Another Way to Make Money on Oil

In 2008, Exxon Mobil set a quarterly record for US companies. They made $15 billion in profits when oil prices were above $100/barrel. With oil prices still lingering above $100/barrel, they (and the rest of the oil majors) may not set a new record but they will still make obscene profits. And there’s another reason to like the oil majors. When inflation kicks in, they will make even more money. Their costs to pull oil out of the ground will undoubtedly increase (wages, equipment, etc.). But oil prices will rise much faster.

So if you can’t beat ’em, join ’em. Buy the oil majors.

And there’s another way to make money on the rise in oil prices… with your profits coming indirectly from the oil majors themselves.

Let’s take a look…

There is much more involved in any oil well than just pumping oil out of the ground and transporting it away.

Long before the oil starts flowing, there’s exploration. And evaluations to determine if the find is commercially viable. Then there is modeling and imaging to figure out the best spot for the well. After all that, the drilling can commence. Followed by cementing the well and well casing.

Once the well is up and running, it needs to be maintained. Repairs need to be made. Production needs to be measured and improved. Computer software needs to be in place to monitor everything.

And before the oil can be transported to a refinery, pipelines need to be built.

The list goes on and on.

The oil majors can’t do all of this. Nor do they want to. So they hire companies to carry out much of the necessary work.

But make no mistake… these aren’t small outfits. Some of these companies are very big. A few carry market caps well over $30 billion. And the oil majors can’t operate without them.

They are called oil services companies, and they might be your best way to make money on oil. Just look at how well they did in the past when oil prices surged…

From October 1988 through October 1990 oil prices increased 160%. During that period the oil services jumped 98% while the S&P 500 only gained 12%.

When oil prices increased 51% from October 1999 through November 2000, the S&P 500 gained 4%. But the oil services jumped 19%.

More recently – from January 2007 through June 2008 – oil prices increased 144%. The oil services jumped 58% while the S&P 500 fell 4%.

And here is what oil services companies have done since March of 2009:

The three oil services companies shown above (the red, blue, and green lines) gained 130%, 150%, and nearly 225%.

Compare that to the S&P 500 (the yellow line), which rose about 65%.

The oil services aren’t through. They should continue to outpace the market for the foreseeable future.

Here’s why…

With oil prices north of $100/barrel, the oil majors want to bring up every last drop of oil they can. The majors need more exploring and testing done to find new fields. They need more rigs to put those fields into production. And getting to the oil is getting harder and harder. That means more specialized drilling.

And all of that means more work for the oil services companies.

Here’s another reason the oil services should continue to do well: With lower oil prices, it might not have made economic sense to go after smaller or harder to reach oil deposits. Those fields require “intensive care,” as our research analyst Andrew Gordon calls it. But with $100/barrel oil, the majors are going to be putting marginal fields into production and keeping them operating longer. And oil majors will be relying on the oil services companies to help coax more of that oil out of the ground.

The scramble for oil has just begun. Many experts project oil demand to increase 70%-120% by 2050. And as the easy to reach oil runs out, the oil majors will need the expertise of the oil services companies more and more to help them find (and put into production) new fields.

If you are looking for another way to profit on the rise in oil prices (or looking to diversify your oil bets), you should take a long look at the oil services.

We like the companies that have dominated the industry for decades. They have the size to handle the increased demand, the expertise to meet the challenge, and the contacts to get the lion’s share of the new business. The oil majors can’t afford to look anywhere else. There is simply too much money on the line.

To gain exposure to these companies, consider the oil services ETFs. A few examples: the OIH, IEZ, and PXJ.