As oil passed an astonishing $52 at press time and gas prices again reached $6, one analyst said E&P stocks are now above fair value and gas prices are in for a big fall. Another said oilfield-service stocks are poised to outperform E&P equities and have an even greater run in 2005 and 2006. The pair spoke at the annual oil and gas investment conference of the New York Society of Security Analysts (NYSSA) last month. "The E&P stocks as a group are up 40% year to date, and they were up last year 48%. We think they are trading at a 5% premium to net asset value. A warm winter could really pound these stocks down," said Joe Allman, who follows 24 E&Ps for 1RBC Capital Markets !- . "With the surplus of natural gas in storage now, which is above the five-year average, I can't justify current gas prices. And the National Oceanic and Atmospheric Administration says there is a 50% chance of an El Niño event this year, which would cause a warmer winter. This is a risk to be aware of." The economy is another risk, he added, citing slow job growth and weak electric-generation data relative to the five-year average. As a reality check in his stock evaluations, Allman looks at trading multiples as well as NAV. But lately these range all over the map, he said, from 19.6 times for Quicksilver Resources to 3.6 times for Pioneer Natural Resources. "The balance sheets of these companies are as good as they've ever been, thanks to high commodity prices and capital discipline. They don't need to pay down debt anymore; they can start drilling more." Drilling more would be the catalyst for the oil-service stocks, agreed Roger Read, a Houston-based vice president and service analyst for Natexis Bleichroeder Inc., a unit of Groupe Banque Populaire. "When an associate and I started the firm earlier this year, we went out with a very bold call for $40 oil, never dreaming we would see $50," Read said. "We're in the early stages of a long-term up-cycle." Reasons include worldwide oil demand growth, especially in China, with OPEC producing flat out and political unrest in key producing nations such as Iraq, Venezuela, Nigeria and Russia. "With these high oil prices, the market in effect is asking the Saudis to 'prove it' when they say they can produce more oil." Oil analysts doubt Saudi Arabia's capacity to increase its current production much beyond 9 million barrels per day. Indeed, another speaker, David Demshur, chairman and chief executive of oilfield-service firm Core Lab, said the kingdom's most important field, Ghawar, is beginning to decline and show more water production. The company, which counts Saudi Aramco as a major client, ought to know, as it offers proprietary technologies to measure and enhance reservoir performance. Read believes good times for service companies are here, as utilization begins to increase and pricing power returns. Under-capacity or a balanced market is here for drillbits, pressure pumping, tubular goods, land well-servicing and deepwater drilling, he said. Over-capacity is still a problem, however, for land drilling, seismic surveys, offshore supply boats and offshore construction. "Nevertheless, 2005 earnings expectations are still too low. We look for 8% growth in the U.S. land rig count in 2005. If the E&P companies are finally at the point they have to give some pricing power to the service stocks, then the latter is the place to be for investors, even though the stocks are not cheap." The Philadelphia Oil Service Index was up about 35% in the 12 months trailing October 4, 2004, he noted.

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