Amid tumbling oil prices, the Market Vectors Oil Service ETF (NYSEArca: OIH), the largest oil services exchange traded fund, has lost more than 26% this year. Reduced capital spending plans have also pressured oil services stocks.
Investors should keep in mind that the oil services sector is heavily reliant on capital spending cycles in the energy industry. The recent sharp cuts in capital expenditure budgets in 2015 contributed to the pullback in oil services – U.S. companies are expected to spend about 20% less than the average over 2014, with some cutting expenditures by around 50%.
For instance, BP Plc (NYSE: BP) plans to sell $3 billion to $5 billion in assets next year and divest a further $2 billion to $3 billion of assets in 2017.
This isn’t the first time the energy sector has been forced to tighten their belts. Through 1987 to 1997, companies suffered through an extended period of lower prices and responded by cutting costs, which ensured “earnings grew strongly,” according to Bernstein research.
With low oil prices pressuring oil producers’ bottom line, industry experts expect capital spending on new projects to decline by 20% and 30% on average, according to Wood Mackenzie, an energy consultancy. The consultant calculated that about $220 billion in investments have been cut so far, or $20 billion more than previously estimated two months ago, after the recent price declines. Some industry analysts see the downturn lingering into next year, though it will not be as severe as what was seen in 2015.