Marginal Slip In U.S. Oil Rig Count

In its weekly release on Friday, Baker Hughes Inc. (BHI) reported a slight dip in the number of rigs searching for oil and gas in the U.S., as producers restricted their drilling activities in response to the current supply overhang in the natural gas market. The number of units exploring and producing in the U.S. fell to 1,040 for the week ended October 16 (as clear from the first chart below from Baker Hughes). This is down by 1 from the previous week’s tally and is the first decline in 5 weeks.

The combined oil and gas rig count is down by 936 from the year-ago period. It rose to a 22-year high in 2008, peaking at 2,031 in the weeks ended August 29 and September 12.

The number of natural gas rigs drilling in the U.S. decreased by 5 to 721, just the second loss in last thirteen weeks. The rig count remains 55% lower than its peak of 1,606 in late summer 2008. In the year-ago period, there were 1,537 active natural gas rigs. This is shown in the following chart, also from Baker Hughes.

The oil rig count was up by 4 to 309, maintaining the positive momentum from the past four weeks. But the tally is down nearly 28% from the previous year’s count of 428, as shown in the following chart from Baker Hughes. Oil rigs peaked at 442 in early November last year.

The number of miscellaneous rigs, at 10, remains unchanged from the previous week.

Producers had scaled back oil and gas drilling operations over the past several months in the midst of falling commodity prices and tighter access to credit. However, during recent weeks, there have been signs that the companies were beginning to bring oil and gas rigs back on line amid signs of economic stabilization that spur energy demand. This pushed the nationwide rig count above 1,040 working units for the week ended October 9, the first time since April.

But the most recent Baker Hughes release suggests that the gains may have already started to peter out, as producers struggle with the commodity volumes that can be added to storage, given the existing supply glut.

The overall picture remains particularly weak for natural gas, whose inventories have recently hit a new record high of 3.72 trillion cubic feet (Tcf) and is threatening to test the maximum capacity of 3.89 Tcf. The supply picture is expected to reverse in the coming months as producers bet on colder weather and the lagging effect of the sharp drop in domestic drilling activity takes hold.

Until then, we believe that natural gas woes (especially in North America) will continue to haunt energy service firms like Halliburton (HAL), Schlumberger Limited (SLB), Baker Hughes, Smith International Inc. (SII), National-Oilwell Varco (NOV) and Weatherford International Ltd. (WFT). These oilfield service names have seen their revenues and earnings plunge in the last few quarters on the back of lower volumes and a very competitive pricing environment. We have Neutral recommendations on all the above-mentioned companies.

We also maintain our Neutral recommendations for land drillers such Nabors Industries (NBR) and Patterson-UTI Energy (PTEN), given the extent of excess capacity in the sector that is expected to weigh on dayrates and margins well into next year.

We prefer to own oilfield companies like Cameron International (CAM) that derives about two-thirds of its revenue from outside North America. Cameron’s international operations are expected to be a key growth driver for the firm going forward and will play an offsetting role to the relatively soft U.S. drilling scene.

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