Rig Analysis – Land

Rig tracking service analyzes land drilling dynamics

Richard Mason,The Land Rig Newsletter

Metrics addressing US land activity range from simple numeric tallies, such as rig counts, to financial industry benchmarks like drilling days or revenue days. Most invariably provide a two-dimensional picture of land activity. To develop a clearer picture of market dynamics, it is useful to explore the qualitative nature of activity, particularly as the industry approaches effective capacity.

As in 1997 and 2001, this latest drilling cycle is characterized by increased waiting-on-rig availability, rising prices for drilling services, and an anticipated decline in rig efficiency, as marginal labor and equipment is pressed into service to meet high drilling services demand. Onshore rig tracking is a fairly complex endeavor due to a number of variables, including geographical fragmentation, market diversification and industry segmentation. The publicly available rig counts typically show trend lines for total units. Although it is possible to break this down into regional themes, nuanced analysis is difficult at best.

Although it provides continuity over time, the Baker Hughes rig count – the most frequently cited industry benchmark – tends to undercount activity. The company develops rig activity levels in each weekly tally through its sales staff, employing a number of parameters to qualify some rigs for inclusion while disqualifying others.

The official definition is, “The BHI rig count includes only those rigs that are significant consumers of oilfield services and supplies and does not include cable tool rigs, very small truck mounted rigs or rigs that can operate without a permit. Non-rotary rigs may be included in the count based on how they are employed. For example, coiled tubing and workover rigs employed in drilling new wells are included in the count. To be counted as active, a rig must be on location and be drilling ‘turning to the right.' A rig is considered active from the moment the well is ‘spudded' until it reaches target depth or TD. Rigs that are in transit from one location to another, rigging up or being used in non-drilling activities such as workovers, completions or production testing, are NOT counted as active.”

Because the count is not transparent, it is difficult to determine where the omissions originate. Thus, the process can lead to anomalies. For example, in 1997, when operators were waiting four months or longer for a drilling rig, combining Baker Hughes land activity with the Reed Tool Rig census of available equipment produced a utilization ratio of less than 70%. In 2001, waits on rigs stretched to six months, and demand was so strong that day rates briefly reached replacement cost levels for the first time in more than two decades. But the ratio of BHI rig count to the Reed census showed utilization at just 76%.

Proprietary rig tracking services such as RigData in Fort Worth, Texas, provide another method for useful analysis of the land drilling market. The company develops both offshore and onshore drilling activity out of drilling permits filed at the state or federal level. In the onshore market, the company follows field activity by tracking progress on permitted wells through weekly surveys of about 265 land contractors. The process generates a substantial amount of real-time data.

A simple comparison shows how different counting methods and definitions of “at work” create differences in activity levels. In June 2004, BHI counted 1,057 rigs at work on average in the US land market, while RigData showed 1,427 units in all sizes drilling for oil or gas onshore, a difference of 370 units, or 35%.

TRISECTING THE MARKET

Using more-detailed, itemized information makes it possible to employ elementary analysis to explore market dynamics. Initially, it is useful to examine the market from the view of drilling program size by dividing the rig market into three tiers. The first tier involves the most aggressive drilling programs, or E&P firms employing 10 or more drilling rigs. This includes the majors and many of the largest independent E&P firms with substantial drilling budgets.

The opposite end of the spectrum includes companies employing three or fewer drilling rigs. This segment primarily comprises small, publicly and privately held independent E&P firms.

Fig. 1. Large, medium and small rig operators' rig usage.

Finally, there is a middle segment of E&P firms employing four to nine rigs that absorbs declining activity levels from the most aggressive programs and from overreaching by the smaller companies.

Trend lines for all three segments over the last month in 2003 and the first half of 2004 are shown in Fig. 1. The most aggressive programs moved forward initially during the first quarter. Rig count for this group rose by 77 units, or 16%, to 556 total rigs. Notably, the group increased market share from 39% of all land rigs at the first of the year, to 42% by the end of the first quarter. Clearly, the most aggressive programs were the primary reason for the rising rig count in the first quarter. However, this tier largely maintained its rig employment levels in the second quarter while market share reverted to 39%, as the smallest tier E&P firms demonstrated renewed interest in drilling.

The smallest tier exhibited an opposite pattern. As a group, this tier steadily employed fewer rigs during the first 90 days of 2004, then moved aggressively to higher levels during the second quarter, when rig employment for this segment rose by 93 units, or 19%.

Clearly, the US land market is essentially split, with the behavior of the most aggressive E&P firms in marked contrast to that of the smallest independents and privately held companies. The first is moderated by an emphasis on capital discipline and steady expenditure on budgeted programs that appears to coincide with the calendar year. The smallest tier is motivated by surges in cash flow from high commodity prices and a drive to maximize production.

OPERATORS

Fig. 2. Number of active operators.

A second metric that demonstrates the interplay between the two groups involves the number of operators drilling between October 2003 and June 2004. Fig. 2 shows the number peaked at more than 515 separate operators early in the fourth quarter, but dropped rapidly in the final weeks of the year, falling to 455 at year end. This was a decline of 60 individual E&P companies, or 11.6%.

Fourth quarter 2003 exhibited a typical year-end rush to meet lease obligations or tax-induced capital spending. Afterward, the smallest tier E&P firms withdrew from the market. Although the number of operators rose marginally in the first quarter, a significant run-up unfolded during the second quarter when 40 additional E&P firms returned to the market. Although only an 8% rise, it boosted the total number of operators participating in the market to fourth quarter 2003 levels. Of interest, there were 510 operators employing land rigs in July/ August 2001 when the previous cycle peaked.

The trendlines from each graph suggest a convergence in demand for drilling services among all segments during the second quarter, resulting in tightness in rig availability that has been accompanied by rising day rates and expanding intervals for rig availability. Furthermore, anecdotal evidence from news releases and the trade press indicates continuing interest in further expanding field programs in 2004 by the smaller independent and privately held E&P firms.

Who is providing the drilling services, and what does that tell the market about capacity? Again, using an elementary analysis that arbitrarily divides the market into three tiers presents a view of where operators are finding equipment. The first tier includes two of the largest publicly held contract drilling companies, Nabors Drilling USA and Patterson-UTI Energy. Each has about 200 rigs active in mid-2004.

The middle tier encompasses fleets with 10 to 99 active rigs. Typically, this will include multi-regional contractors like Grey Wolf Drilling, Helmerich & Payne IDC, Unit Corp. and Caza Drilling. It will also include a number of regional contractors with mid-sized fleets, like Scandrill in the ArkLaTex, Cyclone Drilling in the Rockies, or Capstar Drilling in the Permian basin.

Fig. 3. Small, private contractors activity.

The third tier consists of smaller fleet companies with nine or fewer rigs. These are regional or local contractors, invariably privately held, who most often work for smaller independents or the privately held E&Ps. Fig. 3 demonstrates trends in this segment over the last year. Although rig use increased almost equally between all three tiers between June 2003 and June 2004, the latter part of the period witnessed strong gains among both small and mid-fleet companies, as small E&P firms surged into the market. The largest contractors remained essentially flat during the second quarter.

Coupling the trend lines with contractor telephone surveys indicates that the small and mid-size fleet tiers are essentially at or near effective capacity. The only remaining capacity, therefore, resides in the fleets of the largest drilling contractors. Activating that capacity will mean delays, poorer operating efficiency and higher prices. Of note, the largest tier companies have approximately 90 rigs that worked in the 2001 cycle that have not yet worked in the current cycle.

UTILIZATION

A recurring difficulty in analyzing the US land market concerns utilization. One technique involves examining the market to determine the number of unique rig numbers that were employed on one or more wells during a given time period, then comparing the active rig count to this number.

Using RigData numbers, the US land market had 1,587 rigs that drilled one or more wells in the last few months of 2003. In January 2004, the average rig count was 1,231, yielding a utilization of 77.6%. At the end of May, the number of rigs that had drilled one or more wells in the preceding months rose to 1,672 units. Average rig count for May was 1,379 units, or utilization of 82.5%.

An old industry rule of thumb suggests that day rates begin to rise when utilization reaches 80%. This appears to be confirmed in the current market. Utilization rose above 80% in late March and early April 2004. US rig rates moved up early in the second quarter, increasing $500 a day by the end of June.

Trends point to an impending collision between rising demand and a finite supply of drilling units, further hampered by the first inklings of labor shortages in the US land market. The cap on rig availability – and rig count – resides with the two largest publicly held land drilling contractors, who now control essentially all remaining rig capacity. As a result, expect rig rates to accelerate, moving up from daily increases that ranged from $250 to $500 during second quarter 2004, into the $500 to $1,000 per day range by the 4th quarter 2004, particularly as the year-end approaches and operators begin tax-influenced spending or face lease-stipulated deadlines.