U.S. Rigs Show Steady Increase, But Woes Still Haunt Sector

by: Zacks Investment Research

In its weekly release on Friday, Baker Hughes Inc. (NYSE:BHI) reported another rise in the number of rigs searching for oil and gas in the U.S., reflecting ramped up activity by the producers in response to higher prices amid recent optimism about economic recovery.

Rigs exploring and producing in the U.S. climbed to 1,137 for the week ended Nov. 25 (as clear from the first chart below from Baker Hughes). This is the highest in eight months and is up by 24 from the previous week’s tally. The current nationwide rig count is 30% higher from the 2009 low of 876 (set in the week ended June 12).

The combined oil and gas rig count is down by 729 from the year-ago period. It rose to a 22-year high in 2008, peaking at 2,031 in the weeks ended Aug. 29 and Sept. 12.

The number of natural gas rigs drilling in the U.S. increased by 22 to 748, the fifteenth gain in the last nineteen weeks. However, the rig count remains 53% lower than its peak of 1,606 in late summer 2008. In the year-ago period, there were 1,443 active natural gas rigs. This is shown in the following chart, also from Baker Hughes.

The oil rig count was up by 4 to 379, maintaining the positive momentum from the past ten weeks. But the tally is down approximately 8% from the previous year’s count of 412, as shown in the following chart from Baker Hughes. Oil rigs peaked at 442 in early November last year.

The number of miscellaneous rigs was down by two, to 10.

Producers had scaled back oil and gas drilling operations over the past several months in the midst of falling commodity prices and tighter access to credit. However, during recent weeks, there have been signs that companies were beginning to bring rigs back on line amid signs of economic stabilization that could drive up energy demand. This pushed the nationwide rig count above 1,100 working units for the week ended Nov. 13 for the first time since March.

The overall picture, though, remains weak, particularly for natural gas, whose inventories have recently hit a new record high of 3.84 trillion cubic feet [Tcf] and is on the verge of testing the maximum capacity of 3.89 Tcf. The supply picture is expected to reverse in the coming months as producers bet on colder weather and the lagging effect of the sharp drop in domestic drilling activity takes hold.

Until then, we believe that natural gas woes (especially in North America) will continue to haunt energy service firms like Halliburton Company (NYSE:HAL), Schlumberger Limited (NYSE:SLB), Baker Hughes, Smith International Inc. (SII), National-Oilwell Varco (NYSE:NOV) and Weatherford International Ltd. (NYSE:WFT). These oilfield service names have seen their revenues and earnings plunge in the last few quarters on the back of lower volumes and a very competitive pricing environment. We have Neutral recommendations on all the above-mentioned companies.

We also maintain our Neutral recommendations for contract drillers such as Nabors Industries (NBI), Patterson-UTI Energy (NASDAQ:PTEN) and Helmerich & Payne, Inc. (NYSE:HP), given the extent of excess capacity in the sector that is expected to weigh on dayrates and margins well into next year.

We are positive on oilfield companies like Cameron International (NYSE:CAM) that derives about two-thirds of its revenue from outside North America. Cameron’s international operations are expected to be a key growth driver for the firm going forward and will play an offsetting role to the relatively soft U.S. drilling scene.