US Drilling Activity Off Sharply

NEW YORK (WALL STREET JOURNAL via Dow Jones Newswires), Dec. 15, 2008

As oil and gas prices fall, drilling activity in the U.S. is slowing more than expected, battering shares of drilling companies, hurting economies in energy-producing states and sowing the seeds for supply shortages when the economy recovers.

In its weekly accounting, Baker Hughes Inc. reported Friday that the number of drilling rigs working in the U.S. had fallen to 1,790, down 12% from the September peak and down 2% from the same time last year. It was just the second time the weekly report reflected a year-over-year decline in the past five years.

Most industry analysts now expect hundreds more rigs to fall idle by the middle of next year. Some industry experts suggest a drop of as many as 1,000 rigs, which would represent a 50% decline from the peak set in September. That would leave fewer rigs running than at any time since 2003.

The slowdown is being driven by the collapse in energy prices, which has made many higher-cost oil and gas fields uneconomic while companies have less cash to pursue even those wells that are still worth drilling. At the same time, the credit crisis has made it harder for companies to borrow money, further constraining spending.

"This whole thing is happening more at videogame speed than real life," said Bob Simpson, chairman of oil and gas producer XTO Energy Inc.

The worsening crisis has meant that many producers that began cutting their drilling budgets in September or October, when prices began falling, have been forced to cut again, in some cases multiple times. Chesapeake Energy Corp., the largest U.S. gas producer, has reduced its drilling budget four times since September, and has said it will do so again if necessary.

"These things take time to play out, and we have been reacting for the last four months to worsening credit conditions," Chesapeake chief executive Aubrey McClendon said.

The sudden slowdown is sending shock waves through economies in Texas, Oklahoma and other states that had been until recently relatively insulated from the national economic slowdown by their strong energy sectors. Onshore drilling rigs directly employ around 20 workers, and create dozens more jobs for everyone from equipment manufacturers and truck drivers to geologists, engineers and accountants.

"Those are high-paying jobs and that's high-impact activity," said Karr Ingham, a petroleum economist based in Amarillo, Texas. "It's had a lot to do with economic growth in Texas. . . . Now the tables are going to be turned a little bit."

The drop-off in activity is also bad news for oilfield service providers, especially drilling companies such as Patterson-UTI Energy Inc. and Nabors Industries Ltd.

Not everywhere will be equally affected. Oil prices have fallen faster than natural-gas prices, and oil projects tend to be more expensive, so most analysts expect them to be canceled first. Older, less productive fields in Oklahoma, West Texas and elsewhere will see activity decline faster than newer, less expensive fields.

If prices remain at current levels or fall further, though, the effects will be felt across the U.S. industry. Oil prices of "$40 to $60, that pretty much doesn't work in the U.S.," said Bill Herbert, an analyst with energy-focused investment bank Simmons & Co.

Most production in the U.S. is natural gas, not oil, and industry analysts are counting on the drilling slowdown to ease a gas glut that has helped drive down prices. That hasn't happened yet, as the slowing economy has cut into demand for electricity and for the products from diapers to fertilizer that are made using natural gas. At the same time, recently discovered gas fields are producing at an unprecedented rate.

"We are asking Santa for fewer drilling rigs, less supply and a bit more demand," investment bank Tudor Pickering Holt & Co. wrote in a research note Friday.

Industry executives, however, warn that restoring production takes longer than cutting it. That means the drop-off in drilling activity could lead to supply shortages -- and rapidly rising prices -- when the economy recovers.

"This sets up, I kind of think, the mother of all price recoveries," Chesapeake's Mr. McClendon said.  

Copyright (c) 2008 Dow Jones & Company, Inc.