Oil Services Cos Wait Patiently for Rebound

NEW YORK (Dow Jones Newswires), Jun. 16, 2009

Oilfield services shares will need more than a return to boom-era oil prices to fully recover from the sector's worst downturn in a decade.

Shares in the Oil Service Sector Index have risen by about 50% since February, around when crude futures began a rally that has seen prices more than double. Investors are anticipating that higher prices will encourage producers to increase their budgets, benefitting the drillers and service companies that find and extract oil on their behalf.

The road to recovery isn't so clear cut. Last year, when oil prices were headed toward their July peak above $145 a barrel, the services industry had massively built up capacity to handle what was then a fast-growing market. Producers contracted scarce rigs years in advance, allowing drillers to dictate the prices they charged. When oil plunged into the low $30s during the second half of the year, the power balance flipped. Suddenly, service companies were competing for declining workloads. Producers demanded lower prices and, in many cases, got their wish. Baker Hughes Inc. (BHI), one of the largest service companies by market capitalization, saw its first-quarter earnings drop to 63 cents a share, from $1.27 a year earlier.

Analysts say it could take two years or more for service companies to regain the upper hand, even if oil prices keep rising at their current blistering pace. Many of the biggest producers are still skeptical of the recent rally and won't reinflate their budgets until the end of the year at the earliest. Service companies would then need to run through spare capacity and hope that oil and gas prices support increasing activity over the long run. So while rising share prices indicate that the sector may have hit bottom, stocks are likely in for a bumpy ride over the next year.

"It's way too early to be looking at 2011," said Kurt Hallead, co-head of global energy research at RBC Capital Markets in Austin, Texas. "There are too many variables, and absolutely a very low degree of predictability."

Delayed Gratification

Service companies with a global reach have the best post-2010 outlook.

In the U.S. and Canada, producers are more focused on natural gas, which is still trading near a seven-year low. The number of rigs in service is down about 60% from last summer, and is still falling.

Outside North America, spending cuts weren't nearly as steep, even when oil prices hit their nadir in December. Countries such as Brazil and Angola have pushed ahead with developing offshore oil fields, though in some cases at a slower pace than service companies had hoped.

Schlumberger Ltd. (SLB) earns the largest share of its profits outside North America among the major service companies, though Weatherford (WFT) attracted buzz last month when it agreed to acquire the oilfield services arm of TNK-BP (TNBP.RS), the Russian oil producer half owned by BP PLC (BP).

Lagging behind is Halliburton Co. (HAL), the market leader in pressure pumping, where water or chemicals are sent down a well to boost production. The technique is heavily dependent on rig activity, leaving Halliburton more vulnerable to the weak U.S. market.

But Halliburton may see some immediate returns from rising oil prices, as the company has recently signed contracts with producers that increase payments if oil prices cross a certain threshold, said Bill Herbert, an analyst with Simmons & Co. in Houston.

Weatherford has adopted a similar pricing mechanism for some of its work in Russia, Herbert said.

However, the practice only began in the last six months and is still fairly rare, Herbert said.

"They are the exception, as opposed to the rule," he said.

Weatherford didn't respond to a request for comment on the new pricing structure.

Cathy Mann, a Halliburton spokeswoman, declined to comment on the "specific details" of the company's pricing but described the current environment as "extremely challenging," adding that "we expect that pricing for our services will remain under pressure until activity stabilizes."  

Copyright (c) 2009 Dow Jones & Company, Inc.

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