ACGYF - IEZ: Oil Service Producers Could Be Thinking About Iran

Summary

• We think that near to medium-term factors play heavily in favour of oil prices chugging back up to $100 per barrel.
• Supply side issues remain the crux of the oil proposition, but China contributes to the discussion on the demand side too, and both support investments in oil.
• There is also Iran to consider, where very outdated oil assets could mean fallow ground for IEZ companies if Iran democratises. Although this factor is very remote.
• The problem is the PE. Backlogs are fickle in this industry, and can stutter between high growth and zero growth depending on the cycle. Might be specific plays that are better.

The iShares U.S. Oil Equipment & Services ETF ( IEZ ) gives us an oblique exposure to oil through oil service companies, whose fortunes are actually not that tied to the oil price itself noting the low correlation to the US Brent Oil Fund ( BNO ).

They depend on investment cycles, and with oil being strategic, even green-oriented countries are giving tax rebates or pushing investment in their oil reserves. With both supply and demand factors supportive, oil investment is going to go on for a couple of years, where a typical project takes about two years to complete. Moreover, Iran remains a possible tailwind if it democratises and invites more investment. However, the PE of the IEZ is a little high. Backlogs can whipsaw and we'd rather go deeper into the industry for specific plays that make sense, such as Aker ASA ( AKAAF ) which has exposure to oil services.

IEZ Breakdown

We've covered IEZ in the past, but we have some new comments. TehnipFMC's ( FTI ) and its competitors are getting quite a lot of support in their businesses from activity going on with new subsea construction. Moreover, Schlumberger ( SLB ) continues to be supported at its high levels thanks to continuous build of contracts with offshore drilling, and they continue to operate in Russia, picking up contracts abandoned by rivals . In particular, we note that Norway is supporting substantial investment into the Norwegian Continental Shelf, even offering tax rebates to oil companies to develop these strategic reserves while the markets are still in the phase of accepting oil, and alternative fuel is still nascent. A country that has long been a proponent of reducing oil export and certainly the use of oil internally supporting the oil industry fiscally is a large change, especially when taxes from oil companies contribute to the sovereign wealth fund.

Norway is not alone, with African countries courting investment into their reserves as well. Building backlogs across the industry should mean business for at least another two years as this wave of projects go through the motions.

Remarks

While at least one wave of projects is being observed, there are good reasons for which the market believes these forces are secular. First of all, supply continues to be a support to the oil price. Russia continues to retaliate with supply cuts , and these could actually become permanent if these wells gel-up and freeze, since Russia isn't getting supplied with as much resources as before to fix wells if that happens.

Secondly, the demand environment should be pretty favourable, especially as the Chinese reopening takes effect.

Finally, there is the remote possibility that Iran democratises. Iran is passing a youth bulge , and many people there are more liberal than you'd think. Of course, the current protests just highlights that, but the conditions are about as rife as possible for some sort of new revolution. It's not something to speculate on but it could be an unexpected lift to companies in the IEZ, even if it hits oil prices, because Iran would need a lot of modernisation of its oil infrastructure if it was invited back into the broader global market.

A risk to IEZ is that a longer rate cycle than expected could hit the broader markets, and take IEZ down a peg or two, especially as we see sequential inflation in key consumer categories like shelter. Nonetheless, the trends look good, although we think that a 24x PE is way too high considering that you can get specific companies for so much cheaper in the same industries as the top three holdings in IEZ - we cover Subsea 7 ( SUBCY ) for example.

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