Lower Costs Give Oil Drillers Breathing Room

NEW YORK (THE WALL STREET JOURNAL via Dow Jones Newswires), May 20, 2009

A long-awaited drop in the cost of drilling and maintaining wells has finally materialized, easing the pressure on oil and natural-gas producers whose profits are being squeezed by lower prices.

Executives at the companies that own and develop fields complained for months that as tumbling energy prices ate into revenue, margins were being hurt by the stubbornly high cost of materials, labor and drilling services needed to get oil and gas out of the ground. In recent weeks, that has finally begun to change.

Lower costs, along with a modest rebound in oil prices to more than $55 a barrel, helped several companies deliver better-than-expected earnings in the first quarter.

"We've certainly seen a cost response almost everywhere now," said John Richels, president of oil and gas producer Devon Energy Corp.

The Oklahoma City company said its costs have dropped 10% to 15% from the beginning of 2009 and predicted they will come down another 10% to 20% before the year is out. The decline helped mitigate Devon's $4 billion loss in the first quarter driven by the diminishing value of its oil reserves.

Costs began falling in the first quarter, and the trend has accelerated in recent weeks. XTO Energy Inc., another producer, reported earlier this month that drilling costs fell 15% to 20% in April alone.

"Almost overnight, the costs have dropped like a rock," said Dan McSpirit, an analyst with BMO Capital Markets in Denver.

Several factors are driving the cost declines, including the lower price of steel, which is used to make drilling pipe, and cheaper diesel fuel, which powers most drilling rigs.

The biggest factor, however, is reduced demand for drilling equipment. Lower oil and gas prices have led producers to drastically cut back their drilling, more than halving the number of rigs operating in the U.S. since September.

That has hurt drilling contractors such as Patterson-UTI Energy Inc. and Helmerich & Payne Inc. and services companies such as Schlumberger Ltd. and Halliburton Co. Helmerich & Payne, for example, has seen the rate it can charge for currently available drilling rigs drop by about 30% since last fall. Yet despite the price cuts, only about half its U.S. rigs are currently operating.

Service companies resisted cutting their prices late last year, believing prices would soon rebound. But as lower oil prices persisted and business evaporated, they've become more willing to negotiate lower rates.

"This downturn so far is worse than previous cycles in terms of the speed of the decline," Halliburton Chief Executive Dave Lesar told investors last month. "The steep dropoff in activity has led to reduced volumes and intense pricing pressure for the remaining available work."

Costs have fallen fastest in the U.S., where the decline in drilling activity has been steepest. Schlumberger, the world's largest oilfield services firm by revenue, said its profit margins narrowed 8.6% in North America in the first quarter from the previous quarter, while overseas profit margins were flat or increased slightly.

There are some signs that the slowdown in drilling is beginning to ease as costs fall and oil prices rise. Baker Hughes Inc. reported Friday there were 918 rigs active in the U.S., down by just 10 from the previous week, one of the smallest weekly declines this year.

A few areas, such as the Haynesville Shale natural-gas field in northern Louisiana and parts of the oil-rich Permian Basin in West Texas, saw their rig counts rise slightly.

Executives cautioned that costs need to fall further before most U.S. drilling projects are economic again. "Costs are coming down," Occidental Petroleum Corp. President Steve Chazen said. "But we're still not where we need to be."  

Copyright (c) 2009 Dow Jones & Company, Inc.

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