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Signs suggest we are in the final phase of the oil cycle

Nicole Sinclair
·Markets Correspondent

More consolidation in oilfield services is likely and inevitable given the “lower for longer” environment for oil prices, according to top oil analysts.

Merger and acquisition activity has already been significant in the sector, the Baker Hughes (BHI) - Haliburton (HAL) deal unraveling notwithstanding.

Siemens acquired Dresser-Rand in 2014 for $7.6 billion, Schlumberger (SLB) acquired Cameron in 2014 for $14.8 billion and FMC Corp (FMC) acquired Technip earlier this year.

Oppenheimer analyst Fadel Gheit said he sees an active consolidation environment in the second half of 2016.

“Consolidation is always the last phase in the oil price cycle as companies revise their business model to survive in a lower for longer oil price environment,” he said.

Even with oil prices doubling since their lows earlier this year, many in the industry are preparing for “lower-for-longer” levels.

“Oil producers are adjusting their capital spending budgets to cope with the new realities for a new ‘normal oil price’ of around $65 per barrel level,” Gheit said. He added that “significantly higher or lower prices likely to trigger market response and the price becomes self-correcting.”

Within oil, Gheit said oil service stocks have led other energy industry groups in consolidation. “We think the rest will follow,” he said.

Names ripe for consolidation in the oil services space that have been discussed among a number of analysts include Seadrill (SDRL), National Oilwell Varco (NOV), Weatherford (WFT), Oceaneering International (OII), Diamond Offshore Drilling (DO), Patterson-UTI (PTEN), Nabors Industries (NBR) and Rowan (RDC).

Hedge fund managers are also getting involved. Bruce Berkowitz of Fairholme has advocated for the combination of Now Inc (DNOW) and MRC Global (MRC).

Gheit added that there are five phases of the long oil cycle—(1) Shock, (2) Denial, (3) Panic, (4) Capitulation, (5) Consolidation—and we are nearing the final stages.

“We are at the end of capitulation and the beginning of consolidation,” Gheit said.

“It is still a buyer’s market with modest takeover premium. As oil prices stabilize close to the new normal, the bid-ask gap will narrow and consolidation will accelerate,” he said. “Surviving companies will be more resilient to low oil prices.”

The energy sector is financially constrained and issuing stock, or using treasury share are the only remaining options, he added.