Musings: The 2009 Drilling Rig Correction - A Retrospective

When we began to focus on the potential for an industry correction in the spring of 2008, we never anticipated that it would be as severe or as swift as it turned out to be. When the drilling rig count was in its freefall period early in 2009, we began to look for analog time periods to see if we could gauge the severity of this downturn. After comparing various historical drilling rig corrections, we settled on the 1981-1986 period as the one we wanted to model.

When the drilling rig count was in its freefall period early in 2009, we began to look for analog time periods to see if we could gauge the severity of this downturn

To demonstrate our choice, we show the current rig downturn as of early in 2009 that we then projected based on the pattern of the 2001-2004 downturn. The green line shows how the rig downturn actually developed. It is evident from examining the lines that for part of the year, the forecasted downturn followed the actual rig decline quite closely. But then the rig drop continued while the forecast called for the pace of the downturn to moderate and eventually to turn up. Although the pace of the downturn remained steady, the bottom of this correction occurred at almost the same point that the 2001-2004 correction bottomed. Since the bottom, the pace of the current rig recovery has been steeper than during the earlier correction.

Exhibit10"

The 1981-1986 correction obviously spanned a five-year period as opposed to the 2001-2004 period and it experienced several recovery periods as industry dynamics acted to support oil prices and provided other drilling incentives that extended the entire correction period. In the United States, we experienced a change in federal offshore leasing rules in 1983 (from nominated acreage to area-wide) that opened up substantially more acreage for drilling. Because of government regulation of crude oil and natural gas prices in an attempt to prevent consumers from being burdened by rapidly rising prices, often the price declines being experienced outside of the U.S. were not passed on immediately to the domestic market thereby keeping prices more stable. By 1986, however, global oil prices collapsed and domestic prices also caught up with international prices completing the oil and gas industry correction. 

In reality, the bottom came after 1,155 rigs had stopped drilling, only 39 rigs more than we had forecast

Our assumption in selecting the 1981-1986 rig correction as our model for the current downturn was that the magnitude of the oil and gas price fall in 2008 and the resulting economic recession was similar in scope to the decline experienced in the earlier period. The one difference would be that this correction occurred faster than the earlier five-year correction. The one common factor was that we expected the total decline in rigs to be similar between the two periods. Nearby, we show a chart of the progress of the current correction against our forecast. As can be seen, at the time we prepared the chart, the industry had already shed 1,076 rigs from the peak and we expected another 40 rigs to be released before the bottom would be reached. That would mean the total of 1,116 rigs would be laid down.  In reality, the bottom came after 1,155 rigs had stopped drilling, only 39 rigs more than we had forecast. 

Exhibit11"

Since the rig count bottomed in the 24th week of 2009, or late May, the industry has added 313 rigs to the working rolls, almost a 35% increase. That increase has been driven by higher crude oil prices and accelerated gas shale drilling. The big question for 2010 will be how the rig count will develop from here.

Exhibit12"
Unless oil and gas prices climb meaningfully higher than current levels, the rig count should experience a 9% rise, or just over additional 100 rigs working next year

The recent survey by Barclays Capital of domestic oil and gas industry exploration and production spending in 2010 projects a nearly 12% increase. That increase is driven by expectations of healthy oil and gas prices in 2010. If that happens, then we would expect to see a healthy recovery in working drilling rigs, but maybe less than a commensurate rise to the spending gain. We would guess that unless oil and gas prices climb meaningfully higher than current levels, the rig count should experience a 9% rise, or just over additional 100 rigs working next year. Higher commodity prices could push the rig count up closer to 1,400 rigs for more than a 200-rig gain. Energy market conditions in the spring of 2010 may tell us whether our more conservative view of the rig count increase will need to be adjusted.

G. Allen Brooks works as the Managing Director at PPHB LP. Reprinted with permission of PPHB.

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