Though there is a lingering fear that the oil-service industry may suffer from higher raw-material costs, high commodity prices and improved dayrates were helping companies meet or exceed earnings expectations as they approached year-end. Robert Ford, an analyst with Sanders Morris Harris, says the rig count finally flattened in the third quarter. "First, availability of shallow- and medium-depth rigs is in very short supply and the large contractors with excess capacity...are taking their time reactivating stacked rigs. In short, the industry is essentially at maximum effective capacity." These companies are Nabors Industries, Patterson-UTI Energy and Grey Wolf, he says. "While we do expect Nabors to add a handful of rigs to its active list in this quarter, that should be offset by the decline in activity in the Rockies." He expects the rig count to further strengthen beginning in the latter portion of first-quarter 2005. And, the jump in U.S. land-rig dayrates that began this past summer should continue to push higher in the first half at a modest pace, he says. Oil-country tubular goods (OCTG) manufacturers Maverick Tube Corp. and Lone Star Technologies Inc. showed the largest increases in revenue in the third-quarter among service-company results reviewed by Petroleum Finance Week newsletter. RBC Capital Markets analyst Victor Marchon says he isn't sold on the tubular sector and reduced his rating of it from Sector Perform to Underperform, while expecting lower commodity prices and a shortened oil-industry recovery. Maverick reports that raw-material costs rose in the third quarter but the company benefited from lower-cost inventory. "This, coupled with higher selling prices attributable to the increase in the replacement cost of our steel, yielded higher-than-normal margins," the company reports. As for Lone Star, analyst Allen Brooks of CIBC World Markets called the company's third-quarter results "a relative disappointment because higher selling prices could not keep pace with escalating steel costs and higher manufacturing expenses, which narrowed margins." Marchon lowered his rating on Lone Star due to a sharp reversal in steel prices-which could pressure tubular pricing-and weaker commodity prices. According to Brooks, the OCTG market has been under close scrutiny since the second quarter, when a lack of real pricing power became clear. The shift raised questions among investors and analysts regarding the health of the OCTG market. Brooks says, "Although drilling activity in the U.S. is robust and positively drove Lone Star's volumes upward, [it] was unable to increase pricing on OCTG at the same rate as rising steel costs. In addition, some inefficiencies in manufacturing hurt margins. "However, most of these concerns were put to rest as the fundamentals of the business still appear strong-it was just that some obstacles aligned to restrain Lone Star's ability to increase pricing. These obstacles are in the process of dissolving, which should help widen margins in the future." Drillers' revenues also fared well the third quarter. Onshore drillers Precision Drilling and Patterson-UTI Energy reported 26% and 25% higher third-quarter revenues, respectively, compared with third-quarter 2003 revenues. Diamond Offshore and Transocean Inc. were tops in offshore activity, up 13.0% and 5.0%, respectively. And Nabors Industries and National-Oilwell showed the most improvement among the hybrids, up 23.0% and 21.0%, respectively. "The key to Precision's results was its dominant position in Canada as the country's largest contract driller, even though activity was off this summer, and the addition of 31 international rigs purchased earlier this spring, despite only a portion of this fleet being contracted," says Brooks. Patterson-UTI chief executive Cloyce Talbott says that in his 40 years in the oil-service industry, he has never seen industry conditions as strong as they are now. He expected a shortage of rigs to develop by the end of 2004. Now he believes that shortage came during the third quarter, as the demand for rigs is occurring with all types of operators and from all geographic regions. "The problem is that there is a very limited number of additional rigs available to enter the fleet," Talbott says. "There are only a little more than 100 rigs available to be brought out of stacked status. The challenge is to bring out the right types of rigs that will help meet demand. Every regional market will have differing demands." Meanwhile, service company BJ Services' results fell short, says W. Kevin Wood, an analyst with Susquehanna Financial Group. "BJ Services' shortfall was a big surprise to us and the Street," Wood says. Management reports the company was affected by Hurricane Ivan in the Gulf of Mexico; wet weather in Canada; budgetary constraints in Mexico; and unplanned maintenance of a stimulation vessel in the U.K. North Sea. Citigroup Smith Barney's Geoff Kieburtz says that while caution appears warranted, he believes 2005 earnings for service and supply companies will exceed revised guidance through robust fundamentals and improved pricing. -Bertie Taylor