Oil prices are at their lowest levels in a month. But the oil services sector seems unaffected, with analysts forecasting substantial earnings growth and the sector's index on course to set a new all-time high.


Philadelphia Oilfield Services Index

, or OSX, already reached an all-time high of 142.24 on Sept. 12. But then it suffered its worst one-week loss of the year last week, falling 11.7% to close at 125.12 on Friday, Sept. 22.

Industry analysts aren't worried. They blame the losses in part on growing expectations, confirmed after the market closed Friday, that the administration would release 30 million barrels of oil from the nation's reserves next month to try and pull back prices ahead of winter.

Furthermore, the sharp drop in the index was not a surprise given the volatility of the sector and the unusually high 45.6% increase in the index so far this year, analysts said. The OSX's drop last week mirrored that of crude oil prices percentage-wise. Crude oil fell about 13.5% from Wednesday's high of $37.80 a barrel, the highest level in a decade, to settle at $32.68 a barrel late Friday, Sept.22.

But the oil services sector index began bouncing back this week. On Thursday, the benchmark contract for November delivery of crude oil fell $1.12 to close at $30.34, its lowest level in a month. Meanwhile, the OSX ended Thursday's session 5.53 higher than Friday's close, at 130.65.

Why is the oil sector index climbing even as the price of oil falls?

While crude oil prices have been retreating over the past week, they remain sharply higher than they were just a few months ago. After climbing steadily through the summer, crude oil prices started setting new 10-year highs on a nearly daily basis through much of September.

Analysts cite the impact of strong oil and natural gas prices on earnings and cash flow of the oil and gas industry as the primary reason for their positive outlook on the oil field services sector. Analysts at

A.G. Edwards & Sona

forecast cash flow levels of independent companies to be up "substantially" while major oil and gas companies have reported record operating results with cash flow growth of 50% or more through the first half of the year.

As a result, the firm expects capital spending to be up by almost 20% this year with a strong emphasis on the North American natural gas market. Large independent oil and gas companies are expected to spend at least 40% more this year while smaller independents could increase spending by close to 50%.

"We believe that the fundamental trends in the oil service business are positive," wrote Poe Fratt, an analyst at A.G. Edwards & Sons, in a sector report. "Although there could be additional selling pressure on the group in response to softer oil prices, we believe that the selling will be short-lived and investor confidence will return shortly."

Fratt said oil and gas capital spending should rise in the second half of the year, driving up the oil service companies' earnings. He called the recent dips in oilfield service stocks a "good buying opportunity" -- not a sign of things to come.

"The fundamental outlook for drilling activity could hardly be better with historically high oil and gas prices and oil and gas companies flush with cash flow," agreed Yves Siegal, an oil service sector analyst at

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First Union Securities


First Union Securities expects drilling activity will grow by about 18% in North America and 16% worldwide next year. Among the oil services companies best poised to capitalize on the increased level of activity Siegel pointed to

Smith International



Weatherford International

(WFT) - Get Report

, and


(HAL) - Get Report


Siegal just raised his long-term target price for Smith International shares to $105, from $88, and maintains a "strong buy" rating. That's in part because the Houston-based company makes premium drill bits, drilling fluids, and related products used in drilling wells, so Smith is able to benefit in a variety of ways from the pick-up in drilling activity.

"Smith has a tremendous amount of earnings capacity," said Siegal, whose firm does not underwrite the stock.

Siegal has a buy rating on both Houston-based Weatherford International, which supplies equipment and services used in oil and gas drilling, and Dallas-based Halliburton, which is the world's largest provider of oil field services. His firm does not have underwriting relationships with either company.

Smith International shares closed down 31 cents Thursday at $80.19. Weatherford International ended the day up a quarter at $41.75. Halliburton closed down 6 cents at $48.63.