Drilling advances

	Vol. 230 No.1
LES SKINNER, PE, CONTRIBUTING EDITOR, LSKINNER@SBCGLOBAL.NET

Outlook for 2009

It’s the beginning of a new year, a time usually reserved for fresh-faced optimism in the drilling industry as new budgets come into place and schedules are being revised to reflect lofty plans. This year, however, there seems to be a sense of impending doom as drillers tremble in abject fear of oil prices remaining at artificially low levels brought on by sagging economies worldwide. The question is: Are such fears justified?

A couple of years ago I used the “B” word (boom) in this column to the consternation of many. Now, those same pundits are saying that the “R” word (recession) is more appropriate - to which I say “hogwash.”

It’s true that rig activity levels were down in December, 12% from the September peak (and 2% from the same time last year - gasp!), according to the Baker Hughes survey at the time of this writing. I suspect that will remain about the level of activity in the coming year compared to peak levels in 2008. Others, however, predict that over 1,000 rigs are to be idled by the middle of this year, a 50% decline from the September 2008 peak. Presumably, this is an extrapolation of recent sharp active-rig reductions.

Rig activity is generally a reflection of the broad-based industry floor level with a layer of freneticism added on top as inexperienced investors and operators try to cash in on today’s latest investment opportunity. Certainly, before crude oil prices began dropping in the last half of the year, there was a level of frantic spending in the belief that, if we can jump in this drilling industry, surely we can make lots of money real fast and get out quickly.

I once worked for an independent operator in Midland, Texas, who accurately pointed out that a fast deal in the oil business is usually a bad deal. Some of the drilling contracts I’ve seen over the past year were just that - fast deals with little long-term thought involved. Sure enough, when the well that resulted failed to flow 600 bopd or more, there was despair, wailing and gnashing of teeth. When oil prices fell to less than $50 bbl, the same investors realized that a fast deal is, usually, a bad deal. Now, they are frantically searching for some other industry in which to invest. So do recent drops in rig activity truly reflect long-term attitudes toward drilling in 2009? I think not.

Recently, Ernst & Young predicted strong growth and demand in the oil sector. Clearly, that involves drilling. True, oil prices are down, but recent price drops do not reflect long-term energy prices or activity levels, according to their report. Weak companies will be absorbed by stronger ones to expand prospect portfolios. Credit will be available to firms showing long-term stability, making mergers more attractive. True, some firms will fail as energy prices struggle to recover. These were probably the same ones that attracted impatient investors. So such failures are not unexpected. The patient money generally wins out in these situations.

Other drilling sector indicators remain strong, another sign that the industry is more robust than rig activity levels would indicate. For example, newbuild rigs (particularly deepwater floaters) are still sought along with support equipment, although new orders are lagging right now. Orders placed months ago before oil prices skyrocketed continue to be fabricated in the expectation of long-term price stability. I haven’t heard of any cancellations yet.

Similarly, marginal drilling projects are not being categorically discarded, merely delayed. Several firms have indicated that their 2009 drilling plans are being curtailed until drilling costs return to the pre-foolish point in our industry. Pioneer has indicated that their drilling plans will be suspended until drilling costs return to pre-2008 levels. As we all know, rig rates jump up quickly, but they fall much more slowly. As more rigs become idle, day rates will return to normal levels, crew shake-outs will result in a reduced workforce with only those folks capable of adding value being retained, and support services will follow the trend. Then, drilling will return to “normal” levels.

Over the past few years, operators did not follow the route taken in the boom of the late 1970s-early 1980s. Activity occurred at a more measured pace. True, profits along with oil and gas prices were high, but nobody got trapped into runaway spending (except the small investors), so there is a larger financial foundation beneath most operators, who were bright enough this time to keep emotions out of their investment decisions. In short, we’ve all gotten a little smarter, another indication that drilling activity will likely return to previous levels.

What does that mean for 2009? I predict that crude oil prices will stabilize between $75 and $80/bbl in the second quarter of the year. Most operators will continue a slow, steady course in growth and profits with rig counts returning to a firm, constant level. Completions, pipelines, production facilities and refinery modifications will also assume this steady pace.

Why? At current crude oil prices, consumers will probably recognize the energy bargain and return to their pre-bust consumption habits. Manufacturing facilities and markets temporarily suspended by a lack of credit will become active as the global banking industry recovers from the mortgage debacle (with or without government bailouts). In short, we’ll start spending money again and our appetite for energy will return to previous levels.

In one sense, the recent oil price drop was expected. Consumption is always price-driven in any industry; ours is no different. Conservation was forced on the public by high gasoline, home heating oil and other utility prices. The underlying demand for energy remains. As that demand increases, so will energy prices.

The need to supply energy can be met only by drilling new wells, at least in the short term. There is no doubt that the current crop of well-meaning politicians will attempt to replace hydrocarbons with other energy sources quickly to satisfy the public’s perception that oil is the root of all evil.

So don’t give up that morning-tour drilling job and go to work for an automobile assembly plant. The energy business is much better positioned to sustain a healthy economy, and drilling will always be in demand.