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After years of watching the markets, land drillers have reached a long-awaited pivot point in the current industry cycle: they are retiring or scrapping dozens of land rigs not suitable for operators' increasing focus on unconventional plays.
In the last several months, some of the biggest drilling contractors have announced moves to rid their fleets of large numbers of land rigs, ranging from two or three dozen rigs each for Precision Drilling, Patterson-UTI and Union Drilling to 104 rigs for Nabors Industries.
"Rig retirements have...increased in 2011 -- 315 in 2011 through third quarter reporting, versus 212 retirements in 2010," a recent survey by investment bank Credit Suisse said.
Meanwhile, Global Hunter Securities analyst Brian Uhlmer said in a report this month he counted 207 rigs marked for sale or retirement by six of the major public drillers in the previous 50 days alone.
Extensive rig retirements were widely expected by industry watchers in recent years, because perked-up drilling in unconventional plays requires more efficient rigs. Operators are increasingly willing to pay a premium for higher-horsepower electrical rigs with top drives to reduce manual labor and which can drill multiple wells from a single site.
More recently, oil and liquids activity has been what Doug Wall, CEO of the US' third-largest land driller, Patterson-UTI, recently called "a game changer" for industry. Technologies such as horizontal drilling and fracture stimulation applied to shale, unconventional and mature fields have yielded handsome volumes and investment return rates topping 100% in some cases, and "will be a big driver of our businesses going forward," Wall said at a recent industry conference.
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Industry kicked up a frenzy of shale activity in 2008, especially after big shale operator Chesapeake Energy announced the Haynesville gas shale play was viable. Massive drilling there and in other shales over the next couple of years led to vast volumes of gas which kept prices tamped down. Ironically, at least some of the rapid increase in output stemmed from drilling efficiencies achieved by newer rigs.
At the same time, the price of crude headed north and spurred more drilling in horizontal oil plays, which required better-equipped rigs. Oil plays proved more profitable and, in the relative economic reckoning of oil versus gas drilling, gas lost.
With gas prices stubbornly at the $4s/Mcf level or below, there was just not enough work for conventional rigs, many of which were devoted to gas drilling, Bob Williams, director of news and analysis for the Land Rig Newsletter, said. Even so, many drillers kept waiting for the return of what he called the "conventional gas market," but it failed to materialize.
"A lot of guys were saying it isn't coming back and there isn't enough conventional drilling to warrant rigs below 1000 hp," said Williams. "I think that's when people started pulling the trigger."
In fact, during the third quarter, "for the first time in industry history, [active] rigs 1000 hp or greater outnumbered the smaller ones," Williams added.
Other factors prompting decisions to shed non-core legacy rigs include a greater emphasis on safety and efficiency by larger drillers that have retired or scrapped the most rigs, and a constrained labor force that pressures drillers to dedicate workers to higher-return projects, analysts said.
The longer a rig is stacked, the less likely it is to be reactivated. "Remaining idle conventional rigs likely require uneconomic investments to be reactivated," GHS' Uhlmer said.
He said one large owner of conventional rigs suggested its remaining long-idled equipment that is out of service for two or three years would require the relatively high sum of $3-$4 million to return to work.
At a rate of $20,000/d, 75% yearly utilization and daily operating costs of $11,000, "it would take well over two years to achieve payback on a $3 million investment," said Uhlmer. At $18,000/d, recouping investment would require more than four years, he added.
That means mechanical rigs below 1000 hp that were suitable for decades of drilling vertical and relatively uncomplicated wells are being edged out by newer models, as evidenced by an ongoing land rig-building boom that remains in full swing and shows no sign of stopping.
US onshore rig newbuild orders have totaled about 170 this year through the third quarter, versus 95 in 2010, Credit Suisse said. "We expect an efficiency focus to continue to push the continued 'retooling' of the fleet," the investment bank's report said.
But this does not mean the end of all conventional land rigs. Operators in some cases have found it more efficient for horizontal wells using an older rig to drill the vertical hole and then employing a newer, bigger rig for the horizontal portion. Some operators claim to save $50,000-$100,000/well from this, said Williams.
"There will always be opportunities for conventional rigs, just not enough to warrant the need for [a large] sub-1000 hp fleet," said Williams. "A lot of those will go away and I think the third quarter was the tipping point."
--Starr Spencer in Houston
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