North America's onshore natural gas markets continue to show signs of improving, and the rig count is forecast to be strong in the near term -- all positive factors for the oilfield services market, Barclays Capital analysts said Tuesday.

Gas prices have been higher than expected and drilling results in the shales have been "extremely good," noted Jim Crandell and James West. In addition, oil drilling is gaining in the Eagle Ford and Bakken shales, a lot of gas being produced this year is hedged, and a considerable amount of gas drilling is being done to hold leases.

"This is causing tightening in supply/demand for quality 'fit-for-purpose' land rigs and for many services and equipment areas," noted Crandell and his colleague. "It's particularly true in pressure pumping where it is becoming difficult in some shale plays to find equipment. This is causing strong pricing improvement and should lead to earnings beats among companies with exposure."

Patterson-UTI Energy Inc. struck a $237.7 cash deal with Key Energy Services Inc. on Tuesday that would expand its pressure pumping services for hydraulic fracturing operations in the Barnett and Eagle Ford shales, and in the Permian Basin (see related story).

"The bad news in North America is that it is a short-cycle business, and we think that the second half of 2010 will likely represent a peak in terms of domestic rig activity," said the Barclays duo. "We are simply producing too much natural gas for the market. While a confluence of events have occurred which have pushed out the downturn in natural gas drilling, it has not reduced the chances that this will come."

However, a downturn would come from a "higher level of activity and earnings than we had previously estimated, and in general, we expect companies to have higher 2011 earnings from U.S. and Canadian land operations than we had previously estimated. We continue to de-emphasize North American leveraged companies, although not as emphatically."

The Barclays team is still concerned about the potential for lower gas prices in 2011 and reduced domestic gas drilling; "price and activity have both held up better than expected."

The deepwater is seen as a growth area for the services industry.

"While the Gulf of Mexico will come back in 2011 at a reduced level and remain below the prior peak, we do not see the strong outlook in the rest of the world being affected.

"From a shorter-term perspective, strong earnings from companies oriented to North American land markets, a near-term acceleration in many countries or regions internationally, and (hopefully) some possible news in halting the oil spill should provide catalysts."

Barclays upgraded the oilservice and drilling group to "positive" from "neutral" based on its findings. Halliburton, FMC Technologies and Pride International were upgraded to "overweight" from "equal weight," while Patterson-UTI Energy and CARBO Ceramics were upgraded to "equal weight" from "underweight."

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