US land drilling activity growns, offshore lags

"Given the rate of growth in the rig count, day rates are just beginning to rise," she said. "We believe the additional rig supply today vs. 2001, coupled with the fact that the operating rigs are smaller and [have] lower horsepower, has contributed to the lessened pricing power. We would expect rig count gains will continue to be slow, with day rates beginning to rise more measurably late this year."

Gulf hits a high

Meanwhile, demand for mobile offshore rigs in the Gulf of Mexico hit a 6-month high with 132 mobile drilling units under contract out of an available fleet of 182 for 72.5% utilization during the week ended June 20, said officials at ODS-Petrodata, Houston. Officials at Baker Hughes Inc., however, said the numbers of US rotary rigs actually in the process of drilling offshore during that same week were 105 in the gulf and 109 in the US as a whole.

"We have no doubt that drilling activity in [the gulf during] 2003 will be less than in 2001," said Sedita at Lehman Bros. "This is due to the capital discipline of the independents, debt reduction, and limited drilling prospects. But helping the Gulf of Mexico, as demand declined so did supply. Jack up rig supply fell from 156 to 126 [June 23]. Of the 126 jack ups [available], the industry is marketing 111 rigs, of which possibly 2-6 more rigs could mobilize from the region."

In mid-June, analysts at Texas offices of RBC Dain Rauscher Inc., NY, said, "Revenue growth is not as robust for many service companies as the increase in the US rig count would suggest, due to the relatively flat offshore market, which generally has a much greater revenue intensity than the land market." They noted, "The Gulf of Mexico jack up market appears to be flattening out a bit over the next several months."

RBC Dain Rauscher analysts said some drilling contractors reported a "noticeable" increase in inquiries for the "mid-depth floater market" in the US gulf. "Mexico is expected to tender for another 4 [semisubmersible rigs], which would reduce the available-depth semi supply to 5 rigs" in the gulf, they said. "The deepwater market remains sloppy, in line with our expectations. Potential pick up appears to be a 2004 event."

Still, one veteran of the US offshore contract drilling business told OGJ he sees little hope for a significant increase in activity through the rest of this year or even in 2004.

Meanwhile, a midyear survey of 247 oil and gas producers by Lehman Bros., indicated those companies plan to raise their exploration and production budgets by 2% this year. "Given the rise in the US rig count to date [up 23% at the time of the mid-June report], we had expected spending to be greater than the survey results indicate," Lehman Bros. analysts reported.

"We believe that this is a result of overspending of 2002 budgets [by $1.4 billion, or 5%], and given that the rise in the US rig count has been limited primarily to the land rig count [up 28% at the time], which tends to be driven by the smaller oil and gas companies," they said.

"Smaller independents typically respond more quickly to industry trends. We anticipate that certain larger independents and majors may follow suit and may simply just overspend their existing 2003 budgets or raise budgets after midyear."

Rig forecasts upgraded

In late June, analysts at UBS Investment Research in New York, a division of UBS AG, raised their US rig forecasts to 1,057 from 955 in 2003 and to 1,150 from 1,055 in 2004. They increased their rig estimates for Canada to an average 383 from 345 this year and to 380 from 359 the following year.

All of the expected US gain, however, "comes on the land rig side of the market," which "generates far less revenue per rig than in the offshore environment," said James Stone, managing director for oilfield services equity research for UBS Investment.

In fact, he said, "We have actually modestly lowered our 2003 and 2004 offshore rig count forecasts for the US for several factors.

"Firstly, the average offshore count for the first half of the year has been tracking below expectations. Secondly, the continuing decline in the rig availability in the Gulf of Mexico and the expected softness in semisubmersible demand [are] likely to result in lower activity levels for the remainder of the year and perhaps into 2004 than previously forecast."

Some of the loss of activity in the US sector of the gulf will be made up in other offshore markets "such as Mexico, Africa, and the Middle East," said Stone.

However, he said, "Outside of the US, our revised forecasts [for both land and marine activity] are a mixed bag, with Latin America being stronger than previously anticipated due to a strong ramp up in Mexican activity and the resumption of Venezuela, although Venezuela will be a slow recovery.

"European activity will show some nice improvement in the second half of the year, and since this is a strong revenue-rig market, it should be positive for second half earnings," he said. "Africa will be slightly lower than we had previously modeled, which will be offset somewhat by higher activity in the Middle East. We expect Iraq activity to start picking up later this year and to add materially to the overall Middle East rig count in 2004. Asia should be relatively flat."

Despite a "nearly 30%" surge in the US rig count this year, Stone said, "There has been little meaningful change in [day] rates over the past couple of months." He, too, sees indications "that there is more supply in the land rig market than 2 years ago, and customers do not seem to be panicked about the availability of rigs."

As for offshore, Stone said, "We think clients are much more attune to the economics of well prospects and are being more careful with the day rates that they are willing to pay, relative to the economic returns of each prospect."

"Despite these twin limitations," he said, "we have noticed some positive momentum in offshore and land day rates, which will continue, albeit at a slower rate than in previous cycles."

Permits issued for new land wells through late June "continued to show strength, with the 13-week moving average still at levels not seen since September 2001. The highest weekly change came in the Gulf Coast [region], which increased 79 permits to 116," said James K. Wicklund, an analyst in the Houston office of Banc of America Securities LLC.

Brazil

Meanwhile, Edinburgh-based consultant Wood Mackenzie Ltd. reported that a lack of recent commercial discoveries has damped interest in deepwater drilling off Brazil, once considered one of the hottest new exploration plays when that country opened its upstream sector to foreign investment in the late 1990s.

Initial interest was high when Petroleo Brasileiro SA (Petrobras), Brazil's state-owned company, drilled several significant discoveries in the Campos basin, "including the 1.9 billion bbl Roncador field," discovered in 1996.

International oil companies have now drilled 32 deepwater wildcat wells off Brazil, however, with relatively little to show in return. "We consider that only 7 of the wells that have found oil offer any chance of development," said Matthew Shaw, senior consultant at Wood Mackenzie.

"At present, they are all considered uncommercial for more or less the same reasons: reserves are small; the oil is heavy; and water depths are extreme."

Petrobras remains "the driving force in Brazilian deepwater exploration," having drilled 113 wildcats since the Roncador discovery. But commercial discoveries have been made only in the BC-60 block of the Campos basin, Shaw said.

"Six discoveries have been announced in BC-60, but they all suffer from having heavy oil, and only two are large enough to have any hope of being developed on a stand-alone basis," said Pauline Geddes, another senior consultant at Wood Mackenzie. She identified those two as Jubarte and ESS-121, "with about 600 million bbl each."

Moreover, she said, "The state company has a long portfolio of other uncommercial discoveries in other blocks."

The lack of additional commercial discoveries in deepwater "will have a significant impact on medium to long term oil production" in Brazil, said Wood Mackenzie analysts.

"Production is set to rise substantially in the near term, but this is masking the bad news that it will enter a steep decline post-2007," they said. "If a solution can be found to help make recent discoveries economically more viable, then this would ultimately result in hugely increased revenues to the government."

It may require an improvement in fiscal terms to render these fields commercial, said analysts. Both a "high case scenario" based on reserves of 600 million bbl and a "base case scenario" of 270 million bbl "are uneconomic under the present fiscal terms, assuming that a hurdle rate of return of 15% is required," analysts said.

"Relatively modest changes to the terms could render the larger field economic," they said, "but far more radical changes will be required to enable the exploitation of the base case field."