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How to play the oil rally? Look to the drillers

A rig is set up at Precision Drilling yard in Nisku, Alberta, February 17, 2014. The company rehired 1,000 workers in October and it has reactivated 56 North American rigs since May.

AMBER BRACKEN/The Globe and Mail

The rally in crude oil this week has made one thing clear: Beaten-up drillers stand to benefit the most if there is a long-term recovery in energy prices.

For all the headlines devoted to oil itself, the bigger moves by far were made by companies that help producers get the stuff out of the ground.

Oil surged more than 8 per cent on Wednesday and continued to rise above $51 (U.S.) a barrel on Thursday, after the Organization of Petroleum Exporting Countries (OPEC) agreed to its first production cut in eight years.

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A broad index of Canadian energy stocks, which includes senior producers such as Suncor Energy Inc., followed the rally, rising more than 5 per cent – punctuated, no doubt, by Ottawa's approval of two major pipeline projects.

But oil and gas drillers enjoyed bigger moves, highlighted by the 17-per-cent jump by Calgary-based Precision Drilling Corp. on Wednesday, to its highest level in more than a year.

Who knows whether the rally in crude oil will continue (some observers are already questioning whether OPEC's production cuts will stick). But here's a reasonably sound prediction: If you want to bet on oil, drillers are the way to do it if you can handle some risk.

These companies, which provide drilling rigs to energy producers and explorers, were hit especially hard during the dramatic collapse in crude oil. When prices fell close to 75 per cent between 2014 and February of this year, a lot of oil production became unprofitable and drilling rigs were left looking laughably out of place.

According to data from Baker Hughes, the U.S.-based oil-field services giant, the number of active rigs in North America fell as much as 80 per cent over this period, for the worst decline in decades. Precision Drilling reported seven straight quarterly losses, its annual revenue shrank by more than 60 per cent and its share price – which has tracked the price of oil remarkably well – shed more than two-thirds of its value.

This bad news, though, is looking increasingly out of date. Even before Wednesday's euphoric rebound, the price of crude oil had recovered by about 75 per cent from its February low of $26.21, and oil and gas drillers have been sounding increasingly upbeat.

Okay, maybe they're paid to sound that way. But in the case of Precision Drilling, Canada's largest driller, the optimism is being supported by actions. The company rehired 1,000 workers in October and it has reactivated 56 North American rigs since May. It has even successfully raised prices on some of its rigs.

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The market has noticed the shift. After this week's rally, the shares are trading above $7 and have more than doubled from their lows in February of $3.42.

Missed the rally? Don't worry: If the price of oil continues to recover, there's plenty of upside left in Precision Drilling. The shares would have to double just to get back to their 2014 highs above $15 when oil traded at more than $100 a barrel. This suggests greater potential than, say, a senior producer or pipeline stock.

Oil might not have to recover that much, either. Some observers believe that an oil price within the current range of $50 to $55 a barrel is the point at which many companies see value in exploring and producing again, so even modest gains in oil prices could have a profound effect on oil drillers.

Indeed, Scott Treadwell and Dave Wolters, analysts at TD Securities, noted that last month was the best November over the past four years for adding drilling rigs – partly reflecting better ground conditions but also rising confidence among producers, in their view.

Precision Drilling has also been laying the groundwork for a turn in the commodities cycle, implying that it should emerge as a stronger company if the price of oil plays along. For example, it has more than $350-million in cash – plenty, according to Jason Zhang, an analyst at Cormark Securities, to pay for equipment upgrades that will win market share from rivals.

The company already appears to have made some headway, adding nine rigs in November.

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"As activity continues to ramp up, we believe that Precision's top-tier fleet and high-quality crews will be in high demand both in Canada and the U.S.," the TD Securities analysts said in a note this week.

Oil's recovery is not a sure thing, but that's good – because when the recovery is a sure thing, oil and gas drillers may be out of reach.

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About the Author
Investing Reporter

David Berman has been writing about business and investing since 1995. He has written for a number of magazines, including Canadian Business and MoneySense. He worked at the Financial Post as an investing writer and daily columnist before moving to the Globe and Mail in 2008. More


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