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Stock Strategist Industry Reports

Our Outlook for the Oil Services Industry

Which firms have the competitive advantages to outperform?

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We believe the oil services industry is currently suffering through one of the most difficult industry environments since the 1980s. The industry's earnings reports for the first quarter reflect this, and unfortunately, we think things are unlikely to improve anytime soon. In our opinion, many of the services firms are too optimistic in their opinion that a significant and sustained recovery will begin in the U.S. market as early as the second quarter. We think that a recovery is unlikely to occur prior to 2010 due to continuing credit market tightness and reduced drilling as oil and gas firms are being forced to live within cash flows. We have reviewed the industry's collective first-quarter reports, and we think the following themes bear emphasis.

We expect services pricing to decline dramatically in the United States over the next few quarters. We think oil services firms have little choice but to cave in the face of sharply lower natural gas prices and constrained credit markets, which has led to a 50%-plus collapse in drilling activity. Services firms are offering lower prices for each new well a customer wants to drill, and pricing for many services is off 15%-30% over the past few months. In short, services buyers are wielding a significant amount of market power currently. We believe a services recovery is likely to be a tortured affair, as the supply of natural gas is increasing, while demand for the commodity is declining. Until services customers start to see some stability in their short-term business prospects, services firms are unlikely to find any relief. We believe these issues will remain unresolved until 2010 at the earliest. Therefore, in the short term, we see little chance of the services industry rebounding until at least the second half of 2010.

Stephen Ellis does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.