US drilling surge will continue into the year

May 19, 2003
The upward trend in US drilling activity since the start of this year is likely to continue through the summer and boost day rates for premium offshore rigs in the second half of the year, said industry analysts.

The upward trend in US drilling activity since the start of this year is likely to continue through the summer and boost day rates for premium offshore rigs in the second half of the year, said industry analysts.

"Drilling in the US continues to be much more attractive," said James L. Williams, president of WTRG Economics and publisher of Energy Economist Newsletter, despite continued "price uncertainty" and the fact that current "high prices will not hold over the life of most wells."

Williams said, in a recent North American rig report, that "We expect the rate of increase in drilling activity to pick up in the coming weeks. Gas drilling activity should approach 1,000 [rigs] by the end of the summer and should be enough to boost gas production and refill abnormally low inventories in preparation for next winter's heating season."

As for oil, he said, "We do not expect significant increases in oil production, but [additional drilling] activity should be enough to maintain current levels of production."

Gulf increase expected

Drilling activity in the Gulf of Mexico remained sluggish in late April, but Angeline M. Sedita, an analyst with Lehman Bros. Inc., New York, said she expects to see a modest increase in drilling activity in those waters in the last half of this year, driven by "a diminishing rig supply" as premium equipment "continues to mobilize out of the region." In an Apr. 17 report, she said, "In total, eight premium rigs have mobilized out of the gulf since May 2001."

The US sector of the Gulf of Mexico "is clearly divided into two markets—premium equipment and commodity equipment," Sedita said. "The utilization rate for premium equipment is currently at 94%, while commodity rigs are only at 49% utilization."

As of mid-April, she said, "Leading edge day rates for premium equipment are $29,200, and commodity rigs are currently going to work at $24,900."

Sedita anticipates premium rigs ultimately will realize greater gains in day rates than will the standard and commodity jack ups. "This will be driven by a lower supply of premium equipment and a flight to quality by the larger E&P companies," she said.

Contractors to benefit

Rowan Cos. Inc., a Houston-based offshore drilling contractor, "will be the leading beneficiary of any recovery in the Gulf of Mexico" because of "its premium jack up fleet," Sedita reported Apr. 17.

"The company has 20 of 22 rigs located [in the gulf]," she said. "Current [gulf] jack up utilization for the company is 100%, and it indicated that the higher spec units were beginning to see better job opportunities."

Ensco International Inc., Dallas, also will benefit from an upturn in gulf drilling activity since it is "leveraged to the premium jack up market," said Sedita, in a separate analysis of that drilling contractor on the same date.

Rowan's prospects for deep gas drilling remain firm, she said, with 12-14 of its jack up rigs in the gulf expected to be drilling deep gas wells in the second quarter, up from 11 in the first quarter.

"Rowan has had conversations with several majors regarding deep gas prospects and believes some of its current customers plan to accelerate their deep gas programs," said Sedita.

"Mirroring the trend toward deep gas prospects offshore, the company's land segment has witnessed a move toward deeper plays onshore. The company currently has 14 of 18 land units working, 10 on deep gas projects in Texas and Louisiana," Sedita said.

"Day rates for the land units improved by $300/day from the fourth quarter [2002] and are approximately $800/day above the first quarter of 2002. Permitting activity suggests that the improvements in the company's rig [utilization] and day rates will continue through the second quarter."

The Rowan Louisiana jack up rig is working for Houston-based Walter Oil & Gas Corp. in Galveston Block A-192 off Texas. An analyst says Rowan Cos. Inc. is in a good position to cash in on the expected increase of drilling in the Gulf of Mexico in the second half of this year.
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Meanwhile, she said, "In order to maintain utilization during the downturn in the Gulf of Mexico, drilling contractors had been forced to contract larger, more capable rigs to shallow-water, less-difficult projects at lower day rates. Rowan believes this trend has reversed, and most of its Gorilla units are now working on more technically challenging projects in deeper water.

"High-spec projects typically command higher day rates, and we believe as the larger rigs continue to work on the projects for which they were designed, we should see some improvement in day rates," said Sedita.

In April, she reported Encana Corp., Calgary, was in final negotiations—"the only issue left is the start date"—with Rowan for a 90-day contract to drill one well off Eastern Canada with its Gorilla V jack up rig, "followed by some plugging and abandonment work, with options for two more exploratory wells, which Rowan believes will be drilled."

Sedita said Canadian Superior Energy Inc., Calgary, also is negotiating for the Gorilla V to drill a 19,000-ft well on its Marquee prospect off Nova Scotia. "Canadian Superior has received approval for the second well, and Rowan drilled the original well, which should put the company in line for the follow-up work," she said.

Contracts in place for the Gorilla V and Gorilla VII rigs "will add $300,000/day and $9 million/month [to Rowan's] revenue, which should narrow the company's loss in the second quarter," said Sedita.

F&D costs increased

In an Apr. 9 report, Robert S. Morris at Banc of America Securities, New York, said the aggregate fully loaded finding and development costs among 20 US independents followed by that company "rose roughly 40% in 2002 subsequent to a nearly 30% up tick in 2001, underscored by the continued degradation of project inventories around the globe. This rise occurred despite an estimated 10-15% drop in overall oil field service and drilling costs, on average last year."

Aggregate F&D costs "with the drillbit alone," excluding reserve revisions, averaged roughly $13.20/bbl of oil equivalent last year, "or about 65% higher than in 2001." Once again, however, "the cost to acquire proven reserves was well below that with the drill bit, at nearly $5/boe last year," said Morris.

Such a pricing differential could accelerate the pace of mergers and acquisitions among exploration and production companies, "starting in the second half of this year," he said.

In the US, Morris said, "the aggregate exploration and development tab with the drillbit last year was roughly $13.45/boe, or 60% higher than in 2001. The cost to acquire domestic proven reserves was roughly $5.05/boe.

"Importantly, the continued rise in costs is weighing on economic returns, with our coverage group posting the lowest reserve replacement efficiency ratio since 1998," Morris said. "Consequently, most E&P companies have increased their focus on improving economic returns in 2003."