Oil Drilling Rigs Scale New Peak

In its weekly release, Houston-based oilfield services company Baker Hughes Inc. ( BHI - Analyst Report ) reported a rise in the U.S. rig count (number of rigs searching for oil and gas in the country). This can be attributed to an increase in the tally of both oil and natural gas-directed rigs. In particular, the natural gas rig count climbed for only the third time in 2012, while the oil rig count scaled another record high.

The Baker Hughes rig count, issued since 1944, acts as an important yardstick for drilling contractors such as Transocean Inc. ( RIG - Analyst Report ) , Diamond Offshore (DO) , Noble Corp. ( NE - Analyst Report ) , Nabors Industries ([url=http://www.zacks.com/stock/quote/nbr]NBR[/url]) , Patterson-UTI Energy ([url=http://www.zacks.com/stock/quote/pten]PTEN[/url]), Helmerich & Payne ( HP - Analyst Report ) , 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 1,972 for the week ended April 20, 2012. This was up by 22 from the previous week’s count and represents the fifth increase in the last 10 weeks.

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 1,800. 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 climbed by 19 to 1,904, inland waters activity increased by 1 to 23, while offshore drilling was up by 2 to 45 rigs.

Natural Gas Rig Count: The natural gas rig count – which recently slumped to a 10-year low – increased for just the second time in 15 weeks to 631 (a gain of 7 rigs from the previous week). Despite the weekly improvement, the number of gas-directed rigs is down approximately 33% from its 2011 peak of 936, reached during mid-October.

In fact, the current natural gas rig count remains 61% below its all-time high of 1,606 reached in late summer 2008. In the year-ago period, there were 878 active natural gas rigs.

Oil Rig Count: The oil rig count was up by 15 to 1,337. 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 913. It has recovered strongly from a low of 179 in June 2009, rising almost 7.5 times.

Miscellaneous Rig Count: The miscellaneous rig count (primarily drilling for geothermal energy) at 4 remained unchanged from the previous week.

Rig Count by Type: The number of vertical drilling rigs rose by 3 to 571, 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 up by 19 at 1,401. In particular, horizontal rig units – that reached an all-time high of 1,185 in January this year – increased by 10 from last week’s level to 1,155.

To Conclude

Notwithstanding the modest gain registered by the natural gas drilling activity over the last week, it is still down by 303 rigs (or 32%) 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 still remain at elevated levels – up some 60% above the benchmark five-year average levels.

Hamstrung by this huge surplus, natural gas prices have dropped approximately 60% from 2011 peak of $4.92 per million Btu (MMBtu) in June to the current level of around $2.00 (referring to spot prices at the Henry Hub, the benchmark supply point in Louisiana). Incidentally, prices hit a 31-month low of $1.85 during last week.

To make matters worse, a near-record mild weather across most of the country curbed natural gas demand for heating all winter, 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. ([url=http://www.zacks.com/stock/quote/upl]UPL[/url]), Talisman Energy Inc. ( TLM - Analyst Report ) and Encana Corp. ( ECA - Analyst Report ) have all reduced their 2012 capital budget to minimize investments in development drilling.

On the other hand, Oklahoma-based Chesapeake Energy Corp. ( CHK - Analyst Report ) – the second-largest U.S. producer of natural gas behind Exxon Mobil Corp. ([url=http://www.zacks.com/stock/quote/xom]XOM[/url]) – and rival explorer ConocoPhillips ( COP - Analyst Report ) 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 and natural gas will be out of the dumpster 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 topping $100 a barrel, 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.