A few quick observations this week on the near-term rig count as well as some other oil service considerations.
DEP Update: We are driving the smoker up to East Texas tomorrow to BBQ for some local clients. If you are in the Marshall area, let me know. I’ll drop by if that’s ok. Also, DEP will be taking Christmas off before heading back to Midland next Monday. We may or may not have a note next weekend. In the meantime, we wish everyone on this distribution list a very Merry Christmas. Go enjoy some Flecha Azul Tequila! BTW – total BS that Notre Dame gets into the college playoffs after getting smoked by Clemson. We’re not even Aggies, but they should be there.
Rig Count Rises Again: The BKR U.S. land rig count continues its march higher, adding 5 rigs last week. The count stands at 328 rigs, up 97 rigs from the August trough or +42%. Gains, once again, were in the Permian Basin.
U.S. Rig Count Outlook: We checked-in with six private land drilling contacts to gauge near-term activity expectations. The view is largely consistent. Inquiries and commitments point to further gains in U.S. drilling activity. Our universe of contacts is presently operating ~42 rigs today, but based on expected deployments, this count likely ascends to the ~54 vicinity during Q1. That’s about a 25% increase from today. Extrapolating this rate of growth across the U.S. landscape suggests the U.S. rig count would migrate into the vicinity of 400-410 rigs by late Q1. Mood amongst our contacts remains cautiously optimistic as rising rig counts are partially offset by continued weak dayrates. Anecdotes range from as low as $14,000/day to as high as $18,000/day for one-year work.
Well Service Pricing: We reached out to a well service contact to discuss the state of the market. This company operates in multiple regions, although our contact is largely focused within the state of Texas. The company reports the past two weeks have been its best since the start of COVID. Demand is creeping higher and now the company must decide whether to add crews to meet rising demand or hold steady at current, but respectable, utilization levels. Given higher utilization, the company claims it will raise rates in January. High single-digit percentage increases are likely. Our contact noted employee benefits and wages need to be restored. Current operating margins remain unacceptable. Therefore, the increase will be used to offset likely labor inflation which includes the restoration of the 401k plan as well as increase overall profitability. Important to note, this company still has plenty of equipment to deploy, but the choice of profits over market share is driving the decision to move pricing.
Pricing Outlook for Other OFS Segments. We intend to kick off a formal price strategy inquiry with our readers in the coming days, but here’s a very quick snapshot from industry discussions this week. Price increases (or efforts to raise rates) for well servicing and coiled tubing feel like a Q1 event. Pricing for land rigs appears to be quarters away as none of our land rig contacts feel empowered to move rates now. Sand prices are similarly flat as multiple sand providers report little-to-no traction. Yes, there is the occasional move higher on an emergency spot sale, but the magnitude of such increase remains small; therefore, they collectively describe pricing at flat. All report current pricing remains below operating costs, thus more sand bankruptcies are expected next year. In frac, one player notes bidding activity for 2021 work is still aggressive, particularly for dedicated work. Aggressive price tactics cited, but contact hopes for some price relief in mid-to-late 2021. Admittedly, a small sample thus far, so more to follow.
There is, however, a new twist on which we’ll opine. Specifically, debate over the new normalized activity levels and the impact to pricing. Historically, the service industry would use an 80-85% utilization threshold as the litmus test for pricing. Most often utilization is based on a localized metric, but for purposes of discussion, we dumb it down to a national view. Today, a small contingent of contacts are now questioning the right denominator for the utilization calculation. So, using the drilling rig market as the proxy, should the industry look back to recent peaks (i.e. 2018/2019) when the rig count hovered around 1,110 rigs in early 2019? On that basis, today’s rig count of 328 rigs would be effectively 30% utilized. Alternatively, should the market use a rig count of 600 rigs as the denominator? That’s a figure many point to as the total high-spec rig market. On that basis, the industry is closer to ~50% utilized. What if industry leadership instead set a lower barometer of ~450 rigs as the new standard for full utilization? Seem farfetched? Not really. Just look at our well service contact. This company has no shortage of idle rigs, but at current staffing, the company is maxed out. Yes, more people could be recruited to staff incremental rigs to meet growing customer demand, but why do that if the company will continue to lose money. Moreover, there is an incremental capital cost to deploying equipment and most well service companies are not flush with cash. Rather, the company chose to redefine its denominator for utilization purposes and seemingly appears willing to withhold capacity. Time will tell if local competition follows suit, but we commend the company for its determination.
Another reason the OFS sector should reassess its respective utilization denominator is the growing reality that E&P capital discipline will persist in 2021. Most companies who have announced 2021 budgets and/or a 2021 spending framework are showing restraint. Back of the envelope math using E&P capex spending forecasts from our friends at CapitalOne suggest 2021 spending will be up about 20% from the Q4’20 annualized run rate. Should their forecast prove correct, it’s hard to see a U.S. rig count rising above 450 rigs. Therefore, the OFS sector may wish to reassess how it views utilization.
Consider another scenario such as the situation which confronted the E&P industry. Years ago under duress from shareholders, E&P leadership pushed the narrative of financial discipline. The focus on free cash flow and higher returns trumped production growth. This, in turn, resulted in more capex discipline. In time, the broader E&P industry followed the direction of industry leaders. Don’t believe us? Just look back to 2019 when oil prices were rising, yet activity (i.e. the rig count) kept drifting lower. Yes, some of this was likely a function of efficiencies, but the improvement in cash flow from higher commodity prices went to debt reduction, dividends and share repurchases – not the drillbit.
Could a similar scenario where OFS investors demand profits/cash flow over top line growth and market share unfold? Why not? What would happen if several of the large land drillers were to announce no further equipment reactivations until dayrates exceeded $20,000 or if a leading frac company said no new crew reactivations until EBITDA/fleet surpassed a $10M/fleet threshold? Would public peers scoff and undercut simply to gain share? On the surface, that doesn’t seem like a value-added move. Would investors reward growth for growth’s sake? Or would investors reward OFS companies who pursue returns over market share? Honestly, we don’t know, but to this point, we have yet to hear any OFS leaders address their respective operating strategy should the U.S. activity levels normalize in a 400-500 rig count and/or 175-200 frac crew band.
So why the theorizing on our part? For one, a smart well service contact finally made the determination that price/margin means more than volume. The company didn’t need McKinsey & Company to help it understand higher cash flow and returns are better options than more rigs working and more capex. The company decided it is willing to lose some work in order to make money. It can also staff accordingly to best match its existing footprint. Moreover, in the eyes of this company, its steepest price cuts were implemented at sub-$20 oil in order to help its customer. Now oil prices are approaching $50/barrel. In the eyes of this service company (and we presume others), it seems only fair that the price cuts made this year to help the customer should now begin to be reversed. We suspect quality E&P players will eventually concede this point.
Last comment. Many E&P companies during Q3 earnings season postulated service costs would likely not move higher given the volume of OFS equipment on the sidelines. Should the OFS sector persist in the market share knife fight, those E&P’s will likely be right. If, however, more service companies take the approach as our well service friend, there is reason to believe service costs will actually rise from current levels. Our bet: sustained $45+ oil and a ~400 rig count will give OFS players reason to seek relief and high quality E&P’s will slowly concede, thus we believe ~10% increases from today will materialize by 2H’21. Our E&P contact universe are generally not scrooges. Efficient and safe providers are recognized as important thus some relief, we believe, will be granted.
THRIVE Energy Conference Update: Below are the panel topics for the upcoming THRIVE Energy Conference which will be held on February 25-26th at Minute Maid Park. We have about 80% of our panelists identified/confirmed. We are waiting on few more to commit and then we’ll publish the formal agenda. Interest in the event is also growing as we now have ~42 companies expected to either participate on panels, serve as sponsors and/or exhibit at the expo. The key reason for our E&P audience to strongly consider attending this event will be the featuring of a large number of equipment designs soon coming to market. Notably, the THRIVE conference will feature many service offerings which accelerate your ESG strategy, including new electric frac designs. For our OEM/Capital Equipment friends, if you have a new design which you would like to showcase, please let us know. Remember, most of the competing industry tradeshows will either go virtual in 2021 or have been pushed into late 2021. ESG adoption, however, is not being pushed and won’t go virtual, so the THRIVE event will be a good place to highlight your initiatives. And, for those E&P’s who have policies which limit one’s participation in only those events deemed critical, we can think of no greater use of time (or critical learning experience) than to see all of the new electric/emission-friendly offerings in person and in one place.
|2021 Macro Outlook|
|U.S. Oil Service Outlook|
|Private Equity Perspectives – M&A and Energy Transition|
|Capital Equipment Outlook & Innovation|
|Financing the Future: Sustainability-Linked Bonds and Loans|
|Automating the Backside: Latest Advancements in Well Site Storage and Handling Solutions|
|Large Cap E&P Perspectives|
|Advancing Clean Electric Frac Power Generation & Supply|
|Midstream Outlook & Observations|
|Leadership in the Oilfield – An Interview with our Veterans|
|Cocktail Reception/Batting Practice|
Day Two Panels / Town Hall Discussions
|Permian Basin Outlook|
|Emerging Oilfield Technology Opportunities|
|Private Company Perspectives|
|E&P Supply Chain Perspectives|