Following weeks of double-digit losses, the U.S. natural gas rig count only dropped two rigs last week to a level of 808 rigs — a drop from a peak of 1,606 rigs on Sept. 12. However, several energy analysts think the decline was only a “pause,” and oilfield service providers will have to play nice with producers as service contracts are renegotiated.

Onshore in the United States, the Midcontinent region has witnessed an estimated 67% decline in its rig count since the September peak, according to Baker Hughes Inc. In the East Texas/North Louisiana drilling area the rig count has decline about 42% from last fall’s peak. In West Texas the rig count is off 73% in the past six months. Last week’s loss of two gas rigs in the United States was a blip, said Barclays Capital energy analysts.

“While this is the smallest rig drop this year for the U.S., we believe it is only a pause, with further cuts ahead,” said Barclays Capital analysts. “Nothing has shifted recently that should cause a rebound in drilling.”

Dan Pickering of Tudor, Pickering, Holt & Co. agreed that the U.S. rig count hasn’t reached its lowest level.

“Where does the pain train end?” asked Pickering. “It still feels [like a]15-20% downtick remains.”

The U.S. rig count is tied not only to low prices but also to the surplus in gas supplies. The Energy Information Administration last week reported a sequential decline in January production from December, but it also noted that output in the first month of this year was well ahead of that in January 2008 (see Daily GPI, April 3). Most energy analysts expect domestic gas production to decline only slightly for several more months.

Stephen Smith Energy Associates is forecasting the U.S. gas production surplus to “peak” in early summer, followed by a mid-to-late summer production decline “driven, we believe, by a U.S. gas production capacity decline, which begins slowly but which ultimately more than offsets the anticipated increase in LNG [liquefied natural gas] imports.”

The pullback by producers is hammering oilfield service companies. FBR Capital Markets energy analysts said they expect 1Q2009 oilfield service earnings to “meaningfully” disappoint Wall Street. FBR’s Robert MacKenzie, Doug Garber and Christopher Breaux provided a preview of quarterly earnings on Monday.

U.S. land drillers’ earnings “should benefit from up-front recognition from contract buyouts,” said the FBR trio. “Since the daily rig margin is less than 5% of the overall daily spread cost, contracts will not serve as a floor for the rig count. We believe possible strength in the stocks of land drillers due to earnings strength could be short-lived, given our thesis that 1,000 land rigs need to be stacked/retired.”

Based on rough estimates of legacy rig costs, current labor cost, total well costs in various basins and well drilling times, FBR estimated that exploration and production (E&P) operators spend less than 5% of their total daily spread cost on drilling margin.

“Since project economics are under significant pressure, even in some low-cost shale basins, we expect E&P operators will cut their losses and negotiate to cancel their contracts with land drilling contractors,” wrote MacKenzie and his colleagues. “This should result in operators buying out their current contracts for the aggregate cash margin. Land drilling contractors will subsequently lay off the crew and recognize the same profit with the benefit of the time value of money and the loss of employing a crew.”

Raymond James & Associates Inc. analysts said Monday the short-term outlook for the oilfield services sector is “discouraging.” With each new fleet status, “one thing remains constant,” wrote J. Marshall Adkins, Collin Gerry and Christopher Butschek. “There are very few new jackup contracts. In fact, this past quarter has been one of the slowest in recent memory in terms of contracting activity.”

The market historically has averaged around 90 new jackup contracts a quarter, with an average length of nine months, noted the Raymond James analysts. “In 1Q2009 the industry managed only 46 contracts. When we delve a little deeper, the numbers become even more shocking. CNOOC, one of China’s national oil companies (NOC), accounted for 10 of the new contracts, all with its local drilling subsidiary.”

Petroleos Mexicanos (Pemex), which is Mexico’s NOC, “accounted for another eight contracts, though it is unlikely to maintain such a high level of demand in the coming quarters,” wrote Adkins and his team. “Nearly 20 one-well contracts were announced in the Gulf of Mexico. Net of these, only nine international contracts were awarded in 1Q2009, and these averaged less than four months in duration. The bottom line is that the new fixtures are not being announced nearly as frequently, which points to a serious slowdown in jackup demand.”

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