Basics of the Oil Services Industry That Investors Should Know – Part 1

Anyone who has been reading the papers or watched the news lately would have realised by now that the price of oil has suffered a drubbing. A real drubbing.

With the price of oil having fallen by more than half since its June 2014-peak, companies within oil-related industries have seen their share prices decline in tandem (though not necessarily at the same magnitude as the slide in oil prices).

Falling share prices bring with them the possibility of bargains and this is pertinent for local investors because Singapore happens to be home to many of the region’s largest oil services companies.

But before we can sieve out the wheat from the chaff, it might be wise for us to take a step back and understand the basics of the oil services industry.

The types of companies

In Singapore, there are mainly two types of oil services companies: The builders of rigs and ships; and the ones which provide offshore support services. This article will go on to cover more about the former group; you can read about the basics of the providers of offshore support services by jumping in here.

Companies such as Keppel Corporation Ltd (SGX BN4) and SembCorp Marine Ltd (SGX: S51) are rig builders and can be considered to be amongst the largest of their kind in the world. The duo have been building jack-up rigs for their customers. Such rigs have three to four moveable legs and a triangular platform which is jacked-up to avoid the highest estimated waves.

These rigs are generally used for shallow water (depths of less than 120 metres) drilling. Shallow water drilling typically has a lower cost structure as compared to deep-water drilling. Therefore, owners and users of such rigs – and by extension the builders – might be less affected by the large recent drop in oil prices.

Demand and supply of rigs

Investors looking at a possible investment into rig builders might need to take a look at the demand and supply for various types of rigs.

Current rig utilization rates can help provide an indication of the future demand for whichever type of rig is under study. A high utilization rate would usually mean that the demand for rigs is high and there is a market for more rigs to be built.

Book order

As the rig builders mainly operate on a “build-to-order” business model, their revenue can be more or less predicted from their outstanding book order.

For the case of Keppel Corp and Sembcorp Marine. both declare their book orders every quarter and investors can used that information to estimate their future revenue.

But, there’s also a need for investors to look into the details of the book order as some orders might contain opt-out options which could be exercised by rig owners during an industry downturn like the one we’re experiencing currently.

Balance sheet

Investors should also take a hard look at the balance sheet of the rig builders. This is because the cyclical nature of their business necessitates the need for a strong balance sheet in order to survive or even prosper through the inevitable down-cycles.

Currently, Keppel Corp and Sembcorp Marine are carrying total debt to equity ratios of 50.1% and 56.4% respectively. Although their balance sheets are not exactly fortress-like, the duo does seem to have sustainable finances for now. Investors should keep an eye on the future trend of the two firms’ debt ratios.

Foolish Summary

It is inevitable that oil services companies find their fortunes linked to the price of oil. Unfortunately, no company is able to control the direction of the commodity’s price. But, companies with a strong balance sheet, flexible operations, and strong order book will be better equipped to weather the storm.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Stanley Lim owns Keppel Corporation