Pay Attention to Oilfield Services

As you know, the publicly traded energy providers are roughly divided into the integrated companies, the independent producers, and the services bunch. The trick is to know which segment of the industry to concentrate on, a decision that never is quite as easy as it seems it should be.

But for now, let's take a gander at the oilfield services group, and see if there's anything there for which the rewards appear to materially outdo the risks. To get started, I'll refer you briefly to a recent Morningstar report on the sector, some of which I agree with and some of which I don't. But I will give the firm credit for being knowledgeable, concise, and informative in the report.

But first let's look at some of the companies that make up the core of the oilfield services group:

Source: Yahoo! Finance and Capital IQ.

On the bottom
Now, looking at just a few of its key contentions, the report starts off with the notion that: "North American services pricing has reached the bottom." The report predicts that it will stay low for a while; my belief is that pricing will turn far sooner than most people believe, but I'll focus on that a little later.

Other noteworthy contentions include the notion that "international markets still look weak," along with "modest expectations for [the services group in] 2010." That last includes single-digit revenue growth, along with operating margins between 11% and 13% for Weatherford, Halliburton, and Schlumberger. And among the geographic areas the firm sees expanding during the year are "the Middle East, North and West Africa, Russia, and Brazil."

And finally, the report propounds an expectation that contract resets will eat into the services firms' operating margins during the next few years. The result could be "services pricing down 10%-20%." Beyond that, the firm expects the phenomenon of international contracts lasting for several years to result in international margin expansion that is "limited in 2011 and probably 2012."

Another approach
While this doesn't paint a totally bleak picture for the group, it also isn't particularly enthusiastic. For my part, I have some other thoughts about the sector and how some elements could help the companies to improve their profitability versus general expectations:

• As an erstwhile analyst, I agree with a former colleague who contends that the 914 data (the Energy Information Administration's monthly estimates of natural gas production) continues to improve -- meaning that it is declining slowly -- and that sometime next year, industrial demand could increase. As such, he thinks that gas prices might rise above $6 more quickly than most observers anticipate. That forecast, while not leading to total parity with oil, would nonetheless bring the two fuels somewhat closer in price and likely benefit the North American services market.

• And then there's the deepwater, which has bobbed impressively to the surface during the past couple of years, with one discovery after another. It seems to me that, almost regardless of crude's price, the deepwater world of Brazil, the U.S. Gulf of Mexico, and West Africa will only become more active in 2010. Likely beneficiaries would include the drillers most capable of working down deep -- Transocean and Diamond Offshore. Others who potentially could improve include such bigger services providers as Schlumberger and Halliburton.

• In addition, with Goldman Sachs forecasting $110-per-barrel oil by 2011, the possibilities become brighter. And if several elements in this picture come about, the service companies could be wearing out equipment more quickly on the unforgiving rocks of the shale plays, like the Haynesville and the Marcellus. And as an unspoken sidelight to all this, the rig count, which also has been slowly climbing of late, should continue to move upward.

Energy: a must in your portfolio
And I have a couple of final thoughts for Fools with even the slightest attraction to energy names -- which should include us all. The first is that the services group should receive at least some representation in each of our portfolios. The second is that the companies whose shares you buy should be employed with an eye toward holding periods of a couple of years.

At this time, there are several solid names in the services sector. However, my favorite continues to be Schlumberger. It's a well-run company with the broadest geographic spread in the group.

And I'm not the only one who likes the company. Schlumberger has been rated a full five stars by Motley Fool's CAPS players. Why not check out its CAPS page and add your opinion?