Oil and Oil Service Stocks Rally

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A sustained rally in the oil service sector could be just around the corner.

Oil and oil-service stocks sallied forth in true pre-oil-price-drop fashion Friday as crude oil leapt 74 cents, to $16.13 per barrel, on talk of a weekend meeting in Houston of top-level OPEC and non-OPEC oil ministers.

Further cuts in world oil production, the likelihood of which would push crude oil prices toward $17 or above, has caused a measure of short covering in the crude market and a wave of buying in oil service stocks. After months of dithering in the 110 range, the

Oil Service Index

(OSX) broke out and jumped 5.45, or 4.66% to close at 122.29, a high last seen in early December. Major oil and most segments in the oil service sector followed suit.

Schlumberger

(SLB) - Get Report

, the sector bellwether, closed at 85 9/16, up 2 9/16, or 3%, while

Camco

(CAM)

, the latest name thrown out as a takeover candidate, closed up 4 3/16, or 6.2%, at 72.

"If they decide to cut between half a million and a million barrels incremental to what they already agreed upon," then oil service stocks are poised for some real upside in prices, says an analyst at a New York hedge fund. His fund sold its oil service holdings in the fall and until recently has been uninterested in the group.

What's the potential upside? In the deepwater arena, stocks could climb as much as 30% from present levels, he says. In the jackup market, where rigs drill in water depths up to 350 or 400 feet, it's anywhere from 20% to 40%. The mid-cap service group could feasibly see share increases of 30% to 50%.

Conversely, if crude oil slips backs to the mid-$15-per-barrel level, where it's languished since OPEC and non-OPEC producers agreed to global production cuts back in March, the downside risk to stock prices would depend on how long crude stays in that range.

"It's been a frustrating period," says David Stadlin, portfolio manager of the

(SPMBX)

Smith Barney Natural Resource fund.

Yet regardless of whether the meeting occurs, he sees strong demand aiding equipment and services companies, especially in the deepwater arena. He says he doesn't expect oil to rally back to $20 anytime soon, but he does expect some stabilization in oil prices. "The lows we saw in January were the result of a unique mix of factors that aren't going to be repeated," Stadlin says.

In a research note Friday,

Salomon Smith Barney

analyst Paul Ting says there is a "reasonable" chance further production cuts will happen. "We see this Houston rendezvous signaling that OPEC and non-OPEC cannot withstand the current level of abnormally low prices," he wrote. Ting also upped his ratings on

Chevron

(CHV)

to outperform from neutral and on

Exxon

(XON) - Get Report

to buy from outperform.

"One of the reasons the market needs to take this talk seriously is, it fits closely with the pattern of what happened in March," says Tim Evans, senior energy analyst at

Pegasus Econometric Group

in New York. First there was talk of the need to cut production ahead of OPEC's regular meeting, Evans says, and then, "kaboom! Over the weekend it happened."

The important thing to note about Friday's market speculation is that it has forced crude prices through previous resistance levels. "A close over 16 bucks sends a message as well," Evans says. After testing different lows, "finally the market is saying, 'Enough! We're going higher!' "

Although at this point the crude market is still oversupplied, the glut is already worked into the price, Evans says. "What's not worked in here is a further cut in production sooner rather than later."