Historical Context for the Recent Downturn and Ongoing Recovery
Driven by a confluence of factors including the credit crunch, commodity price collapse and widespread economic malaise, the U.S. land rig count decline witnessed between August 2008 and June 2009 was by far the most devastating downturn of the last 20 years. On a percentage basis, the recent downturn was similar to the 1998-1999 downturn, it just occurred in half the time. In absolute terms, more than twice as many rigs fell out of the rig count in the 2008-2009 downturn than in each of the last two major collapses.
However, the recovery so far has been promising, and in the five months since the downturn, the rig count has recovered by 241 rigs or 29%. In absolute terms, this is more than in the first five months of either of the prior two recoveries. On a percentage basis, the current rebound is unfolding faster than the 2001-2002 recovery but not as quickly as the 1998-1999 recovery. The table below summarizes the last three downturns and the five-month periods following the troughs.
Rig Count Likely Headed Higher, but Risks Abound
Although a general consensus has formed that the land rig count will continue to increase during 2010, it would be wise to balance optimism with a sense of caution in the current recovery. While the recovery periods in each of the last two cycles generally exhibited an up and to the right pattern (for two and six years respectively), the present upturn is occurring in a noisy environment where multiple variables could take a course that would result in a plateauing rig count or possibly even a second bottom. That said, we would hasten to note that any material retrenchment appears unlikely in the near term given the increased inquiry levels being received by drilling contractors and the expected uptick in E&P capex next year.
The most visible and pervasive threat to the onshore recovery is a significant setback in the progression of the U.S. economic recovery and the adverse impact that would have on hydrocarbon demand. After showing signs of leveling off a few months ago, recent data released on the U.S. housing market as well as some other economic indicators has resulted in the phrase "double dip recession" popping up more frequently in the mainstream financial media. With industrial demand for natural gas already crippled by the downturn in the U.S., any major setback in the broader economic recovery would adversely impact natural gas demand, prices and ultimately, rig activity.
Other variables include more efficient drilling technology, shallow decline rates for wells drilled in new shale plays, the threat of additional LNG imports and the ultimate magnitude of the production response to the rig count decline. In addition, high natural gas inventories remain a significant concern. Gas in storage currently stands at 3,833 bcf, 10% above the year ago level and 12% higher than the five-year average.
It is also worth noting that there is a substantial backlog of uncompleted wells that have been drilled but deferred. With industry sources indicating that as many as 1,500 wells may fall into this category, completing these wells to bring "easy" production online may take priority over drilling new exploratory wells - good for the well servicing rigs which usually perform this work due to their lower cost, bad for land drilling rigs.
Furthermore, a substantial backlog of deferred well maintenance and workover jobs may take operators' focus off of new drilling activities and result in relatively easy production gains. These activities present a compelling, low risk and low cost economic proposition to operators. While not extremely capital intensive, workover and maintenance jobs may take priority over drilling new exploration wells given some operators' risk adverse psychology after the recent downturn. In fact, based on today's crude oil price and well servicing costs, a maintenance job for a mature oil well can pay for itself in under two months while the payback on investment for a workover job is about half a year.
Not a surprise given the rig count decline, data from the EIA reveals that total oil and gas well completions so far this year are tracking about 40% below the same period last year. This should eventually lead to a nice production response, however the extent of the response may be somewhat muted by multiple factors including the backlog of uncompleted wells and high IP rates observed in growing shale plays.
Detailed forecasts of land rig demand can be found in the RigOutlook reports, brought to you by Rigzone.
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