Inconvenient Truth: Recovery But No Recovery at Driller Patterson-UTI

Patterson-UTI Energy had an average of 88 drilling rigs operating in October, up from an average count of 73 in the third-quarter ended September. Talk of a significant recovery in demand might be premature, however, given the current supply overhang in the natural gas market.

With about 350 marketable rigs, Patterson-UTI is the second largest onshore driller in North America, behind Nabors Industries. Size has not immunized the company to the downturn, as average revenue per operating day declined 5.5 percent year-on-year to $16,800.

In addition to pricing power residing with producers, the drilling slowdown has eroded the company’s U.S. land rig market share, which is down some 50 percent in the last 24 months to about 7.5 percent. Competitor Helmerich & Payne has been able to snag market share and maintain a relatively higher utilization due to stronger drilling demand — and longer duration of term contracts — for their higher horse-power rigs specially adapted for shale play operations, according to industry trade magazine RigZone.

Shale play operators are more reluctant to curtail spudding activities principally because of economics –the pockets of gas are more difficult and costly to extract compared to conventional reservoirs. Partly in — totally in, to the extent a producer has already committed millions gaining regulatory approval, actual drilling costs for many (in the Haynesville Shale) have dropped from between $8 million and $9 million to about $6.5 million per well, on average. The Baker Hughes Rotary Rig Count data released for last week showed a 58 percent year-on-year decline in vertical drilling (straight down into conventional fossil fuel reservoirs) compared with a 17 percent fall-off in horizontal rig activity.

An internal distraction could account for the company’s tardiness to the shale players’ table: erstwhile chief financial officer Jonathan Nelson was convicted of embezzling more than $77 million from Patterson-UTI and imprisoned for 25 years back in October 2006. That said, I could also postulate that management mistakenly believed drilling demand would remain strong beyond 2007, as the company benefited during past boom times by sticking with day-work deals. Mobilizing drill crews and rigs quickly for energy producers looking to meet exploration and spud deadlines lends itself to more flexibility in charging higher rates on a per-day basis.

Most of the company’s contracts are still on a well-to-well basis, as the average number of days to drill a well (including moving to the drill site, rigging up, and closing down) was only about 22 days during 2008. “Draw lessons from the past — but don’t live in it,” said the late President Lyndon B. Johnson. Looks like the Houston-based driller is listening to its fellow Texan, having spent more than $1.7 billion in the last 3 ½ years to build new land drilling rigs and to upgrade its existing fleet.

Patterson-UTI is optimistic about 2010. Chairman Mark Siegel said spot market day rates stabilized in the third-quarter.

Chief executive Thomas Wall added the company expects to have, on average, approximately 34 rigs under long-term contracts next year, up from 28 rigs during the third quarter. The contractor secured additional contracts for six of its new-build Apex rigs, which were deployed to shale and unconventional resource plays.

The most visible threat to a sustainable onshore recovery is a material setback in domestic economic growth. The Commerce Department’s Bureau of Economic Analysis said yesterday it was revising GDP growth in the third quarter from a previous estimate of 3.5 percent annual growth rate down to 2.8 percent, citing lower than expected personal consumption and a higher trade deficit. Anyone at 1400 Pennsylvania Ave want to tweet me on the positive impact proposed carbon taxes and higher industry-specific ‘fees’ would have on private investment spending?

In addition, RigZone’s staff writes that the substantial backlog of deferred well maintenance and wells (drilled but uncompleted) could take producers’ focus off new drillings — easy production gains present compelling, low risk and low cost economic propositions.

More bad news in the last few weeks too:

• Working natural gas in underground storage increased to a record-setting level of 3.83 billion cubic feet (Bcf) as of November 13, up 10 percent from last year, according to Energy Information Administration estimates.
• On November 24, the Henry Hub (located in southern Louisiana and the preferred reference point for most of the domestic gas destined for the East Coast) natural gas spot price closed at $3.62 per million British thermal units (mmBtu), almost 43 percent lower than year-ago prices.

Given a landscape littered with idled land rigs, an easy prediction to confidently forecast an upswing in rig counts during 2010. Harder to predict, when will Patterson-UTI’s profit margin expand too?