Dear OGIB Reader,

Following is a story my research team put together on the oil field service sector, including what it is that’s driving the positive numbers… and two ways to play the momentum. Enjoy,

– Keith

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Drilling levels in Western Canada are often a good barometer of the weather. And according to the Canadian Association of Oilwell Drilling Contractors (CAODC), January’s rig utilization averaged 66 per cent compared to 46 per cent last year… making it the best start since 2007.

That says two things:

First, it’s been a cold, cold winter, which is a good thing for service companies – the ground is rock hard and it’s easier to move rigs.

Second, it tells us the oil field service sector as a group could be in for the best year since the financial crash.

Likewise, the Petroleum Services Association of Canada (PSAC) on Monday increased its forecast 2011 well count by 500 wells to 12,750 compared to 12,000 or so rig released last year. While it’s a far cry from the 24,000 wells punched in 2006, the trend is moving in the right direction.

Typically drilling is overwhelmingly weighted to natural gas, but the interesting thing thus far in 2011 is that oil is carrying the day for only the second time in a decade (the first was in 2010) thanks to the application of horizontal drilling and multi-stage fracking technology.

Some third-party engineering firms in Canada and the U.S. are saying onshore conventional oil production could start rising again for the first time in 30 years. In the U.S., it already has, according to a report last week from the Energy Information Agency (EIA).

Analysts agree the renewed focus on oil is what’s driving the positive drilling numbers.

Despite a 20% drop in the number of new gas wells, Canadian brokerage firm Wellington West is forecasting a 30% increase in overall capital spending this year to more than $30 billion in Canada alone.

Like fishing and farming, drilling is a seasonal activity and it’s overwhelmingly front end loaded onto the first quarter, which can make or break the entire year. Wellington also pegs 2011 as the start of a multi-year “super-cycle” that won’t peak until 2013.

According to services analyst Greg Colman, that increased capex will mean a further 13% year over year revenue growth for his group of service stocks in 2012.

Most service outfits have already had some big runs – up anywhere from 75-100% in the last six months.

As a result, we’re seeing some big names get bigger through consolidation… and we’re also seeing some new entrants that present opportunistic buying opportunities (many of which we’ve bought into in the Oil & Gas Investments Bulletin portfolio.)

One example is Western Energy Services Corp. (WRG-TSX). This is a small, early-stage entrant that’s already managed to pull off a few acquisitions while it strives to gain critical mass.

The company is run by former Precision VP Dale Tremblay, who was arguably the driving force behind the creation of the country’s largest contract drilling firm.

It’s always a good play to invest in management and the stock has doubled since October, from 20 cents to 40 cents as of Friday.

That’s when the company outlined a $50 million capital budget to add new iron tailored specifically to the new resource plays.

Watch for Western to hit the acquisition trail to further speed its growth, as there are quite a few smaller mom and pops that are ripe for the picking.

Thanks to the uptick in drilling, there is no shortage of work. And as margins and profitability return to the sector, companies like Western will be poised to execute even if gas prices don’t recover over the longer term.

Longer term, it takes a couple of quarters to get companies like this rolling. The proof will come in the next winter drilling season in 2012, when Western could be a much bigger company, and very active.

Tuscany International Drilling Inc. (TID-TSX) is a relatively new Calgary-based drilling company but focused exclusively in Latin America, where demand – and profit margins – are high.

The company is initially focused on Colombia and Peru with plans to expand into Brazil. Foreign service companies are still relatively scarce even as several Canadian juniors and intermediates are starting to make waves, which gives it a first-mover advantage in an area where services are still relatively scarce.

After going public last April, the company has managed to pull off a clean double since September, closing Monday at $1.87.

– Oil & Gas Investments Bulletin Research Team

DISCLOSURE – Keith Schaefer has a position in Tuscany.

P.S. Here’s an article from December, written by guest columnist Brian Hoffman:
Why oil services stocks are outperforming oil producer stocks

Want to learn more about investing in junior oil and natural gas stocks? If you have a Facebook account, just “like” this article and a hidden link to Keith’s 10 page how-to on oil and gas investing will appear:

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