only oil but other natural resources in its article entitled, “China Goes on a Smart Shopping Spree.” Erika Downs, China energy fellow at the Brookings Institute in Washington told Time:

“There are editorials in the Chinese press saying that this is a one-in-100-years opportunity. There is a sense that this is a moment to be seized, that with competition lower they can get a good deal,” she stated.

China expects the supply of oil to be tight. The oil (as well as other commodities) deals made by the economic juggernaut appear in the news each week. Tight supplies mean higher oil prices. And higher prices create shortages of rigs, qualified personnel and available service contractors available to the industry, raising labor costs, revenue streams and stock prices as well.

An investment in the oil price is one way to play the oil market, but the commodity doesn’t offer the needed leverage sought by the aggressive investor. The major oil producers don’t move like their smaller siblings in a bull market. Besides, major oil companies may easily become targets of Washington lawmakers when it comes time to find more money to shrink the federal budget deficit, while oil service companies fly under the radar of the tax man.

If China has been buying everything oil with both hands, should you be, too?