Happy Sunday. We hope you are presently at the golf course, on the lake or at the beach and not reading this note as it is published.
We are just around the corner from Q2 earnings season. While we would love to hear oodles of optimism and joy, we expect a much more subdued dialogue will unfold. Things to consider: (1) Q2 results will be terrible; look for more asset impairments, charges, etc.; (2) while activity is percolating higher, OFS pricing collapsed in Q2 which means Q3 results could be down q/q; and (3) some companies are likely purging non-core assets/divisions – we’ll look for granular commentary on go-forward business plans.
As for our thoughts from this past week, they are summarized below.
- Recent Land Driller Commentary
- Coiled Tubing Worse Than Pressure Pumping?
- Auctioned Frac Assets – Circle of Life Repeating Itself?
- New Start-Up’s In A Downturn? Yep, it’s happening.
- OPEC Virtual Meeting This Week
Land Driller Commentary: Recent field tours provided clear evidence of the uptick in completion and production-related services. Land drilling visibility, meanwhile, was a bit less clear, thus this week we took time to reach out to a number of our land drilling friends to gauge leading edge sentiment. Unfortunately, visibility remains cloudy, although more see rig additions vs. rig releases thus providing evidence we have hit bottom (or will hit within the next 1-2 weeks). As a quick reminder, the BKR U.S. land rig count fell 5 rigs on Friday to 246 while the preceding two weeks, it declined a total of 4 rigs. In the prior eleven weeks, the average weekly decline was in excess of ~30 rigs.
Based on our query of several private land drillers who collectively are running 35 rigs today (~15% of total U.S. rig count), they foresee a slight rebound in 2H’20 with total incremental rig deployments expected to total 5-7 rigs. Yes, this is both a small sample and a small increase, but these private drillers were the ones who foretold a pending collapse at the time of the DEP first research note in early April. As a reminder, when we queried this group over three months ago, they noted an expectation of a ~70-80% rig count contraction. Per Baker Hughes, the rig count is now down ~68% from the Q1 average through this past Friday, thus their prophesy proved pretty good.
Land Rig Inquiries: Many drillers report rising inquiries for small opportunities, generally 1-2 well packages. In one case, a driller claims there are ~10 private E&P’s looking for short-term drilling work in the Eagle Ford. The challenge, however, is the short duration of the work, particularly when leading edge dayrates stink. For instance, we are told leading edge dayrates for high quality SCR rigs are in the sub-$15,000/day range. Several privates report Tier 1 AC rigs are being bid in the $16,000 range. Those who are bidding performance-based pricing are reported to be bidding dayrates in the $15,000/day vicinity. To be fair, we often receive push back from some of the public players who claim our pricing anecdotes do not always reflect the pricing strategy of larger, public players. In other cases, we are reminded the dayrate examples we cite do not mirror the true revenue per day figures as Tier 1 rigs often have add-on’s to the dayrate. That’s a fair criticism and we’re not trying to pick a fight. Nevertheless, one driller claims it recently lost work to a large name-brand player who bid $16,000/day for an AC rig with three mud pumps, four gen sets and 5 ½” pipe. That’s not a great price (if true), but not surprising when the U.S. rig count is at a generational low right now.
Here’s another thing to consider. One reason E&P’s, particularly the small ones, want rigs is for the cheap dayrate. But let’s do some quick math first. We’ll assume a $15,000/day rate for a two well package. We’ll further assume an operating cost of $12,000/day, thus a cash margin of $3,000/day. Let’s pretend it takes 20 days to drill each well, so 40 total drilling days. That implies a $120,000 cash return. But wait. If the rig is presently stacked, the driller probably has to go find a crew. There will potentially be some form of cost to return a rig from stacked status to working status. Does $25,000 to $50,000 sound reasonable? Probably. That’s what our drilling friends say, so now the profit is down to $75,000 to $100,000. What about the rig move? Who eats that cost? Will a crew which works 7-on and 7-off really come back for two-to-three shifts? If work can’t be lined up after this project, is the hiring and then subsequent layoff process worth the hassle? What about the increased liability risk? Most land drillers are self-insured with high deductibles. One incident and profitability from a short-term reactivation is wiped out. So, without an ability to line up dedicated work beyond just a couple wells per rig, the idea of bringing back a stacked rig for short-term, low-priced work probably doesn’t make much sense. Of course, the rejoinder is it’s easier to find work for a “hot” rig than a “cold” rig. We get that, but it’s an awfully unattractive risk/reward proposition, in our view. Nevertheless, we are happy to hear of growing one-off opportunities, but we would rather see more meatier projects as opposed to lean cuisine. Regardless, if the drillers choose to pursue these small projects, it supports our view the rig count improves in Q3/Q4.
Coiled Tubing Update: Back in the day, everyone loved to talk about coiled tubing. Remember when 2” units were considered large diameter coil units? Those certainly were happier times. Today, happiness is a distant memory for the U.S. coil market. Like other OFS segments, CT is burdened by too much capacity given the total collapse in E&P capital spending. Over the past several quarters, we have witnessed the closure of several players, but we’ve also seen units end up at the auction block. In some cases, the assets are being sold by existing coil companies. That’s not good. What really jumped out to us this week are the pricing anecdotes. CT friends claim leading edge pricing for 2 5/8” units are at $25,000/day. This would be just above one’s fully loaded cost leaving little room for error. The pricing is also nearly 40-50% below last year’s level (according to some). One contact who plays in both coil and frac claims coil is the worse of the two. That’s scary. Consequently, the company is making a pivot away from the sexy drill-out work and focusing on other CT-type jobs instead. A theme conveyed by several CT contacts is a belief some CT companies may be using PPP money to subsidize pricing. This was a similar message conveyed by well service companies during our last trip to Midland. Probably not the best strategy and if true, it will be interesting to see what happens as PPP money goes away.
Frac Assets Changing Hands: There are those who profess the current downturn will lead to a purge in OFS enterprises. They contend company failures will persist which will lead to a permanent removal of industry capacity. While there may be some truth to this view, there is another side to this story as well. Could legacy assets simply get recirculated back into the market? We believe so. Case in point, consider the Basic pressure pumping business. Those assets were sold earlier this year with at least three different frac companies picking up the equipment. In some cases, the equipment helped expand the buyer’s respective operation. What is strange is we still see references by some research firms suggesting this equipment was permanently retired. That said, the Basic example is not a one-off. Within the past few weeks, several other frac asset packages were put on the market. Both of these packages are/were being sold by vertically integrated E&P’s. In one case, we have been told the buyer of ~40 pumps is a former employee of a top-10 public frac enterprise. We are told these assets will be repositioned from the Bakken to Texas and will be used as the foundation of a two fleet company. In full disclosure, we have not visited with the purported buyer, so for now, we are assuming our field contacts have accurately conveyed the nature of this purchase. In a second case, the frac assets from another vertically-integrated E&P are listed online. We do not believe these ~40 pumps have sold yet. Finally, we understand a third private enterprise is selling its pumps (as many as 40-50), although we have not yet seen these units hit any auction website yet. Separately, we are told one large frac company recently divested at least one old fleet which it had planned to cut up. We’ll confirm with the company post Q2 earnings whether this field commentary is correct. If so, shame on them. It’s one thing to unload assets if you are completely exiting a business. It’s an entirely different matter to sell equipment in a business in which you continue to compete.
To summarize. Companies are in distress. Some will liquidate as a consequence, but like weeds in your yard, the assets keep coming back. Sure, this is old equipment, but some E&P’s don’t differentiate based on equipment quality. For that portion of the E&P world, those service companies offering cheap prices can get the work regardless of the equipment specs. This means old equipment will continue to resurface and this will have an effect of suppressing industry pricing. One would hope big companies would see this and recognize defensive deals might be needed, even as distasteful as doing these deals may be.
Start-Up’s Emerging. We are tracking a new CT company with two units. This company is run by an experienced CT exec who built CT companies before. The company started via the purchase of two used units. Separately, we are tracking a new Williston well service company who recently started a new workover company with three new well service rigs. One of the founders previously worked for another large well service company. These two examples indicate the entrepreneurial nature of the oilfield. Looking ahead, we know of one enterprise wishing to enter the coil market while another contact is looking for multiple units to start a pump down business. Dare to be great.
OPEC Meeting: OPEC is set to meet via a web conference on Wednesday. The expectation is OPEC will relax recent production curbs by 2M bbl/day, bringing curbs to 7.7M bbl/day. The potential increase, according to a WSJ article, is probable given the IEA’s recent comments about global demand not being as bad originally forecast.