National Oilwell Varco (NYSE: NOV) recently reported its results for the fourth quarter of last year. They showed another step forward for the oil-field equipment company as it marches back toward profitability. It’s a turn that CEO Clay Williams believes is just around the corner; this led him, on the accompanying conference call, to detail five factors that drive the company’s optimistic outlook.
The tide is turning
Williams started off his oil-market overview by saying:
After three extraordinarily difficult years, it feels to us that the market is nearing an inflection point. Oil inventories are rapidly approaching normal levels, pushing oil prices up and facilitating the return, in our view, of a geopolitical risk premium. Industry surveys are pointing toward a modest increase in upstream capex [capital expenditures], the second straight year following a cumulative two-year drop that nearly halved global upstream capex. This all sets the stage for a brighter outlook for 2018.
As Williams looks at the data, he sees a definite improvement in market fundamentals, which should drive customers to increase spending on much-needed equipment. That uptick in demand would help accelerate the recovery in his company’s financial results.
Image source: Getty Images.
Oil companies are afraid current pricing won’t last
That said, while the numbers suggest things are getting better, “it’s not clear that oil companies believe higher oil prices, at least not yet,” according to Williams. That’s because they’re under pressure from investors to generate returns, which they can’t do to the same extent if crude takes another dive; Williams said “there persist fears that the oil price could revisit” $45 a barrel, so oil companies are making investment decisions on projects based on crude “closer to $45 a barrel than the spot price of Brent, which is about $70 a barrel.”
Most major oil companies are sticking to their plan to live within the cash flows they could generate if oil averages $50 a barrel this year. Instead of reinvesting the cash produced at current prices, companies like Anadarko Petroleum (NYSE: APC) and ConocoPhillips (NYSE: COP) are using the excess money to reduce debt and ramp up cash returns to investors. Anadarko recently boosted its dividend fivefold, added $500 million to its share repurchase program, and pledged to reduce debt by another $1 billion. Meanwhile, ConocoPhillips raised its dividend 7.5%, added $500 million to this year’s buyback plan, and paid off another $2.25 billion in debt. Both Anadarko and ConocoPhillips took those actions to demonstrate that they’ll maintain discipline this year in case crude tumbles.
Some oil companies can’t get funding
While several larger oil companies are generating free cash flow this year at current prices, others aren’t at that point yet. That’s hindering their ability to spend, which banks have further compounded by “reduc[ing] exposure to the oil and gas industry,” according to Williams. That’s a problem because, according to a study by Rystad Energy, the top 33 shale drillers need $2.4 billion of debt financing this year to bridge their funding gap — but many drillers are having trouble securing it because banks don’t want to lend to the sector. Without that debt financing and a projected $8.3 billion in additional equity financing, the industry might complete 1,300 fewer wells this year than expected. “In short, the newfound fidelity to capital discipline and lack of bank financing will likely, in my view, result in higher oil prices on down the road,” said Williams.
After a rough stretch, industry fundamentals are getting better
One of the reasons the market’s downturn had been so brutal is that “the last three years have witnessed a succession of bad breaks,” said Williams. He pointed out that:
OPEC relinquished its traditional role of swing supplier, at least for a while. Libya and Iraq grew production meaningfully. Other large long-term projects came online. Iranian oil returned to the market. And finally, U.S. shale production continued to grow well into 2015.
However, Williams stated that, while “these all contributed to an oversupply picture that got progressively worse through the first two years of the downturn,” the market “has since turned the corner and is rapidly improving.”
Image source: Getty Images.
The race back onshore is still in the early legs
The final observation Williams made was that the industry shifted its spending habits. He pointed out that “over the past year, the rig count in Midland has risen dramatically while the offshore rig count has fallen,” so “2018 will see the U.S. break production records dating back to 1970.”
Williams believes that this shift back onshore is only beginning; he said that “we’re confident unconventional shale technology will be adopted elsewhere around the world too.” That’s leading his company to turn its focus from outfitting expensive offshore-drilling rigs to finding solutions for shale drillers. That will enable National Oilwell Varco to fully participate as the industry moves more of its spending onshore.
The upward turn is just beginning
National Oilwell Varco’s CEO firmly believes that oil industry conditions are on the upswing. In fact, he thinks that oil prices could have much more upside because companies that can spend aren’t, while those that want to spend can’t get funding. Those and other factors drive his confidence that the company has a bright future.
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Matthew DiLallo owns shares of ConocoPhillips and National Oilwell Varco. The Motley Fool owns shares of and recommends National Oilwell Varco. The Motley Fool has a disclosure policy .
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.