Oil and Gas Investor asked service and supply analysts to detail the sector's main themes and describe what will benefit the companies most in 2012.

The domestic E&P industry is entering its third year of recovery, while international activity is in an earlier phase in the recovery cycle, explained Jim Crandell, Dahlman Rose & Co. LLC managing director and head of oilfield service research.

During the past two years, E&P spending increased by 30% in North America, and he expects this year's amount to rise 10%. Internationally, spending should grow 9% as the industry enters the second year of a recovery that began midway through 2011.

Service companies see revenue at the beginning of an E&P development cycle. The current cycle may be in different phases across the world, but oil above $80 per barrel assures strong E&P activity will continue.

The upward E&P spending trend should continue globally, spurred by oil demand from key developing economies, according to a recent report from CLSA Asia-Pacific Markets,

"China and India, with expected GDP growth rates above 7% in 2012, will continue to be the drivers of rising oil demand," CLSA analysts said. This in turn will drive worldwide capex spending, particularly outside of North America, where development will increasingly occur in more complex formations.

Scott Gruber, senior oil services and equipment analyst, Sanford C. Bernstein & Co. LLC U.S., is even more bullish. His team forecasts international spending growth of about 15% in 2012, based on recent customer spending announcements as well as offshore rig contracts.

Ultra-Deepwater

Jefferies & Co. analysts expect more upside from offshore development for drillers and providers of subsea equipment, in particular. And they favor stocks involved in ultra-deepwater (UDW) plays.

Drillers will benefit from higher day rates, while equipment makers related to subsea completions and tiebacks should see more contracts and better margins in 2012, since it is still early in the deepwater capex cycle.

Offshore drillers resonate with Crandell, who says ultra-deepwater "is one of the few areas major oil companies can explore to add significant reserves."

"Brazil is a good growth area for industry, and there are eight or nine countries in the Asia-Pacific where activity is picking up. It's a global phenomenon." He calculated more than 70 UDW rigs under construction globally, which would increase the overall count by 40%.

Africa is also a hot spot, with 11% more offshore rigs expected to enter the region as activity expands, according to CLSA analysts.

Gruber pointed out that deepwater rig rates have eclipsed previously reported figures in the low-$500,000s and are now heading into the high $500,000s. But, that is not the only drilling segment that should see growth. Some 200- and 250-foot jackups in the Gulf of Mexico posted day rates in the high-$50,000s, exceeding expectations.

Crandell expected a resurgent UDW Gulf of Mexico to add back a rig a month, potentially going from 24 to 36 rigs by year-end.

Both Crandell and Gruber like the contract drillers, especially those exposed to the international market.

Customer budgets are coming in ahead of expectations, and Gruber foresees offshore spending hikes of almost 20% in 2012.  

Of the drillers, Gruber favors Ensco Plc, and both analysts pick Noble Corp. Gruber likes the newbuild programs being executed by Ensco and Noble, as well as the companies’ solid safety track records, earnings growth, and commitment to maintaining legacy rigs.

"In a tight market like today, these are capturing rising demand and rig rates versus peers that have not maintained legacy assets and cannot jump on the opportunity," emphasized Gruber.

Offshore drillers have pricing power now and no exposure to gas.

Last summer, the Bernstein team completed a study on demand prospects for deepwater rigs, based on known deepwater projects.

"Surprisingly, the rig market shows a shortage of supply into 2014. Our conclusion is a large expansion of deepwater rigs is under way. Yet the current newbuild program will not satiate demand with global crude over $90," Gruber emphasized.

Crandell noted the deepwater growth trend also plays to specialized segments leveraged to the deep water. He likes companies like Oceaneering International Inc. for its strength in the remotely operated vehicle market since ROVs are on every deepwater rig.  Oceaneering is in better debt shape than it has been for most cycles, and is not overly leveraged.  

He also is partial to Tidewater Inc. for its deepwater exposure.

Service Company Expectations, Markets

Expectations of growth in international E&P spending over the long-term lead Crandell to favor Schlumberger Ltd.  Weatherford International and Tenaris SA, a manufacturer of tubular goods -- particularly higher-end seamless pipe -- also make Crandell's buy list.

Gruber thinks Schlumberger is interesting for the full year, because margins in offshore and completions services look good through 2013.

There will also be opportunity for makers of subsea equipment that includes an outstanding long-term outlook. But low, capacity utilization is holding the segment back. "My only caution is near-term, we could see some jobs with significant price competition in segments like trees and completion systems," added Crandell.

Last year, National Oilwell Varco Inc. (NOV) was a hot name. This year, that is not the case -- and it is one of the reasons John Lawrence, Tudor, Pickering Holt & Co.'s vice president of oil service research, is intrigued.

"The buzz isn't there now, but our thesis is offshore newbuild orders will drive the stock," explained Lawrence. This stock fits both the offshore-exposure and the land-drilling-expansion themes, but analysts have keyed on the offshore theme. It offers the most upside due to margins.

Lawrence says NOV's margins are roughly 20% now, but will steadily ramp up to exit 2012 at 21.5% --atypical for large integrated service companies this year in his view.

Gruber agrees, suggesting that NOV's rig-tech margins are bottoming out, and should positively inflect in 2012 and 2013. Petroleum services and supplies (PS&S) margins, on the other hand, are already strong, because they involve short-cycle items like drill pipe and bits.

NOV's PS&S margins should edge higher, but the growth rate in margins for this business should slow in 2012. Orders are expected to pick up in the second half of the year as the market tightens.

"Contracts for key equipment like drillships are being signed well ahead of delivery, and capacity will be absorbed over the next six months or so," said Lawrence.

The company's floating production, storage and offloading (FPSO) business could lift its stock.

Crandell stated there are over 100 FPSO contract prospects.  "We expected FPSO orders to come a bit quicker, but it still looks attractive.”