Fourth-quarter 2004 showed solid revenue gains for most oil-service companies, and many analysts say the numbers may get even better, despite looming cost pressures. "The oilfield-service market tone remains solid thanks to expanding E&P/integrated oil capex in 2005, in spite of some E&P companies beginning to express concern about a potential squeeze in margins," says A.G. Edwards analyst Poe Fratt. Scott Gill, an analyst with Simmons & Co. International, says the stellar combination of positive macro energy fundamentals and very healthy producer returns has created an exceptionally favorable outlook for the service sector. "We believe there is a growing sense of urgency on the part of major oil companies with regard to securing necessary oilfield equipment and the resources needed to execute drilling programs," Gill says. How much upside remains for oil-service stocks? Gill forecasts potential of up to 30% during the next 12 months and believes the sector is poised to outperform the broader equity markets in 2005. W. Kevin Wood, an analyst with Susquehanna Financial Group, says potential gains are considerable given that valuation multiples are well below levels achieved at the peak of the two prior oil services cycles. "Although the longer-term outlook for oil-services shares remains strong, high U.S. natural gas inventory levels are a near-term concern to us," Wood says. The storage level is currently 22% above the five-year average and Wood says a pronounced dip in natural gas prices-somewhere below $5 per million Btu-could lead to slowed drilling in North America. "Another risk to our bullish outlook is the apparent acceleration of cost pressures on oilfield-service operating margins," Wood adds. "Although we believe cost pressures will dampen incremental operating margins in 2005, we project total operating margins to continue to expand." He gives a thumbs-up to shares of Baker Hughes, Halliburton and W-H Energy Services, and adds that the success of new technologies-rotary steerable drilling systems, underbalanced drilling and intelligent wells-will determine the degree of sector outperformance. Among the largest service companies, FMC Technologies, Varco International and Weatherford had the most notable jumps in fourth-quarter revenue at 30.8%, 27.1% and 24.2% respectively, versus the third quarter. Halliburton, the only laggard of the group, fell 4.8% from the previous quarter. Onshore drillers Patterson-UTI Energy and Precision Drilling came in at 38.4% and 29.8% respectively. Offshore drillers Diamond Offshore and Noble Corp. were top revenue dogs in that group at 26.4% and 26%; Todco improved 71.7% in the hybrid category; and in the tubular category, Lone Star Technology was up a whopping 102.4%. Though Halliburton did not have the same strength in fourth-quarter numbers as its peers, chairman and chief executive Dave Lesar says, "The fourth quarter was a busy and important one for the future of Halliburton." The company closed its asbestos exposure and it saw increased prices and demand for its services. "Our customers are expected to continue to increase their spending, which will allow for a strong market for our services to continue through 2005 and beyond." In 2005, Gill expects the increase in drilling activity to be modest because of persistent capital discipline and a shortage of available rigs. "For the oil-service industry, business fundamentals improved markedly during 2004 and, importantly, activity rose to the point where the excess capacity that dampened pricing power during 2003/2004 has been absorbed across many product lines, most notably in the contract drilling and pressure pumping segments. "Thus, while activity gains are likely to be modest for oil services, pricing power will likely be much improved." (For more on the oil-service outlook, see "On the Money" in this issue.)