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(David McNew/David McNew/Getty Images)
(David McNew/David McNew/Getty Images)


Oil patch demand pumps up interest in service stocks Add to ...

North American oil services stocks have taken a sharp tumble after heady gains earlier this year, but their recent weakness could be a buying opportunity for investors.

Oil futures in New York, which spiked to $114 (U.S.) per barrel in early May because of concerns about unrest in the Middle East and North Africa, have slid to about $95, a level that market observers say is still elevated enough to allow the service stocks to sustain earnings momentum.

"The industry is firing on all cylinders right now, especially in Canada," said Joanne Hruska, a portfolio manager with Aston Hill Investments in Calgary.

Oil services stocks include companies that do everything from drilling and rock fracturing to providing waste management for the energy industry. Their stocks have pulled back as a result of the larger market correction as well as worries about the short-term direction of oil prices.

Despite the recent losses, the S&P/TSX Energy Equipment & Services Industry Index is still up nearly 10 per cent this year compared with the broader Canadian stock market, which is off nearly 3 per cent.

Spring is usually a slow season for oil services, as thawing ground prevents rigs from moving on to new sites, but the year is shaping up strongly as oil prices continue to levitate close to the $100-a-barrel level.

Many oil services companies had "an amazing first quarter this year," said Ms. Hruska, and she expects the third quarter to be even better. "If you look at Alberta's petroleum and natural gas land sales on June 1, it was a record. And land sales are usually a leading indicator for future drilling activity."

The increasing use of horizontal-drilling technology along with rock fracturing to tap oil and gas trapped in shale and other formations is spurring more companies to search for new resource plays and re-drill old ones that were not profitable under previous extraction methods.

Top Picks

Ms. Hruska likes drillers such as Patterson-Uti Energy Inc. (one-year target of $35 Canadian a share) and Ensign Energy Services Inc. ($22 a share). She recently bought IROC Energy Services Corp. ($2.40 a share), which provides ancillary services, such as well servicing.

Rafi Tahmazian, a energy fund manager with Canoe Financial LP in Calgary, remains bullish on the sector because oil drillers are having trouble keeping up with the demand for rigs in Western Canada.

Day rates charged by drillers, which range from $10,000 to $20,000, will likely go up substantially by winter, and that will increase profitability, Mr. Tahmazian said. "Savannah Energy Services is raising rates on smaller rigs by $1,000 a day this summer. It is their first raise in five years."

Mr. Tahmazian, who focuses on smaller companies, likes IROC Energy Services (one-year target of $2.65 a share), Secure Energy Services Inc. ($11.50 a share) and Calmena Energy Services Inc. (80 cents a share), which is run by former executives of Precision Drilling Corp.

In the United States, the Philadelphia Oil Service Sector Index is up 4.4 cent this year, just lightly better than 2.4 per cent for broader S&P 500 Index.

Picking the Bottom

The U.S. oil services sector has pulled back because summer is typically a seasonally weak period for their shares, said Scott Burk, a Houston-based analyst with Canaccord Genuity. "Sixty per cent of the time, oil service stocks bottom in July and August."

While concerns about slowing global growth do weigh on the sector, he expects oil services will still benefit from a gradual U.S. economic recovery, and "significant demand growth" from China. "As long as oil prices stay between $80 (U.S.) and $90 a barrel, I am bullish on the sector."

He likes diversified oil services firms such as Halliburton Co. (per-share target of $61 U.S.) and Weatherford International Ltd. ($28), partly because they are cheaper than their peers. Among offshore drillers, he favours Atwood Oceanic Inc. ($57) and Ensco PLC ($82).

Investors can also get access the U.S. industry through exchange-traded funds such as Oil Service HOLDRs , PowerShares Dynamic Oil Services ; SPDR S&P Oil & Gas Equipment and Services and iShares Dow Jones Oil Equipment & Services .

"The biggest risk is that we go back into some kind of a recession or double dip, and that has a negative impact on oil prices," said Mr. Burk, who thinks such a dire scenario is unlikely. "The U.S. is a big driver of oil demand. ... If the world went into a recession that would be even worse."

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