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Raymond James: Natural Gas Rigs to Slow Descent in 2013

Raymond James & Associates Inc. energy analysts last week modestly reduced their near-term outlook for U.S. drilling activity and raised expectations for 2013, but only slightly. Drilling activity in the coming year still is "much lower than consensus expectations," but the natural gas rig count should begin to stabilize.

Analysts J. Marshall Adkins, James M. Rollyson and Collin Gerry said they now believe the 2012 total oil and natural gas rig count will average 1,930 rigs, down 15 rigs (about 0.75%) from a previous forecast. The 2013 rig count is forecast to average 1,720 rigs, down 11% from the 2012 average rig count assumption but up 1% from a previous forecast.

It's no surprise that the natural gas rig count has continued to decline this year, said the trio.

"The speed of the decline has, on the other hand, been much faster than we had expected, as the gas rig count has decayed by 45% over the past nine months. Despite such a rapidly declining gas rig count, there are still 448 gas directed rigs, of which we estimate approximately one-third are drilling for 'dry' gas. As gas prices slowly improve over the next year, we expect that the dry gas rig count will slow its rate of descent, falling only another 30 rigs from its current level (or 145 rigs down to 115 rigs) by the end of next year."

The "wet side of the gas rig count has not held up much better than the dry gas side," they wrote. Because natural gas liquids (NGL) prices have fallen sharply, many wet gas rigs have shifted to the oil window or been reclassified as oil wells. The wet gas count is predicted to fall from 304 rigs active today to 245 by the end of 2013.

"Similar to the dry gas rig count, we expect the wet gas rig decline to continue; however, we expect the pace to slow," said the analysts. "Much of the switching (or reclassification) to oil windows has already occurred and will likely slow over the coming months. That said, with low NGL prices, these wet gas plays are less economic than oil and should decline faster than the oil rig count."

The "negativity" about U.S. drilling stems from a belief that "rising U.S. oil production in the face of weaker global oil demand growth will drive oil prices substantially lower in 2013," wrote Adkins and his colleagues. Because of this, U.S. drilling activity overall should follow U.S. exploration and production (E&P) cash flows lower next year.

The average annual onshore oil and gas rig count now is expected to be up 3% this year from 2011, while 2013's rig count could should increase 11%.

"That means we still think deteriorating oil fundamentals will drive the U.S. rig count down roughly 15% over the next 15 months," wrote the Raymond James team. "Keep in mind that consensus expectations for 2013 still assume the U.S. will increase drilling activity some 5-10% next year. To put this into a bit of perspective, we think the U.S. rig count will fall roughly 275 rigs (from 1,864 to 1,588) by the end of next year" with most of the decline in the second half of 2013.

U.S. E&P cash flows this year are expected to remain relatively flat with 2011 at about $130 billion, the analysts estimate. However, Raymond James is forecasting West Texas Intermediate crude oil prices of $65/bbl in 2013 to drive cash flows "meaningfully lower."

Rising production volumes, lower service costs and higher natural gas prices "should slightly mute the full brunt of 30%-plus lower oil prices. After inserting our new price deck and adjusting for our current production forecasts given the lower rig count, U.S. E&P cash flows are expected to decline a whopping 25% in 2013," said the analysts.

"That said, we do expect a stout recovery in U.S. E&P cash flows in 2014 and a strong rebound in drilling activity with our expectations for rising oil prices, rising natural gas prices and rising production volumes in 2014 and beyond. Under our forecasts, 2014 cash flows should rebound to near 2011 levels, while our 2015 cash flows should be 7% higher than 2014. That means we expect U.S. drilling activity to rebound strongly in 2014 from a dismal 2013."

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