When Subsea 7 (OB:SUBC) reported second quarter results recently, the share price had doubled in the span of five months. Between February and June global oil prices had risen from $28 to just over $50, and investors had extrapolated that the cycle had turned. With rising oil prices, Subsea 7 would be sitting in the catbird seat.
But a funny thing has happened in the last month. The oil price has fallen 20% to around $40 a barrel. Among the factors that have contributed to this decline are rising storage volumes and an uptick in the North American onshore rig count, bucking recent trends. Both are bearish for future oil prices, but the latter more directly impacts Subsea 7. It indicates that North American shale drillers will increase drilling at relatively low oil prices, potentially crowding out activity from Subsea 7’s deepwater clients. A more worrisome inference is that low oil prices could last longer than the market had expected.
During the quarterly call, management was very bearish on the state of client spending—which makes sense given the return of lower oil prices recently. Over the next couple of years, the company will have to work through a backlog of contracts that were signed in the depths of this downturn with very sharp pricing. Earnings are likely to be ugly.
Investors are looking right over these hurdles. They see past an upturn in the oil price cycle and past the years it might take to flow through to Subsea 7’s results, given long contract lead times. But with oil prices lower again and perhaps down for a while, they might be in for a shock.
Disclosure: Needless to say, the Forager International Shares Fund sold its stake in Subsea 7 recently at around current prices.
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