Land Rig Market Softens As Operators Tighten Belts

rig count

Hart Energy—Throw a rock in the financial district in Manhattan these days and you are bound to hit someone who is bearish on the outlook for oil and gas. Wall Street has all but abandoned the sector as an investment destination, and while commodities prices have continued to dance around the $50 to $60 range for oil and $2 to $2.50 for natural gas, producers have stymied spending for the second half of 2019 in search of further stability in the uncertain market. The result can be seen very tellingly in the U.S. land rig market. A year ago, there were a combined 1,042 land rigs searching for oil and gas in the U.S. As of Sept. 1, 2019, that number was 916 and falling. About 40%, or 485, of the working units a year ago were drilling shale wells in the prolific Permian Basin of West Texas and southern New Mexico. The Permian has lost more than 50 rigs over the past 12 months and indications are that more rigs will be rolling off over the balance of the year.

Chevron, one of the largest landholders in the region with 1.7 million unconventional net acres, is looking at its factory model to make a planned 20-rig program perform like one 40% larger. Speaking to investors at a Barclays event in September, Jeff Gustavson, vice president of the Chevron North America Exploration & Production Midcontinent business unit stressed the current level of activity would still allow the supermajor to grow Permian production to 900,000 bbl/d of oil by 2023.

“We were targeting getting to a 20 rig count for what we could see right now,” he said. “We’re comfortable with that 20 rig pace for now. We are always looking at whether that is the right pace and could that number go up or down over time. Absolutely. But we’ll take a measured, value-based approach when we make those decision. What we are really focused on now is making those 20 rigs that support that bigger factory operate as if they are 24 rigs, or 28 rigs. If we can bring the efficiency up on a given rig, the overall, absolute rig count is really not as meaningful as some may think. That is how we are looking at that going forward.”

Delivering more from less is an overarching theme for an industry mired in murky outlook. The future is clouded by reduced operator spending and a mid-to-low grade rig oversupply. Rig counts are down across most active basins. Beyond the Permian, the South Texas Eagle Ford has lost a dozen units over the past 12 months. The Cana Woodford of Oklahoma is down 20 rigs year-over-year. The count in Granite Wash is 11 rigs lower than this time in 2018. Those basins doing better now than a year ago can be tallied on one hand, as can the number of rig count improvements for each.

Super-Spec Rigs

“The land drilling market appears poised to soften heading into 2020 as operator budget management and continued gains in drilling efficiency constrain demand, while there has been additional supply of super-spec, or at least ‘super-spec-able,’ rigs added to the U.S. market over the last six to nine months,” said Brad Handler, equity analyst at Jefferies. “Rates for super-spec rigs have begun falling, and we expect companies’ average rates to continue to fall into next year.”

Super-spec rigs are the highest end, most capable units usually associated with having 1,500-hp  drawworks, a 750,000-lb hookload rating, 7,500-psi mud circulating system and multiple well pad capabilities. Utilization for super-spec rigs had been in the 90%-plus range for the first half of the year, but now it is seen slipping with Jefferies pointing to pricing erosion in the market that could see the utilization number dip into the mid-80%. The investment house is estimating that year-end 2019 demand for super-spec rigs will be down more than 9% versus the second quarter of 2019 average and the average rig count in 2020 down 6% year over year. This is due mostly to growth in the fleet couple with softening demand.

To that end, many drillers have suspended their upgrade programs. Patterson-UTI said as early as February 2019 that they would not go through with additional super-spec upgrades without a long-term contract attached. Citing fiscal responsibility, many drillers have reduced capital spending plans all together. It lowered its planned 2019 expenditures to $400 million over the summer across all business units, about $65 million lower than expected. The company also said its 2020 spending would track lower if drilling and completion activity remained around current levels.

“We expect our rig count to average 142 rigs in the third quarter,” Patterson-UTI CEO Andy Hendricks told investors in late July. “Our super-spec rigs continue to have high utilization. However, within our fleet, our non-APEX rigs are the most likely to be released, and by the end of the third quarter, we expect our active fleet in the U.S. to comprise solely of APEX rigs.”

Financial Strain

The contractors’ drilling business is seeing the status quo from many of its larger major oil clients. However, public independent producers are putting the squeeze on spending, which is why Patterson is guiding toward lower for its future rig count. Many smaller and private clients remain on the sidelines waiting to see what happens with commodities pricing.

Some of the smaller players have already succumbed to financial strain coupled with pricing tensions. According to an August report by the law firm Haynes & Boone LLP, 26 oil and gas producers have filed for bankruptcy protection in 2019—just two shy of the total number of producer bankruptcies for all of 2018. Sanchez Energy and Halcón Resources (for the second time in three years) are two of the most recent Permian players to file Chapter 11. With commodities pricing still a guessing game and fresh funding harder and harder to come by, additional debt-burdened producers are expected to seek bankruptcy protection before year-end 2019.

Rig contractor H&P responded to market volatility by reducing budgeted capex by more than 20%. The driller holds about a 40% market share on the super spec with about 230 rigs. It also boasts that it has the most upgradeable rigs available at the lowest cost. Management told investors in May that upgrades to a skidding super-spec rig would cost between $2 million and $3 million each. A walking super-spec rig would run about $8 million. Around mid-year, H&P completed an evaluation of its Flex4 fleet, which resulted in a downsizing and impairment charge of $225 million. The Flex4 rigs, originally built starting in 2005, are not good economic candidates for super-spec upgrading, according to the company.

In addition, land drilling giant Nabors Industries has experienced rig count declines. During the second quarter of 2019, the company’s U.S. Lower 48 land industry rig count declined by 44 rigs—a 4.5% reduction. The contractor’s most recent customer survey, conducted during the second quarter of the year, polled its top 20 Lower 48 customers about potential future activity, and it found that a further decline of 20 rigs is planned for the remainder of the year.

“The largest planned declines are within a handful of respondents,” explained Nabors CEO Anthony Petrelli when discussing the results with investors in late July. “About two-thirds of the respondents indicated no change or, in fact, modest increases. The previous version of our April survey indicated a similar magnitude decline among a narrower subset of respondents. The latest version of the survey indicates those customers now intend to drop 10 more rigs than they had planned three months ago. Among the companies surveyed, the latest since the April survey, the market has dropped 58 rigs. Clearly the total number of rigs dropped for the year has significantly worsened over the past three months.”

Precision Drilling said in August that it would reign in its 2019 capex plan to about $144 million, down $25 million from its previously stated budget of $169 million, following the completion of a newbuild project for Kuwait. The contractor’s preliminary guidance on its 2020 planned capex range of $60 million to $80 million, primarily consists of maintenance capital, in line with 2019 maintenance capital spending. The preliminary plan is based on current activity levels and market conditions, allowing for cash generation flexibility in what remains a volatile commodity environment.

“I think the biggest risk we face is increasing commodity price volatility,” Kevin Neveu, Precision’s president, told investors recently. “Our customers got nervous when we saw commodity price again drift into the lower 50s in June. That is a risk.”

As long as oil prices remain volatile and the industry’s “do more with less” mantra holds, the U.S. land rig market could be in for a protracted stretch of lower demand.

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