Drilling advances

	Vol. 228 No. 8
LES SKINNER, PE, CONTRIBUTING EDITOR, LSKINNER@SBCGLOBAL.NET

Slowing down yet? Oh, where will it end? This could go on for another 20 years! Oil could be $80 within the next year or two! Sound familiar? These were the same things uttered by excitable, passionate oilmen back in 1980. I remember them well. I was sucked in like lots of other investors and put my life savings into business ventures that looked far too good to be true. Turns out, they were too good to be true.

Earlier this year, I heard projections of oil reaching $120/bbl within six years. Recently, low gasoline stocks pushed oil prices over $70/bbl. Current thinking is that drilling activity and rig counts will remain at the high level they have occupied for the past three years, based on prices in excess of $60/bbl. Economics for long-term projects, formerly based on $30-$35/bbl, are now being recalculated at $45-$55/bbl, because of the high price plateau over the last few years.

The future looks rosy for the oil business, right? Yes it does, if one looks only as far as crude futures traders can see. With dwindling reserves and the inability to replace reserves, coupled with production restrictions by some oil exporters, price stabilization certainly looks good.

We are rapidly rebuilding the workforce, particularly on rigs. Once again, young workers are looking to the oil business and the drilling industry as a good career choice. It reminds me so much of the late 1970s-back when being in the oil business was still fun, and the drilling sector was the place to be. Now, it seems that being anywhere in the oil business is becoming attractive.

With all this optimism, why aren’t oil company stock prices increasing astronomically? Record profits over several years should have fueled frenzied stock speculation. Instead, both E&P and service company stocks have experienced only measured growth relative to oil prices. Astronomical operating expense increases have offset much of the oil price increase (something the media often fails to report), but oil companies are still showing high profits. One would think that this should have spawned speculation about company valuations, forcing stocks way off the charts. Oddly, that hasn’t happened.

Investors, at least the experienced ones, recall 1982, 1986 and 1995 with disdain. Oil company stock investments tumbled to all-time lows, literally overnight. Investors were burned once (or twice, or more) and they refuse to be blistered again.

Just a few months back, I read stock analysts’ reports warning that oil stocks were a poor long-term investment, while oil prices were still rising by several dollars per barrel every day. The crude price increase could not possibly be sustained according to these soothsayers, none of whom ever worked in the oil business a day of their lives. The analysts were wrong then; but what about today?

History has clearly demonstrated the cyclic nature of oil prices. They have never remained at a sustained plateau for very long. So their present run is more than a bit surprising. Still, stock prices have not responded as expected.

Perhaps it’s because we have peaked on drilling, recompletion and workover activity. Rig counts have held steady for the past year. Newbuilds are offset by rig retirements. Crew levels have risen to meet the demand, but the total number of US land rigs (US GOM rig count has been dropping since 2006) is staying about the same. In some parts of the world, the working rig count is dropping slowly. Strange...

Well, not really. Most E&P companies maintain an inventory of prospects, yet to be developed, on long-term secured acreage. Prospect viability is a bit like a pyramid: As oil price increases, a new pyramid layer rises above the minimum economic threshold and development becomes a feasible reality. The problem is that it often requires five to seven years to take a new prospect from exploration, through appraisal, to full development. Even with three years of stable oil prices, we are still two to five years short of convincing many investors that these new (and expensive) prospects should be the object of their attention.

Drilling spread costs continue to increase along with steel, rubber, personnel, rope, soap and dope. Wells that cost a few hundred-thousand dollars years ago now cost millions. Thus, the economic trigger keeps moving upward. It’s hard to drill a new prospect with the uncertainty in the present oil price “bubble.”

Most of the really nice prospects in the global drilling bank now are being drilled, leaving fewer in the depository. Explorationists are working at breakneck speed to develop new prospects, but we still aren’t replacing reserves as fast as we are depleting them.

In the last big boom during the late-1970s, there was a wild time of drilling, selling leases, acquiring companies and trading personnel, which followed major oil price increases in 1973 and again in 1979 up to $31/bbl. About 2½ years after the boom started, this frenzied tempo was followed by a slump, for the same reasons the industry is facing now. So it should not be surprising if there is a slight slowdown over the next six months or so. That’s what I expect to happen-all the indicators present now are those that existed 30 years ago.

The bad news is that there will be a large number of “industry experts” that will adopt an alarmist mentality, and oil company stock values will probably drop-overnight. Stock analysts will again start walking in circles with their hands clasped behind their backs, shaking their heads and mumbling about the industry’s sorry state. The public will once again lose confidence in our ability to drill wells and keep gasoline prices within their budgets. We will probably see punitive measures proposed by ambitious politicians, implemented by poorly informed bureaucrats, working in under-budgeted agencies and each trying to exact retribution against “Big Oil.” Young folks will flee to other industries. There will be predictions of gloom, doom and financial ruin.

The good news is that the dip will be temporary. After a very short time, prices will rebound and increase above the current price. Drilling activity will return to high levels as a new set of exploratory projects demands accelerated development. Who knows how long it will continue?

So, based on experience, we should anticipate a temporary downturn in drilling activity soon. When that occurs and oil company stock prices drop, don’t panic. Buy. Go long. They will go back up.