TLM

In its weekly release, Houston-based oilfield services company Baker Hughes Inc. (BHI) reported a dip in the U.S. rig count (number of rigs searching for oil and gas in the country).

This can be attributed to cutbacks in the tally of gas-directed rigs, partially offset by increase in oil and miscellaneous rig counts. In particular, the natural gas rig count dropped for the seventeenth time in 20 weeks to touch a new 10-year low, while oil drilling jumped to another 25-year high.

The Baker Hughes rig count, issued since 1944, acts as an important yardstick for drilling contractors such as Transocean Inc. (RIG), Diamond Offshore (DO), Noble Corp. (NE), Nabors Industries (NBR), Patterson-UTI Energy (PTEN), Helmerich & Payne (HP), etc. in gauging the overall business environment of the oil and gas industry.

Analysis of the Data

Weekly Summary: Rigs engaged in exploration and production in the U.S. totaled 1,983 for the week ended May 25, 2012. This was down by 3 from the previous week’s count and represents the eighth decrease in the past 17 weeks.

Despite this, the current nationwide rig count is more than double that of the 6-year low of 876 (in the week ended June 12, 2009) and significantly exceeds the prior-year level of 1,847. It rose to a 22-year high in 2008, peaking at 2,031 in the weeks ending August 29 and September 12.

Rigs engaged in land operations descended by 4 to 1,913, while offshore drilling was up by 1 to 48 rigs. Meanwhile, inland waters activity remained steady at 22 units.

Natural Gas Rig Count: The natural gas rig count decreased for the seventeenth time in 20 weeks to 594 (a drop of 6 rigs from the previous week). As per the most recent report, the number of gas-directed rigs is at their lowest level since April 5, 2002 and is down more than 36% from its 2011 peak of 936, reached during mid-October.

The current natural gas rig count remains 63% below its all-time high of 1,606 reached in late summer 2008. In the year-ago period, there were 881 active natural gas rigs.

Oil Rig Count: The oil rig count was up by 1 to 1,383. The current tally – the highest since Baker Hughes started breaking up oil and natural gas rig counts in 1987 – is way above the previous year’s rig count of 958. It has recovered strongly from a low of 179 in June 2009, rising more than 7.7 times.

Miscellaneous Rig Count: The miscellaneous rig count (primarily drilling for geothermal energy) at 6 was up by 2 from the previous week.

Rig Count by Type: The number of vertical drilling rigs rose by 4 to 570, while the horizontal/directional rig count (encompassing new drilling technology that has the ability to drill and extract gas from dense rock formations, also known as shale formations) was down by 7 at 1,413. In particular, horizontal rig units came off by 2 from last week’s all-time high of 1,191.

To Conclude

As mentioned above, the natural gas rig count has been falling since the last few weeks, 340 rigs in fact (or 36%) from the recent highs of 934 in October 28.

Is this bullish for natural gas fundamentals? The answer is "no," if we look at the U.S. production and the shift in rig composition.

With horizontal rig count – the technology responsible for the abundant gas drilling in domestic shale basins – currently close to its all-time high, output from these fields remains robust. As a result, gas inventories remain at elevated levels – up some 40% above the benchmark five-year average levels.

Hamstrung by this huge surplus, natural gas prices have dropped approximately 48% from 2011 peak of $4.92 per million Btu (MMBtu) in June to the current level of around $2.55 (referring to spot prices at the Henry Hub, the benchmark supply point in Louisiana). Incidentally, prices hit a 10-year low of $1.82 during late April.

To make matters worse, a near-record mild weather across most of the country curbed natural gas demand for heating, leading to an early beginning for the stock-building season. The grossly oversupplied market continues to pressure commodity prices in the backdrop of sustained strong production.

This has forced several natural gas players to announce drilling/volume curtailments. Exploration and production outfits like Ultra Petroleum Corp. (UPL), Talisman Energy Inc. (TLM) and Encana Corp. (ECA) have all reduced their 2012 capital budget to minimize investments in development drilling.

On the other hand, Oklahoma-based Chesapeake Energy Corp. (CHK) – the second-largest U.S. producer of natural gas behind Exxon Mobil Corp. (XOM) – and rival explorer ConocoPhillips (COP) have opted for production shut-ins to cope with the weak environment for natural gas that is likely to prevail during the year.

However, we feel these planned reductions will not be enough to balance out the massive natural gas supply/demand disparity, and therefore we do not expect much upside in gas prices in the near term. In other words, there appears no reason to believe that the supply overhang will subside in 2012.

With natural gas unlikely to witness a durable rebound in prices from their multi-year plight and at the same time crude prices trading in the $90–$100 a barrel range, energy producers are boosting liquids exploration to take advantage of this trend. As a result of movement of rigs away from natural gas towards oil, the tally of liquids-directed rigs has climbed to another 25-year high.

 
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