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 (NYSE:NBR) and Helmerich & Payne Inc. (NYSE:HP) are best positioned to benefit from the industry shakeout and the eventual increase in drilling activity.
Disclosure: No Positions