Providing coverage of Alaska and northern Canada's oil and gas industry
July 2004

Vol. 9, No. 30 Week of July 25, 2004

It is getting harder to find land drilling rigs

Demand for drilling services is on the verge of outstripping supply as the U.S. land market tightens

Richard Mason

Publisher Land Rig Newsletter

Richard Mason is publisher of The Land Rig Newsletter, a monthly publication that provides trends analysis for the land-based contract drilling sector of the oil and gas industry. He previously worked as a field historian for the Texas Tech University archives, collecting historical materials on petroleum, agriculture and irrigation development in the American Southwest. He is a 1974 graduate of Ohio University with a Bachelor of Arts degree, with honors, in history.

A simple question for the E&P firms out there. Got your drilling rigs lined up for 2004?

If not, it may be an agonizing second half of 2004 while prospects lie fallow, waiting on rigs during a period of extraordinarily high oil and gas prices.

It is getting harder to find land drilling rigs as the current cycle nears boom-like activity levels. Most U.S. drilling contractors have the best equipment and crews spoken for through year-end. Several have equipment committed into 2005. Waits on rigs are now exceeding 45 days in many areas for spot market work of just a well or two. Operators wanting rigs for extensive drilling programs will find little available until 2005.

What had been an industry characterized by tight balance between demand for drilling services and the supply of crews and equipment is now evolving into an industry that is showing signs of constraint.

Rising rig rates

It registers as rising rig rates, a trend that accelerated during the second quarter. In fact, U.S. rig rates moved more in the last 90 days than in the previous year. And if demand continues to tighten, rates are headed higher yet. Expectations are that rig rates will rise an average $500 a day per quarter through year end.

It also registers as small remuneration increases for the labor that works the rigs. Usually it amounts to higher per diem, or bonuses — items that can be easily removed if the industry turns south. But it is also appearing as wage increases in highly utilized markets like the Rockies, the ArkLaTex, or the Midcontinent. Labor shortages are starting to plague the larger drilling firms who are scrambling to re-work overtime schedules in order to maintain customer service, or importing workers from Canadian divisions to work in labor-constrained markets like the Rockies.

And several land drilling contractors say any additional demand will result in inexperienced employees, re-activation of marginal equipment, and the ensuing decline in efficiency — even while the charges for those services continue to increase.

Drilling activity in the U.S. land market has now exceeded the 2001 peak. When looking at rigs of all classes drilling oil and gas wells, the count at mid-July was 1,441 units, roughly 60 units higher than the peak in July 2001. And there is still a reservoir of pent-up demand flowing toward the oil patch, buoyed by surging free cash flows for operators and an influx of outside capital to pursue additional work.

Segmentation in operating community

Meanwhile the operating community has evolved into two industries now. The first is the large independents who have been solemnly insisting they are paragons of capital discipline. It is a theme that brings comfort to the folks on Wall Street, no doubt. But these same firms are paying exceptional prices to expand reserves and grow production through acquisitions and/or mergers.

The second segment of the industry includes the smaller independents and privately held E&P firms. A glance at recent press releases delineates a different business model for this group. It has nothing to do with capital discipline. Rather, it is about monetizing reserves and generating additional cash in a high commodity price environment.

Both segments are actively drilling at the moment with indications that the smaller independents are going to expand activity levels in the second half of the year.

Of course things are never as good — or as bad — as they appear at any given moment in the oil patch. So the question is what lurks over the horizon that would short-circuit a full return to boom-like conditions?

There are a couple of items to monitor. First, keep a sharp eye peeled for evidence of capital expenditure frontloading on the basis of the larger independents over the next 30 days. These are the firms employing a dozen or more U.S. land rigs currently. This group moved forward aggressively in rig employment after the first of the year. They did the same in 2003. But in the summer of 2003, they collectively pulled back. Rig count in the third quarter 2003 ended up flat because smaller independents were able to pick the rigs up about as fast as the bigger firms laid them down.

The question is whether last year represented an anomaly, or a new trend in the oil patch. This summer will bring confirmation of whether front-loading capital expenditures has brought seasonality to rig employment for the largest E&P firms.

At the moment, it appears that frontloading has gone by the wayside in a $6 gas market.

The second item is natural gas storage. Gas is moving into storage at a slightly reduced rate versus 2003. On the other hand, storage levels are slightly above the five-year average. While the U.S. Department of Energy has improved its weekly statistical sampling, the fact remains that these are estimates only and the DOE has a track record of understating the volume of gas that actually moves into storage during refill season.

Adequate storage later this summer could prove bearish for commodity pricing. Once expectations of future commodity pricing fall, operators will be less committed to pursuing field work, particularly if costs rise.

Industry at junction

As the anniversary of the 2001 peak approaches, today’s oil and gas industry finds itself at the junction of two paths. The first is the natural pressures brought on by attempting to maintain volumes in an environment that has operators chasing fewer, smaller targets. Symptoms include an escalating property acquisition binge and sky-high commodity prices. This trend argues that drilling levels will stay strong in part because operators have to monetize reserves to pay for the purchases. Under this scenario, the cycle is longer and flatter at the top rather than the usual upside down ‘V’ that has characterized the oil patch over the last century.

The second path involves the inherent tendency in a cyclical industry to revert towards the mean. Right now, the industry resides in an historically rarified part of the cycle thanks to record-setting activity levels and commodity pricing. At some point gravity takes over, and the cycle turns.

It is about to get very interesting in the land drilling sector — whichever path the industry takes.

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