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RBC: Oil Service Sector Rally Expected to Continue in 2004

RBC: Oil Service Sector Rally Expected to Continue in 2004

The oil service sector ended the year on a strong note, with stocks gaining more than 10% in December, and the rally is expected to continue "along a bumpy path" for the first half of 2004, according to a new report by RBC Capital Markets analysts.

Kurt Hallead, Victor Marchon and Kevin G. Pollard said in a research note that even with expected weakness in January, they are confident of the continuing strength in the sector, driven by a "strong underlying demand for crude oil and natural gas and moderately improving drilling rig activity." The near-term risks for the sector include typical weather-driven gas price volatility and the uncertainty related to 2004 earnings per share revisions.

"We would use any correction as a buying opportunity given our view that the OSX is in the second stage of a three-stage rally. Stage 1 was driven by value investors, Stage 2 is driven by chart momentum and the third stage will be a function of earnings momentum," the report said.

For 2004, the RBC analysts see several positives over last year, including increased drilling in the North Sea and off West Africa. In North America, they said the deepwater Gulf of Mexico will see an incremental pick up in rig activity of five to 10 rigs, while in the United States, land drilling is forecast to rise 7-10% year-over-year.

"The tone has become incrementally more positive, especially for the ultra-deep segment of the Gulf of Mexico and West Africa." Analysts said the higher activity in the North Sea, West Africa and deepwater Gulf "are all positives given high revenue and margin intensity."

The U.S. business mix, they said, "remains unfavorable given the large land content, which typically generates lower revenues and margins for service companies." However, in the United States, sequential increases in drilling of 2-5% per quarter "should provide some pricing power" by the second quarter of 2004.

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