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.
“The research team at Rystad Energy said on Tuesday that the downturn in the oilfield services business was the worst since the 1980s. Average service purchases fell by about 19% year over year, and Rystad expects the downturn to expand by 9% in 2016,” reports Paul Ausick for 24/7 Wall Street.
There are some positive catalysts, though. While there are still concerns that Halliburton (NYSE: HAL) will not be able to complete its acquisition of rival Baker Hughes (NYSE: BHI), August’s deal-making in the oil services space predictably touched-off speculation that more oil services firms are ripe takeover candidates. [More M&A for Oil Services ETFs]
“The researchers expect more cost cutting and layoffs, new alliances and collaborations, more mergers and acquisitions, and more pricing battles as service firms try to lock-in multiyear agreements with exploration and production companies,” adds 24/7 Wall Street.
Market Vectors Oil Service ETF
