Land Driller Gains Unsustainable

By Sheraz Mian

We are scratching our heads to justify the impressive recent gains made by land drillers such as Nabors (NBR) and Patterson-UTI (PTEN). We are of the view that these gains lack fundamental support and remain unsustainable.

Shares of land drillers have been star performers lately. In the last 12 weeks, land drillers are up an average 41%, compared to a little over-12% gain for the S&P 500. During the same time period, the deepwater offshore drillers gained roughly 25%, while the large-cap oilfield service companies, such as Schlumberger (SLB) and Baker Hughes (BHI) went up by about 32%. Year-to-date, the land drillers are up 31%, while the deepwater offshore and the oilfield service groups are up 56% and 53%, respectively.

Oilfield service activities outside the U.S. are largely centered on looking for, developing and maintaining oil production. Offshore drilling, particularly the deepwater end of it, is similarly oil-centered. As such, it makes perfect sense for the stock prices of the large global oilfield serve players and the deepwater offshore drillers to be making handsome gains given the roughly doubling of oil prices from their Feb’09 lows.

But land drilling in the U.S. is primarily for natural gas. And natural gas prices have not moved much, if any, in recent days. In the last 12 weeks, natural gas prices are flat to modestly down, basically stuck around $4. A massive storage overhang, still growing domestic production, fears of increased LNG imports, and recession-hit demand, particularly in the industrial sector, continues weighing on natural gas prices.

So why have the shares of land drillers done so well in recent days? Two reasons, in our view. The rising-tide-lifting-all-boats explanation does not need any further elaboration. The second explanation relates to the expectation of a bottoming rig count and its impact on domestic production and the outlook for onshore drilling activities.

As this Baker Hughes rig count report shows, drilling activities are off sharply from their Sept’08 peak. The land rig count of 829, as of June 12, was off 55% year over year and 37% year to date.



A number of major industry players, Halliburton (HAL) being the most prominent, mentioned on the first-quarter calls that we are nearing the bottom for the U.S. rig count. Our view is that the playing out of that outlook over the next few of months would be a very modest start for the next leg of the cycle, and hardly an occasion for uncorking champagne bottles, as the recent performance of land-drilling stocks indicates.

It will take a very long time for the land-drilling market to stabilize, where contractors can boast some level of pricing power. The current rig count of around 829 is more than a 1,000 rigs lower than the year-earlier level. So a near-term bottoming out, at say 750, would mean that the total U.S. land-drilling fleet has roughly 60% idle capacity.

Granted, we do not need to re-employ all of those rigs for pricing power to make a comeback. But you do need a significant dent in that idle capacity for the supply overhang to dissipate. And with the structural changes in the U.S. natural gas scene, primarily the emergence of prolific shale plays, we may not get the level of improvement in natural gas prices to incentivize drilling in conventional producing regions.

Comments

[one eye:]

You can maintain whatever you want. The Emerging Markets now use 44% of the World's oil. If the developed world wants to get out of their Recessions, they will have to drill as fast as they can to tie up as much as they can.

Every single rig in the World will be working again plus some.

Jun 17 02:12 PM

[Elliott:]

Nat gas drillers will be more profitable. Look at 2010 futures, they are at $7, a profitable price. Drillers have been locking in hedges and futures at that price, and should have a good 2010. Don't let the current $4 spot price fool you. Even if the spot price in 2010 stays at $4, it won't matter to the drillers, they will have locked in $7.

Jun 17 11:42 PM