Average dayrates fell by only $58 per day in first-quarter 2008, signaling the turnaround. Rates are expected to rise in second-half 2008, says a Calyon Securities (USA) Inc. report.

?The U.S. land-drilling market is reviving smartly. It soared in 2005 and 2006, was relatively flat in 2007, and now is rising again. At press time, the overall rig count (onshore and offshore) had surpassed 1,900 for the first time since 1985, with the land count reaching a 23-year high.

Since January 2004, the land-rig count, as tallied by Baker Hughes Inc., has gone up 77% from 1,005 units to about 1,800 now. There’s more to come. Observers report hearing whispers that the count could reach 2,000 by year-end. This is significant too in that a higher percentage of today’s rig fleet is more advanced, so these rigs can efficiently drill more wells per year than the rigs of a decade ago.

Recent company announcements (especially concerning shale deals) and industry-wide spending surveys show that many operators have boosted their 2008 drilling budgets. They have higher cash flows than expected—and their strong emphasis is on reaching critical mass in unconventional plays that boast thousands of locations, and tighter well spacing.

It appears the rig market bottomed out in the first quarter of the year and is on track to move higher in the second half. Both public and private E&P companies are adding rigs to the count, and utilities are using rigs as they drill to put more natural gas in storage. Of note, smaller private E&Ps that usually do not increase their rig activity until the latter half of the year increased their rig count earlier this year because of high oil prices.

“Usually, the U.S. land-rig count lags the growth in commodity prices by about 90 days. We believe that the recent rally in crude oil and natural gas prices is not yet fully reflected in the land-rig count. As a result, we expect the count to increase through the end of the year,” says Calyon Securities (USA) Inc. managing director Mark Urness.

The last land-rig peak was in November and December 2006 in terms of dayrates and rig count, but in June, the rig count surpassed that peak. Stock prices for rig contractors have been on a tear and Urness says he remains bullish.

Dayrates at press time were starting to go up.

“When utilization rates reach about 80% we start to see dayrates go up,” says Richard Mason, editor of The Land Rig Newsletter. “We’re about there now. The utilization rate was below 80% for much of the past year.”

The land-drilling business is partly driven by changes in crude oil and natural gas prices. Approximately 80% of the rigs currently drilling in the U.S. are drilling for gas. A cold winter and unexpectedly strong oil and gas prices have encouraged E&P companies to increase land-drilling activity, analysts say.

“The strong crude oil rally has further supported the increase in demand for land rigs. We believe that, with crude oil prices remaining north of $130 a barrel and the natural gas strip above $12 per million Btu, operators are able to lock in substantial cash flows,” says Urness.

Average utilization of the industry sample followed by Urness decreased merely 100 basis points to 77% in first-quarter 2008 versus fourth-quarter 2007.

“While Bronco Drilling, Unit Drilling, Nabors Industries and Grey Wolf showed a modest decline in utilization during the first quarter, Helmerich & Payne and Patterson-UTI were able to maintain their utilization at the same level as the previous quarter. Oil States International was the only company that saw its utilization rate increase, going from 74% to 75% during the quarter,” Urness says.

In the second quarter, Patterson-UTI’s average U.S. count rose to 243 rigs versus 231 in fourth-quarter 2007.

New rigs on order

With utilization inching upward, there is demand for additional rigs, and the rig-building industry is responding. Some 250 new-build rigs were added to the fleet in 2006 and another 190 were added in 2007. Approximately 70 more new-builds will join the fleet this year, Urness said in a May report. Most of these are already under contract.

However, as he points out, the overall size of the U.S. land fleet is not expanding as much as these numbers imply, because there are nearly 400 rigs stacked, and many of those will not be returned to service. Advanced rigs that cut costs or shave drilling time to target depth are supplanting these older rigs, Mason says.

Urness agrees: “Operators are showing a strong preference for new purpose-built rigs, especially for their active drilling campaigns in the unconventional gas plays. A lot of the old capacity is no longer desired.”

Tulsa-based Unit Corp.’s drilling segment added one rig in May and one in June, bringing its fleet to 131. Another new 1,500-horsepower rig, already under contract, is expected to go into service in November 2008, and a second identical rig, also under contract, is scheduled to enter service in early 2009. These two drilling rigs, both of which will be working in the Bakken oil-shale play in North Dakota, will bring the total fleet to 133 drilling rigs.

Unit chief executive and president Larry Pinkston says activity in the company’s contract-drilling segment is strong: 100% of its 1,000- and 1,500-horsepower rigs are under contract. “As customer requests for newly built drilling rigs increase, we plan to add rigs to our fleet…We are currently ordering the major components necessary to allow us to build six additional drilling rigs that we plan to have contracted and placed into service by mid-2009.”

Helmerich & Payne’s stock has “performed brilliantly this year,” going up 79% as of late June, according to a report by Byron Pope and Jeff Tillery of Tudor, Pickering, Holt & Co. Securities Inc. Helmerich & Payne usually trades at a premium valuation because it has the newest, highest-quality fleet, they say. Its high-spec FlexRigs can command about $24,000 a day. Its land fleet currently consists of about 180 rigs.?

“Its average daily cash margins and utilization never dipped below about $12,000 a day and 93%, respectively, even during the sluggish 2007 U.S. rig-count environment,” they report.

What’s more, the company has the capacity to deliver up to 50 rigs per year, given its in-house rig design, engineering and manufacturing. In the second quarter, it delivered six new-build FlexRigs. More are expected by year-end.

Mason says other contractors also are building such hyper-efficient rigs due to increased market demand.

Dayrates to rise

Many companies now expect dayrates to improve in the second half of 2008 as rig demand grows and the full impact of high oil and gas prices is felt.

When rig utilization reaches about 80% dayrates begin to rise, says Richard Mason of The Land Rig Newsletter.

Urness says, “The first quarter of 2008 already signaled a transition in many ways. Contrary to the expectation that U.S. land dayrates will continue to decline significantly, the industry has experienced stronger rig demand. Although dayrates continued to decline, the decline was not nearly as severe as expected.”

He reports average dayrates for land rigs fell to $19,430 in first-quarter 2008, from $19,487 per day in the previous quarter, a decline of just $58 a day for his sample group. The average quarterly decline in the group over the past four quarters was $354 a day.

“We believe that the marginal decline in dayrates signals a bottoming out of the land-drilling market.”

In first-quarter 2008, Helmerich & Payne reported the highest dayrate in the group of drillers that Urness follows, averaging $24,415. This was 26% higher than the group average, primarily due to the dayrates obtained by its FlexRigs, which are very profitable and in strong demand.

At the lower end of Urness’ sample land-drilling group was Oil States International with an average dayrate of $15,500. Bad weather in the Rockies during the first quarter pulled down its fleet average rate.

The costs associated with land-drilling operations continue to increase, however, so as dayrates go up, the margins lag behind. Daily operating costs increased $270 to $10,966 for Urness’ industry sample.

“Part of the overall cost increase was due to the New Year increase in labor costs for companies such as Nabors Industries. Restating of the employment taxes at the beginning of the year increased costs for Unit Corp.’s Unit Drilling Co.

“Overall, the margin decline in the first quarter was driven by higher costs rather than a revenue decline. Utilization remained almost flat during the quarter, another trend that indicates the land-drilling market was bottoming out.”

Tudor Pickering Holt reported in early July, “With more capable rigs—like the 1,500-horsepower rigs for the Haynesville shale—it seems the industry is back to the point where availability is more important than price.”

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