Stock prices are plunging for tubular manufacturers. But most are counting on a rosier 2002.

Like most of the rest of the oil and gas industry, recent news has gone from bad to worse for the oil country tubular goods (OCTG) sector.
First gas prices stalled as storage neared capacity. Then the rig count began to drop. Then terrorists attacked the United States in September, creating uncertainty in the world market and causing oil prices to plummet.
Analysts are sending mixed signals about the coming months. Moody's Investor Service reported the industry is "heading into what appears to be a period of reduced oil and gas drilling and general economic uncertainty." Further, the report predicted, "Decreased drilling activity is likely to lead to a buildup of OCTG inventory and pressure on all tubular product prices as well as lower volumes and cost absorption."
According to a Merrill Lynch analysis, the drilling rig market, an indicator of the future fortunes of the tubulars market, is quickly slacking and is not expected to recover in the near term. For instance, it noted, pricing for jackup rigs in the Gulf of Mexico is rapidly approaching cash break-even, "a much steeper decline than previously expected." Merrill Lynch also has scaled back its international pricing assumptions to reflect the probability that oil companies will use the Gulf of Mexico price weakness as leverage.
"Overall, we expect utilization and pricing to trough in (first quarter 2002), with rates resuming an up trend in (third quarter 2002)," the report stated.
Plummeting stock prices are no picnic for OCTG manufacturers, but they're not particularly surprising, either. "It's not new, but it was unexpected," said Byron Dunn, president of Lone Star Steel. "We didn't expect natural gas prices to be as high as they were last winter, but we also projected them to be higher than they were this summer. We project the drilling rig count based on what we expect the wellhead prices to be, and natural gas has been the driver for the rig count. The falling price of natural gas has caused a wait-and-see attitude on the part of our active E&P customers."
Added Marshall Adkins, managing director of energy research for Raymond James & Associates, "The OCTG companies tend to be more operationally leveraged than most companies to both downturns and upturns. In this downturn their stocks are reflecting the fact that they tend to take a bigger hit on the down side and move up more quickly on the up side."
Grant Prideco, the largest manufacturer of drill pipe in the world, concentrates on premium grades and made-to-order products. The company hasn't seen a decline in orders, but it hasn't seen an increase either, said Lori Tipton, director of corporate communications. This generally is an uncertain time of year, with some companies rushing to get budgets spent by the end of the year and others shutting down spending to meet year-end budget numbers.
Under normal conditions, she added, the company's results for its OCTG don't reflect a downturn or upturn in rig activity until 3 to 6 months after the turn. For drill pipe, the lag time is slightly longer.
An analyst gauging the industry strictly by the rig count would have to conclude results look better this year than last year but that declining recent rig counts will soften those results. "The near-term outlook is driven by gas prices, and gas prices under $2 have caused concern. For the tubular industry, there is a risk of not adjusting inventory. It probably will be building, near term," said S. Magnus Fyhr, analyst with Jefferies & Co. in Houston, Texas.
Falling rig counts in the United States also could have an impact on manufacturers in other countries. During the past couple of years, oilfield activity strengthened in North America while much of the rest of the world remained stagnant. That led manufacturers in other countries to start importing to North America, Fyhr said.
Now, he added, there is some concern that drilling activity will fall 5% to 10% and tubular companies won't react quickly enough to avoid inventory overload. Non-US tubular producers may shift their marketing operations back to international markets.
The cyclical nature of the business comes as no surprise to the companies that are engaged in it. They choose different approaches to weather the downturns. Many companies are hopeful that their specialty products - expandable casing, high-temperature, high-pressure tubing, anti-corrosive products - will sustain them through the downturn. Dunn said Lone Star has an alliance with Enventure, a joint venture between Shell and Halliburton that manufactures expandable casing. "It's a new and unique application, and that market seems to be growing," he said.
But he's not staking the fortunes of the company on a new direction. "The best thing that can happen for us is a stabilization of commodity prices and a stabilization in the rig count," he said.
Hydril, which specializes in tough-job tubulars, has felt less of a pinch. "We haven't seen much change in activity. The Gulf of Mexico has slowed a little. We have a lower rig count, but deep water and deep gas are good," said John Greenip, manager of technical services for premium connections. "We have a good amount of high-temperature, high-pressure, corrosive (drilling), extended reach and directional."
In the first half of the year, Hydril reported an overall 28% gain in revenues from the same period a year earlier. Its premium connections segment revenues increased 56% in the second quarter of 2001compared to the same quarter in 2000.
Grant Prideco is working the specialty product route as well. With a major oil company it developed a 5 7/8-in. drill pipe for deep, extended-reach deepwater and ultradeepwater wells. It allows use of a high-performance connection joint with more steel and has higher torsional strength than 5 1/2-in. pipe. It's easier to handle than 6 5/8-in. pipe, Tipton said.
For others, diversification has helped dilute the hard hits. Charles DeVoe, commercial manager for Hunting's Vinson unit, said Hunting's purchase of Vinson Supply, Iberia Threading, Performance Drilling and Performance Boring Technologies in Wyoming and Orbital Machining & Manufacturing in Canada has helped the company branch into other services such as trenchless drilling and mud pumps, and other industries such as mining and construction. He called diversity a "stabilizing mechanism" that has helped smooth the valleys and peaks in the OCTG industry.
"Vinson's been in business since 1938, and we've seen plenty of ups and downs," DeVoe said. "That's part of it. We try not to get too excited with each swing. Everything cycles up again."
Diversification has been important for Ipsco as well, said David Britten, vice president and general manager of tubular products. Britten said his company decided several years ago to grow in several segments of the steel industry, including OCTG. Ipsco owns three major steel mills in the United States and Canada as well as smaller specialty mills.
"If you're a one-trick pony, you're very vulnerable," he said. "It helps to have more irons in the fire."
At the NS Group, restructuring has taken some of the sting out of the latest downturn. Said Rene Robichaud, chief executive officer, the company had a strong second quarter, but it didn't have record shipments. "We managed to get our costs in line following a major restructuring, which was very successful," he said. "The business is cyclical, but you always have to improve your business, no matter what point of the cycle you're in."
Does that mean restructuring every time commodity prices dip? "We'll do what's needed to make sure we're a viable competitor," he said. "Nothing's off the table, ever, and shouldn't be."
NS also is broadening its product line, increasing its welded output to 100,000 tons of alloy casing a year and entering the seamless casing market.
In the longer term, the outlook for the OCTG sector isn't all bad. "The silver lining is that long-term fundamentals associated with energy, and natural gas in particular, are pretty good," said Bill Herbert of Simmons & Co. International. "We had a record level of gas drilling activity persisting for a prolonged period of time, and the supply response in terms of production growth was anemic at best. The reason is that depletion is so significant, and it's so relentless.
"With any significant contraction in drilling activity, we believe the supply response will be immediate and profound."
Oil prices are harder to predict given the Sept. 11 terrorist attacks. But Herbert said long-term supply dynamics support a return to higher prices eventually. Many analysts expect oil prices to recover within a few months.
"In the non-Opec world, getting any significant production growth is very difficult to do," he said. "And I think people tend to exaggerate how much excess productive capacity Opec really has. They're running into their own challenges."
A shortage of used tubulars might also prop up demand for new goods, said Harvey Davis, president of Hadco International, the Conroe, Texas-based rig appraisal and consulting company. "The cost of used tubulars is moving up," he said. "If we put more rigs to work, we will be short of used tubulars."
The industry has been short of used goods for some time. As the North American active rig count climbed rapidly from the 1,000 level to more than 1,300, the industry ate supplies of tubulars like children going through Halloween loot.
In the near term, however, the earnings visibility associated with the tubular segment of the oil services industry is "opaque at best," Herbert said, given the weakness in gas prices and the expected decline in rig activity in the second half of this year. "Accordingly, earnings estimates are extremely fluid and likely to contract meaningfully," he said.
Overall hopes are strong that 2002 will be a solid year for OCTG, even if it begins rather timidly. "We are confident that in the first half we'll see some improvement, and the second half could be absolutely terrific," said Robichaud. "But the next few months are going to be lousy."

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