Very quiet week, thus DEP forced to go out and generate the news by way of our semi-annual update on the coil tubing market. Notwithstanding the holidays, we were able to conduct updates and/or receive feedback from a number of CT companies in order to dig into current trends and sentiment. Before reviewing coil, however, we kick-off with a quick DEP update as well as summarize the Q4 rig count.
DEP Update: With 2022 now before us, we have a couple quick housekeeping items. First, the DEP research team takes the first week of the year off – family just arrived in the Florida Keys and preparing to now go enjoy a few cold drinks at the beach (thus the very early note today). The good news is the remainder of the DEP team is in the Houston office, happy to help our loyal clients. Second, we are going through withdrawal having not been to the field in over two weeks. Consequently, we are making plans to return to Midland on January 18-20th. Honestly, because we have no life, we prefer West Texas sand over the clear white sands of the Florida coast (we don’t fish, golf and we easily sunburn). For Midland locals, please look for meeting requests from us soon. Lastly, our THRIVE 2022 registration email blast is expected to go out on Monday evening (maybe Tuesday). The team has been working on final IT stuff related to the registration process and we think we’ve worked out all kinks. We also believe we have finally nailed down the agenda, so be on the lookout for event details. Please plan on attending. We could use your support.
BKR U.S. Land Rig Count. The U.S. land rig count closed out the year at 570 rigs, flat w/w. For the quarter, the BKR U.S. land rig count averaged ~547 rigs, +13% q/q. During Q4, the BKR rig count added a total of 57 rigs. We presently model the Q1’22 rig count averaging 584 rigs (we have a slight upwards bias to this view, but we’ll update the rig forecast in February).
U.S. Coiled Tubing Market – Overview. We had the opportunity to visit/get feedback from 14 U.S. coiled tubing companies as well as chat with those tied to coiled tubing capital equipment. Our CT survey participants collectively own 151 large diameter units, or nearly 80% of the U.S. market, so a decent sample size. The messaging is very consistent – (i) efforts to move price continue as margins remain anemic while greater equipment wear-and-tear is occurring; (ii) labor challenges are significant; (iii) growing concerns of idle assets emerging under new labels; and (iv) supply chain headwinds.
Our discussions, as well as market share tallies, largely focused on the large diameter market. This has been the case for years as big coil was the cool place to hang out. What we learned through discussions, however, is the rise of P&A and production-related remediation work is leading to a greater call for small diameter units, perhaps a better place to be right now. This shift will necessitate another dive into the sector as there are several small diameter-only folks out there with whom we didn’t update this week, but with whom we need to visit in the coming weeks.
Competitive Landscape. As noted above, we estimate the U.S. large diameter market is roughly 194 units, of which we estimate 97 are active today. Our use of the word “estimated” should not be glossed over lightly as the continued lack of disclosure on the part of industry participants grows worse by the quarter. In some cases, the reduced disclosure is a function of companies no longer in existence (i.e., BAS or PES). In other cases, companies have simply dialed back their respective CT reporting altogether. Is this a nefarious move? Not really. The reason is simple. For the last several quarters, the coil market has been a total disaster with little in the way of good news to report. Moreover, the collapse in the business for some companies eliminated the need to report data because the coil business effectively became immaterial. Consequently, for OFS geeks like ourselves, digging into the sector now takes a bit more work. Moreover, in some cases, companies who used to provide helpful granularity are now forced to speak to the business in terms of ranges, etc. – perhaps due to competitive reasons; perhaps because of fears of Reg FD disclosure issues or perhaps because they don’t like us.
Now with this disclaimer aside, the ~97 active large diameter unit count includes a respectable amount of guess work on our part. Perhaps a better way to think about this is to use a range instead, so let’s call it 95-100 active units. Like frac, an active unit is not necessarily a working unit. What really matters most is the true demand for CT services today and where it goes from here. We get this question frequently and the answer to it is really hard to address as the types of services provided by coiled tubing vary and other competitive solutions or products such as well service rigs, snubbing units and/or dissolvable plugs can influence demand, particularly for drill-outs. Further, our survey generally focuses on the large diameter unit market as that’s where the juice has been historically. As noted earlier, growth in production-related work as well as P&A services is leading to renewed demand for small diameter units which is not part of this reports survey.
Back to the demand question. Here’s one leading CT players rule of thumb. We steal it because this the CT exec is pretty smart, and his rule of thumb is simple to understand. First, the exec believes roughly 75% of drill-outs are handled with coiled tubing. Second, the exec believes the ratio of frac crews to coil units is 2-to-1. So, if the U.S. active frac crew count is close to 230-235 fleets, which is the DEP view (to be updated soon). Then 75% of this would be roughly 175 fleets. Now cut this in half and the implied active CT count for drill-outs should be in the 85-90 range. Hardly a precise science, but it just so happens the methodology lands right near our tally of active units.
Looking ahead, we entered 2022 with a view the U.S. frac crew count would likely move into the 250-260 vicinity, so a gain of about 20-30 crews. Applying the aforementioned methodology to the high-end of our expectation would suggest an incremental 11 CT units might be required. After conducting our survey, only one of the CT companies definitively sees an idle unit being reactivated. Several believe additional units may go out, but none gave us an affirmative yes. Most simply hope to fill white space on the calendar so existing units get better utilization. This, they contend, is the right solution given labor shortages and the need to generate better pricing. Net, our frac crew forecast, if correct, suggests rising demand for completion activity, thus for CT services. Yet essentially all of our CT contacts report an expectation for a tad better utilization, but few with concrete plans to add units. The takeaway is either our frac crew count forecast is a tad optimistic; our contacts are being guarded due to competitive reasons or perhaps those with whom we didn’t chat may be the beneficiaries of incremental units. Either way, it’s difficult to see a sharp acceleration in U.S. coiled tubing activity, perhaps +5% from here and over the course of 1H’22.
Near-Term Headwinds: Labor remains a prominent gripe. Not new news. Also, there is some consternation regarding coil string life. This was not a universal response, but multiple contacts noted CT string life is not meeting expectations. One reason imparted was the continued growth in laterals and the impact of agitators on the string. Consequently, multiple CT companies are now trying to raise the run footage charge and/or raise the agitator charge. The need for this increase is to better match the life of the string and the returns necessary to invest in the strings. CT companies also report lead times for new strings are elongating. Another sign of supply chain woes. What used to take 4-6 weeks is now taking 8-10 weeks. A coil OEM confirms this is the case. CT strings have also moved up in price due to rising steel prices.
Another new concern rests with previously idle capacity which is returning to the market. Namely, there have been two asset sales highlighted by most CT respondents. First, we understand that previously idle assets from Legend Energy Services have now resurrected as Red Hawk Coiled Tubing. What’s not clear is whether or not the entire Legend portfolio of equipment went to Red Hawk. At the time of this note, we have not been able to fully vet this. The second transaction is the Q4 sale of Axis Energy Services CT assets to Yellow Jacket Oilfield Services. Lastly, a social media post within the past day highlight’s Pro Coil’s recent purchase of two 2.375” units which were originally built in 2019. Pro Coil, a Midland player, is also seeking to add a small diameter unit per the post. Finally, one builder reports a few former industry folks seeking quotes to buy used equipment while another CT player whose business is presently idle is seeking to sell the units. What we call the circle of life in OFS continues.
Here’s the big picture problem. We are calling for modest demand growth, yet new entrants are returning to the market with desires to deploy capital. In other cases, existing players are adding used units in an effort to bolster their respective operations. All of these units are going to need people. Where do they then come from? Most likely via poaching. So, the labor situation in coil is already bad, but likely to get worse. Pricing is recovering from the 2020 trough with more pricing needed to generate acceptable returns, but the bidder lists are about to expand once again. That’s not bullish for CT pricing. Without an inflection higher in demand, we believe the CT market will continue to see competitive tensions in 2022.
Need For M&A Remains. All CT respondents understand the obvious, which is the need for rationalization of the CT market. For some companies, coiled tubing is a small part of their overall corporate portfolio, thus not deemed core to the business. These companies are generally willing sellers. On the other hand, there is a smaller universe of players who view coiled tubing as core to the portfolio and would like to grow. For those who are willing sellers, the challenge is potential buyers generally don’t have cash to buy or the sellers don’t want to take stock in a privately held business. Sellers also have to deal with banks who might not be so willing to release collateral for an illiquid investment in a private company – not that having actual CT units as collateral is really that good either. For buyers, the challenge is the perception that deploying one’s own idle asset yields a better return that buying someone else’s business. Frankly, we can’t argue that point, but in the same discussion, potential buyers often highlight the need for better pricing, something which is challenging to obtain when so many companies bid on work. Yet, why would one want to pursue a consolidation strategy when we keep seeing old CT units returning to the market? Again, we can’t argue this point as CT capacity is like kudzu which is similarly hard to get rid of. Keep in mind, back in the day Superior Energy Services advertised its ownership of nearly 80 CT units and as of right now, we have no idea where all these went.
Limited Newbuild Activity but Rebuilds Will Be Needed. Only one CT noted a desire to increase capacity via newbuilds and none of our respondents have any on order. Companies are, however, refurbing/replacing injectors while an emerging capex trend is the need to rebuild and/or buy pumps. In the yesteryears, CT companies typically employed a double pumper. Now, with greater pumping horsepower needed for some jobs, CT companies have had to add a frac pump to the CT spread. This unit, along with the double pumper, yields three fluid ends on location. While the fluid ends don’t take the same beating as fluid ends on a true frac unit, they still need to be replaced and maintained. Moreover, CT requiring these frac pumps have been required to buy them, a capital cost likely not contemplated at the time the original CT spread was purchased. In recent quarters, these pumps, often used, have been purchased at discounted prices of ~$200,000 to $400,000 per trailer. This might sound like much, but when CT spreads have been generating ~10%-type EBITDA margins, this is a big nut. By the way, in the Pro Coil social media post regarding its CT expansion, it also noted the purchase of three frac pumps. For a quick and simple financial scenario, assume a CT spread working in 2021 averaged 22 days/month at $35,000 revenue per day. The implied annual revenue is $9M, thus implied EBITDA equal to about $900,000. That’s before maintenance capex and any corporate overhead. Not very good and certainly not enough to justify adding pump capacity, but that’s what some were forced to do in order to remain competitive.
Summary. The CT market is better today than 2020/2021. Utilization, pricing and margins are all up, but with rising demand and significant used assets available for purchase in the market, we are now witnessing the onset of another market deconsolidation. Optimism for an improved competitive landscape was better a few months ago when companies were shutting down, but the assets are slowly returning. On the other hand, multiple companies who operate coil acknowledge it’s not core to their company. They admit they are willing sellers. A few players see it the other way. They contend coil is core and would opportunistically buy. As we sit in the cheap seats, it would appear matches can be made. Getting this done is now even more critical given the aforementioned emerging new entrants. Further, companies generally acknowledge that scale at the district level is needed. In a flat-to-slightly higher demand market, deploying idle capacity to achieve scale makes sense on paper, but if everyone takes this approach, pricing will falter, labor costs will rise, and companies will report higher reactivation costs. Instead, companies should see the forest through the trees and smart people need to get in the room and hash out a deal. That’s how the market can improve in a $70+ WTI environment and it’s something we hope to report on in our next CT update in July.CT_Update_January_2022