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Baker Hughes 'Cautiously Optimistic' on North America

Baker Hughes Inc. is seeing some deterioration in U.S. natural gas liquids (NGL) drilling activity, but activity in the Gulf of Mexico (GOM) has returned to pre-moratorium levels, CEO Martin Craighead told analysts on Friday.

The CEO spoke with financial analysts during a conference call to discuss the Houston-based oilfield service companies 2Q2012 performance. He was asked about how prepared Baker would be for the "sprint" back to gas, now that the oilfield service industry has packed up and moved into more oily targets.

When North American producers pivot back to gas targets, which they inevitably will do at some point, Baker will have "all hands on deck," he said. "It will be a good problem to address and we will have to address it...But it will be different for Baker Hughes. When we dislocated from gas to oil, we didn't have the facilities to move...and basically went into Walmart parking lots. There were a lot of logistic issues, given what happened to gas."

Baker already had gas services facilities "well under way" in several areas before the gas price bust and those sites now "sit underutilized in big gas basins. It will be a much easier relocation back in than what we experienced into oil. Staffing may be an issue, but that should be the only issue to cause us any kind of pain because we've got the infrastructure."

The U.S. natural gas rig count is forecast to fall to 488 at the end of this year, down 321 from 2011 levels, according to Baker forecasts. The domestic oil rig count is seen rising to to 1,430 at year's end, up 300 from the end of 2011.

Baker today has more than enough business to stay busy in the United States fulfilling customer orders for NGL and oil equipment, said Craighead. However, defining where North America's pressure pumping business is headed in even the next six months is difficult, he acknowledged.

"We are cautiously optimistic about the market outlook for the remainder of the year. If commodity prices remain at current levels, we believe activity in onshore U.S. should remain stable. In the Gulf of Mexico and international, we expect continuing improvement as these markets expand."

Most of Baker's U.S. activity is NGL-driven now, said Craighead. However, there's been some "deterioration" in the business that's made it more uncertain to make any near-term forecasts.

The CEO was asked about "concerns" in NGL differentials in various onshore U.S. plays. "The shoe is dropping in South Texas, no doubt about it. In the Bakken, Permian...there's more concern about the Bakken than the Permian because the Permian has more NGLs. There's a difference in the Bakken depending on the player and the core property...There's probably an average of 14 differential points probably as 85-plus in the Bakken. If it's close to 80, you get nervous, and if it's lower than that, you'll see rigs coming off.

"The whole NGL situation has unfolded so fast. Some are down 40% year/year. We still don't know on the shoe dropping, but it's already dropping in South Texas, that's for sure."

Although he didn't name the particular area, Craighead said there's "a knife fight in one NGL basin, and some slippage in oil basins, and it's okay in gas basins now...We've gotten our hands around [gas basin activity]." Baker has been instituting some efficiency into its fields and "in terms of utilization, in terms of the changes, the benefits come in 4Q2012 and into next year." Beyond pressure pumping, which still is at overcapacity, costs are down, "everything else is folding together."

Baker today is "pretty much out of the gas basins, if not all there, we've got what we want to move," said the CEO. "We don't see any more price deterioration as in the past. Obviously, the oil basins are well balanced. It's been a rapid change, given NGLs. Other than that, we're more optimistic now. I'm not saying pricing won't creep down, but it's decelerated from where it was earlier."

The pricing deterioration among service providers, which some analysts have said would dent the balance sheets across the board, has been somewhat overstated, according to the Baker chief. What customers are more focused on today is technology, he explained.

North American unconventional basin activity "is really a technology-driven type event," he explained. "You can go through all of the product lines...rotary, artificial lift, [hydraulic] fracking...and we're still driving pretty impressive price gains depending on the basin and the customer."

North American margins are expected to "improve from here," although the service provider is a bit cautious about activity levels in Canada, said CFO Peter Ragauss. "We feel good about the rig count," but the overcapacity issues that have impacted the U.S. pressure pumping market are creeping across the border.

The Canadian rig count is "flattish" from what it was at the same point a year ago, which is expected with the spring breakup, but "it's different in the way it's coming back," said Craighead. "It's very soft...Looking at some of the rig count numbers, it's at a three- or four-year low, and with natural gas prices, pressure pumping, there is saturation up there...We're not expecting to deliver out of that business like we have sequentially" in the second and third quarters.

Oilfield service companies serving onshore markets have been attempting to stay one step ahead with new drilling techniques and it remains a "tremendous business" going forward, said Craighead.

There are still "tailwinds" expected on costs, especially proppant costs for guar in the second half of the year, but "we'll pick up steam in 4Q2012 and into 1Q2012 and hopefully it will get to be a nonevent," he said. "We're taking actions to minimize that through better contracting and replacing that."

Sharing "absolute projections" in the U.S. onshore isn't possible, said the CEO. "But there's a real bias toward this absorption of technology into the basins. We can't keep up with demand on some products and services at this stage. We have a limited amount of pricing power. We don't have any worries about where our products sit. Relative to our competitors, our portfolio, especially around production chemicals, artificial lift and completions are as oily as you can find..."

The Gulf of Mexico operations are performing above expectations as well. "Pricing is getting better, utilization is getting better, and the mix of the well types is more favorable for us and will be into 2013," Craighead said.

The North American rig count may be flattening out, but that's no longer a good way to estimate business activity. Technology is making the count somewhat moot, Craighead said. Baker historically provides international rig count numbers, which are used as an indicator of business activity in the onshore and offshore. North American rig counts are falling in the gas fields on low prices, but overall, the rigs are falling in general because of better technology, he said.

"A flat rig count is not a good indicator of your business." Customers today are drilling "longer and longer laterals faster...there's greater and greater density...The number of stages per day per fleet [for hydraulic fracturing] are going up. So a flat rig count, given the longer laterals, more stages -- in addition to customers downspacing in some fields -- a flat rig count is fine."

Craighead said, "Everybody has learned their lesson" about building up too much pressure pumping capacity. "We're being disciplined in how much horsepower we'll put into it...We're not putting anymore into the herd. We feel optimistic, granted cautiously optimistic. But we feel good about the mix."

Net income was $439 million ($1.00/share) in 2Q2012), versus earnings of $338 million (77 cents) in the year-ago period. Revenue rose to $5.33 billion, up 12% from $474 billion in 2Q2011, but down 0.5% sequentially.

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