Oil's 'Deflategate' Gives Traders A Buying Opportunity

• Citi has further cut its oil services pricing forecasts through 2016.
• While the firm expects prices to recover in time, they will remain depressed through 2018.
• Citi recommends investors take advantage of the slump and buy Schlumberger and Halliburton.

In a new report, Citi Research analyst Scott Gruber discusses the lingering deflationary environment for U.S. Oil Services stocks. Citi now expects that U.S. shale well prices will be lower than they previously forecast through 2016, but the firm believes that investors should take advantage of the cyclical pricing downturn by buying industry-leading names.

New Forecast

Citi previously called for a 20-25 percent drop in the average cost of a U.S. shale well in 2015 and up to another 3 percent decline in 2016. However, the firm now projects about a 30 percent drop in pricing in 2015 with 5-10 percent further downside in 2016.

Citi is now calling for 40 percent declines in stimulation pricing and 20 percent deflation in equipment pricing.

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Secular Vs. Cyclical

From an investment standpoint, the most critical question is whether or not this downturn in pricing is permanent or just temporary. While Citi believes that prices will eventually recover from current levels, investors should keep their expectations tempered over the next several years.

“The average shale well cost may rise ~15% in 2017/2018 as activity ramps (assuming zero efficiency gains). Yet this would still leave shale well costs about 25% lower than the 2H 2014 level,” Gruber explained.

Stock Picks

For now, Citi is taking a cautious approach to Oil Services stocks, as the firm expects further downward pressure on prices from E&P spending cuts over the next year. However, Gruber encourages investors to take advantage of the pricing weakness to build positions in the two Buy-rated stocks Citi considers “premier franchises” in U.S. oil services: Schlumberger Ltd SLB and Halliburton Co HAL.

Disclosure: the author owns shares of Halliburton and Schlumberger.