$80 Oil Boosts Service Cos' Stocks, But No Milestone

HOUSTON Sep 21, 2007 (Dow Jones Newswires)

Although $40 oil ushered in an era of skyrocketing project costs in 2004 and $60 oil turned a rig shortage into a famine a year later, $80 oil isn't likely to have the same transformative effect.

Service company stocks tend to rise and fall with the price of oil, under the belief that they will see more business and more favorable contract terms when producers earn more. The Oil Service Sector index on the Philadelphia Stock Exchange crossed $300 for the first time ever Friday morning, after a string of records set over the last year.

But in the short term, producers, not the service companies, pocket the extra cash generated by rising oil prices. Only when that cash finds its way into exploration and production budgets do the drillers and technology companies benefit. That can take between six months and three years of high oil prices, said Roger Read, an analyst with Natixis Bleichroeder in Houston.

"In the very near term, it has no impact (on services companies); for producers it's immediate cash flow," he said.

Benchmark crude oil prices in New York hit $80 on Sept. 12 for the first time, extending a rally that's since brought the front-month contract as high as $84.10 a barrel, up some 20% in the past month alone. Prices have benefited from financial flows into oil markets in search of greater returns, as well as perceptions of strong demand in the fourth quarter and tighter supplies.

While it's unclear whether oil is set to stay above the $80 mark - the November contract on the New York Mercantile Exchange was trading down 98 cents Friday at $80.80 - the breach has prompted questions about what the fallout might be across the oil industry, not least for the oil services companies that have seen their profits soar in line with the oil boom that took hold in earnest in 2003.

With capacity still tight and demand rising, especially in the offshore drilling sector, $80 oil is less of a watershed than past price milestones - when the market is already perfectly aligned in the service companies' favor, things can't get much better.

"There doesn't seem to be any limitations on deepwater (drilling) at this point," Read said. "There doesn't seem to be anything capping service pricing power."

Rates Continue To Rise

When prices first started to rise this decade, oil companies suddenly found themselves able to justify heavy expenditure in frontiers such as deepwater and heavy oil. Service companies were caught by surprise and lacked the manpower or equipment to meet the windfall headed their way. Costs began to increase around the world and across the services sector. Even after three years of scaling up, labor shortages have kept rates rising through the present day.

"From an infrastructure standpoint, they're spending as much as they can...there isn't much ability to expand," said Poe Fratt, an analyst with AG Edwards in St. Louis.

As long as oil prices are rising, producers can grumble about escalating costs, but lack the leverage to push back. Costs have therefore become a much bigger factor in where energy companies choose to operate, with service companies following producers out of North America and offshore.

"One of the...benefits of having longer life assets and quality assets is it reduces your maintenance capital," said Charles Davidson, chief executive of Noble Energy Inc. (NBL) at a recent industry conference. Noble has moved away from older and smaller fields that require more upkeep to maintain production, as rising costs have eaten into margins there, he said.

In areas where energy companies are regaining control of project costs, including in the U.S. and Canada, $80 oil hasn't tilted power back to the services companies, however.

Recession Wildcard

Onshore work in North America is still one of the largest markets for the oilfield services companies, but the region is heavily tilted toward natural gas production. Gas prices rose with oil for several years, but flattened at the end of 2005, putting a cap on producers' budgets. Higher oil prices have almost no impact.

Early hints that North America was fading forced services companies, such as Halliburton Co. (HAL) and Baker Hughes Inc. (BHI) to shift their focus overseas. All are chasing companies like Noble Energy, which is hunting for oil off the coast of West Africa and China, as well as national oil companies undertaking big projects in their home countries.

Analysts say the entire international services sector - companies that perform various technological tasks rather than operate rigs - is a good buy. Oil prices over $80 only encourage more international exploration by publicly traded companies, and provide national oil companies with the cash to pursue their growth plans.

"We believe (Baker Hughes') investment in international infrastructure will start to yield better-than-expected results," Douglas Becker, an analyst at Banc of America Securities wrote in a note to clients.

On the other hand, months of $80 oil could send the global economy into recession, curbing demand for crude and ultimately hurting producers and services companies, Fratt said.

"As long as demand growth doesn't go negative...($80 oil) should have positive implications for the oil services industry," he said. "Production capacity continues to be well utilized, they will have to add additional capacity."

>Copyright (c) 2007 Dow Jones & Company, Inc.

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