It is often said that in a gold boom investors would do well to buy the companies making the shovels. The point being that identifying a particular firm that will find gold might be hard it is a certainty that those supplying the gold firms in general will do well. The same can also be said for the oil and gas industry.

Oil and Gas services are those firms helping the energy producers and explorers in their operations. This could be in finding oil, in running drilling rigs or in hiring out the necessary equipment. Thus the services firms are exposed to the continual operational spending of the energy firms as well as capital spending to find and develop new sources of supply.

Unsurprisingly, the exposure to capital spending makes oil and gas services firms very dependent on energy prices. This is because if the oil price drops below a certain level capital spending can potentially be cut to zero. Alternatively, high energy prices can encourage significant investment in exploration and new production.

The recent events in the Gulf of Mexico have illustrated that the services companies are not without risk. The two services firms involved with BP’s leaking oil well, Haliburton and Transocean, have seen their share prices suffer as the liability for the leak has not been clear.

Unfortunately, for investors in the Powershares Oil & Gas services ETF these two companies were not insignificant among the fund’s holdings. Haliburton was the largest holding with a weight of 5.26% when we last reviewed the fund in mid-January. Transocean was the seventh largest holding with a weight of 4.85% at the same date.

Taking a look at the weekly chart of the Powershares Oil and Gas ETF we can see that the price action has formed an orderly ascending channel since the March 2009 low. This move has seen the price jump from a low of $8.77 to a 2010 high of $19.09 on the 30thof April. Of some concern is the recent negative MACD signal as the indicator has turned lower and crossed below the zero signal line.

Looking at the daily chart of PXJ we can see that the corrective downtrend that started in April has now been broken. The prior downtrend resistance line has now acted as support with the price currently testing horizontal resistance at the $16 level. The 200 day moving average is just above this resistance at $16.65 and may provide some further resistance. The daily RSI is in a healthy uptrend and suggests we may well witness a move above the 200 day MA in the near future.

As a large diversified firm Haliburton has been relatively resilient to Gulf of Mexico worries with the stock falling from around $34 in mid-January to around $30 today. In fact quarterly profits announced this week beat expectations with a rise of 83% lifting the shares up 5% and boosting the whole oilfield services sector.

Haliburton believes it is indemnified from any damages in the BP spill but has said that there will be profound changes in how deepwater drilling is done. It expects the six-month deepwater drilling moratorium to reduce earnings slightly in 2010 but more drilling in shallow-water may offset this. It is also notable that the group has said that the number of oil rigs working in the US was the most since the early 1990s.

Fund Top Ten Holdings (22nd July 2010)

Thus at the very least Transocean appears to have been poor at maintaining safety levels. Whether this opens up direct liability or just reduces future business for the firm is the key issue for investors. However, for holders of the Powershares Oil and Gas services ETF this is not really an issue given that lost contracts for one firm in the ETF will be gains for another.

The big picture is of increased energy demand and this will serve to benefit the energy services sector. Reduced deep-water drilling may have an effect in the short-term but it may simply lead to more on-shore or shallow-water drilling.

However, clearly deep-water oil and gas is an area which was set to benefit the services companies given the costs and expertise involved. We would expect though that activity in this area will return as the West and developing economies are eager to be less reliant on the Middle East.

It is also notable that the major integrated energy firms, excluding BP, have pooled resources to establish a deep-water response capability. In all likelihood though the failures at the BP well appear to have been avoidable and the result of human error and so more deep-water drilling will return but on a more restricted basis.

Other opportunities for the services firms are in shale gas which has been a huge growth area in the US and looks set to become one for Europe too. This is natural gas from previously inaccessible geologies and has been developed so successful that gas prices in the US have fallen to historically low levels.

The recent dramas in the Gulf of Mexico have shown that the energy services firms are exposed to operational risk. However, it also illustrates the benefits of owning a diversified group of companies. Any lost business for Transocean, for example, will be new business for one of the other companies.

Accordingly, we rate Powershares Oil & Gas Services ETF a hold.