I always suspected that last year’s OPEC and non-OPEC production cuts wouldn’t lift the oil price for long. Why? Because even a small increase in the price of crude was likely to open the floodgates to the second wave of the US shale oil revolution, and so it has come to pass.
Beyond the shale
The US isn’t bound by any production agreement so can carry on fracking and pumping at will, and with Donald Trump in the White House, that is exactly what it is going to do. Producers in the vast Texas Permian Basin reckon they can break even at prices as low as $30 a barrel, which makes me sceptical about investing in low-margin producers in other oil sectors and regions. I have been looking for a domestic way to play shale and I wondered whether these two companies might fight the bill.
London listed engineers Amec Foster Wheeler (LSE: AMFW) and Wood Group (LSE: WG), which agreed a £2.225bn merger last week, have both made acquisitions, giving them exposure to unconventional oil and gas markets in the US. Amec paid £1.9bn for petrochemicals engineering company Foster Wheeler in 2014, while Wood Group bought PSN in 2010 for around £600m. Wood Group has also said it would support UK shale companies if fracking is allowed here, although that could take time.
The two Aberdeen-based companies have been squeezed in the wider oil sector crunch. Amec Foster Wheeler has seen its share price almost halve in the past two years. Last week’s update showed trading profits down from £374m to £318m, with like-for-like revenues down 8% to £5.44bn, as continuing weakness in the oil and gas market offset a strong performance in its solar division. Trading margins fell 110 basis points to 5.8%.
Wood Group has also floundered, with total revenues shrinking 15.7% in 2016 to $4.93bn, while operating profits fell 22.8% in EBITDA terms. However, its £2.2bn all-share takeover gave its shares a lift, with the new entity anticipating sustainable cost synergies of at least £110m, plus diversification benefits. Let’s hope this link-up, assuming it completes, goes better than Amec’s merger with Foster Wheeler, which brought shale exposure and global diversification but saddled the company with £1bn in debt.
Amec Foster Wheeler has some diversification through its engineering and installation capabilities, while Wood Group also operates in the power plant, industrial and key energy sectors. However, oil and gas remains a tough sector to be in, and I cannot see that changing.
Although both companies now have access to US shale, their exposure simply isn’t enough to be a game-changer. Shale also has challenges, as salaries and costs are starting to climb as the boom gets back into gear, pushing up costs and cutting margins. Also, shale is likely to turn into a global revolution, with new production popping up everywhere, including a massive new basin in Mexico.
Boom or bust
If the merger goes through, the new entity will hold a combined 60% share of the North Sea oil services market, which is where their major interests lie. Their exposure to shale is relatively small. In fact, the shale boom, if it continues, is likely to inflict more harm than good on their wider energy interests.
In uncertain times like these, you cannot afford to make life harder for yourself by committing simple investment mistakes. Thankfully, you can learn from the errors made by others.
This BRAND NEW Motley Fool report, Worst Mistakes Investors Make, asks investors from all over the world for advice on how to avoid some of the biggest disasters investors bring on themselves.
Click here to read this no-obligation report. It will be yours in seconds and won't cost you a penny.
Harvey Jones has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.