Is It Time To Buy The Land Drillers?

Rig Ownership
Helmerich and Payne owns 221 land rigs and nine offshore rigs. The company has another 32 rigs under construction.

Nabors Industries owns 535 land rigs and is the largest land driller in North America. Almost all of its revenues come from contract drilling, but it has some other smaller energy-related businesses including an exploration and production segment.

Patterson-UTI Energy owns a fleet of about 350 rigs, and while the company gets most of its revenues from contract drilling, it is also not a pure play and has a pressure pumping, drilling and completion fluids business.

Precision Drilling Trust just completed its acquisition of Grey Wolf, another land driller. The combined company will have 370 land rigs.

Macro Outlook
Demand for land rigs is driven by the capital expenditures of exploration and production companies. These budgets are typically set at the beginning of the calendar year and can be adjusted either down or up depending on cash flows realized. Current surveys show that capital expenditures are set to fall sharply from 2008. (Find out how energy-related companies operate; check out Oil And Gas Industry Primer.)

A recent survey from Barclays Capital predicts that capital expenditures will fall 12% in 2009 to $400 billion. The survey polled 357 companies, so it is fairly comprehensive. Two parts of this survey are even more ominous for the land drillers:

1) The responses were based on average prices of $58/bbl for oil and $6.35/Mcf for gas. The survey was done in October, and prices for oil and gas have fallen far below those levels. More recent surveys put the decline at closer to 25-30%.

2) The survey also found that exploration and production spending in North America is expected to fall the most, as much as 26% from 2008 to $79 billion. Again, since this survey was published in October, we can assume that the actual decline will be much greater than that in North America, where the four land drillers get most of their revenue.

The Main Problem For Land Drillers
Most land-drilling customers are North American-based independent oil and gas companies that are sensitive to the immediate drop in cash flows that occur when commodity prices decline, rather than the large integrated companies that have longer time horizons and can operate at cash flow deficits temporarily while waiting for prices to recover.

The deepwater drillers at least are protected by a multi-year backlog, while the land drillers typically have only one-year contracts or work on spot (well by well).

More Pain To Come
As of January 9, the number of rigs working stands at 1,589 in the U.S. and 360 in Canada for a North American total of 1,949 rigs, according to Baker Hughes. In the U.S., the rig count peaked at 2,031 over the summer of 2008 and has been declining steadily since then. It is expected to decline even further during 2009.

During the last significant bear market in energy, which occurred in the late 1990s, the U.S. land rig count fell from a peak of 1,032 in mid-1997 to its trough of 488 in early 1999. This was a 53% decline. A similar decline today would bring the rig count down from the current 1,949 to approximately 1,000.

Final Thoughts
While the sell-off in the land drillers may tempt investors looking for bargains, it is unclear when capital spending on exploration and production will bottom. If you use the last cycle as a guide, the rig count is due for a much larger drop than is currently discounted in the stocks. This will keep the land drillers treading water or worse in 2009.