The number of drilling rigs exploring for natural gas in the United States has fallen to a 14-year low as weak natural gas prices continue to discourage oil and gas companies from drilling new wells. As of last week, the number of active gas rigs was around 407, down by around 40% year over year. The oil directed rig count, however, grew by around 3.5% to 1,341.
The rotary rig count, which is published weekly by Baker Hughes (BHI), serves as the key indicator of activity in the oil field services industry. While we believe that most large oil field services firms could be impacted by lower gas-directed drilling, we think that Baker Hughes could be affected the most due to its large exposure to the North American hydraulic fracturing market.
Shifting of Fracking Capacity From Gas to Oil
Hydraulic fracturing (fracking) is used to produce hydrocarbons from shale wells by pumping a highly pressurized mixture of water, sand, and chemicals to create cracks in the shale rocks and stimulate the flow of hydrocarbons like natural gas and oil. The market for these services has taken a beating over the last year due to low natural gas prices and the oversupply of capacity caused by aggressive expansion across the industry.
Strong production caused natural gas prices in the U.S. to touch their 10-year lows last year, dropping below $2/MMBtu. While gas prices have recovered since then to current levels of around $3.5/MMBtu, they are still well below their historical averages, making it less profitable for oil and gas companies. In comparison, prices for liquids such as oil have been much less volatile and more lucrative. This has caused pumping capacity to move away from gas plays to liquid rich plays. This has impacted pricing and margins for fracking services, since liquid-plays typically require lower pressures and hence lower pumping capacities, causing an oversupply of pumping capacity in the North American market.
How Baker Hughes Could Be Impacted
Baker Hughes' profitability over the last few quarters has been weighed down by the pressure pumping market, and by the looks of it, this could continue into 2013 as well. The firm derives over half its revenue from the North American market and the firm is the world's second largest provider of fracking services. Weaker gas drilling could impact pricing and utilization levels for Baker Hughes' fracking fleet. While the firm has been focusing on improving operational efficiency and controlling input costs by running longer continuous shifts and replacing raw materials and transitioning some of its fleet from diesel fuel to natural gas, a complete recovery will be contingent on supply/demand rationalization in the fracking market.
We estimate that the overall (oil and gas) average rig count in North America will grow modestly by around 3% this year. However in a scenario where the rig count actually declined by 10% to 2,000 this year and then resumed our estimated growth and if pricing pressure causes the North American revenue per rig to decline by around 10% in 2013 to an average of near $4.25 million per rig before resuming our estimate growth rate, this would shave almost 20% off the price estimate.
Disclosure: No positions.