Ensign Energy Services' (ESVIF) COO Bob Geddes on Q2 2016 Results - Earnings Call Transcript

| About: Ensign Energy (ESVIF)
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Ensign Energy Services Inc. (OTCPK:ESVIF) Q2 2016 Earnings Conference Call August 9, 2016 4:00 PM ET

Executives

Bob Geddes - President and COO

Ed Kautz - President, US and Latin American Operations

Brage Johannessen - EVP, International-East Operations

Tom Connors - SVP, Canadian Operations

Tim Lemke - CFO

Analysts

Scott Treadwell - TD Securities

Jon Morrison - CIBC World Markets

Jeff Fetterly - Peters & Company

Operator

Good day. My name is Steve, and I will be your conference operator today. At this time, I would like to welcome everyone to the Ensign Energy Services Second Quarter Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions]

Thank you. Mr. Bob Geddes, President and Chief Operating Officer, please go ahead.

Bob Geddes

Thanks Steve. Good afternoon everyone. Let me start with some introductions, down in Houston today along with myself is Ed Kautz, President of US and Latin American Operations and Brage Johannessen, EVP for International-East Operations. In Calgary today, we have Tom Connors, Senior VP, Canadian Operations and also as you all will have noted in the press release Tim Lemke, CFO for Ensign will be handing over the role to Mr. Mike Gray. Both of those guys are in Calgary for the call. As such, this will be the last quarterly call for Tim, and both Tim and Mike Gray are on the call as I mentioned. So, let me just introduce Ensign, Ensign is a premier oilfield services provider with operations in six different countries worldwide, over 200 drilled rigs, 115 service rigs, 78 directional drilling kits, 90 frac flowback units, core rigs and a rental divisions.

Before we dive into some of the details for the quarter, I’ll start with a backdrop to the quarter. The second quarter once again saw all of our operating divisions capture more than their market share in each area performing once again with a stellar safety record. We see the proxy for the ADR’s efficiency combined with a world-class training protocol to be realized with operators choosing to keep Ensign drilling ahead on their programs. I’ll point out now that our second quarter EBITDA was earned without any one-time contract termination payments of any significant with $3 billion invested over the last 10 to 15 years and expanding ADR fleet, we a fleet that is ready enabled to manage increased utilizations without requiring capital.

With that brief introduction, I will turn over to Tim for a second quarter financial detailed summary.

Tim Lemke

Thank you Bob, first the usual disclaimer. Our discussion may include forward-looking statements based on current expectations that involve a number of business risks and uncertainties. The factors that could cause results to differ materially include but are not limited to political and economic conditions; crude oil and natural gas prices; foreign currency fluctuations; weather conditions; the Company's defense of lawsuits; and the ability of oil and natural gas companies to pay accounts receivable balances and raise capital or other unforeseen conditions, which could have an impact on the use of the services supplied by the Company.

As expected, persistent lower level of oil and natural gas commodity prices resulted in reduced levels of demand for oilfield services in the second quarter of 2016 compared with the second quarter of 2015. Operating days were lower across the Company's fleet in comparison with last year and consequently Ensign reported a decrease in operating and financial results for the second quarter ended June 30, 2016 compared to the second quarter of the prior year. The second quarter also generally represents a low seasonal point for the year as the company's Canadian operations endured spring break-up, the time of the year when activity levels are hampered by the ability to move oilfield services equipment due to spring weather conditions. Reduced financial contributions were partially offset by the positive translational impact of the stronger United States dollar on United States and international operations in the second quarter of 2016 when compared with the second quarter of 2015.

Second-quarter revenue decreased 47% from the second quarter of the prior year to $175.9 million compared with revenue of $323.8 million in the second quarter of 2015. Revenue of $434.4 million for the six months ended June 30, 2016 was 45% lower than the $783.1 million recorded in the corresponding period of the prior year. Operating earnings expressed as adjusted EBITDA further defined as earnings before interest, taxes, depreciation, share-based compensation expense recovery and foreign exchange and other were $31.5 million for the quarter ended June 30, 2016, a 55% decrease from adjusted EBITDA of $69.5 million for the quarter ended June 30, 2015. Adjusted EBITDA for the six months ended June 30, 2016 was $91.1 million, a decrease of 50% from adjusted EBITDA of $181.9 million for the first six months of the prior year.

The second quarter year over year decrease in adjusted EBITDA can be attributed to general industry weakness particularly in North America. Adjusted net loss which excludes the tax affected impact of share-based compensation expense and foreign exchange and other was $35.0 million or $0.23 per share for the second quarter of 2016 compared with adjusted net income of $1.3 million or $0.01 per share recorded in the second quarter of 2015. Adjusted net loss for the six months ended June 30 was $60.1 million or $0.39 per share compared with adjusted net income of $29.0 million or $0.19 per share recorded in the first six months of the prior year. The net loss of $40 million or $0.26 per share in the current quarter compares with net loss of $1 million or $0.01 per share in the second quarter of 2015.

Net loss for the first six months of 2016 was $54.9 million or $0.36 per share compared to net income of $14.4 million or $0.09 per share recorded in the first half of 2015. The change in net loss year-over-year was reduced by net recovery in foreign exchange and other, which is primarily due to movements in the Australian dollar on United States dollar denominated debt in the company's Australian operations. The Australian dollar appreciated 2% against the US dollar in the first half of this year versus the Australian dollar depreciating 6% against the US dollar in the first half of last year. Funds from operations of $36.3 million or $0.24 per share for the current quarter were down 48% in comparison with funds from operations of $69.4 million or $0.46 per share for the second quarter of 2015.

Funds from operations for the six months ended June 30, 2016 were $91.5 million or $0.60 per share, a 49% decrease from funds from operation of $179.1 million or $1.17 per share recorded in the first half of 2015. Internally generated funds were used to fund completion of one new build drilling rig, the dividend payment in the second quarter and debt reduction. Revenue adjusted EBITDA, net income, funds from operations all decreased in the three and six months ended June 30, 2016 compared to the comparable periods of the prior year. In addition to the lower activity from the current industry downturn, Canadian operating and financial results were negatively impacted by a more harsh than usual spring break up, offset by a beneficial mix of deeper drilling rigs. The decreased results from United States and international operations were mitigated by an approximate 7% increase in the average United States exchange rate versus the Canadian dollar in the first half of 2016 compared to the first half of last year.

And now some geographical details. Canadian revenue decreased 25% in the second quarter of 2015 [ph] to $34.1 million compared to revenue of $45.6 million in the second quarter of the prior year. Revenue generated in Canada for the first half of the current year was down 33% to $109.7 million compared with $163.6 million in the first half of the prior year. The decrease in Canadian revenues is primarily due to the overall industry downturn with a harsher spring break up offset by the mix of deeper equipment. Canadian oilfield services accounted for approximately 25% of Ensign’s total revenues in the first half of 2016 compared with 21% of Ensign’s total revenues in the first half of 2015. United States revenue decreased to $73 million in the second quarter of 2016 versus $146.9 million in the second quarter of the prior year.

Revenue generated in the United States during the first six months of 2016 was $173.2 million, a 48% decrease from revenue of $333.3 million generated in the first six months of 2015. United States oilfield services accounted for approximately 40% of the Company's total revenue in the first half of 2016, down from 43% in the corresponding period last year. And finally, international revenue during the second quarter decreased by 51% to $68.8 million compared to $141.3 million in the second quarter of the prior year, of which a significant portion of the reduction was the recognition of Venezuelan bolivars at an average exchange rate of 450 per single US dollar based on the new floating discretionary rate in 2016 compared with using the pegged official rate of 6.3 per $1 in the second quarter of 2015.

Revenue generated outside of North America was $151.5 million in the first six months of 2015 [ph], a decrease of 47% from $286.2 million generated in the first half of 2015. Ensign’s international oilfield services operations accounted for approximately 35% of the Company’s total revenues in the first half of 2016, down from 36% of revenues in the first half of last year. Gross margin for the second quarter of 2016 was $45.4 million or 29% of revenue net of third-party compared to 88.8% or 30.2% of revenue net of third-party for the second quarter of 2015. The 49% decrease in overall margins from that of the prior year reflects overall reduced levels of operating activity in 2016 versus 2015. The gross margin percentage of revenue net of third-party for the six months ended June 30, 2016 was 31.7%, down slightly from 32.1% for the first six months of 2015. The decreases in gross margin percentages for the three and six months ended June 30, 2016 versus those of the corresponding periods in 2015 were primarily due to increased competition and lower day rates offset by management efforts since late 2014 to control costs in the current challenging environment for oilfield services.

Depreciation expense in the first six months of 2016 was $175.9 million, 40% higher than $125.2 million for six months of last year. Deprecation was higher this year compared with last year, due to idle equipment depreciation, the impact of higher dollar equipment being utilized, the negative translational impact of a stronger United States dollar, a non-Canadian domiciled fixed asset, a greater proportion of deprecation on those assets we depreciate using straight-line amortization, all of that partially offset by the overall decrease in operating activity this year when compared with last year. General and administrative expense in the second quarter of 2016 was 28% lower than the second quarter of last year. The lower expense in the recently completed quarter relates to the rationalization of supervisory and overhead costs to align with lower activity levels offset by severance and other costs to implement the changes together with the transitional impact of the stronger United States dollar on expenses incurred outside of Canada.

Share-based compensation expense in each of the three and six months period ended June 30, 2016 was lower than the corresponding periods in prior year. The liability for share-based compensation is determined based on the Black-Scholes valuation accounting that takes into account the effect of the number of variables including granting, investing of employee stock options and changes in the underlying price of the Company's common shares. The closing price of the Company's common shares was $7.25 at June 30, down 2% from the closing price of $7.38 at the end of 2015 [ph] for comparison last year, the closing price at June 30 was $12.24, up 20% from the closing price of $10.20 at the end of the previous year. Net capital expenditures from the first half of 2016 totaled of $24.2 million compared to net capital expenditures of $125.8 million in the first half of last year. In the first half of 2016, the Company completed one new ADR drilling rig for the United States fleet. We expect to exit 2016 with capital expenditures of approximately $40 million to $44 million. Finally the third quarter dividend rate remains unchanged at $0.12 per common share.

On that note I will turn the call back to Bob.

Bob Geddes

Thanks Tim, next we’ll circle around the globe with an operation update and outlook starting with Ed Kautz for the US and Latin America operations.

Ed Kautz

Thank you Bob, and good afternoon ladies and gentlemen. First I’d like to start with the United States overview. At the end of the second quarter 2016, the Ensign’s United States division operated a fleet of 90 drilling rigs, the company also operates 44 well service units and 47 frac flowback testing units in the US and directional drilling business with 31 kits. United States’ drilling recorded 1,609 operating days in the second quarter of 2016, 46% decrease in from 2,987 operating days in the second quarter of 2015. The United States well servicing recorded 15,229 operating hours in the second quarter of 2016, a 13% decrease from 17,452 operating hours in the second quarter of 2015. Revenue was down 50% in the second quarter of ‘16 compared to the second quarter of ‘15. The company's United States operation accounted for 43% of company’s revenue in the second quarter compared to 43% in the second quarter of 2015. As Tim mentioned, the Company added one new ADR rig to its fleet in the first quarter of 2016 and is now contracted and drilling in West Texas.

We continue to maintain our 31 directional kits in the US that are working in the Rocky Mountains with the utilization of 10% to 20%. Directional drilling has been a very competitive business and it all comes down to cost, control and service. Of our 97 frac flowback units in the company we operate in North America, 47 operate in the US. Activity and revenue in the US drilling and wells services continue to decline under pressure in the first quarter. In a competitive market, we are currently running a utilization rate of 25% to 30% in drilling and 40% to 50% in our well service fleet. Moving to Latin America, currently in Latin America, the Ensign International division operates a total of 17 rig, the company operates nine rigs in Argentina while running approximately 45% to 50% utilization. Ensign has eight rigs in Venezuela of which we’re running 50% to 80% activity on any given month. We continue to monitor our accounts receivable in both countries in a challenging oil market and our relationship continue to good with the national oil companies and the mystery and domestic companies. As always, the current economic and political climates in Argentina and Venezuela will continue to play a major role in the path forward for the industry. We are currently running between 50% and 60% of our rigs in Latin America.

With that I will turn it back over to you Bob.

Bob Geddes

Thanks Ed, will turn it over now to Tom Connors, who will give us an update outlook on the Canadian business unit.

Tom Connors

Thanks Bob, good afternoon everyone. I will start with Canadian drilling, Canadian drilling, Q2 drilling activity in Canada decreased approximately 25% year over year from 902 days in Q2 2015 to 674 days in Q2 2016. The second quarter in Canada is typically the slowest with this year being further hampered by American uncertainty; commodity prices reduce CapEx and the general macroeconomic environment. Industry utilization in the second quarter bottomed below 6% and averaged roughly 8% throughout the quarter. With 69 [ph] rigs listed in the Canadian fleet, we continue to maintain American shares slightly above our portion of the total Canadian fleet. Ensign is one of the top three drillers by wells drilled in the quarter having drilled 14% of the wells in the WCSB. As a result of our recent additions to the fleet and a process of continuous and consistent fleet renewal, we continue to maintain above average market share in the more active marketplace such as Duverney and Montney. By positioning ourselves at the right rigs and the right markets, our activity has proven resilient in the tough market with Ensign utilization consistently exceeding the industry average during the quarter by 2 to 3%.

While spot market pricing translates to margins near historical lows, pricing remained relatively stable throughout the quarter with roughly 16% of our global fleet on firm take or pay contract, some of that same contract coverage will provide pricing stability in the Canadian market throughout the remainder of ‘16 and into 17 and beyond. We anticipate highly competitive spot market pricing in Q3 as deeper rigs and the industry roll-off contracts and oversupplied shallow rigs compete for minimal activity. In the directional drilling market, while the overall market declined we continue to maintain or show modest growth in our market share as performance minded customers continue to recognize the value and efficiencies gained for more holistic expertise supplied by a contractor focused on the entire well both above service and below ground. It continues to be highly competitive market with most of our peers experiencing significantly reduced days in pricing. Pricing trends remained stable during the quarter year over year and while days were low overall, we actually grew days 65% versus the same period last year. Pricing will remain challenged for the remainder of the year, slightly being offset by Ensign having some of the lowest operating costs in the industry which assists in maintaining more resilient margins than many of appears.

In our well servicing business similar to industry activity levels, Canadian well service hours remained relatively stable year-over-year with a decrease in activity of 4% versus the same period last year and experienced relatively similar utilization rate of 21%, although overall activity has substantially decreased. The businesses demonstrated the capacity to protect and maintain margins through disciplined cost control initiatives. In our testing business in Canada, had a relatively challenging quarter for activity in Q2 versus relatively robust Q2 in 2015, we do remain positioned and get above average market share in some key areas but expect overall activity remained somewhat depressed for this business in the short to medium term.

Our managed pressure business had a quite Q2 in Canada, but we continue to find some niche opportunities in key areas as the market moves into Q3 and Q4. Our rentals business is highly independent on drilling activity and as such experienced a significant reduction in rental activity in Q2 while maintaining strong although reduced margins and positive cash flow for the quarter. The outlook for the year remains challenged with activity for the drilling industry forecasted near the 40-year lows experienced in 1992 and somewhere in the 40,000 to 45,000 day range was translated to an industry utilization below 20%. Deeper rigs operating in only the most economic plays will remain relatively active and some of those operating under guaranteed contracts into 2017 and beyond.

And with that, Bob I will turn it back to you.

Bob Geddes

Thanks Tom, next we will swing over to Brage for the International-East conversation.

Brage Johannessen

Thank you Bob, at the end of the quarter, Ensign’s international operations accounts a total of 29 rigs in its Australia and Middle East regions. [indiscernible] utilization rates had around 45% in Eastern Hemisphere excluding Libya. The company operates six rigs in Australia running at 30% utilization against an Australian overall rig activity level of 20%. As predicted on the last quarterly call, the activity levels appear to have bottomed out in Q2 of ‘16. Given the current oil price outlook, we expect activity levels to remain relatively flat in Australia through the remainder of ‘16 and the first half of 2017. We also expect that any future increase in activity to be extremely competitive given the amount of idle equipment in the market. With a current market share more than 40%, term contracts with a larger Australian operators and rigs ready to go to work, we are well positioned to maintain and increase market share when the market conditions improve.

Activity levels in our MENA region remained robust as we continue to operate seven rigs or around 90% utilization on longer term contracts in a month. Our superior 80-yard design is continuing to provide strong operational performance for our customers. Pricing concessions negotiated with key customers in the region during the downturn will begin to progressively unwind when oil prices recover. However, as the timing of the recoveries is uncertain, we do not expect to see the benefit of this price concession unwinding until the latter part of 2016. In the Middle East, apart from Iraq activity levels are expected to remain flat to a slight growth with all upcoming tenders and opportunities for additional work to be heavily contested. The company's total international operations accounted for 39% of the Company's revenue in the second quarter of 2016 and 35% of the company's revenue for the six months ending June 30, 2016 and this compares to 27% of the company's revenue prior to the industry downturn and also speaks to the company's long-term strategy of diversifying our geographical spread by growing our international business. MENA growth will remain an important part of the company's future and it well aligned with the major customers’ growth strategies in the region.

And with that I will turn it back to Bob.

Bob Geddes

Thanks Brage, so operator back to you for Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from Scott Treadwell with TD Securities. Your line is now open.

Scott Treadwell

Thanks. Good afternoon, everybody. Congrats on the promotions and retirements. I wanted to maybe start with, I don't know, higher-level question. You guys have always talked about the shifting, Ensign shifting market share versus where the industry is, based on where pricing is, where contract appetites are. Can you give us a sense of where you feel you are today if you feel that you’ll need to give up market share because spot rates are rational at this point or if you feel now is the time to reach out and maybe start to grow that market share in an advantageous manner because you’ve got the cash flow in the balance sheet to put rigs back to work, can you just maybe walk us through that high-level?

Tom Connors

Yes. Well, good question, Scott. A lot of question in that. How we view things, we try and stay higher up the value chain, offering directional drilling and drilling. We also have $60 million of rental assets that allow us flexibility on competing. We tend not to compete strictly on price. We also tend not to jump after the lowest spot bid in an area. Obviously, we move with the flow in areas that we do operate and we’ve certainly seen stability in the deeper rig market, the 1500 horsepower class market, we've seen a slowdown and a drop of those rigs. We do see a very, very competitive market in the doubles and central Alberta as market is starting to turn over there and we’re up against some contractors that haven't turned to the right in 6 or 7 months. But we don't let the anecdotal story, general story, we have the capability to move rigs from market to market, you had seen us do that in the past and we’ll continue to do that into the future. We will tend to report what we have done in the prior quarter, where we’re not one to tend to telegraph that into the future.

Scott Treadwell

Okay. I guess maybe a finer point on it, there’s been a couple of peers who've announced some contracts, specifically in the States, and it sounds like it's kind of the highest spec rigs, those discussions I'm sure you guys have been part of them to some degree, have those been something that you guys have been interested in or interested in at $500 or $1000 a day better rate, just specifically onto your point about the high spec 1500 rigs in the state?

Tom Connors

Yes, the rigs that are most in demand are of course are the 1500 horsepower AC walking rig with 7500 PSI system and we've got a bunch of those, we've got 80% or 90% utilization on those types of rigs. We typically are not balancing around the [indiscernible] in that pool and we are typically working with clients that we’ve worked with in the past and we’re having, as I've described before, better conversations these days about picking up a rig into the future, albeit not in the immediate future, but we're starting to see a little bit of blue sky.

Scott Treadwell

Okay. And I guess, to paraphrase what you’ve said there, that high utilization, you guys aren’t that motivated to get that last 10% to 20% to work and give up any potential short-term torque to day rates, is that sort of fair to say?

Tom Connors

Well, we are in a fair way. Scott, I think it wouldn't be, all right, let’s say we’re not in the fair way of course, there is a market in the fairway and the fairway has been getting a little lighter, but I would say that at any cost, we won’t try and find the bottom.

Scott Treadwell

Okay, perfect. I wanted to shift internationally. One of the topics that’s come up have been some of the larger tenders that are pending, certainly in the Gulf Coast region, there has been some talk about Russia, if and when things get normalized there. Can you just give us a sense of any substantial BD opportunities, specifically in the Middle East, obviously a god basin, but opportunities to grow the footprint?

Brage Johannessen

This is Brage here, there are upcoming tenders we know of in the Middle East, Kuwait in particular. When it comes to Saudi, there seems to be some change out of older assets there, but it is pretty much flat. Oman the same story, PDO is renewing part of their fleet, but its overall count is flat to a slight growth. We will -- we are paying attention to the whole region. There and it’s a focus area for us, but of course we will pair that up against our total fleet worldwide and see how that matches up with what we have sitting idle and how that matches with the requirements from the end of season in the season.

Scott Treadwell

Okay, good. Thank you. Last one for me, I just wanted to hit specifically on managed pressure drilling, it seems to kind of be a bit of, I don’t want to say device, but a little bit binary where some people are very strong believers and others aren’t. Have you seen any improved traction in the sort of never-ending search for better ROP in the drilling process that MPD is getting more traction even at the kind of lunch and learn and discussion level rather than maybe out in the field?

Tom Connors

Yeah. No, I can answer that. I would say the general trend last couple of years has definitely been, yes, it's still a niche business, you can have two operators in the same resource play and one is an absolute believer in managed pressure and the other one not, but I would say more so, it is more of an integration solution with the drilling rig and in certain place, especially as it starts to manufacturer some of these well bores and I can think of a couple of operators and more of the Duvernay and Montney. So -- and I think it is really two things there, a, they’re more picking it up and then also that they are integrating it with the drilling rig as part of the normal core part of the service. So I would almost call it the simplified managed pressure service. It seems to me the general trend, it is still a niche business, like I said, you could have 10 operators in one area and half of them might be believers and the other half think not, but certainly I would say the general trend is more opportunities than there was a couple of years ago.

Scott Treadwell

Okay, good. And I guess a follow-up on that, has there been, obviously, maybe early days for this yet, any thoughts that at some point capital needs to be directed there, maybe not today, but in the sort of relatively short-term or do you feel that the equipment and the basin is going to take a while before that gets absorbed?

Bob Geddes

You’re talking about managed pressure drilling or just generally, Scott.

Scott Treadwell

Yeah. Just for the MPD segment?

Bob Geddes

Go ahead, Tom.

Tom Connors

I think it's going to be a while, I still think there is enough equipment, there may be some areas that look more specialized equipment, so maybe some capital is spent, but not a lot, not a material amount in the next, in the foreseeable future.

Scott Treadwell

Okay, perfect. That's all I’ve got guys. I really appreciate the color. I’ll turn it back.

Operator

Your next question comes from Jon Morrison with CIBC World Markets. Your line is now open.

Jon Morrison

Good afternoon, all. Tom, within Canada, can you give a sense of a degree of which the average day rate was down year-over-year. I realize you don't want to discuss too many details, but just some idea of percentage decline would be helpful?

Tom Connors

Yes. I think you've got to keep in mind the rig mix as well changes as we continue to get deeper and the deeper rigs are working. So, and the deeper rigs tend also to be on, from contracts, so that really, if you look at the total average day rate per day, there really hasn't been much of a change, it's really been at best. I didn’t even know if you would give it a 5% decline year-over-year, so it's really been more the -- if you look at specific rig segments like single, for example, with 6% or 7% utilization today, I mean they are down in the $8,000 to $10,000 a day range and you're seeing double, of course, so they’d be down substantially year-over-year, they’d be down maybe 30% of what the pricing was last year.

If you look at the more oversupplied segments like shallow rigs or even some of the shallower doubles and even some of the heavier doubles, pricing certainly would be down quite a bit, but as you get up deeper in the less oversupplied categories and the rigs that are on contract, seeing less pricing change and those are rigs that are working. So I guess it's a bit more nuance and I would say overall, the average day rates haven't changed much year-over-year, but you've got to look at the type of rigs that are working.

Jon Morrison

Can you share how much of your Canadian operating days in Q2 came from contracted versus spot or call it short-term contracts?

Tom Connors

I would say, just about 90% of everything that works in Q2 is under some kind of contract.

Jon Morrison

Okay. Can you give an idea of where Canadian service rig pricing is right now and your market share was fairly resilient in the quarter, when you benchmark yourself against everybody else that’s reported, do you believe that’s pricing driven or something else?

Tim Lemke

Well, our pricing year-over-year has been fairly stable and I think it's and utilization really year-over-year has been notably relatively stable as well. So you’re seeing relationships, are we in the right areas, and I guess from a margin point of view as well as just cost control initiatives.

Jon Morrison

Okay, so your actual hourly rates aren’t down more than single-digit percentages year-on-year?

Tim Lemke

No.

Jon Morrison

Okay. Ed, can you give an idea of the number of active drilling rigs you believe you could potentially add in the back half of the year, just based on your ongoing customer conversations and your ability to staff rigs at this point?

Ed Kautz

Staffing to start with. It wouldn't be a problem, I think we've got a lot of key guys I guess placed would be the entry-level, rough neck, as far as the rigs in the last half of the year, we probably increased from what we are currently running, probably 10% to 15%.

Tim Lemke

Yeah. John, I don't think a lack of labor has ever been an issue for the drilling business, I think that -- the data in the past has been higher than it may ever be in the future. I think that's probably fair to say to Ed’s point, we have a lot of drillers that we keep in touch with and that will come back, but things ramp up. [indiscernible] most of the rigs that do go back to work for, it’s usually on programs and programs are the longevity and work that people are working for. There is a lot of unemployed workers in the US, in spite of the claimed 4.9% unemployment rate, we have not had any challenges. I don't expect we will, I mean, Ensign has got a world-class safety record and not a bad place to work we think.

Jon Morrison

So it's fair to assume that you don't think the US labor market is going to be any tighter than Canada in a ramp up over the next two, four, six, eight quarters like that?

Tim Lemke

No, not at all. That’s what you call a ramp up. First of all, I don’t know that we’d see a ramp up, that we hope with a steady increase in activity, but I think we can accommodate it with the people we have and bring some new people in.

Tom Connors

Yes. We have a rigorous training process. It's fair to say that if a driller has been out of work for three or four years, he probably comes back on to the rig as an assistant driller until he gets his training back up to speed again. But we have a process that handles that for the controls, but it's been talked a lot, I don't think it will be a position of constraint in to the future on the supply side.

Jon Morrison

Tim, as activity picks up, can you give us any sense of what we should be thinking about from a cost outlay perspective per activated rig in the US and is it fair to assume that these are going to be capitalized costs, or are they just going to be run through the P&L at this point?

Bob Geddes

I’m sorry, Tim. The after fleet that we have requires essentially no capital to put that to work. These are rigs that if they’ve got a job tomorrow, they can turn to the right and work. I think what you're seeing though is some move to the 7500 psi systems, operators are able to demand what they want and we are takers of the conversation. To put it in perspective, if one wanted to have a 7500 psi system to an existing AC walking rig, it's probably in the $750,000, $800,000 range.

Jon Morrison

Okay, so it's fair to assume that any incremental capital outlay you believe is largely going to be an upgrading spend and you don't have 50,000 to 100,000 plus to spend per rig to get it back to work?

Bob Geddes

No, it is usual ancillary stuff, but generally we suggested that to stay at this run rate, we're running anywhere between 15, 16 rigs this year. We think that that will start moving up right into the 60 to 70 rig category and we feel that our CapEx will stay in that 45 to 50 range.

Jon Morrison

And can you talk about the impact that union strikes might have had in Argentina in Q2 and are you experiencing any fall in Q3 so far, if you did experience some challenges there?

Tom Connors

We have experienced some union strikes in the past. At the moment, everything seems to be going along pretty good there. So with the change in government there, that transpired here a year or so ago, things have been pretty quiet on that front. Periodic, one-day strike or two-day strike surprisingly, Bob and I were in Argentina a couple of years ago, and we didn’t go, the field and things were shut down because there was a taxi strike in the city. So you just never know what might hold there in that line, but so far things have been pretty quiet on that front.

Jon Morrison

You mentioned running kind of 4 to 6 rigs in Venezuela right now, are you expecting to limit activity levels in the back half of the year based on credit questions around your key customer or want a site currently looks for running fairly flat at this point?

Tom Connors

It's going to run fairly flat.

Jon Morrison

Okay, is there any update you can give on the receivable situation in Venezuela from a DSO perspective or anything that you might be able to share?

Tim Lemke

If you compare this quarter versus last quarter, I’d characterize collections have really picked up a fair amount, not to the point where we’re at all complacent though, we’re going to watch it very carefully, and calibrate our activities accordingly.

Jon Morrison

Okay. Tim, is the second quarter depreciation number on an absolute basis is the fair way to think about what it might look like in the coming quarters?

Tim Lemke

I think generally, you’ll see, it’s sort of predictable directionally along the basis of days and hours at current levels. So, for example, Q3 of the activity levels are up somewhat, which is normal because of the seasonality. You’ll see the depreciation swing up a bit, but as we had said in earlier calls, we've strived to kind of get that number settled down and relatively predictable and we think we are there for the balance of the year.

Jon Morrison

Okay. Last one just for me, within Australia, you guys mentioned that you see things being fairly flat, have you seen any incremental bidding opportunities to add rigs in relation to Coal Seam Gas rigs in Queensland. It seems like there is a couple of things on the market right now?

Bob Geddes

Currently, we are talking to the main three, there is four active operators right now and we are in dialog with all of them, and we are, as we currently have term contracts with two of them, the statement I did provide that that’s our forecast going forward. There is no significant change in the activity levels. They’re definitely not at the current oil price levels, it is for LNG, but it is affected by oil price that will drive their budgets as well, because it’s more tied to market dynamics than in the past. So, we don't see any significant uptick in the activity level in the next three to four quarters.

Jon Morrison

Okay, I appreciate the quarter. I'll turn it back guys.

Operator

[Operator Instructions] Your next question comes from Jeff Fetterly with Peters & Company. Your line is now open.

Jeff Fetterly

Good afternoon, guys. First question on the US side, I know you talked about utilization in the US, but the date that we’re seeing suggests that you've seen some decline over the last five or six weeks in the US, is that consistent?

Tom Connors

Jeff, I'm trying to think, I think it's been pretty flat over the last 2 or 3 months.

Jeff Fetterly

Okay. I guess specifically, I'm wondering, have you seen incremental rigs go on to stand by, have you seen any contract buyouts?

Tom Connors

We have not, no.

Jeff Fetterly

Okay. And Bob, did I hear correctly really where you said in the US, for the highest spec rig, you’re running about 80% to 90% utilization today?

Bob Geddes

Correct.

Jeff Fetterly

So when you think about incremental activity for your US business, your demand is focused on that highest backup rigs, and you're running virtually all of those rigs. Is it safe to assume that you’re going to have to invest incremental capital to get incremental rigs running?

Bob Geddes

We have two that are both ready to hit the ground at the yard that have been upgraded to 7500 psi systems. We’re kind of approaching it on a kind of a demand basis and staying a little bit ahead of it. We're just having some conversations today with one of our clients that is talking about picking up an amount of our rigs in the fourth quarter. So we don't have our pockets full of cash and we’re very mindful of making sure that we stay just enough ahead of it to fill the gap and not oversupply.

We’re also finding that not everyone needs 7500 psi systems, going out 10,000 feet, 5000 pound systems works quite well. Guys who want to go close to over 2 mile laterals are definitely thinking of the 7500 psi systems. And everyone has slightly different land pictures too, not everyone can go out that far before they've been into their land, right. So, but we are suggesting that our 7500 psi self-locking pad rigs are having very good utilization.

Jeff Fetterly

The incremental upgrades that you just referenced, would that all be reflected in the $40 million to $45 million depending on the number you guided to for this year?

Bob Geddes

Yes.

Jeff Fetterly

The reference in terms of running 50 to 60 rigs across the fleet year-to-date and targeting to move into that 60 to 70, where would your cost structure be set today, like how many rigs could you run under the cost structure as setup today?

Tim Lemke

Well, as you know, Jeff, all of our feeder costs is variable costs. So as rigs go up, we hire crews and as they come down, they go down. So that is a completely variable cost. Our fixed cost overhead obviously goes down on a per rig basis. So as we move up into the 60, 70 rig category, and right now, we’ve built our overhead to operate in a 50 rig environment profitably and you see that in our second quarter, we’re applying systems and driving efficiency through the system. So as we move up, you will see our overhead per day cost go down on a per day basis.

Jeff Fetterly

But if you’re scaled on a fixed cost structure basis, if you’re scaled for a 50 rig environment today, does that mean that you are going to have to add some additional spend to the system if you really go to 60 or 70 rigs active?

Tim Lemke

No, we've got the capacity to manage it with the personnel that we have.

Jeff Fetterly

Okay. Great, that's all I have. Thanks, guys.

Operator

This concludes today's question-and-answer session. I now turn the call back over to the presenters.

Bob Geddes

Okay, thanks, operator. Just summary in closing, you've heard us describe the market today with the metaphor, we’re [indiscernible] but we see some blue sky in the horizon, that really holds true. Ensign has the balance sheet and experienced management to get through the 15.2. Since July, we continue to see our rig count rise. Today, we have roughly 50 plus rigs operating around between 40 to 50 well service rigs daily around the world. Also, our directional drilling group continues to capture more and more market share as operators continue to witness value proposition it provides and our other business lines continue to find a way.

Behind us are the conversations about dropping rigs and canceled programs, today our conversations about putting rigs back to work and operators high grading their fleet to ADR type rigs and how we approach the drilling contracting business a little differently. The more integrated value-based approach, where we work closely with the clients to deliver advanced performance with reduced well cost is clearly how we continue to bifurcated Ensign from its peers. Ensign is all about bright rigs, bright people and the right markets.

Before we leave the call, I just want to thank Tim for his rigorous dedication to Ensign as a shareholder and we’ll miss you Tim. And we will look forward to having Mr. Gray on our next quarterly call in the fall. Thanks very much.

Operator

This concludes today's conference call. You may now disconnect.

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