Despite oil’s bear market performance, year to date, oil development activity in North America has exhibited a “V”-shaped recovery, with the U.S. oil rig count more than doubling over last year’s depressed levels. We think Core Labs’ (NYSE:CLB) Production Enhancement (PE) unit is most levered to North American development budgets, as they provide niche completion products and services, especially when the one-size-fits-all completion systems of competitors run into the limits of applicability. During the quarter, Core Labs’ PE unit reported 15% year-on-year revenue growth, and 19% sequential revenue growth, along with healthy margin expansion. While Core Labs’ other business unit, Reservoir Description (RD), reported less impressive growth – flat sequentially, and down slightly over last year – RD is much less cyclical than the PE unit and we think will likely return to more robust growth as international production budgets inevitably inflect higher, after an unprecedented 3-year decline.
We think the market largely has ignored the fact that OPEC and its partners have been behaving remarkably rationally over the last several quarters—a marked departure from what we had seen for the prior two years. In fact, compliance with the production cuts agreed upon late last year has been historically high. We believe that most of the governments involved, many of which are quasi-authoritarian, are uneasily watching the events unfolding in member states, where the unwinding of governmental ability to placate populations with the proceeds of high oil prices is causing massive unrest (e.g., Venezuela). We believe it remains in OPEC’s long-term interest to do everything it can to support oil prices.
Despite the headlines crowing about tight U.S. oil output, we think there is less than meets the eye. According to EIA, data through April 2017, U.S. onshore production has risen just 350,000 barrels per day (bbl/d) above its September 2016 trough, which should be more than offset by global demand growth of over 1 million bbl/d, in addition to the over 1 million bbl/d in OPEC production cuts. In addition, oil rig counts in some of the U.S.’s most prolific shale basins have started plateauing as early as April (Eagle Ford), as the full-cycle economics of $40-$50 oil is challenging to even the best operators. Furthermore, setting aside debates about the short-term price of oil, we note that we are now in the middle of a third year of constrained investment in the development of large-scale fields, and we continue to believe that this will lead to a longer-term supply-demand imbalance. We believe much of this imbalance will have to be cured through catch-up investments, particularly in international markets, which should benefit Schlumberger both from a demand and pricing standpoint. We believe Core Labs is more focused on maintaining pricing throughout the cycle, and we think that they will drive growth by doing more work in more basins, globally.
From David Rolfe (Trades, Portfolio)'s Wedgewood Partners second-quarter 2017 shareholder letter.
