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Schlumberger's Outlook Is Foreboding for Energy Sector

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Natural gas remains weak and oil demand uncertain.

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Earnings at Schlumberger (SLB) dropped by 48% during the third quarter as energy prices fell and low demand forced producers to cut back.

The world's largest provider of oil-field services, including seismic surveys, drilling, and project management, looks for a modest recovery in North American drilling in the remainder of 2009, but little improvement in service pricing. Overseas, rig activity is stabilizing, but price cuts and the onset of winter are likely to result in a small dip in revenue.

"The worst, provided the economy continues to show signs of recovery, is behind us," Andrew Gould, Schlumberger's chairman and chief executive officer, said Friday in a prepared statement. "…For oil, the current robust price will lead to operators maintaining their spending levels and this, coupled with the lowering of their cost structures, may produce some modest increases in activity."

The company also said that the outlook for North American natural gas remains weak through 2010.

In mid-day trading, Schlumberger's stock fell by about 4%, and broader energy indices also dropped.

A barrel of oil recently fetched $80.86 on the New York Mercantile Exchange, the highest since last October, but 45.1% lower than the high of $146.27 reached in July 2008. Crude oil prices have risen about 20% in the last three months despite ample stockpiles of refined fuel. The run-up in price therefore may be hard to sustain. Demand for oil is likely to remain bearish with unemployment near 10%, slow economic growth ahead, and ample fuel supplies on hand. Last summer, prices spiked on high worldwide demand and limited supply.

Schlumberger's outlook is encouraging, but it may be too optimistic. The weak dollar and fear of inflation has led some investors to bet on oil as a hedge against the falling greenback, driving the price of oil higher. (See What $100 Oil Means for the Economy.)

In short, the recent rise in oil prices isn't about nasty oil companies gouging consumers at the pump or an indication of a nascent economic recovery.

Oil's recent rise in price likely would ease if investors moved their money elsewhere. In any case, with unemployment near 10%, it's hard to see strong demand for oil that will require extensive new drilling.

If the economy rebounds, demand for gasoline is expected to rise slowly in the US, but almost certainly won't track the annual summer run-up in price. At best, this suggests the "modest" increases in drilling activity offered by Schlumberger's CEO. If crude oil prices don't increase sharply due to an international crisis, gasoline prices typically increase $0.10 to $0.20 a gallon from January through summer. The vacation season typically causes US gasoline prices to average about 5% higher during summer than the rest of the year.

Nevertheless, Schlumberger's long-term prospects remain strong.

"We think Schlumberger's one-stop approach earns it customer loyalty, which results in premium prices for its services," Stephen Ellis, an analyst for Morningstar, says in a research report. "…In our view, the company is well-positioned to benefit from the industry's current weakness and future rebound, given its financial strength, geographical and product diversification, well-regarded research labs, and unique technology acquisition strategy."

But don't look for an immediate turnaround. Schlumberger reported third-quarter revenue of $5.4 billion compared with $7.3 billion in the same period a year ago, a decline of 26%. Income totaled $787 million compared with $1.5 billion a year ago, a 48% decline. Third-quarter oil-field-service revenue was about flat -- $4.95 billion compared with $4.96 billion in the second quarter.

Halliburton
(HAL), the world's second-largest oilfield serviced provider and Schlumberger's top competitor, said last week that third-quarter net income fell to $262 million from $672 million in the same period a year ago, a decline of 61%. The company has cut about 6,000 jobs since January, mostly in North America, and has cut the pay of top executives.

Another Schlumberger competitor, Baker Hughes (BHI), is scheduled to report earnings on November 4.
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No positions in stocks mentioned.
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