Oil-service stocks have given investors more head fakes in the past seven months than Barry Sanders puts on a defense on a good day.
Yet each time the group has turned south since a September rally, the
Philadelphia Stock Exchange's
oil-service index has dropped only so far -- each time halting its slide above 45, its 52-week low. Add to that the pending
agreement and signs that demand is rising, and observers say oil-service stocks have found a floor.
A bottom would mark a significant change for the oil-service group. After all, it has been hammered for months by weak oil prices, which have translated into spending cuts by the group's customers, oil producers. But a growing number of signs point toward better times ahead.
On March 12, a group of key oil producers agreed to cut production by just over 2 million barrels per day, beginning April 1. The move, led by Saudi Arabia, the world's largest producer, was
much more aggressive than expected. The agreement, expected to be ratified by OPEC Tuesday, is the third in a year and comes just before crude-oil inventories were expected to bulge further thanks to a seasonal decline in use. In addition, supply from other producers also is expected to decline, a fallout from low oil prices that crunched cash flow and retrained spending to find more oil.
Meanwhile, demand seems likely to rise. For instance, Japan's economy is showing nascent signs of a long-awaited rebound, which could spur crucial Asian demand. If global demand creeps back up to 2% a year from roughly flat demand recently, crude prices are more likely to remain above $15 per barrel.
Crude-oil prices have remained near that level for more than a week, about 30% above February lows. If that price can be sustained, producers will eventually become more willing to ramp spending on exploration, pumping money into oil-service providers' coffers.
Still, even the bulls are cautious in their proclamations. Although observers are impressed with Saudi Arabia's aggressive stance in the latest round of cuts, OPEC's compliance in the past has been weak.
"We always come back to the credibility issue," says Ronny Kraft, chief executive of
Gotham Capital Management
, a New York-based hedge fund. Kraft says there are two key questions: Are the Saudis "going to live up to their part of the deal, and are they going to ensure compliance?"
But it will take months before higher oil prices affect the oil-service industry's poor fundamentals. No dramatic changes in the fundamentals have occurred in the past two weeks even as shares have raced upward.
On the contrary, rig counts, the industry's health-o-meter, are still expected to fall throughout the coming quarters, which means the contract drilling group will not be able to increase rig rental rates, and ever-larger oil companies will continue to squeeze suppliers. In short, competition among oil-service providers will continue to intensify throughout the year with every contract signed.
In addition, the larger, more liquid oil-service stocks may already be getting ahead of themselves.
, for example, is trading at a price-to-earnings ratio of 30 based on its 2000 earnings estimate. That compares with a P/E of 26 for the
The run-up has made some investors hesitant to jump in, while others who bought weeks ago have made tidy profits. One portfolio manager in San Francisco, who asked not to be named, said he would consider buying on the dips.
Instead, the change that has powered oil-service stocks to a 32% gain since March 1 is the perception among investors that oil company spending increases next year will tighten oil-service capacity. In other words, they're betting on future earnings growth.
"All that matters is perception at this point," says Wes Maat, an oil-service analyst and director at
Deutsche Bank Securities
in New York. But, he adds, "We're still very concerned about demand."
But with the OPEC agreement and healthier demand, there are at least some fundamentals to back the perception. And the following weeks and months will be telling, starting with Tuesday's OPEC meeting. Then, in April, earnings season picks up. Some investors may not have the stomachs to sit through a dismal earnings season. That reason alone may cause small selloffs. By early May, OPEC production figures for April will hit the market -- full compliance, or at least as full as the market expects, 75% or so -- will help the stocks.
By midyear, oil-service companies will have a feel for what their business looks like for next year, says Jim Wicklund, an oil-service analyst at
Dain Rauscher Wessels
in Dallas. This will enable the companies to guide analysts better.
And at least for now, many observers expect better news and fewer head fakes in all of this.