Land Driller Sector Outlook: It's All About the Natural Gas

Data Source: Baker Hughes

The Baker Hughes rig count rose by 23 last week, marked only the second time this year the weekly count has increased. Meanwhile, the possibility the rig count has bottomed seems to have led some to believe it is a green light to buy shares of land drillers. The market is also anticipating a natural gas price rebound sometime late this year partly because producers have sharply cut back their gas production over the past few months, as well as seasonal factors like hurricane & the upcoming winter heating months.

Domestic rig count has crashed 56% since the peak of 1,906 at the end of last August as weak demand has hampered activity. The amount of natural gas production in the U.S. has soared 58% in the past four years as a result of a five-year-long drilling boom spurred by high natural-gas prices, easy credit and new technologies that allowed companies to produce gas from the discovery of huge new shale gas fields in Texas, Louisiana and Pennsylvania. The sudden increase in supplies, combined with a drop in demand amid the recession, has led to a gas glut, pushing prices down to $3.98/mmbtu Monday at NYMEX, down approximately 71% from the 2008 high of $13.694/mmbtu.

Tudor, Pickering, Holt & Co. now estimates that the domestic natural gas market is oversupplied by 4 bcf/d. Power companies are beginning to ratchet back investments in coal-generated plants to take advantage of low gas prices and hedge against costly climate-change legislation. Some believe coal-to-gas switching has created incremental gas demand, and further switching potential is still large. However, the production cut, and the incremental demand from the power gen sector are unlikely to balance the domestic natgas market anytime soon with the exiting inventory overhang and the expected new LNG cargos coming into the US.

Since 80% of the U.S. rigs are chasing natural gas, the poor market fundamentals could mean an extended L-shaped pattern for domestic drilling activity through at least 2010, and quite possibly 2014. This could certainly mean a shake-out coming among land drilling contractors. As lower commodity prices and an uncertain economic outlook continue to plague the oilfield service industry, the near-term market could remain volatile.

For now, it is best to remain on the sidelines as utilization and dayrates of all rig classes will suffer under larger macroeconomic issues, which will likely be an overhang for these stocks. Investments with international exposure, term contracts, and companies with higher quality assets are better defensive plays. Big drillers with high quality rig fleet such as Nabors Industries, Ltd (NBR) and Helmerich & Payne Inc. (HP) are best positioned to benefit from the industry shakeout and the eventual increase in drilling activity.

Disclosure: No Positions

Comments

[Shale Gas:]

I agree with your conclusions. Good article.

Jun 24 08:43 AM

[Tom Armistead:]

Good article. I am long BJS, which is largely dependent on North American natural gas drillers, looking for a very strong rebound. I am going to have to re-evaluate my assumptions, maybe the stock is more a case like NBR and HP, strong player that will do well after the shakeout.

Jun 24 09:22 AM

[Dian L. Chu:]

Tom Armistead: BJS is a solid company, but you are correct that it has a high exposure to the North America market (NAM). The company also lacks the breath/depth of SLB and HAL to take on full project managment. In my opinion, NAM is unlikely to resume growth before 2015. Depending on portfolio makeup, BJS probably should not be part of the short or even mid term holdings.

Jun 24 10:27 AM

[basehitz:]

Good summary. I've traded this often. Sitting out for now. Storage continues to build even while rig count has bottomed for now. What happens if storage is maxed out before the winter draw season?

I considered writing out-of-the-money puts today given the premium due to elevated volatility of UNG. But it seems very possible we'll take out the previous lows. If that happens now that the WS frat boys piled in ballooning the size of the fund, the selloff should be impressive and generate a durable floor to prices.

I'll let someone else play this casino for now.

Jun 24 10:28 AM

[BigOlDave:]

It sure is nice to have someone make a firm recommendation for once, rather than just do an analysis! Saying "For now, it is best to remain on the sidelines" sounds like Cramer when he says, "Don't Buy! Don't Buy! Don't Buy!" ...except you back it up with tidy rationale.

I made myself a "Follower". Write More! Write More! Write More!

Dave

Jun 24 05:36 PM

[Dian L. Chu:]

Thank you, sir, for your readership and encouragement.


On Jun 24 05:36 PM BigOlDave wrote:

> It sure is nice to have someone make a firm recommendation for once,
> rather than just do an analysis! Saying "For now, it is best to remain
> on the sidelines" sounds like Cramer when he says, "Don't Buy! Don't
> Buy! Don't Buy!" ...except you back it up with tidy rationale.<br/>
>
> I made myself a "Follower". Write More! Write More! Write More!
>
>
> Dave

Jun 24 05:40 PM

[Energy Trader:]

What would also be informational is to show production on the same graph with the rig count.

Basehitz made me wonder is it the WS people that are in the UNG or is the individual? I have been of the opinion that WS has better options than the UNG, like directly buying the forwards, and that the investors are the individual traders. What do others think?

Also, the WS reports/commments I see are bashing UNG while cites like this are talking up UNG

Jun 24 09:59 PM

[TradingHelp...:]

Glad to see your fan club is growing. Another nice article.

Jun 25 09:47 AM

[Dian L. Chu:]

I updated the rig count chart to show the marketed natgas production data from the EIA on my blog: dianchu.blogspot.com. However, the EIA data are a few month behind, only to Mar. 2009. Feel free to check it out. Thanks.


On Jun 24 09:59 PM Energy Trader wrote:

> What would also be informational is to show production on the same
> graph with the rig count.
>
> Basehitz made me wonder is it the WS people that are in the UNG or
> is the individual? I have been of the opinion that WS has better
> options than the UNG, like directly buying the forwards, and that
> the investors are the individual traders. What do others think?
>
>
> Also, the WS reports/commments I see are bashing UNG while cites
> like this are talking up UNG

Jun 25 06:43 PM

[Dian L. Chu:]

Mike, Thank you.


On Jun 25 09:47 AM Michael Young wrote:

> Glad to see your fan club is growing. Another nice article.

Jun 25 06:44 PM

[Rice_Rocket...:]

Great article. Check out my blog for more short term fundamentals on ng. I need to learn how to post my charts. SA readers are visual.

Jun 25 10:14 PM

[enki09:]

I agree that domestic production is at a plateau but I think that it is one which is only temporary due to many factors. As you mentioned there is the current trend to transition from coal to nat gas in the power generation sector. At the same time though there is a coming trend in moving to a new vehicle fuel which is going to make investment in feedstocks now very lucrative in the mid term future (5 to 10 years).

I see hydrogen and fuel cell vehicles becoming the ultimate, logical choice for the transportation sector. Exxon is already running ads confirming their intent in this respect. At the same time coal is promoting the FutureGen technology which is essentially steam reforming coupled with sequestration as in the Exxon ads.

Using steam reforming H2 fuel can be produced from oil, coal, nat gas, veg oil, biomass, alcohol and even sucrose. This common fuel from multiple feedstocks has the potential for allowing the US to become energy independent in a relatively short time andat the same time create massive growth in these related industries as well as introducing price competition into the market where there previously really was none.

Jun 30 10:23 AM

[tailspin:]

enki09,

if you compare the heating values of the feed and fuel that go to a steam reforming process with the heating value of the H2 product hat you want to use as fuel you will conclude that you are loosing about 25 % in the conversion, even if you allocate a decent thermodynamic value to the by-product steam. Why in the world would you do this just to convert one fuel to another? You can use your veggie oil directly in a motor and use all of the heating value.

On Jun 30 10:23 AM enki09 wrote:
>
> I see hydrogen and fuel cell vehicles becoming the ultimate, logical
> choice for the transportation sector. Exxon is already running ads
> confirming their intent in this respect. At the same time coal is
> promoting the FutureGen technology which is essentially steam reforming
> coupled with sequestration as in the Exxon ads.
>
> Using steam reforming H2 fuel can be produced from oil, coal, nat
> gas, veg oil, biomass, alcohol and even sucrose. This common fuel
> from multiple feedstocks has the potential for allowing the US to
> become energy independent in a relatively short time andat the same
> time create massive growth in these related industries as well as
> introducing price competition into the market where there previously
> really was none.

Jul 13 08:16 AM

[10Q Detective:]

Will likely take NG prices of $6 - $7 to stimulate Rig activity hour growth: 10qdetective.blogspot....

Aug 03 10:35 AM