Don't look now, but the rig market for oil and gas projects is heating up again.
After suffering through a period when rigs were being "retired" from the field, the pendulum is swinging back again. Rigs are suddenly in high demand -- and hold the secret to how to invest in the growing U.S. shale oil boom.
This is hardly surprising. Without a rig, a well is nothing more than a place marked on a map.
That's why the oil field service (OFS) business always improves before the fortunes of field production companies.
But did you know there's an even earlier link in this profit chain?
Without it, the OFS business wouldn't exist and neither would the all of those oil wells. Yet what goes on in this portion of the business rarely gets reported on.
Nonetheless, it's the home of one of my favorite oil and gas plays...
The Equipment That Keeps it All Running
Of course, I'm talking about the companies that manufacture and distribute all of the massive equipment each well requires.
From pressure pumps to drill bits, down-hole motors and more, these are the companies that keep the OFS business humming.
It's part of an ongoing move by the big OFS outfits to consolidate access and increase profitability.
But the market for equipment in general and rigs in particular is a very fluid one.
There is also another factor to consider: when there's an upsurge in equipment demand like the one developing right now, there is also an inflationary factor.
Put simply, as demand heats up, so does the pricing spiral. But that's good news for the individual investor in the equipment sector.
In this case, the returns on the equipment slice of the business are registered up front, while the downward drag takes place further down the chain.
When considering how to invest, it is also important to remember that the oil-and-gas-equipment market is global. While rig demand is growing in North America, the need to develop fields is even more pressing in other parts of the world.
That's adding even more overall demand to a business with already limited availability. And unconventional production (shale gas, tight gas, shale oil, tight oil) has only made this situation worse.
Since the pay zones in these fields are horizontal rather than vertical, drilling equipment is more expensive and subject to more frequent delays in availability.
And then there is the peripheral footprint on the surface.
Fracking work at unconventional sites requires water pushed downhole under heavy pressure. That, in turn, requires a large array of pumping trucks and ancillary equipment surrounding the well head, along with compressor stations (to maintain pipeline pressure levels), retention basins (for flowback water) and a range of site-specific processing and separation units.
A working well is a massive array of parts and machinery.
In fact, here's a photo that shows just a portion of what the pumping footprint at a small frack operation looks like:
And this picture does not include everything else that is needed on the surface.
All of these things have major implications for the use and rates of a broad range of equipment. Add to this the repair/maintenance component, and there are solid prospects for a retail investment return.
The only question is how to invest in this trend...
How to Invest in Oil and Gas Field Equipment
With all the M&A going on in the OFS sector, and its reach further "upstream" into the manufacturing and distribution segment, figuring out how to invest in these opportunities could be a full-time job.
But it doesn't have to be with the two suggestions I'm about to give you.
The first is to use exchange traded funds (ETFs) that focus on the equipment and its utilization.
The second identifies a company likely to be in the center of this move up.
Remember, however, that this trend is cyclical. Once costs reach a certain level, the profitability of equipment application declines. At that point, inflationary pressures have moved into supplies, labor, transport, and other elements, and the field applications begin to taper off.
But in the interim, here's how to invest in the equipment side of the oil businsess.
First, let's talk about the ETFs.
I have periodically recommended to Energy Advantageand Energy Inner Circlemembers two standouts in this sector - the SPDR S&P Oil & Gas Equipment and Services ETF (NYSEArca: XES) and the Market Vectors Oil Service Holders ETF (NYSE MKT: OIH).
Both of these funds encompass the equipment and OFS sides of the business, although XES may be the more focused play if you're looking to primarily target the equipment prospects. But XES has been performing better than OIH of late, making it the better move.
It is important to keep in mind that ETFs also charge fees. While those fees are merely deducted from the share level realized, they nonetheless also reduce your returns.
But there is one company that stands to benefit most directly from what is happening in the equipment sector.
It's National Oilwell Varco (NYSE: NOV). This is one of the primary stand-alone (i.e., has not been acquired by an OFS big boy) providers of oilfield equipment and service.
The company had been sluggish until recently. Over the last two weeks, NOV is up 6.17%--but given the business that it's in, this one is likely to head much higher.
Just be sure to use a trailing stop. I typically recommend my readers use a 30% trailing stop for most investments.
Trailing stops dictate when to sell based on a percentage from its highest level since acquisition. That protects your profits while limiting your risk.
And be sure to keep an eye on the equipment side of the business. It's not exactly sexy, but that's not always the best way to make money in the markets.
Editor's Note: The shale oil boom may have started in the U.S. and Canada, but now has begun to spread to many other parts of the world. Here Dr. Moors explains how to invest in this golden opportunity for those oil and gas companies that possess the expertise needed to exploit these vast new resources.
About the Author
Dr. Kent Moors is an internationally recognized expert in oil and natural gas policy, risk assessment, and emerging market economic development. He serves as an advisor to many U.S. governors and foreign governments. Kent details his latest global travels in his free Oil & Energy Investor e-letter. He makes specific investment recommendations in his newsletter, the Energy Advantage. For more active investors, he issues shorter-term trades in his Energy Inner Circle.