In its weekly release, Houston-based oilfield services company Baker Hughes Inc. (BHI) reported a rise in the U.S. rig count (number of rigs searching for oil and gas in the country), reflecting intensified drilling activity in Texas . This was partly offset by the growing oil spill in the U.S. Gulf of Mexico (GoM) and ensuing drilling ban in the region that pared back activity.
 
Rigs operating in the state of Texas climbed to their highest level in 16 months, while rig count in the GoM plunged further to a 16-year low of 20 (after dropping by a whopping 50% last week).
 
Rigs exploring and producing in the U.S. totaled 1,527 for the week ended June 11, 2010. This is up by 21 from the previous week’s rig count and represents the second highest level achieved this year, just behind the 1,535 attained for the week ended May 28, 2010. The current nation-wide rig count is 74% higher from the prior-year level and the 2009 low of 876. It rose to a 22-year high in 2008, peaking at 2,031 in the weeks ended August 29 and September 12.
 
The natural gas rig count increased for the first time in 3 weeks to 954 (a gain of 7 from the previous week). Buoyed by the week-over-week improvement, the number of natural gas rigs is just 19 short of the 14-month high of 973 hit during the week ended April 16. The U.S. gas drilling rig count has rebounded strongly after bottoming to a 7-year low of 665 on July 17, 2009. Still, the rig count remains 41% lower than its peak of 1,606 in late summer 2008. In the year-ago period, there were 685 active natural gas rigs.
 
The oil rig count was, however, up by 16 to 561, the fourth gain in the last 6 weeks. The current tally is considerably higher than the previous year’s rig count of 183. It has recovered nicely from a low of 179 in June 2009, more than tripling in number.
 
The miscellaneous rig count (primarily drilling for geothermal energy), at 12, was down 2 from the previous week.
 
Producers had scaled back oil and gas drilling operations over the past year (leading to a drastic reduction in rig count) in the midst of falling commodity prices and tighter access to credit. However, during recent months, companies have been beginning to bring rigs back on line amid signs of economic stabilization that could drive up energy demand (and therefore rig count).
 
Amid this growing optimism and expectations of faster-than-expected economic recovery, oil prices recently hit an 18-month high, climbing toward $86 per barrel. This pushed the nationwide rig count above 1,500 working units for the week ended May 14, 2010, for the first time in more than a year.
 
However, with product inventories (gasoline and distillate stocks) remaining above the upper boundary of the average range for this time of year and commercial oil supplies soaring, we take this as a sign that crude fundamentals continue to be weak. High oil inventories have dragged the oil market below $75 a barrel.
 
The overall picture also remains weak for natural gas. The specter of a continued glut in domestic gas supplies still exists, with storage levels remaining 14% above their five-year average.
 
Further pressurizing the commodity is the rapid rise in the number of drilling rigs working in the U.S. (the natural gas rig count has climbed 42% from a seven-year low reached last July) that signals a supply glut later this year in the face of sluggish industrial activity.
 
More importantly, production from dense rock formations (shale) remains robust. In fact, the share of shale gas in the country’s natural gas production has shot up from zero to 8% in the last decade. This has created a massive oversupply, sending natural gas prices plummeting from $13 per million Btu (MMBtu) four years ago to just around $4.5 per MMBtu today (referring to Henry Hub spot prices).
 
There are concerns among traders that the market will be oversupplied in the short- to- medium term, with rig counts going up and industrial demand still struggling due to the weak economy.
 
In tandem with the natural gas outlook, the uncertainty related to the huge oil spill accident in the GoM and the subsequent moratorium on offshore drilling in the region (at water depths of more than 500′ through November 30, 2010) is also expected to have a some impact on rig counts in the following weeks.
 
As a reminder, on April 20, offshore driller Transocean Inc’s (RIG) ultra-deepwater Horizon drilling platform, contracted to British major BP Plc (BP), sank following a fire and explosion while operating in the U.S. Gulf of Mexico off Louisiana’s coast. The incident killed 11 workers and caused what is likely the worst oil spill in U.S. history.
 
The deepwater drilling ban invoked in the wake of the Horizon disaster took the Gulf rig count down by 3 to 20, the lowest level in 16 years. Oil drilling was down by one to 8 rigs from 9 a week ago, while gas rigs fell to 12 from 14.
 
Considering the potential fallout from the GoM incident, we take a bearish stance on offshore contract drilling services provider like Transocean, Diamond Offshore (DO), Ensco Plc (ESV), Rowan Companies (RDC) and Noble Corp. (NE), fearing an adverse effect to their contract backlogs.
 
In particular, we remain wary of Transocean and Diamond Offshore because of their big presence in the GoM. We currently have Zacks #4 Ranks (Sell) on both of these stocks, expecting them to under-perform the overall market over the coming 1-3 months. The remaining companies (Ensco, Rowan, and Noble) currently have Zacks #3 Ranks (Hold), meaning that these stocks are expected to perform in line with the overall market during the next 1-3 months.
 
Land drillers such as Nabors Industries (NBR), Patterson-UTI Energy (PTEN) and Helmerich & Payne (HP) are also expected to remain under pressure (all with Zacks #3 Ranks). Although we expect the land rig count to continue with its steady rise during 2010, the large amount of excess capacity in the sector will weigh on day rates and margins well into the year.
Read the full analyst report on “BHI”
Read the full analyst report on “RIG”
Read the full analyst report on “BP”
Read the full analyst report on “DO”
Read the full analyst report on “ESV”
Read the full analyst report on “RDC”
Read the full analyst report on “NE”
Read the full analyst report on “NBR”
Read the full analyst report on “PTEN”
Read the full analyst report on “HP”
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