11.28.21 – DEP Industry Observations: OCTG Anecdotes, Rig Count Rises Yet Again; Updating Our Rig Forecast

DEP Update:  In NYC/Boston this week visiting clients.  Houston meetings, including the DEP Christmas party next week and then back to Midland the week of December 12^th.  Lastly, be on the lookout for our THRIVE 2022 sponsorship brochure.  We hope to blast it out soon to industry friends.  Any and all support is appreciated.

OCTG/Casing Thoughts:  Lots of chatter about casing challenges given the rapid price escalation due to a tightening market.  OCTG is not historically a focal point of DEP’s research, but we did reach out to folks this week to inquire about the current situation.  Specifically, one E&P contact reports buying casing last year at prices as low as $10-$12/foot while today prices for similar 4 ½” casing are in the low-$20’s.  A distributor reports clients who paid nearly $11/ft for 5 ½” last year but are now being quoted $25/ft for surplus pipe.  As most know, prices vary between types of casing, but the issue is the magnitude of the price increase.  Fears about casing access are driven by shortages or reports of shortages, a function of pipe supply still stranded on vessels, uncertainty over future imports/imports costs due to potential trade-related issues, mills slow to recover/fire back up and overall higher demand.  Below are a few observations from contacts within the pipe distributor/mill community.

1. Pipe contacts foresee the market stabilizing this summer as some distributors report some mills accepting orders for June/July.
2. Reasons supply is expected to stabilize include: imports on the rise, supply chain delays expected to moderate; vessels will eventually unload cargoes; and more mills have fired back up.
3. There are multiple reports of larger steel companies passing over smaller buyers of pipe.  In some cases, if an E&P doesn’t run a certain level of activity, the mill purportedly won’t sell to them.  The purported threshold, according to some, is at least five rigs.  In other cases, the mills are trying to sell premium grades only.
4. Field contacts report distributors, who are protective of large customers, are now dropping smaller pipe buyers to allocate pipe to larger buyers.
5. Distributor contacts claim you don’t want to let someone else into what might be a historically strong relationship.
6. The combination of #’s 3-5 mean small E&P’s may and/or are having trouble accessing pipe.
7. Point #6 is confirmed by private land drillers who claim select customers are indicating the potential of dropping the rig due to a lack of pipe.
8. One small E&P contends dropping a rig in the short-term may be the right call as it too sees a normalization of supply/demand and potentially a moderation in pipe costs.
9. Distributors claim there is still surplus pipe on the market, but this pipe is often outside the mills warranty period.  In one case a distributor points to pipe that has been in a yard since 2018, but is available for use.  That said, distributor acknowledges buyers beware.
10. Some distributors contend pipe ordered months ago at lower prices is not arriving due to “pipe inspections”.  The distributors suspect the mills are selling it out from under them at higher spot prices.  Not sure about merits of this claim, but an interesting one, if true.
11. In another case, a distributor points to a 3-to-4-month delay in orders due to shipping issues.
12. Our take:  We believe in the laws of supply/demand.  The fact that both distributors and mills each see light at the end of the tunnel, specifically in the summer of 2022, tells us the market should normalize.  No reason for them to make this up.  Second, feedback is consistent that larger E&P players will be taken care of, so we don’t see pipe as an issue for the larger public universe.  On the other hand, small players who don’t have pipe secured for Q1 won’t get it unless they buy surplus.  Final point, all of the land drillers we updated with this week will be deploying incremental rigs (see below).  This wouldn’t happen if no pipe was available.  Therefore, we do not envision the casing challenge as a near-term threat to another ~10% gain in the rig count.  Rather, E&P’s will just pay more.

BKR U.S. Land Rig Count:  Up 6 rigs to 552 rigs on an abbreviated reporting week with half the gain coming from the Williston.

DEP Land Rig Forecast:  Cleaning up our forecast to reflect a sharper recovery than previously anticipated.  The U.S. land count per BKR stands at 552 rigs as of Wednesday.  QTD the rig count is averaging 535 rigs, but if one simply assumes a continued weekly increase of 4-5 rigs/week through YE’21, the Q4 rig count should average roughly 545-550 rigs.  This compares to our old Q4’21 forecast of 512 rigs, so clearly we are off.   Additional gains should be expected given recent commentary from the public land drillers.  Recall HP had 141 rigs operating as of its earnings call just over one week ago.  Management predicted gains of 10-15 rigs by year-end with several additional rigs going to work in early Q1.  Let’s assume their total incremental deployment is 15-20 rigs – that’s a ~12-14% gain.

We also reached out to multiple private land drilling contacts to hear their views. These companies are collectively running 80 rigs today (~15% of US rig count) but see their combined rig count rising to 95 rigs over the next 2-3 months.  That’s a ~19% increase.  Several of these companies contend rig crew availability is limiting growth while casing concerns also exist.  Two of the private drillers do not intend to reactivate additional rigs while others are pursuing rig upgrade programs.  Leading edge dayrates, subject to the type of rig, are reported in the $18,000 to $22,000/day vicinity.

In light of the feedback and making a few educated guesses, we update our rig count forecast and summarize the forecast in the table below.  The change vis-à-vis our prior forecast is a ~6.5% increase in our 2022 forecast (now = 623 vs. 585 previously).  A large part of the change, frankly, is correcting the forecast to reflect the faster-than-anticipated ramp in Q4 and the corresponding flow-through effect into 2022.  While we would like to be more assertive with the forecast, we are reluctant to do so given a multitude of variables.  Namely, prudence may be the order of the day.  First, COVID fears abound as the new Omicron variant is leading multiple countries to restrict travel.  Countries such as Israel imposed a short-term travel ban for non-residents while Austria recently imposed a 10-day lockdown.  The U.S., meanwhile, recently advised folks not to travel to Germany or Italy.  These restrictive measures sent oil prices down ~13% on Friday (WTI trading at $68/bbl) while the market sold off nearly 2.5% (Dow down ~900 points).  Second, service costs are screaming higher; access to equipment is increasingly challenged and the entire supply chain is still messed up.  Finally, E&P companies remain committed to capital discipline, not a shocker.  Package all these considerations together and we submit E&P players remain measured going into 2022 and some might become more cautious, particularly in light of the macro noise.

Where could we be wrong?  Lots of places, but the obvious mistake would be data which suggests Omicron is a mild variant; evidence regarding booster’s ability to render Omicron a trivial threat; further traction in COVID treatments (CNBC reports Sunday that Moderna’s Chief Medical Officer says a reformulated vaccine could be ready by early 2022); and/or a willingness by OPEC+ to suspend production increases and/or cut supply proactively in the face of growing travel restrictions or the Biden’s effort to dump crude into the market.  All of this would be a positive for oil prices.  Also, the decline in oil prices on Friday may turn out to be a shoot-first, look-second event (our opinion BTW) whereby a swift correction to the upside could materialize as people realize life must still goes on and that global oil demand likely rises over time.  Time will tell, but for now, we opt to be conservative with our forecast and will revisit our rig outlook in mid-January.

Source: DEP