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Schlumberger Limited. (SLB) and Core Laboratories N.V. (CLB): Here’s What Wedgewood Says About Oil Stocks

Investors and oil executives are confident about growth this year. Among those optimistic investors is Wedgewood Partners, a Missouri-based investment firm, which is hoping for 2018 to be a happy year for the oil industry. The St. Louis-based firm holds positions in five energy stocks: Schlumberger Limited. (NYSE:SLB), Core Laboratories N.V. (NYSE:CLB), Exxon Mobil Corporation (NYSE:XOM), National-Oilwell Varco, Inc. (NYSE:NOV), and BP plc (ADR) (NYSE:BP), according to the 13F filings. Wedgewood recently published its Q4 investor letter (you can download a copy here). In the letter, the firm talked about Schlumberger and Core Laboratories, noting that both stocks did not perform well during the last year. Let’s take a look at what Wedgewood said about those oil stocks as well as about the oil industry in 2018.

According to Wedgewood, oil prices rebound in the second half of 2017 as both Brent Crude and WTI prices returned 30%, but its energy names returned dismal low-to-mid-single-digit return rates. Schlumberger was down nearly 20%, while Core Labs lost 9% of its value in 2017.

Here are the investment firm’s comments:

While we go to lengths to explain that both Schlumberger and Core Labs create value far beyond that of owning the underlying commodity, we also must ask why they have not benefited from the apparent rebound of the energy market following one of the worst oil market crashes in recent history. The answer likely lies in the uncertainty around the production estimates for unconventional shale numbers.

Unlike conventional projects, unconventional shale wells have a rather short life, and most of a shale well’s production comes during its first year after completion. Take the Bakken fields for example. A well in the Bakken will experience a production decline of -72% after the first year. More than half of the reserves of that well will be depleted by the beginning of year three and annual production will fall dramatically. To generate constant or increasing revenue, producers need to constantly drill new wells. In addition, work on a new shale well can be postponed after the drilling phase, and before the fracturing of the shale structure, so production can be taken on and off rather quickly in response to price swings in oil.

As oil prices rose into the $100 range following the Great Recession, discovery and development of shale fields and production rates grew rapidly. Upon the subsequent crash in oil prices, shale production nearly stalled when prices fell to the low $30s (and for a short period, below). As oil prices have once again begun to rise toward $60 per barrel, we’ve seen capital spending rebound sharply in North American production. And yet international (unconventional) capital spending commitments remain hesitant, with some estimates indicating only modest growth for the year ahead, although this would be the first year-over year increase in capex spending in four years.

It is this limited investment in international E&P spending that has likely contributed to the sluggish turnaround of our oil service companies relative to the commodity. International, conventional field production houses the higher-margin, bigger pay-off projects. Any stall in committing capital to this group will flow through to the companies that service that work.

Schlumberger generates less than one quarter of the company’s total revenue from the North American region. The majority of revenue is generated in servicing the international plays. So, what gives us confidence that capital commitment toward international fields will increase beyond the modest rates projected for 2018? It is the broad belief that 2018 as a whole should operate as a closely balanced market and that supply and demand will come into balance at some point in the year – this is as a result of OPEC and non-OPEC members’ continued compliance with an agreement reached over a year ago, which took more than 1 million barrels per day (bpd) out of production. In addition, global demand growth remains above 1 million bpd. This is offset, however, by the U.S. oil production increase of 800,000 bpd projected for 20183. And while NAM production growth is robust, the EIA currently forecasts a moderation of U.S. production growth to a more reasonable 200,000 bpd by the end of the decade.

Of important note is the fact that U.S. oil production contributes a small fraction of total worldwide production. Global exploration expenditures have decreased year-over-year for three consecutive years, falling by over -60% from 2014-2017, with only modest increases estimated for 2018. If things stay at status quo – where global demand growth continues at its steady pace, the OPEC production-cut agreement remains in place, and investment levels in the production base outside NAM land remain at low levels – we could see a medium-term global supply challenge. We believe the need for higher investment in international production is imminent.

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Schlumberger Limited. (NYSE:SLB) has been doing well so far in 2018. The stock has moved up 14.75% since the beginning of the year. The company generated a total revenue of $30.44 billion in 2017, versus $28.01 billion in 2016. It booked a loss of $1.51 billion for the full year, versus a loss of $1.69 billion in 2016. Meanwhile, Core Laboratories N.V. (NYSE:CLB), an oilfield service company with a market cap of $5.28 billion, is also performing well this year, with the stock gaining nearly 9% year-to-date. The company trades with a P/E ratio of 68.94x.

Our database shows that 42 hedge funds were holding Schlumberger at the end of the third quarter of 2017, down compared to 48 funds at the end of the first quarter. Meanwhile, there were eight funds in Insider Monkey’s database at the end of third quarter with positions in Core Laboratories.

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