Schlumberger and the crude oil bear market

The Baker Hughes US rig count has begun to creep up to 371, clear evidence that shale oil output rises after the big move in spot crude since January.

Crude oil has fallen from $50 to $42 on West Texas light sweet futures, a three month low, on awful fundamentals and macro fund short selling. The gasoline glut has led to midsummer night's nightmare in the oil market that faces a global glut, high inventories and weak demand. The rise in the US dollar Index after Brexit a month ago has amplified selling pressure on crude oil, as have rising short positions on both benchmark contracts. Chinese demand has been mediocre. Barclays data that global oil demand growth is just one third its rate since Q3 2015, clear evidence that large swathes of the global economy are in recession.
The supply data reinforces my bearishness on crude oil. The Baker Hughes US rig count has begun to creep up to 371, clear evidence that shale oil output rises after the big move in spot crude since January. We have now seen four successive weekly increases in the US rig count, a bad omen for black gold/Texas tea bulls. As oil hedges from 2015 expire and fracking rises, US oil output will surge. In fact, supply will rise at the precisely the moment US refiners begin their seasonal drawdowns, when crude demand falls. Global oil storage has also begun to creep higher. The political crisis in Venezuela, the coup attempt in Turkey, the Nigerian currency devaluation and Azerbaijani banking failures have not prevented a major fall in oil prices in July. I believe it is entirely possible that West Texas falls below $40 by the time the US summer driving season ends on Labour Day in September.
Schlumberger is unquestionably the world's biggest, classiest oil services company. However, if I am correct in my West Texas crude macro call, Schlumberger will fall from its current price of 81 to 72-74 in the next two months. I estimate my buy/sell trading range (for now) in this iconic Houston/Paris oil services colossus as 72/90.
The Cameron International acquisition and restructuring meant a second quarter 2016 loss. Schlumberger has also cut 16,000 jobs in the first half of 2016, a clear sign that exploration and production companies worldwide are still in capex/output cutting mode. I was surprised chairman/CEO Paal Kibsgaard concluded "we are at the bottom of the cycle" since it is so obvious that drilling/oilfield capex/equipment supply/deepwater still faces the Black Death in the world's oil provinces that began in the summer of 2014, when Brent peaked at $115. However, financial markets extrapolate the future, not discount the past. Halliburton rose 30 per cent in 2016 and Schlumberger 16 per cent on this principle, though Weatherford, as usual, was a big time loser. Obviously, Mr Market has bet on an oil market rebalancing that I doubt will happen this autumn. If I am right, the next 10 per cent more in Schlumberger is down, not up, even though I believe the epic job cuts, the Cameron deal, the new product areas and the firm's historic ties to both the Seven Sisters/global state oil companies (eg ADNOC, Aramco, Rosneft, Petro China, Pemex etc.) make this company a must own blue chip in any rational investment portfolio.
Despite the US land rig count rise this month, I concede that a fall in crude prices could derail this momentum. I believe Schlumberger's rise from 59 to 81 has been due to "irrational exuberance" on a recovery/rebalancing that will take a lot longer than corporate oracles in the oil services industry project. It is also almost certain that oil prices will remain "lower for longer", mired in a potential $35-45 trading range on West Texas. Geopolitics and the US dollar are, as usual, a wild card but the core reality in crude oil is a global glut and record gasoline stockpiles. If I am right, investors should only accumulate companies with the strongest balance sheets, the best management/technology infrastructure and the lowest beta to crude oil prices. This again leads me to Schlumberger but only at 72.
Shell has been a global supermajor even since colonial Dutch geologists drilled for oil in Sumatra in 1890. Yet its $70 billion BG deal was awful timing though it has creates the world's lowest cost LNG/natural gas producer. Shell trades at 1.2 time book, has a 6.5 per cent dividend yield. Unfortunately the scale of the loss last week once again raises the odds of a capex or dividend cut - or both. This risk makes Shell a short in its New York ADR.
Researched and compiled by Matein Khalid. Mr Khalid is a global equities strategist and fund manager. He can be contacted at: matein@emirates.net.ae