Analysis: Industry Gears Up for Drilling as Crude Rises
After plunging to their lowest levels since 2003, NYMEX crude oil futures have rallied strongly during the first half of 2009 and appear set to move even higher, giving oil and gas companies the incentive to start drilling with renewed vigor.
Raising Price Predictions with Rising Demand
As the price of oil climbed steadily during 2008, passing the $100 mark and moving well beyond, predictions for even higher oil prices abounded. In fact, in May 2008, Goldman Sachs predicted that oil prices could experience a “super-spike” to $150-200 within the next 6 to 24 months. While oil prices came close to $150 in July 2008, they quickly fell as the global financial crisis and clear evidence of a worldwide recession cooled the market.
During the first half of 2009, the price of oil has more than doubled from its late-2008 nadir near $32, rebounding to settle past the $70-mark during June.
Recently responding to this encouraging rally in the energy market, Goldman Sachs increased its oil price forecast to $85 by the end of 2009. The U.S. investment bank had earlier predicted $65 by December 2009 after the price per barrel of crude oil fell below $40 in the last month of 2008.
In October 2008, OPEC agreed to reduce its output by 1.5 million barrels per day to help stabilize oil prices but decided in May 2009 to keep its existing levels. OPEC reportedly hopes to see crude tagged at $80 as an impetus for the industry's future investments, but has lowered its energy outlook due to "uncertainties" about future demand.
In line with a popular prediction of $80-$90 oil by year-end, Alexei Miller, head of Russian oil giant Gazprom, believes there are "sufficient grounds" that oil will hit $85/barrel by the end of 2009. Miller said that today's prices were "a return to a pre-crisis trend."
Adding fuel to the fire, the EIA reported this month that it expects world oil demand to increase by 10,000 barrels a day as the world economy rebounds from the current recession.
What's the Connection? Oil Prices - Investment - Drilling
Since capital budgets are driven largely by whether projects will be commercially viable, commodity prices play a key roll in determining which and how many oil & gas projects will be developed. Now that crude prices have recovered and may continue climbing, oil companies will be more likely to invest in exploration and development as they can do it more profitably and with more certainty than just 6 months ago.
In fact, UK bank Barclays Capital confirmed this month that it expects more oil companies to raise capital budgets next year. About half of some 400 companies surveyed by Barclays expects to increase capital spending, with 32% of those hoping to boost spending levels by 20% or more from 2009 levels.
This combination of higher oil prices, long-term demand growth, and more liberal investments is set to usher in a rally in the number and value of rig contracts.
Looking Back to See the Way Forward
While there are many factors that affect the number of new contracts being signed and the day rates for those contracts, the value of the oil and natural gas for which the rigs are drilling is a key determinant in the number, length, and value of the contracts. It is certainly a simplification to focus exclusively on oil prices as a predictive measure for the rig contract pricing process, but this analysis is still informative and has a broad predictive power.
Looking back to 2008, it is clear that the $100 and higher oil prices helped to drive a higher number of offshore rig contracts. It is also painfully clear that the drop in oil and natural gas prices during the last half of 2008 dried up a great deal of the offshore rig contracting activity.
Among the floating rig fleet, on average, 23 new contracts were signed each month from March through July while oil prices were above $100 and still climbing. This compares with an average of 15 new floater contracts signed each month during 2007 when oil prices climbed from the $50s to the $90s.
Between July and November, as the recession deepened and financial markets stumbled, average crude prices declined 57% from an average of $133 in July to $57 in November. During this time, new contracts signed for the floating rig fleet dwindled to just three new contracts in November – an 84% decline from an average of 19 contracts per month for the first 10 months of 2008 and a 79% decline from the 14 contracts signed in October.
Since the collapse in November 2008, an average of only 4 new floating rig contracts have been signed each month for the seven months through May 2009. Interestingly, among the floating rig contracts that have been signed, day rates have only dipped by 5% from the $401,000 average for new contracts signed in the first 10 months of 2008.
As oil prices have climbed back out of the deep trough that they hit in late 2008 and early 2009, some increased optimism for the floating rig fleet is certainly merited. Already in June, which has seen oil climb to above $70/barrel, 7 new floater contracts have been signed – the most for any month since October 2008.
With predictions of oil prices continuing to rise into the $80-90 range by the end of the year, the number of new floating rig contracts being signed each month should move back up to above 10 per month before the end of 2009. Assuming that oil prices level off and stay more consistently in the $70-90 range, a return to 2007 contracting levels of about 15 new contracts per month would seem quite likely for 2010.
As with the floating rig fleet, from March through July 2008 when oil prices were averaging over $100 and still moving higher, the average number of jackup contracts being signed each month was significantly higher than in 2007. For those five months, there was an average of 48 new jackup contracts signed each month. This is 20 new contracts more each month above the average of 28 per month in 2007.
Similarly, the number of new jackup contracts being signed each month dropped significantly in November 2008. The 57% decline in crude prices mentioned above drove a 53% drop in the number of new jackup contracts signed in November 2008 when compared with the previous month. The 21 new jackup contracts signed in November represents a 50% drop from the average for the previous 10 months of 2008.
Since November 2008, the number of new jackup contracts signed each month has averaged just 17 new contracts. Over that same time period, the average day rate for those new contracts has dipped markedly. While the average day rate for new jackup contracts in January through October 2008 was $122,000, the average for the six months from December 2008 through May 2009 was $93,000, a 23% decrease.
Even though the jackup market has not yet begun to show the early signs of recovery that the floating rig market has begun to exhibit, there is still reason to look forward to a recovery in jackup contracting.
Assuming that oil prices rise and stabilize near the $80-90 range in the second half of 2009, the number of new jackup contracts signed each month during 2010 would likely rise to close to the 2007 level of 28 new contracts per month.
The $80-90 price range would mark a $30-40 (60-80%) increase over the average oil price from December 2008 through mid-June 2009. Since a 57% decline between July and November 2008 drove a 50% decline in new jackup contracts, a 60-80% increase could drive as much as a 70% increase in jackup contracts. That would amount to an increase of 12 new contracts per month, bringing the number of new jackup contracts per month up to 29.
Any prediction for the jackup fleet needs to be tempered with the knowledge that natural gas prices are currently somewhat disconnected from crude prices and therefore much lower by comparison than they have been at any time this decade. Since many jackups, especially in the US GOM, drill for natural gas, their day rates are more affected by natural gas prices than are those of floating rigs. So, the low level of natural gas prices requires a discount to the number of new jackup contracts being signed, making a range of 22 to 26 a more reasonable estimate for new jackup contracts per month in 2010.
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