So, who cares if the onshore rig count dropped less than expected in January? You should, according to Jim Wicklund, an analyst with Bank of America. He says that rig counts onshore typically drop by about 6% between December and January. Boom or bust, that is a typical decline.
This year that drop was only 0.3%. That is a significant change, and according to Wicklund, it is reason for optimism. If this means the onshore rig market is poised for a recovery, it is a very reliable indicator that we will see a similar turnaround offshore in the not too distant future.
Wicklund explained it this way: Whenever the drilling cycle picks up, land drilling is always the first to move. Why? Three reasons – it's cheaper, faster, and easier to bring these rigs back on line. When a company goes to dip its toe back into the market, it will dip its onshore toe first.
The good news is, if the onshore market is recovering, it's a sure bet that natural gas is driving recovery. When one considers that 28% of domestic gas production comes from the Gulf of Mexico shelf, it makes sense that this region will enjoy some of the benefits of sustained higher prices. That said, Wicklund pointed out that the fields producing these reserves are growing smaller all the time. The same drivers that led to the majors' exit of the on-shelf gas market are now driving what Wicklund called the "super independents" out as well. Just as the majors left the Gulf in the past decade to look for bigger fish, now the top tier of independents, who have ballooned ten-fold in size over that period, are following suit.
Who's left? A large number of smaller independents. These are companies that can lease a couple of rigs and make a significant impact on their bottom line by producing a 20 bcf field at $3-$4/Mcf. Smaller companies can do very well drilling simple gas wells with commodity jackup rigs in areas of the GoM where there is plentiful infrastructure to transport production to shore. And these are the projects that will be early indicators of the overall recovery, according to Wicklund.
The bottom line is that we should see a turnaround in offshore rig utilization by the second quarter of this year. The first signs will be an increase in utilization rates for the rigs already in service. Wicklund said this will be necessary before any of the stacked rigs can be reactivated. Once these rigs are on contracts, inquiries to the companies with stacked rigs will follow. When companies gain enough commitments to backlog six months' worth of activity, they can afford to bring rigs out of mothballs.
What happens next is a sort of stair-step growth. Utilization rates of existing rigs will grow beyond 80%, pulling more rigs into the market. As stacked rigs come on line, the overall utilization will plateau, being absorbed by the new entrants. Once the wave of stacked rigs comes into the market and begins working, the utilization rate will grow for all the rigs in service, generating increasing day rates.
It sounds exciting, but is there enough staying power in the gas price to support such an evolution in utilization? Oil companies are currently using natural gas prices of about $3.25/Mcf in their well economics, and Wicklund said gas will likely be priced far above that threshold well into 2005. With depleted stocks already being reported and an annual drop of 7%-8% in domestic production, Wicklund predicted short-term prices could top $5/Mcf for a sustained period.
This is not only good news for the commodity jackup market, which will be directly affected. It should also lead to an overall increase in day rates for all types of rigs. If so, this may be a first whiff of the overall recovery everyone has been waiting so long for. Ironically, according to Wicklund, this time it won't be driven by the super majors and fifth-generation ultra-deepwater rigs, but by the smallest of the independents working 20-year-old rigs in less than 300-ft water depth.
William Furlow
