Day Rates Don't Bode Well for Oil Service

The recent advance by the Oil Service HOLDRs(OIH Quote) ETF and drillers such as Transocean(RIG Quote) and National Oilwell Varco(NOV Quote) and has generated investor chatter about a possible rally from service, drilling and rig stocks.

When choosing the right time to enter a bruised market, it is important to pay attention to the right metrics. For energy service and drilling stocks, rig day rates and asset-replacement costs have excellent track records for indicating the future price direction of a stock. Oil prices are less dependable. A stock's recent market performance has proven to be a horrible indicator of future price direction.

Demand for drilling rigs of all kinds evaporated when energy commodity prices bottomed last fall, and they have stayed low as the price of oil crept higher over the last month. When production companies slow the pace of leasing drilling rigs, rig operators tend to slash prices. They also stop ordering new rigs from manufacturers.

Oil Services HOLDRs (OIH) 2009 Yahoo! Inc.

Analysts at TPH Energy Research are predicting that rig day rates will fall further before they improve, and that low day rates will likely extend through 2010. This is bad news for the oil service sector and for the Oil Service HOLDRs. It is very bad news for offshore rig operators like Transocean, Noble(NE Quote) and Diamond Offshore(DO Quote).

"Historically, this group has been very simple in terms of when you make money owning these stocks, and that is when day rates are increasing, " TPH Energy said Wednesday in a email. "We don't see this happening in 2009 or early 2010."