Newbuild Rigs Signal Start of Recapitalization Cycle for U.S

Abstract: With 50 new rigs and more than 200 refurbished units entering the U.S. land drilling fleet between 1998 and 2003, the land drilling industry is gearing up for greater operator demand. But it will cost more to rent rigs.

Analysis: Can't tell you what day it occurred, but it is possible to pinpoint the era. Sometime in the 1997 to 1998 period the land contract drilling industry passed an inflection point on the issue of industry retooling.

For nearly two decades land drillers had relied on cannibalization of existing parts and equipment left over from the building boom in the late 1970s. Essentially contractors were consuming the remnants of the old fleet. But as the 1997 mini-boom worn on, spare parts disappeared from the aftermarket. By early 1998 some in the land drilling industry began looking at ways to retool for an anticipated increase in demand for drilling services, including the construction of new drilling rigs.

Between 1998 and 2003, 50 new land rigs will have been added to the U.S. drilling market. The number of refurbishments or upgrades will exceed 200 units. Although new construction represents less than one half of one percent of the fleet, it signals the beginnings of a recapitalization cycle in the land drilling business.

These days, new rig construction features improved technologies for instrumentation, mud systems, and rig power systems. Think of it as more muscle, applied more intelligently with more efficiency.

There is a tendency toward replacing old, reliable diesel electric power systems with variable frequency AC drives. More often than not, new rigs feature top drives, rounded tank mud systems, and energy and pollution efficient power plants.

This trend has some very specific implications for operators. Ultimately it will cost more to rent equipment. After all, the large cache of aftermarket parts left over from the 1978 to 1982 building boom essentially subsidized drilling operating costs for nearly two decades. But that subsidy is gone. Contractors can almost identify the weeks when various used components ran out nationwide. In some cases, costs went up by a factor of 10 over a matter of months as used parts disappeared, followed by the transition to refurbished parts, which was followed by the necessity of acquiring newly manufactured components from companies that had downsized over the last couple of decades.

As a result, day rates approached replacement cost economics for the first time since the late 1970s when rig counts peaked in the summer of 2001.

But while the new equipment will cost more to rent, operators are also gaining value in terms of specialization and efficiency. Many new rig packages are able to drill more wells per year because of improvements in mobility, which reduce the amount of time between jobs. That concept, based on system modularity, has also been extended to the refurbished rig packages contractors are assembling. Here is a sampling of some of the new rig/refurbishment programs underway:

• Helmerich & Payne—The company has embarked on the land industry's most ambitious building project. The company's FlexRig program is now in its third phase and will produce 25 rigs by the end of 2003 at the rate of two units per month. HP has capitalized on each cycle of the program, which began in 1998, and currently assembles its own units using advanced manufacturing principles at their Houston facility. The estimated per unit cost for each FlexRig is $10.75 million, including top drive. The FlexRigs feature advanced control and information systems, a patented mud system, top drives, automated BOP handling, and AC VFD drawworks.

The units reportedly drill for the same economics on well depths from 8,000 to 18,000 feet—hence the FlexRig name—and feature improved environmental and safety characteristics. Because of drilling efficiencies, the new FlexRigs are able to command a 15 percent premium over standard market rates. By the time the five-year FlexRig construction program finishes, HP will have added 43 new land rigs at a cost of $400 million.

• Rowan Company—This offshore drilling contractor has quietly built four new 2,000 hp deep-rated land units capable of drilling in the high-temperature/high-pressure wells common to the Gulf Coast. The land rigs feature AC drive systems, a one-million-pound hookload, and massive 2,200 hp mudpumps from the company's LEWCO manufacturing division. Rowan is refurbishing four additional land units for redeployment in 2003.

• Nabors Industries—The world's largest land drilling company retains the largest cache of inventoried equipment in the industry after more than a decade of shrewd acquisitions. When demand for drilling services rose in 2000-01 the company began drawing on this resource as part of a massive refurbishment program, upgrading or refurbishing 113 units with larger pumps and mud systems, new energy-efficient power plants, and SCR systems. In all, the company spent one-half billion dollars over the last 18 months on the program. Nabors is currently building a winterized 3,000 hp unit for the Canadian market.

• Cactus Drilling—The Tulsa, Oklahoma-based driller, a subsidiary of Kaiser Francis Oil Company, acquired the remnants of several land fleets a decade or more ago. In 2000, the company began upgrading these units and eventually returned 20 to the marketplace. Unit Corporation purchased the 20-rig fleet for $120 million this past summer. Cactus still has several rig packages it can upgrade for the market.

• Grey Wolf Drilling—This Houston-based land driller refurbishes high-end rigs as the market requires, usually on term contracts that amortize the cost of refurbishment over a multi-year drilling program. Rigs mobilized under this program have been relocated to deep gas projects in Wyoming and the Permian Basin.

• Pioneer Drilling Company—This South Texas driller has built two new rigs similar to the Helmerich & Payne FlexRig units and purchased four more rigs built to like-new condition with updated power plants and mud systems. Pioneer was the first U.S. land driller to commission an AC variable frequency drive unit in July 2001. Through acquisitions, refurbishments, and newbuilds, Pioneer has increased the size of its land fleet from six to 22 units in less than three years.

• Parker Drilling—The international land driller will design and build a multipurpose winterized state-of-the-art drilling unit for use at Sakhalin Island. This unit will be located on land but involved in extended reach drilling to targets offshore.

Additionally there are a number of smaller, privately held companies such as Houston-based Scan Drilling who are able to refurbish like-new rig packages at regular intervals.

New build programs extend beyond traditional drilling contractors. Tesco Drilling Technologies has now demonstrated commercial viability for its casing drilling program. The prototype units were built and tested in Canada, but have since been used in both the Rocky Mountains and South Texas.

So what will happen in the future? There are some pressures from the operating community that will shape new rigs in years to come. BP, for example, is studying how to improve rig safety as part of its “Rig of the Future” program. Essentially the operator is exploring ways to “engineer out” safety hazards and “engineer in” performance.

Basically, the study, which is just now getting underway, will address remote operational capabilities and automated pipe handling as well as safe and efficient rig moves.

Capitalization is a multi-decade cycle in the land drilling industry. But contractors are embarking upon this journey in anticipation that the nation’s demand for additional hydrocarbons will create the business conditions necessary to finance and stimulate retooling of the land drilling fleet.