Natural Gas Fundamentals Point to Sustainable Upturn

Abstract: The word at this year's IADC Land Contractors Day Conference is that things are looking up for land drilling contractors. Way up.

Analysis: Eleven and counting.

That's the number of times land contractors and colleagues have convened for the International Association of Drilling Contractors (IADC) annual land drillers conference in Houston.

This year's edition featured a virulent outbreak of cautious optimism mixed with the usual review of the industry's current status. That status is good (U.S. land rig counts are up more than 250 units since the first of the year), and getting better.

Conference panel discussions ranged from the technical, including an overview of AC technologies in rig construction, to the theoretical, which provided a depiction of where the land drilling market is headed.

The conference consensus indicated the drilling market was headed higher because of underlying fundamentals in the natural gas industry.

It was pleasant news for land contractors. After all, at events like this conference, there is always enough gray hair that sprouted in response to numerous false starts in the past, including one this same time last year when land rig counts made a quick jump in the second quarter only to deflate for the remainder of 2002.

While contractors have yet to see any meaningful change in day rates, there are indications that the balance of pricing power is shifting toward the field service industry, if for no other reason than demand for rigs will likely be colliding with constraints on rig supply later this year.

Dennis Smith, Corporate Business Development manager for Nabors Industries, Ltd., told conferees that expanding demand for 1,500 to 2,000 horsepower land drilling units is now global. The industry is headed towards deeper targets, not just in the United States but elsewhere. Mr. Smith outlined growing interest in deeper horizons in Canada and Saudi Arabia as well as other international venues. Those projects will draw capacity from the U.S. land market.

Mr. Smith sees a sustained upturn, and he outlined a scenario where the cycle begins with an emphasis on low cost/low risk prospects, then shifts to higher risk/reward targets as customers recognize that an increasing rate of cash flow is real. The current cycle will be more orderly and sustainable than the boom/bust patterns that have characterized the last two events, Mr. Smith said, primarily because of operator spending discipline.

Similarly, Marshall Adkins, the managing director for the energy equity group at Raymond James and Associates, saw a secular change underway as a result of a dynamic natural gas market. This marked the beginning of a multi-year improvement in field activity, Mr. Adkins told attendees. He argued that the present situation is similar to the early 1970s, only this time the commodity is natural gas instead of oil.

Short term, Mr. Adkins envisions a potential train wreck in the natural gas market as production falls, drilling is unable to stem the decline, and the resulting shortfall in supplies can only be offset this summer through driving 700 bcf of demand out of the market via price rationalization.

That destruction must come from the industrial sector, he opined, which has already cut natural gas demand by 10 bcf/d since January 2000. He predicted natural gas prices could exceed $6 per mmcf this summer and that June would provide the first signals of where the market was headed.

Mr. Adkins characterized present trends as part of a long-term move, buoyed by a step-level change in natural gas prices. Fundamentals look good for oil, too, though there are wild cards in oil that make it difficult to project. These include the level of potential fuel switching as natural gas prices stay strong. The result is the same, however. The next four years will be good years for energy and for energy stocks, Mr. Adkins told the audience.

Those words were sweet music to the ears of land drilling contractors.

To understand why, it helps to review the history of the Houston conference. This year's seminar had a new name, Drilling Onshore America, though everyone still refers to it--somewhat affectionately--as Land Contractors Day. The event dates back to the early 1990s. At the time there was grumbling among land contractors that the IADC was focused on the interests of larger contractors in the offshore and international arenas. The IADC initiated the conference as a way to demonstrate to its members that land contractors still occupied a crucial role in the organization.

Of course for most of the 1990s the news was pretty much the same during Land Contractors Day. The rig fleet was declining, day rates were headed lower, and operators were moving offshore or overseas.

But a funny thing happened in 1997. As the gas play in the Gulf of Mexico tightened, operators suddenly began looking toward the U.S. land sector for incremental supplies of natural gas. Telephones started ringing for the land drilling contractor as the nation struggled to meet a shortfall in natural gas. At the same time, the land drilling industry was undergoing a roll up of smaller, privately held drilling fleets into larger publicly held companies, which introduced the sector to Wall Street. The once-forgotten land contractor suddenly discovered that the spotlight was shining on his niche.

Indeed, the 2000-01 cycle started in the land sector first as operators began to harvest existing reserves. While the U.S. land sector offered smaller targets and lower reserves than those offshore, land targets were readily accessible and operators could get natural gas into the pipeline system quickly. The reality today is that more than 60 percent of U.S. gas production originates onshore. That won't change soon. If the U.S. is going to drill its way out of a tightening natural gas situation in the coming months, it will need the land contractor to do so.

While many industry conferences have an early bloom, then fade in a few years' time, Land Contractors Day continues to improve in the quality of its presentations and attendance. The audience topped 270 contractors, vendors, and operators for the one-day event.

The level of sophistication may surprise some observers who view land drilling as a nuts-and-bolts endeavor while assuming all the high-tech developments are for offshore drilling. Stephen Bosworth, manager for Anadarko Petroleum Corporation's onshore drilling division, noted drilling performance on land, as measured by time spent on well, had improved 20 percent within just a year for his company's land drilling program, thanks to PDC bits. He identified this efficiency growth as one of the industry's most significant technological improvements in the last 20 years.

Meanwhile, Steve Johnston, president of CDX-Dart Drilling & Technology, outlined how his company uses proprietary techniques to drill multiple horizontal multilaterals through coalbed methane deposits, essentially mining natural gas in a pattern that resembles the veins in a leaf.

Drilling Onshore America packs a lot of information into a single-day seminar. This year's conference confirms impressions that the oil and gas industry has embarked on one of its periodic episodes of rebirth.

And that's good news for the land drilling contractor.