With prices for crude oil plunging to new lows and the Russian economy basically imploding, making a big investment in the nation’s crude oil production isn’t necessarily at the top of many oil companies’ lists. But that’s exactly what oil services giant Schlumberger Limited (NYSE:SLB) recently did.
Fresh off its dour 2015 outlook for the energy sector, SLB is opening up its wallet to give it a huge leg up in Russia.
While move seems pretty risky at first, it could turn out to be one heck of a calculated gamble for the oil services giant. And it just goes to show that SLB is thinking long term with its moves and not just reacting the current oil price environment.
Russia’s Largest Driller
With its latest earnings report, as did rivals Halliburton Company (NYSE:HAL) and Baker Hughes Incorporated (NYSE:BHI), SLB painted a picture of darker skies ahead for the energy sector — one that will see capital expenditures spending fall by the wayside, oil prices drifting lower, and lower profits. But that’s just the near-term picture: longer term, Schlumberger thinks things are going to be just fine.
In fact, SLB feels confident enough to drop some serious coin on a acquisition in one of the most hated nations right now, Mother Russia.
In kind of surprise move, SLB will pay $1.7 billion for a minority stake in Russia’s largest drilling and oilfield services company, Eurasia Drilling Co Ltd. For that money, Schlumberger will acquire a 45.7% stake in the firm and shares of Eurasia will delist from trading in London and Russia. As part of the deal, SLB will have an option to buy the rest of Eurasia after three years.
At first blush, it seems like SLB is just taking advantage of acquiring a weaker competitor during a fire sale. Eurasia’s shares have collapsed about 71% as the price for oil has plunged and sanctions against Russia for intervening in the Ukraine have taken hold.
But there’s more to it than just that.
First, there’s the opportunity in Russia. The nation’s sheer size has provided it with an abundance of natural resources. Aside from its rich mineral wealth, the nation is blessed with some of the largest oil and natural gas reserves on the planet. Russia holds 32% of world’s proven natural gas reserves and 12% of the proven oil reserves.
Adding in the potential oil/natural reserves of Eastern Siberia, the Russian Arctic, the Caspian Sea and Sakhalin Island, and you start to realize just how large the potential in Russia is.
And that’s where SLB wants to be and where Eurasia operates. Russian drilling controls about 30% of the onshore market and operates several deepwater rigs in the Caspian Sea.
The problem is the sanctions that impact Russian and Western energy firms. As the situation in the Ukraine has escalated, the U.S. and European governments have placed bans on energy firms helping certain Russian companies from exploring/producing energy in many of these new regions. That’s put the kibosh on drilling in the Arctic, deepwater or exploring Russia’s shale.
But here’s the money sound bite from SLB:
“From our careful review of the sanctions in place today, we do not believe that this transaction would be in conflict with the current sanction regime.”
Eurasia isn’t a target of the sanctions. Nor are its two biggest shareholders, CEO Alexander Djaparidze and businessman Alexander Putilov. Also helping SLB’s cause is the fact that the purchase was just a minority stake for now.
By buying Eurasia, Schlumberger basically skirts the sanctions and is still able to get its technology into the hands of various Russia energy firms needing it. For example, two of Eurasia’s largest customers are Lukoil and Gazprom Neft — both of which are under sanctions. SLB can’t sell directly to them, but it can via its minority stake in Eurasia.
All in all, the deal strengthens SLB’s presence in Russia currently and prepares for the future, once Russia’s President Vladimir Putin stops acting “so” insane and the sanctions are lifted. Meanwhile, SLB can just back and collect the revenues.
Still Some Risk For SLB
The deal isn’t a 100% slam dunk for SLB. There is the possibility that the sanctions could grow if the situation in the Ukraine gets worse. But it does provide an interesting risk/reward proposition for Schlumberger and investors of SLB stock.
And that risk/reward is certainly cheaper since oil has plunged. Over the last six months, SLB stock has fallen about 30%.
That has SLB trading at a forward price-to-earnings ratio of 18 based on new earnings estimates coming from its recent write-downs and less-than-stellar near-term forecasts for the sector. That may seem still a tad bit expensive, but you are paying for perhaps the “best of breed” oil services firm. That top-dog moniker is certainly warranted longer term as SLB is clearly focusing on the next five to 10 years rather than just 2015.
The recent deal to buy a stake in Eurasia and fully commit to Russia highlights this. For investors looking ahead, you can’t go wrong with SLB stock.
As of this writing, Aaron Levitt was long Vanguard Energy ETF (NYSEARCA:VDE), which holds SLB, HAL and BHI.
