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Stock Strategist Industry Reports

Midyear 2011 Outlook for Oil Services

A red-hot sector is set up to continue its winning ways.

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This is shaping up to be quite a year for the oil services sector. Already in the first few months of 2011, we've seen a very unusual environment with global unrest in the Middle East, the loss of Libya's oil production for the foreseeable future, and abnormal weather events across the globe. In our view, it's been one of the most difficult global services environments in recent memory. The challenging environment took a toll on the services industry's international margins in the first quarter, but the rest of the year looks quite a bit better. There are several key takeaways from the first quarter that offer some insight into the industry's performance in the second half of the year.

First, we believe that the international growth story for the industry has been rebooted, and the industry is set up for some very healthy growth rates in the later stages of 2011 and early 2012. Saudi Aramco plans to boosts its active rig count to 118 by the end of the year from 92 rigs today, and Abu Dhabi also is adding another 16 rigs. The unexpected shift in rig demand by two key services customers should tighten up services capacity internationally as other national oil companies follow Saudi Aramco's lead. National oil companies have noted that global oil spare production capacity has become stretched and it may not be enough given the current political unrest in the Middle East. The loss of production from Libya, likely for the rest of 2011, the strengthening global economies and recovery in demand, and the events in Japan have all accelerated the need for more oil and gas investment. Even  Schlumberger (SLB), which is typically conservative, indicated that its drilling services group should see significant pricing power internationally starting in the second half of 2011. The pricing benefits shouldn't just accrue to Schlumberger, as its peers will benefit from a preference for quality work in this rapidly tightening environment. Our top idea to play this trend is  Halliburton (HAL), which trades slightly below our fair value estimate.

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