Black Cats captain Cattermole signed a new four-year deal today to keep him at the Stadium of Light until 2016.
O'Neill thinks that there is a lot more to come from his skipper if he can maintain a consistent level of performance and avoid disciplinary trouble.
He told the club's official website: "Lee is a very good captain, and he's excellent in the dressing room with the players as well.
"I think he can go to another level. He has exceptional potential. I've only got to know Lee in the last nine or 10 months and during that time he has been looking to improve his game.
"Sometimes he maybe needs to concentrate on his own particular game, but I do think he can flourish. A lot of it is up to himself, but I think Lee is capable of doing more."
Sunderland entertain local rivals Middlesbrough in the League Cup on Tuesday with Cattermole closing in on 100 appearances for the Mackems.