Summary
The Rigzone Newsletter of May 20 quoted Ben Casselman of Dow Jones Newswires who reported that the cost of drilling and maintaining wells has dropped, taking some pressure off of oil and natural gas producers. Margins have been squeezed as operating costs rose while crude oil and natural gas prices were falling. Now this is changing. Several companies reported better-than-expected earning for the first quarter. John Richards of Devon Energy noted that costs are down by 10% to 15% from the beginning of 2009. He thinks they will decline another 10% to 20% by year end. XTO Energy also noted lower costs. Driving the declines are lower steel prices and cheaper fuel. But the biggest factor is reduced demand for drilling equipment. Drilling has been cut in half since September 2008. Day rates are down by 30%. Service companies have become willing to negotiate lower rates. The speed of the decline in activity is more severe than in previous cycles. But signs exist that the slowdown is easing.
Analysis
The main reason for the lower day rates for land rigs is that many are now coming to the end of their term contracts which were for the most part one to two years in duration. With so many rigs down, operators could bid low on new contracts. Whoever won the bid still faced much lower rates. The end is not yet in sight because about 300 rigs are under construction and will be delivered during the coming months. Few, if any, of these new rigs will have long-term contracts and in fact will face extraordinary odds of getting even one or two well contracts. When this happens, day rates fall to just about break-even for contractors who will accept such jobs just to keep their skilled drilling crews on the payroll. A skilled crew is just as valuable to a drilling contractor as a modern well-equipped rig. The service companies including Schlumberger, Halliburton, BJ Services, Baker Hughes and Weatherford International were hard-pressed to keep up with demand for equipment and man power during the hectic days of 2007-8. Efficiency inevitably dropped as new employees were hurriedly trained. Much of this excess has disappeared from the market place. Both drilling contractors and service companies kept their stellar employees and laid off the rest. So rigs work faster and with fewer problems. Logging, perforating and fracturing jobs run more smoothly with experienced operating personnel. This, added to lower prices for steel, cement, drilling fluid chemicals and additives has taken much out of the constantly inflating prices of the last few years. The inflation was measured as being over 15%/year for at least the three years ending mid-2008. The producers all began to high grade drilling prospects as the price of crude oil and natural gas fell. Instead of every location in the portfolio, only those leases where higher production rates were likely to obtain are being drilled. Quite some time has transpired since last July. Time enough for natural declines of oil and gas fields to narrow the gap between supply and demand. Thus the creeping higher commodity prices now evident. For once, OPEC has basically delivered on promised production cutbacks strengthening prices in the international markets. Crude oil appears to be facing smoother sailing than natural gas. Even though shale gas drilling has dropped off drastically, the supply of liquefied natural gas continues to increase. This bodes badly for any real recovery of natural gas prices which seem to be doomed to remain in the $3.50-4.50/million btu range at least through 2009 and quite possibly through all of 2010. Perhaps the most important signal imparted by the multitude of reports is that oil and gas producers have come to terms with the likelihood of a five to ten year period where demand for crude oil will remain relatively low compared to natural gas. A detailed analysis of oil and gas production trends made by Chris Skrebowski of the Institute of Petroleum (London) shows that global oil and natural gas liquids increased steadily from 76.950 million bbl/day in 2002 to 86.460 million in 2008. But 2009 will be lower because of OPEC shut ins and budget reductions across the board except for the super majors. Crude oil and natural gas liquids production for the first two months of this year appear to be about 78.5 million bbl/day (my estimate). If Canadian oil sand, Orinoco Tar belt and biofuels are added in, total production is about 81.6 million. Current indications are that these figures will not increase for the next few months. Global natural gas production has similarly increased from 244,311.8 million cubic feet/day in 2002 to 284,139.6 in 2007 (2008 figures not yet available). Skrebowski’s conclusion is that global natural gas production is growing faster than crude oil production and oil companies are becoming gas companies. Still he noted that natural gas production for Exxon Mobil, Royal Dutch Shell and BP produce less gas today than they did in 2002. Of 24 companies surveyed which did not include Gazprom or any of the Middle Eastern IOCs, seven companies saw falling natural gas production while 17 showed increases. ConocoPhillips, Chevron and Total were the only super majors showing increases. What we know today is that natural gas resources (conventional and non-conventional) are to all extents and purposes, limitless, at least as far as this century is concerned. What is expected is that all oil and gas producers will try to match production to expected demand. The historical record shows that this is the secret to profits in all kinds of markets.
