Low Oil, Gas Prices Affect Canada's Drilling Companies

CALGARY Sep 27, 2006 (Dow Jones Newswires from the Wall Street Journal)

The consequences of higher costs and lower commodity prices are trickling down to Canada's oil and natural-gas service companies.

The country's energy companies for months have been grappling with rising labor and materials costs and, more recently, have been saddled with a decline in crude-oil prices. This uncertain environment likely will lead to cutbacks in drilling this winter.

Less drilling means less revenue for service firms, a sign of moderation that could depress share prices going into 2007, analysts say.

"Indications of slowing growth have been evident for some time," said Alan Laws, who covers oil-service companies for Merrill Lynch. Mr. Laws recommends that investors hold off from stocks in North American-based oil-service companies, despite attractive valuations.

The boom in commodities, the start of which some date back to 1998, has resulted in a frenzy of exploration activity and surging drilling costs in western Canada sedimentary basin. Rates for hiring a drilling rig for a day have increased 50%, from around $14,000 in 2000 to $21,000 in 2006.

In just the past two years, the cost for Baytex Energy, a Calgary-based energy trust, to drill one heavy-oil well has increased 20% to $360,000, said Steve Brownridge, manager of the company's heavy-oil business unit.

Those prices are on the lower end of the industry scale, and there are plenty of other firms paying more, Mr. Brownridge said.

While oil and gas prices were on the rise, producers tolerated increased drilling costs in order to bring new production on stream. However, crude prices have declined more than $15 a barrel in the past month to just over $60. Natural gas, which is geographically trapped in North America, has been hit harder by forecasts for a warm winter and a relatively peaceful storm season in the Gulf of Mexico production province. Gas prices, which now trade below $5 a million British thermal units, are more than a third off their December 2005 peaks.

The two biggest Canadian oil and gas firms, EnCana Corp. and Canadian Natural Resources Ltd., are pondering capital cutbacks in 2007. EnCana has said it will wait until prices moderate before deciding its 2007 plans, while Canadian Natural expects to reduce its 2007 conventional crude and natural-gas capital expenditure budget by between $800 million and $1 billion, in part because it is seeking to reduce expenses after acquiring Anadarko Petroleum Corp.'s Canadian assets for $4.1 billion.

Consequently, the share prices of Canada's service firms are suffering.

Stock of Precision Drilling Trust, the largest player in the sector, has sunk from 43.40 Canadian dollars (US$38.83) a share in August to C$33.70 Friday.

"We expect to see a widespread reduction in gas drilling into 2007 before things turn better in late 2007 or 2008," said Angela Guo, analyst at Toronto-based investment bank RBC Capital Markets. She expects the number of oil and gas wells drilled in 2006 to fall 15% to 21,400, while only 20,260 are seen drilled in 2007.

Ms. Guo has lowered her 12-month target share prices for the sector by 10%.

While drilling rates have flattened off in the third quarter of 2006, they haven't actually started coming down yet. Drilling firms are well aware that a cold winter could easily ramp up gas demand again, sparking firms to expand their exploration programs once more.

Natural gas for delivery in 2007 is hovering around $7.50 a million BTUs on the New York Mercantile Exchange, while the October contract is at about $4.50. Futures prices for 2007 would likely have to drop below $7 to force rigs out of the market, said Lloyd Byrne, an analyst at Morgan Stanley in New York.

The direction of drilling rates won't be clear until all companies reveal their programs for next year, said Roger Soucy, president of the Petroleum Services Association of Canada. "We might see a fall in activity, but not a precipitous fall," Mr. Soucy said.

While most analysts agree there will be short-term turbulence in the drilling sector, many maintain that falling North American gas supplies and spiraling global crude demand should result in demand rebounding in the second half of 2007 and beyond.

Claims by Canadian firms that they are planning cutbacks may be just sabre-rattling, said John Tasdemir, analyst at Calgary-based investment bank Tristone Capital.

"It happens every year," Mr. Tasdemir said. "Every single rig in Canada has a name on it for this winter. Prices will go up October 1, although they will come down if we have another warm winter."

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