It seems the bulls and the bears disagree about the oilfield service and supply industry's prospects for 2003 and beyond. Whenever that happens, we say this must be a buying opportunity. Jitters about the Middle East, the economy and the stock market in general have obscured the excellent fundamentals of the energy industry. These support a new and higher floor price for natural gas, coupled with growing deliverability challenges that can only be solved by more exploration and development drilling in North America. That in turn means exploration and production companies will have better economics and drill more-and that means service companies stand to benefit soon thereafter. The only remaining challenge is to determine exactly when this chain of events will kick in. It takes these companies some time to bring their geological prospects to a drill-ready state and line up appropriate drilling partners. "For 2003, our view is that oil service stocks will outperform the S&P 500, as they have in six of the past eight years," says analyst Kurt Hallead of RBC Capital Markets. He reminds us, however, that stock selection is the key. "In our view, tubulars, land drillers, midcap service stocks and gas-sensitive offshore drillers should outperform." The Philadelphia Oilfield Service Index (OSX) has returned an average 30% from January through May since 1998. The tubular companies have returned 48%, land-drilling companies have returned 42%, and the midcaps, 40%, he says. Who can argue with returns like these? Hallead envisions a different outcome for service stocks in 2003 than occurred after the Gulf War in 1991. First, the stocks have decoupled from high oil prices and more important, oil and gas fundamentals support much higher commodity prices now than in 1991. U.S. crude inventories are at historical lows and gas storage is at a five-year low. Finally, U.S. companies will increase drilling in this year's second half and in 2004, thanks to the historically robust cash flows they are now enjoying. Some analysts say activity may go up by 4% to 6% in the U.S. In Canada, operators are predicted to drill a record or near-record number of wells this year. RBC now estimates the U.S. rig count will rise 18% this year. The bottom line? Many experts believe we are at the beginning of an upturn in U.S. and Canadian drilling. That translates into a boost for service company activity and backlogs-and earnings power.
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