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Drillers, oilfield service stocks end already challenging year with Q4'18 plunge

Negatively impacted by widespread producer spending discipline and a falling crude oil price, businesses in the oilfield services and equipment sector saw investor returns significantly decline into the end of 2018.

But after a bumpy start to 2019, the oilfield service sector should get a boost, as crude oil prices are forecast to recover and drive higher spending in exploration and production.

The West Texas Intermediate, or WTI, crude oil futures price fell 24.8% year over year to $45.41 per barrel on the last trading day of 2018, rekindling exploration and production capital budgeting uncertainty and stoking concerns that the oilfield services industry may be heading into another downturn, analyst with Tudor Pickering Holt and Co. said.

On the last day of trading in 2018, while the S&P 500's year-over-year total return was a loss of 4.4%, the S&P 500 oil and gas drillers' total return was a loss of 22.6% and the S&P 500 oil and gas equipment and services' total return was a loss of 41.5%.

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The health of the oilfield services sector is still quite weak as oilfield service companies and their exploration and production customers are seeing significant inflation in labor costs, according to Moody's. Most oilfield service companies also need to reinvest in their operations to boost service capacity and meet customer demand, Moody's said in a Jan. 3 research note.

Tudor Pickering Holt analysts expect earnings across the oilfield service sector to head in the "wrong direction" in January and during the fourth-quarter 2018 earnings season.

Moody's analysts said that even if oilfield service companies book more revenue in 2019, they may not generate significant discretionary cash flow and boost financial flexibility.

In the challenging market environment, investor returns declined sharply across all sector businesses. Majors Schlumberger Ltd. and Halliburton Co. each saw investor returns tumble 44.6%. TechnipFMC PLC investor returns dropped 37% while Baker Hughes a GE company returns fell by 30.4%.

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In some cases, company performances in 2018 were impacted by exposure to the Permian Basin, where a lack of pipeline capacity has slowed production projects.

Baker Hughes in November 2018 repurchased about $1.5 billion shares in conjunction with parent company GE lessening its stake in the company, but even with the return of excess capital and the company's diversified product/service portfolios, total investor returns suffered into the year's end.

The negative impact from Permian exposure is expected to continue for majors including Baker Hughes and Halliburton into this year, however the U.S. onshore markets still present more growth opportunities than other markets, Moody's analysts said.

"Exploration and production companies and oil majors have committed much of their capital in expanding unconventional production, and current prices should support their ongoing development," the Moody's analysts said.

Despite 2018 struggles, "The strong producer focus on low-risk, flexible and quick-payback shale assets in a low and volatile price environment should lift utilization and pricing in the oilfield service sector in 2019, while infrastructure hurdles gradually dissipate."

Struggles in the North America land market also had negative implications for drillers in 2018 as the number of drilled but uncompleted wells increased and pressure pumping activity declined.

Total investor returns ranged widely in the negative for drillers from 22.7% lower for Okla.-based Helmerich & Payne Inc. to 54.6% lower for Patterson-UTI Energy Inc.

Helmerich & Payne said during a Dec. 4, 2018, energy conference that drilling market conditions are improving even as oil prices have moved lower, and as the replacement cycle persists and well complexity increases.

Drilling efficiency, increasing pad drilling and longer lateral lengths continue to drive the demand for super-spec rigs, the company said.

Likewise, despite Patterson-UTI's troubles, Chairman Mark Siegel said during the company's third-quarter 2018 earnings call that fundamentals remain strong for U.S. onshore drilling and completion activity despite the near-term slowdown in pressure pumping.

The near-term challenges related to exploration and production budget exhaustion and pipeline constraints are expected to be temporary, he said, adding that the company's position as a leading provider of super-spec drilling rigs gives it visibility in both near-term drilling activity and longer-term completion demand.

"Customer appetite for term contracts on drilling rigs in a rising dayrate environment confirms that super-spec drilling activity should remain strong and continue to drive the number of wells being drilled," Siegel said. "The current slowdown in completion activity is leading to an increase in the backlog of wells waiting to be completed, which bodes wells for increasing demand for pressure pumping in the not too distant future."