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 ramped-up drilling activity by producers in response to the recent optimism about an economic recovery and higher commodity prices.

Rig count in the U.S. climbed to 1,220 for the week ended Jan. 8, 2010 (as clear from the first chart below from Baker Hughes). This is up by 31 from the previous week’s tally and represents the 11th gain in the past 12 weeks. The current nationwide rig count is 39% higher from the 2009 low of 876 (set in the week ended June 12).

The natural gas rig count increased by 22 to 781, the 19th gain in last 25 weeks, after bottoming at 665 on July 17, 2009 (its lowest level since May 3, 2002). However, the rig count remains 51% lower than its peak of 1,606 in late summer 2008. In the year-ago period, there were 1,239 active natural gas rigs. This is shown in the following chart, also from Baker Hughes.

The oil rig count was also up by 9 to 427, maintaining the positive momentum from the past 16 weeks. The tally is up approximately 25% from the previous year’s count of 341, as shown in the following chart from Baker Hughes. Oil rig count peaked at 442 in early Nov 2008.

The miscellaneous rig count, at 12, remains unchanged from the previous week.

Producers had scaled back oil and gas drilling operations over the past several months (leading to a drastic reduction in rig count) in the midst of falling commodity prices and tighter access to credit. However, during recent weeks, companies have been beginning to bring rigs back on line amid signs of economic stabilization that could drive up energy demand.

Oil prices jumped over 75% in 2009 (following a 54% dip in 2008), while gas futures have also gained significantly from their Sept. 2009 lows. This pushed the nationwide rig count above 1,100 working units for the week ended Nov. 13, 2009, for the first time in 8 months.

The overall picture, though, remains weak, particularly for natural gas, whose inventories remains more than 11% above their five-year average and much higher than the normal range at this time of the year. While drilling has declined significantly over the past 12 months (as reinforced by the still-depressed natural gas rig count), production has not slowed that much.

As a result, there is a feeling that more cuts in rig count may be required to bring the oversupplied market into equilibrium, particularly with gas inventories at such high levels and industrial demand still down sharply due to a lackluster economy.

The bulk of the decline in rig count has occurred in vertical gas drilling rigs, which drill straight down in search of conventional gas deposits. The number of vertical drilling rigs has dropped nearly 42% since the beginning of 2009.

On the other hand, horizontal/directional rig count (encompassing new drilling technology that have the ability to drill and extract gas from dense rock formations, also known as shale formations) have fallen at a much slower pace, with rig count down just 10% from the Jan 2009 levels, as depicted in the following chart from Baker Hughes. Consequently, gas production from the highly prolific shale plays have continued to surge, fueling the glut in domestic natural gas volumes over the last few years.

The supply picture is expected to reverse in the coming months as producers bet on demand for heating in a cold winter season and the lagging effect of the sharp drop in domestic drilling activity takes hold.

Until then, we believe that natural gas woes (especially in North America) will continue to haunt energy service firms like Halliburton Company (HAL), Schlumberger Limited (SLB), Baker Hughes, National Oilwell Varco (NOV) Smith International Inc. (SII) and Weatherford International Ltd. (WFT). These oilfield service names have seen their revenues and earnings plunge in the last few quarters on the back of lower volumes and a very competitive pricing environment. We have Neutral recommendations on all of the above-mentioned companies.

We also maintain our Neutral recommendations for contract drillers such as Nabors Industries (NBR), Patterson-UTI Energy (PTEN) and Helmerich & Payne, Inc. (HP). 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 dayrates and margins well into the year.

We are positive on oilfield companies like Cameron International (CAM) that derives about two-thirds of its revenue from outside North America. Cameron’s international operations are expected to be a key growth driver for the firm going forward and will play an offsetting role to the relatively soft U.S. drilling scene.

Read the full analyst report on “BHI”
Read the full analyst report on “HAL”
Read the full analyst report on “SLB”
Read the full analyst report on “NOV”
Read the full analyst report on “SII”
Read the full analyst report on “WFT”
Read the full analyst report on “NBR”
Read the full analyst report on “PTEN”
Read the full analyst report on “HP”
Read the full analyst report on “CAM”
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