Oil-Service Stocks: Short on Fuel


By Heesun Wee Evidence is mounting that the economy has pulled out of a recession and is headed into recovery. On Feb. 25, the National Association of Realtors said sales of existing homes soared by a record 16.2% in January to a strongest-ever annual pace of 6.04 million units. Home-building activity is also on the rise. On Feb. 19, the Commerce Dept. said it jumped in January at the fastest rate in nearly two years. Meanwhile, fewer people are seeking unemployment aid, fourth-quarter gross domestic product posted a surprising rise, and the resilient consumer continues to spend.

But for all the encouraging signs, crude-oil demand and prices have seen little to no increase. A barrel of crude has been stuck recently at roughly $20, compared to a recent high of about $27 in September before the terrorist attacks. Conventional wisdom holds that as the economy gains further momentum, demand for crude will climb, lifting oil prices.

LUKEWARM PROSPECTS. For investors, though, that won't necessarily translate into a sharp rise in oil-service stocks, analysts say. Everything from an unusually mild winter, which has cut demand for heating oil and sharply boosted inventories, to an ineffective OPEC will prevent the oil sector from enjoying the big stock jumps that usually accompany price hikes. "The outlook for oil-service stocks in 2002 will be moderate at best, regardless of the recovery in the U.S. economy," says Gary Russell, an oil-service analyst at Frost Securities in Dallas.

Among the largest oil-field companies, Schlumberger (SLB) is trading around $58 a share, down 19% from its 52-week high of $69. Baker Hughes (BHI) is at $34, 32% lower than its yearly high of $45. And Cooper Cameron (CAM) is changing hands at $45, 62% below its yearly high of $73.

And things seem to be getting worse, not better. Oil-service and related drilling stocks declined an average 6.5% the first two weeks of February, compared to a 3.1% drop for the broad Standard & Poor's 500-stock index, according to Salomon Smith Barney research. The group's stocks also fell an average 5.2% in January.

Some oil watchers say inventory levels of crude oil and related products are so high that even an improved economy won't mean higher prices until late this year or early 2003. Recent data show total U.S. petroleum inventories -- which include crude oil, gasoline, and distillates such as heating oil -- at roughly 674 million barrels. That's 5.7% higher than the past five-year average.

QUOTA CHEATS. One hope the sector has is production cuts by OPEC, the oil cartel whose 11 member nations contribute roughly 40% of the world's petroleum output. In December, the cartel agreed to slash production quotas by 1.5 million barrels a day, to 21.7 million barrels daily, beginning in January. But the price uptick in anticipation was short-lived because it's far from clear that those cuts have been carried out.

More reductions will likely be agreed upon at the next OPEC gathering on Mar. 15 in Vienna because oil is trading below the cartel's price target of $22 to $28 a barrel. Such an agreement might initially buttress prices, but the gain won't be maintained without evidence that OPEC nations are making good on their word.

However, any OPEC cuts might be offset by production increases in Russia, which is keen on building its market share. On Feb. 20, the world's largest non-OPEC producer said it wanted to maximize exports of refined products such as gasoline and diesel. "The murmurs are the big oil generators in Russia are eager to get the spigots cranking again," says Coast Sullenger, a fund manager with investments in oil at Lombard Odier, a private Swiss bank.

GOING NOWHERE. Of course, an unexpected late-winter chill could deplete inventories and help send prices higher. Dan Pickering, an oil-service analyst at Simmons & Co. in Houston, believes that crude prices hit a bottom after September 11. While he and other bullish observers don't expect a massive revenue run-up at oil-field companies in 2002, they argue that $23 a barrel by yearend could spark a modest recovery in oil-service stocks.

In the meantime, crude stockpiles are bulging, and it'll take a while to work them down -- even if a sustained economic recovery materializes in the second half. And that's no sure thing given the drop in consumer confidence reported by The Conference Board in its latest data, released on Feb. 26. The bottom line: Until demand picks up and supplies are trimmed, oil prices and stocks are likely to remain stuck at current levels. Wee covers financial markets for BusinessWeek Online in New York


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