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Onshore contract driller Patterson-UTI Energy Inc. (PTEN - Analyst Report) declared that its May 2012 drill rig count averaged 223, down from 227 in the previous month. The company operated 223 rigs in the U.S. and none in Canada in May, compared with 226 rigs in the U.S. and 1 rig in Canada during April this year.

Patterson-UTI’s activity levels in the U.S. peaked in early October 2008 with a rig count of 275. Since then through the second quarter of 2009, the company witnessed a steep and rapid decline in rig count on the back of decreased demand, largely caused by lower commodity prices for natural gas and tighter access to credit.

However, during the last few quarters, there have been signs that companies were beginning to bring rigs back on line amid signs of economic stabilization pushed by energy demand. This is reflected in Patterson-UTI’s monthly rig count numbers, which recovered substantially from a low of 60 in May 2009 to reach around 240 few months back.

Rating

There is considerable tightness in the market for shale-suitable rigs, and dayrates across the rig fleet have been going up. In the near term, Patterson-UTI stands to benefit from the current boom in pressure pumping services (an umbrella term used to describe a number of vital services performed on new and existing wells).

Despite these positives, Patterson-UTI – the second-largest North American land drilling contractor after Nabors Industries Ltd. (NBR - Analyst Report) – currently retains a Zacks #4 Rank, which translates into a short-term Sell rating.

This can be mainly attributed to the higher-than-expected spike in the costs for guar gum – a key constituent of the ‘hydraulic fracturing’ procedure – which is by far the largest part of the pressure pumping market.

Guar gum, a bean grown mostly in India, apart from being a dairy products thickener is also a main ingredient of the hydraulic fracturing (or fracking) process, which is used to extract natural gas by blasting underground rock formations with a mixture of water, sand and chemicals.

The demand for guar gum has gone through the roof in North America following the growing use of hydraulic fracturing in the extraction of oil and natural gas liquids from shale. This has led to concerns about the commodity’s potential shortage later in 2012, thereby driving up guar gum prices more rapidly than previously thought. We believe that the rising costs may affect Patterson-UTI’s second quarter profitability more than expected.

Moreover, with natural gas fundamentals remaining weak, we see no price upside for Patterson-UTI stock in the near-to-medium term. Plus, increased labor costs for contract drilling may put a brake on the segment’s margin expansion, which could further limit the company’s ability to generate positive earnings surprises.

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