The oilfield services sector had been benefiting from improving economic conditions, strong oil prices and a nascent recovery in global demand fundamentals before being waylaid by a combination of sovereign debt concerns, China's tightening moves, the Deepwater Horizon accident and perhaps most damaging in our view, the government's reaction to the spill in the Gulf of Mexico. The combination of these events has left investors attempting to assess the short- and long-term implications of the spill for oilfield services providers, equipment manufacturers, oil and gas producers, and more broadly, energy use as we know it.

The immediate impact of the accident and oil spill was on oilfield services companies directly involved with the ruptured well, which included several of the industry's largest companies. However, the U.S. government's deepwater drilling moratorium cast a pall over the entire sector as management teams and investors sought to assess the financial impact of the drilling ban. Although the ban is only for six months, the contract drilling sector was already facing potential overcapacity as newly built rigs were delivered into the market. The moratorium could possibly upset an already fragile supply and demand balance, potentially leading to a global decline in rates and a reduction in earnings for drilling contractors. In our view, diversified services providers appear more insulated from the ban given their market diversity, but the expected reduction in activity also created a great deal of uncertainty for those companies as well.

In addition to the moratorium, the U.S. Department of the Interior has also issued new guidelines for offshore drilling that could further pressure companies in the sector.

Some guidelines should be relatively easy to institute, such as increased training and more rigorous inspections, but others, such as stronger well-control practices, may require new or retooled equipment. Ultimately, however, new regulations such as more frequent inspections and standardized operating practices, while increasing costs for exploration and production companies, could lead to more business for companies providing related services.

Developing an accurate estimate of the ban's ultimate financial impact is difficult since the government has not issued detailed guidance on the ban and the length of the ban is uncertain. Indeed, the moratorium was struck down by a federal court in Louisiana, and an appeals court recently ruled against the government's request for a stay of the verdict. Still, few expect offshore drilling to resume quickly as operators will be reluctant to return to work given the ongoing uncertainty. Regardless of the outcome, we believe offshore drilling contractors will feel the biggest impact while the effect on diversified oilfield services companies appears to be less than investors initially feared. We continue to believe deepwater exploration and development can provide opportunities for potentially healthy investment returns over the long term, although companies focused on this segment look likely to suffer from excess capacity until the Gulf of Mexico reopens. Overall, however, many energy companies currently appear inexpensive in our view, and we have been seeking to take advantage of recent volatility by adding to our core holdings.

The company also has reserves in the Middle East and Latin America, which gives it development upside potential in those markets. In addition, only about half of its cash flow has been needed to keep production growing in its core assets. This allows more cash to be reinvested in growth opportunities.

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